Replies to post #25881 on Biotech Values

[DewDiligence]

This chart is from the WSJ
story in the preceding post:

[Biowatch]

Backdating options - that's sleazy. It gives the CEO an incentive to make the stock perform badly at least once a year, which is the opposite of what options are meant to do.

[masterlongevity]

great article!

[poorgradstudent]

I concur; that is a good article from the WSJ.

I think that any corporate action that concentrates too strongly on stock price is a distraction and should be avoided. This includes convening to determine dates of option grants, publicly addressing "shorts" and their affect on share price, etc...

I caught your comment on SI regarding prespecified dates. I had the same thought at first, but it could also be subject to abuse. As you said, companies could compensate for the single day's stock price by playing with the number of options granted.

One alternative would be to tie the exercise price subject to an "x" month average of the share price, prefereably a timeframe of the most recent 6 - 12 months. For annual option grants tied to the 10K filing, the 6-12 month timeframe would be the most recent 6-12 months for the fiscal year that is being reported. For options granted on dates not coinciding with a 10K filing, you could tie the price to the most recent 6-12 months of stock prices.

I think this would more strongly align management interests with those of the shareholders. With a 6 month rolling period (for example), management that performed well over the past year would still reap rewards for their performance by being granted options that are likely priced below current market levels. This would also make management responsible for poor performance over the year, as a declining stock price would mean that their option grants are at strike prices above current market levels.

Making it a 6 month rolling average would also prevent management from unduly rewarding themselves if they undertook a recent initiative that appeared to turns things around for the company following a year's worth of dismal performance. Or if their stock simply hit bottom following a horrible year for shareholders.

So case in point, Colin Goddard's brutal impact on the OSI shareprice over the recent fiscal year would mean that he gets some options that are priced around 50 per share, rather than the ~30 dollar share price that the stock currently trades at.

[DewDiligence]

Further to the WSJ article
on option-grant timing
(from the DNDN ymb):

>>
Re: Option-grant timing
by: DewDiligence
03/19/06 03:15 pm
Msg: 183191 of 183195

>…as the article in the wall-street journal that Dew posted yesterday states, often insiders abuse the trust by granting themselves grants and cheap options when the stock is decimated. This IMO is much worse than them buying shares in the open market if they are privy to insider info, don't you think? So, since Gold and management received all these grants last month, I would assume they could have easily just as well bought shares in the open market at the same time. You cannot have it both ways claiming insider priviliges for not buying shares in the open market and then also granting yourself cheap options and free grants knowing that exact material info!<

Actually, the SEC does make such a distinction. The basis for the distinction is that is that option grants are transactions between the company and the insiders—there is no third party involved. Open-market purchases, on the other hand, have an innocent party on the other side of the transaction (i.e. the seller, if the buyer is an insider), who the SEC seeks to protect. If an insider is buying on the open market based on material non-public information, then the SEC’s contention is that the seller of these shares is being defrauded.

I agree that there ought to be strict rules about when options can be granted (or when they can be exercised); however, under current SEC rules, companies are allowed to do almost anything they want in the timing of option grants (provided that they are not backdated as in the WSJ article). Regards, Dew

[Posted as a reply to: Msg 183167 by croumagnon]
<<

[midastouch017]

Re : CEOs Reap Millions

Last week the New York Times quoted Street analysts on an interesting development involving the three biggest giants of hi-tech: Intel, Dell and Texas Instruments. Their shares have been dropping in the last year even though the companies have been reporting steeply climbing profits, well beyond analysts' expectations.

The analysts pointed at an interesting item in said companies' financial statements, an item that tends to get overlooked in analytical reports and in articles in the press. Namely, the companies' book equity. While Dell, Intel and Texas report profits in the billions of dollars each year, their shareholders equity (the difference between assets and liabilities) keeps shrinking, even though they hardly pay any dividends to shareholders.

Where is the money going?

Why is that? Because the companies are using the cash they generate to buy back their own shares on the market. In the last year Dell bought back $7.2 billion worth of stock, which was greater than its earnings. Intel repurchased $10.6 billion worth and Texas Instruments bought back $4.15 billion worth of its shares.

Why are the companies buying back their stock so aggressively? Naturally - because they want to reduce their float and increase profit per share, which is the main parameter by which analysts measure their performance.

So if they are buying back so many shares on the market, why is their number of floating shares not dropping?

Naturally - because they keep handing out stock options to managers and employees. The options get converted into shares, which increases the number of floating shares, the company buys back the shares on the market using its cash, and around and around it goes.

What is the bottom line? Simple. Much of the cash the companies are earning is streaming straight to the pockets of the management. Even better from the managers' perspective is that the tremendous perk they're getting doesn't get booked in the company's report, if the options were granted at the market price.

