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[DewDiligence]

U.S. Intensifies Stock-Options Probe

[The latest in a running story that began—literally—with the WSJ’s exposé two months ago (#msg-10227150). At VTSS, the BoD recently canned the CEO on account of this.]

http://online.wsj.com/article/SB114796021885756560.html

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Subpoenas by Prosecutors
In Manhattan Office Signal
Major Step-Up in Scrutiny

By JAMES BANDLER and JENNIFER LEVITZ
May 19, 2006

In a dramatic widening of the investigations into potential stock-option abuses, federal prosecutors in Manhattan have launched criminal probes of at least five U.S. companies.

Caremark Rx Inc., SafeNet Inc., Affiliated Computer Services Inc. and Vitesse Semiconductor Corp. said yesterday that they had received subpoenas from the U.S. attorney for the Southern District of New York. Late Wednesday night, giant health insurer UnitedHealth Group Inc. said it also had received a subpoena from the same prosecutor, along with a document request from the Internal Revenue Service.

Caremark, a big pharmacy-benefits manager based in Nashville, Tenn., and SafeNet, a software firm based in Belcamp, Md., said they also received informal inquiries from the Securities and Exchange Commission.

The entry of the U.S. attorney's office in Manhattan, considered among the most experienced in prosecuting white-collar crimes, signals a significant ratcheting up of government scrutiny of option-granting practices. The SEC, which has been probing the matter for more than a year, is scrutinizing about 20 companies. A spokeswoman for the U.S. attorney's office declined to comment.

Stock options, a popular way to pay senior executives, are intended to give managers incentive to improve their company's share price. Generally, each option represents the chance to buy a share of company stock at a certain "strike price" on a future date. Thus, a recipient stands to gain only if the share price rises.

But an analysis of options awards at some companies has shown that executives benefited from extraordinary timing, getting grants dated at times when share prices hit lows. The strike price on options generally is equal to the market price on the day they are granted by a company's board. The lower the strike price, the greater the chance for future profit.

Federal prosecutors and securities regulators are trying to determine whether the effective dates on some of those options were deliberately and improperly changed -- a practice known as backdating -- securing extra pay for executives regardless of the stock's performance. Backdating would undermine the incentive purpose of the option grant and could violate a host of securities laws. It could also create thorny tax and accounting problems for companies.

Separately, Brooks Automation Inc., which had previously announced it will restate about seven years of results due to problems with its options grants, announced the resignation of two directors who received highly favorable stock options in 2000. Brooks said the board members, Amin J. Khoury and Roger D. Emerick, would "renounce" all of their options and restricted stock. The two men weren't available to comment late yesterday.

The resignations bring to 10 the number of executives or directors who have left their companies in recent weeks in the wake of the spiraling options scandal. The options-granting practices of at least one other company, Comverse Technology Inc., are being examined in a separate criminal probe by federal prosecutors in the Eastern District of New York.

A March 18 page-one article in the Wall Street Journal examined options-granting patterns at six companies, including Comverse, ACS and UnitedHealth. The article found a number of highly favorable grants to the top executives of each company, and concluded the odds of the grant pattern having occurred by chance were highly remote.

Lesley Pool, a spokeswoman for ACS, said, "We are fully cooperating with authorities." UnitedHealth and SafeNet also said they are cooperating. A Caremark representative couldn't be reached for comment. Backdating could lead to a number of potential criminal charges, legal experts said, including securities fraud, wire fraud, or even tax-related charges.

"If somebody actually backdated an option grant that could well be like shooting fish in a barrel for prosecutors," said Harvey Pitt, a former chairman of the SEC. "If you were sitting on a jury and somebody told you that the CEO was granted the option on May 18 but he put down the date of April 18, do you think you would have a lot of difficulty concluding that the CEO committed fraud? I don't think so," Mr. Pitt said.

Lynn Turner, a former chief accountant for the SEC, said unlike some complicated revenue-recognition cases brought by federal prosecutors in recent years, backdating would be easy for jurors to grasp. Mr. Turner predicted pressure would mount for boards to fire chief executives who had been involved in backdating. "It is already put in motion that if the CEO is found to have done it, he has to go," Mr. Turner said. He said that if board members are given the choice of deciding whether the CEO takes the hit, or the directors, "it is going to be about a two-second decision."

In recent weeks, CEOs have been forced out at Comverse and Vitesse. Last night, Vitesse said the U.S. Attorney for the Southern District of New York notified it that it is seeking documents dating back to 1999 related to the company's stock-option grants. The Camarillo, Calif.-based company also said it has been notified that the SEC is investigating and requesting documents dating back to 1995 related to the grant of stock options. Vitesse said it plans to cooperate fully with both requests.

At Caremark, the company's chairman and chief executive, Edwin Crawford, was awarded 3.875 million stock options dated March 8, 2000. The options gave him the right to buy shares for 15% more than the stock's closing price that day, which turned out to be tied for the low point of that year. The company said Mr. Crawford agreed to forgo his bonus for four years -- 2000 through 2003 -- in exchange for the large grant.

A company spokesman has said the March 8 grant was made at a scheduled board meeting and came at the time of year when options were typically awarded. Mr. Crawford also has denied receiving any backdated options or grants, saying his options are approved by Caremark's board at regularly scheduled meetings, granted by the date approved and priced at fair market value on the date of the grant. Caremark also said it had received a request from the SEC about its relocation program. Mr. Crawford received $2.9 million from Caremark's program two years ago for the sale of his Birmingham, Ala., home, even though as of earlier this month his house hadn't been put on the market and his wife still lived there.

At Brooks Automation, a semiconductor equipment maker in Chelmsford, Mass., the compensation committee granted 233,000 options to its chief executive, Robert Therrien, with a date of May 31, 2000. Brooks's stock plunged more than 20% that day and surged over 30% the next day.

What was unusual was that Messrs. Khoury and Emerick, the compensation-committee members who oversaw the CEO option grants, also benefited. Although Brooks directors typically got options only in July, that year a special grant was awarded just to these two directors. In a statement, Brooks said Messrs. Khoury and Emerick had resigned voluntarily.

Also yesterday, five public pension funds filed a lawsuit in federal court in Minneapolis, seeking to prevent UnitedHealth's top two executives from exercising about $1.5 billion in options. The suit claims the company unlawfully backdated options to Chief Executive William McGuire, Chief Operating Officer Stephen Hemsley and other executives "to provide the recipients with windfall compensation at the direct expense of UnitedHealth."

UnitedHealth has said it may have to restate three years of results due to a "significant deficiency" in how it administered and accounted for past option grants.

The unusual legal request asks the court to place a "constructive trust" over all option contracts held by Messrs. McGuire and Hemsley. A UnitedHealth spokesman said the company hadn't seen the lawsuit and in any event doesn't comment on pending litigation.
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