Biotech Values

[DewDiligence]

Old-fashioned investigative journalism,
such as the recent WSJ cover story on
backdated stock options, can have a
forceful effect on corporate policy.

http://yahoo.reuters.com/stocks/QuoteCompanyNewsArticle.aspx?storyID=urn:newsml:reuters.com:20060419...

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Uproar Over Option Awards New Front in Pay Row

Wed Apr 19, 2006 5:39 PM ET
By Anna Driver

NEW YORK, April 19 (Reuters) - U.S. corporations already weathering fallout from headlines about multimillion-dollar executive pay packages now face a new front in the storm -- heightened scrutiny over the timing of stock option awards.

And the recent focus on "back-dating" options, where a grant price is set at a lower, more profitable level, may cause more corporations to abandon the practice.

On Tuesday, Vitesse Semiconductor Corp. <VTSS.O> dropped a bombshell on investors, announcing that its chief executive officer and its chief financial officer were placed on administrative leave and it had appointed a special committee to investigate the timing and accounting of past stock option grants. That news sent Vitesse shares plunging 20 percent to $2.48 a share on Nasdaq on Wednesday.

UnitedHealth Group Inc. <UNH.N> has also said it is conducting its own review of its stock grant practices after some recent negative publicity and a shareholder lawsuit. The lawsuit, filed in U.S. District Court in Minnesota on behalf of a shareholder, charges executives at the company with breaching their fiduciary duty and enriching themselves by "back-dating" stock option grants.

"This is a very sorry practice," Duke University School of Law Professor James Cox said on Wednesday. "It's like letting CEOs bet on a race when they know who the winner will be."

UnitedHealth Chief Executive William McGuire on Tuesday told stock analysts that the company would be "transparent" about the results of its review of options grants. He also took the unusual step of recommending the health insurer's board stop handing out equity-based grants to most senior executives.

Even so, the scrutiny of UnitedHealth promises to grow. Minnesota Attorney General Mike Hatch said he will file a motion on Wednesday to join the lawsuit against UnitedHealth, motivated by public anger of McGuire's pay package. "The fact that the CEO of a HMO (health maintenance organization) would get $1.6 billion has generated more complaints from the public than anything else since I've been attorney general," Hatch said.

In another example, Comverse Technology Inc. <CMVT.O> on Monday said it will probably restate earnings back to 2001. The restatement stemmed from the need to change the recorded date of some of its stock option grants, it said.

The practice of back-dating options is not prohibited under SEC regulations if it is disclosed in regulatory filings, is allowed by the company's compensation plan, and if the accounting is proper, but there are "substantial problems" on the fiduciary side, Duke University's Cox said.

Larry Ribstein, a law professor at the University of Illinois, said that it is unlikely that the board of directors of a company would be found liable for allowing back-dating, but with all the attention on executive pay, it has become a public relations issue.

"I think companies concerned about the public reaction now may stay away from it," Ribstein said.

Back-dating options appears to be a long-standing and common practice. A working paper on stock option grants published in January 2005 by the University of Michigan Ross School of Business found managers had "substantial" influence on their compensation.

Analysis of a database of 605,106 option grants at all publicly listed companies from 1992 to 2002 found that stock prices fell significantly prior to option grant dates and rose significantly following the grant dates, some of which may be explained by back-dating options.

M.P. Narayanan, a finance professor who authored the paper, said lawyers from the SEC had asked for data from the study last year. "We have given them data, and I'd be surprised if they are doing nothing with it," he said.

But proving the existence of back-dating is hard because you have to know the date that the board granted the option, which is information that typically the executive receiving the grant and a few others know, Narayanan.
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