The gambit is nothing new. What has changed is that Wall Street analysts are paying closer attention to it. They are asking whether these companies really are generating value for shareholders, or mainly for their own people.

http://www.haaretz.com/hasen/pages/ArticleContent.jhtml?itemNo=696854

Dubi

[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...

>>
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.
<<

[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

>>
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.
<<

[DewDiligence]

Medarex Gets Informal SEC Stock Option Inquiry

[Until now, this scandal had taken in mostly tech companies rather than biotech. All of these SEC actions are a consequence of the WSJ exposé two months ago (#msg-10227150). Isn’t it scary that, without the WSJ’s help, the SEC might never have taken any action on this?]

http://yahoo.reuters.com/stocks/QuoteCompanyNewsArticle.aspx?storyID=urn:newsml:reuters.com:20060524...

>>
Wed May 24, 2006 5:09 PM ET

NEW YORK, May 24 (Reuters) - Medarex Inc. < MEDX >, a biopharmaceutical company, on Wednesday said the U.S. Securities and Exchange Commission has begun an informal inquiry into its stock option grants and practices.

Princeton, New Jersey-based Medarex and San Francisco-based CNET are the latest of roughly 20 companies to say in recent days that federal prosecutors or regulators are examining their stock options practices.

Investigators are questioning whether companies are awarding executives backdated options exercisable at lower prices, making the options more valuable.
<<

[DewDiligence]

Latest on backdating: this story reminds
me of Watergate in the way it keeps getting
bigger and bigger and BIGGER. There are
now thought to be at least 2,000 companies
at risk. The soundbite in #msg-12052613 is
looking more and more prophetic with each
passing day.

http://www.nytimes.com/2006/07/17/business/17options.html

>>
Study Finds Backdating of Options Widespread

July 17, 2006
By STEPHANIE SAUL

More than 2,000 companies appear to have used backdated stock options to sweeten their top executives’ pay packages, according to a new study that suggests the practice is far more widespread than previously disclosed.

The new statistical analysis, which comes amid a broadening federal inquiry of the practice of timing options to the stock market, estimates that 29.2 percent of companies have used backdated options and 13.6 percent of options granted to top executives from 1996 to 2005 were backdated or otherwise manipulated.

So far, more than 60 companies have disclosed that they are the targets of government investigations, are the subject of investor lawsuits or have conducted internal audits involving the practice, in which options are backdated to days when the company’s shares trade at low prices. They include Apple Computer, CNet and Juniper Networks.

Last week, the United States attorney in San Francisco announced a task force to investigate the backdating of options, which appears to have been particularly popular in Silicon Valley during the 1990’s dot-com boom. The study found that the abuse was more prevalent in high-technology firms, where an estimated 32 percent of unscheduled grants were backdated; at other firms, an estimated 20 percent were backdated.

An author of the study said the analysis suggested that the disclosures so far about backdated stock options may be just the tip of the iceberg.

“It is pretty scary, and it’s quite surprising to see,” said Erik Lie, an associate professor of finance at the Tippie College of Business at the University of Iowa.

Professor Lie said the findings were so surprising that he asked several colleagues to check his numbers. Together, they concluded that the numbers probably erred on the low side.

The study by Professor Lie and Randall A. Heron, of the Kelley School of Business at Indiana University, was posted Saturday to a University of Iowa Web site. Using information from the Thomson Financial Insider Filing database of insider transactions reported to the Securities and Exchange Commission, the two men examined 39,888 stock option grants to top executives at 7,774 companies dated from Jan. 1, 1996 to Dec. 1, 2005.

The findings were based on an analysis of whether share values increased or declined after option grant dates. “Half should be negative and half should be positive,” said Professor Lie. “That’s the underlying logic.”

But the analysis revealed that the distribution was shifted upward.

“This is not random chance. It’s something that’s manipulated, clearly,” said Professor Lie.

Of the companies examined, 29.2 percent, or 2,270, had at some point during the period manipulated stock option grants, the study estimated.

“Over all, our results suggest that backdated or otherwise manipulated grants are spread across a remarkable number of firms, although these firms did not manipulate all their grants,” the authors said.

The study concluded that before Aug. 29, 2002, 23 percent of unscheduled grants — as distinguished from grants that companies routinely schedule annually — were backdated. Unscheduled grants are easier to backdate.

On that day, the S.E.C. tightened reporting requirements to require that executives report stock option grants they receive within two business days. After that, the backdating figure declined to 10 percent of unscheduled grants, the paper said.

Professor Lie said that a number of companies simply ignored the new reporting rule. “You still see problems. The rule is not enforced,” he said.

Professor Lie, who first alerted S.E.C. investigators to problems with backdating after an analysis that he conducted in 2004, said there was some positive news in his new research.

“It has been suggested that some accounting firms have been pushing this practice more than others,” he said. “There’s actually very little evidence of that, which to me is very comforting.”

The study found that smaller auditors rather than larger ones were associated with a larger proportion of late filings and unscheduled grants, which most likely lead to more backdating and manipulative practices.

It also singled out two firms — PricewaterhouseCoopers and KPMG — as being associated with a lower percentage of manipulation.
<<

[DewDiligence]

Curiosity Has Its Merits and Its Profits

[A hedge fund makes money from backdated stock options, but not the way you might think.]

http://select.nytimes.com/2006/09/23/business/23nocera.html

>>
September 23, 2006
By JOE NOCERA

“I think we’re people who are just curious about things,” said Andrew J. Redleaf, with a tone of mock innocence.

Mr. Redleaf, 48, runs Whitebox Advisors, a $1.8 billion Minneapolis hedge fund that has had sparkling returns since he started it in 2000. Mr. Redleaf is one of those hedge fund guys who write letters to investors that are filled with big ideas about the market. He’s also funny, cynical, cranky and unabashedly opportunistic.

“Could that professor really be right?” he continued. The professor he was referring to was Erik Lie of the University of Iowa, who published a study last year that essentially set off the options backdating scandal [#msg-10227150, #msg-12052613]. Although Mr. Lie did not name names, his work showed, indisputably, that there were simply too many cases where options were granted to top executives just before a nice run-up for it to be happening randomly. He suggested that companies had to be backdating option grants to enrich executives.

That study, in turn, piqued the interest of the Securities and Exchange Commission and The Wall Street Journal, which began looking at individual companies. At this point, 115 companies have been identified as being under some sort of investigation, either by the S.E.C., the Justice Department or an internal investigation. So far, executives from two companies that backdated options, Converse and Brocade, have been indicted. This week, Cablevision revealed that it gave backdated options to a deceased executive — making it appear as though he had received the options while still among the living.

A few months ago, Mr. Redleaf and several of his Whitebox colleagues decided to do their own options backdating study. They ran 6,000 companies — and 60,000 options grants — through their computers. They looked at a 40-day window: 20 days before the options were granted and 20 days after. And sure enough they discovered several hundred companies whose pattern of granting options at the precise moment the stock was about to jump was eyebrow-raising, to say the least. And while Whitebox Advisors does not have absolute proof that options backdating took place, neither did Mr. Lie. It was statistical detective work.

Mr. Redleaf is quick to express outrage at executives who backdated options. Of the series of recent Wall Street scandals, Mr. Redleaf told me: “This is by far the worst. It is a direct transfer of wealth from stockholders to insiders.”

But let’s be honest here. Hedge funds don’t do deep dives into options backdating just to satisfy their curiosity or to gain justice. Rather, they do it to find an edge — and to use that edge to get richer than they already are. What Mr. Redleaf has begun to do with this options backdating information raises a question that is being asked a lot these days about hedge fund operators. Is he an activist, helping to make the market a better place? Is he a holdup artist? Or is he both?

When you ask the folks at Whitebox Advisors how they make money, they have a hard time explaining it in layman’s terms. “Relative value arbitrage,” Mr. Redleaf replied when I asked him to describe his fund. “Generally,” he continued, “we focus on mispriced securities that have a relationship to each other” like a company’s stock and bonds. “That,” he added, “tends to cause us to skew towards distressed companies.”

Often, for instance, a company’s bonds will send up an early warning signal that there may be internal problems, even as its stock remains buoyant. In that mispricing is an opportunity for a smart hedge fund guy who sniffs it out. Sometimes, though, the hedge fund guy won’t be willing to just sit on his hands while waiting for the market to catch up with his insight. That’s when he becomes an “activist.”

Earlier this year, for instance, Whitebox was among a number of hedge funds that were holding General Motors bonds. “We were betting that they would cut the dividend because we thought it was inevitable,” Mr. Redleaf said. He also felt, though, that cutting the dividend was the right move for G.M. to make — so he went to Detroit and met with members of G.M.’s finance team to press that case. Sure enough, in February, when General Motors cut its dividend in half, the bond market applauded, and Whitebox’s G.M. bonds were suddenly more valuable.

Mr. Redleaf became interested in options backdating because of another, more controversial bond play that Whitebox and a number of hedge funds began using a few years ago. When a company fails to file its financial documents on time, its bonds are technically in default. For decades, though, bondholders have generally looked the other way when that happened.

But Whitebox did not. Instead, it took to buying up bonds “below par” — that is, bonds trading below their face value — of companies that had failed to deliver their financial documents on time, usually because of an accounting problem.

Then, Whitebox and other activist bondholders would tell the company that since it was in default on its bonds it was liable for the full face amount — immediately. Sometimes, the company would wind up paying off the bonds. Other times, it would negotiate an agreement, usually a one-time payment to the bondholders in return for a waiver. Either way, Whitebox won.

Mr. Redleaf argues that what he is doing is “being vigilant in asserting our rights,” unlike mutual funds and other big institutional investors that have ill-served their investors by not fighting for everything they are entitled to. Of course, most companies don’t see it quite that way. They view Whitebox as taking advantage of a technicality to make a quick buck.

Companies that are caught backdating options, of course, have huge accounting problems. Options that have been backdated require a different accounting treatment, and companies usually have to restate their financials for the years during which they were backdating. This almost inevitably means that they will also not be able to file their current quarterly or annual report on time. Which therefore means their bonds will technically be in default. Which therefore means the bondholders can squeeze them.

Is it any wonder Mr. Redleaf suddenly became interested in options backdating?

Once he had his list of potential options abusers, Mr. Redleaf and his team shorted about 80 of them. But Whitebox also went into the marketplace and bought bonds of some of the companies in question. (In other cases, it already owned the bonds.) And then the firm got to work.

Consider the case of Affiliated Computer Services, a Texas-based technology outsourcing company with over $4 billion in 2005 revenue and 50,000 employees. It was one of the first companies to be fingered as a possible options backdater, and instigated an internal investigation in March. In July, when the company released its quarterly results, it also said that while the investigation wasn’t complete, it didn’t think it would have to restate results. “We do not believe that any director or officer of the company has engaged in the intentional backdating of stock options grants,” it added.

Mr. Redleaf shot back in a letter he sent to the company in early August. “There were 14 grants between November 1995 and March 2005,” he wrote to Darwin Deason, the chairman of the board. “Every single grant was better than a random day for the period, a 1-in-16,384 occurrence.” He added, “if we look at the stock return for the 20 days after the grant, the award days were in the 91st percentile, a result very consistent with backdating but hard to square with legitimate methods.”

Within days of receiving the letter, A.C.S. announced that its previous statement about options backdating “can no longer be relied upon” [LOL] — strongly implying that things were worse than it had claimed a few weeks earlier. A few days later, a lawyer working for the company’s audit committee contacted Whitebox to see what the firm had found. Last week, A.C.S. announced that it had missed the deadline for filing its annual report — the exact event Whitebox was hoping would result from its letter.

The company also reported that because of that missed deadline it “may face covenant compliance issues,” meaning that it may be in default of some $2 billion worth of loans. The company said it would seek a waiver. You know what that means: money in the pockets of Whitebox Advisors.

A spokeswoman for Affiliated Computer Services wouldn’t comment on its option backdating investigation except to say that it was a coincidence that the company made its tougher announcement so soon after getting the letter from Mr. Redleaf [LMAO]. She also wouldn’t comment on Mr. Redleaf’s tactics.

Indeed, of the half-dozen companies I called for this column — all of whom received similar letters from Whitebox, and several of whom face the prospect of having to pay off their bonds at full value because they missed filing deadlines — only one spokesman was willing to say what they undoubtedly all feel. That was Jeff Luth of Amkor, a company whose options problems caused it to fail to file its quarterly report last June —and is now dealing with the consequences.

“We don’t think opportunistic hedge funds should hold Amkor hostage for a financial windfall,” he said. “We believe it siphons off corporate assets to the detriment of our shareholders.”

But doesn’t that also describe options backdating? As Mr. Redleaf pointed out: “By cheating on options grants these companies filed phony financial statements and they used those phony financials to borrow money from bondholders. Shareholders have the right to fire management. All bondholders can do is try to get their money back.”

The punishment Mr. Redleaf is meting out may be harsh. And it may be a hold up. But it’s hardly undeserved. “Eventually,” he said, “the market punishes the wicked.”
<<

[midastouch017]

>>CEOs Reap Millions by Landing Stock
Options When They Are Most Valuable.
Luck—or Something Else?

[Cover story in Saturday’s WSJ] >>

~ 13months later,

WSJ reap the Pulitzer Prize,

>>Awarded to The Wall Street Journal for its creative and comprehensive probe into backdated stock options for business executives that triggered investigations, the ouster of top officials and widespread change in corporate America.>>

http://www.pulitzer.org/year/2007/public-service/

Well done, well deserved.

Dubi

[DewDiligence]

Companies Dole Out Executive Options During Merger Discussions

[This practice cheats ordinary shareholders in much the same way as the issuance of backdated options, which became a scandal three years ago thanks in part to a page-one story in the WSJ (#msg-10227150). One major difference between the two kinds of abuses: issuing pre-merger options is evidently not illegal, and the SEC doesn’t seem to object.]

http://online.wsj.com/article/SB125530435544579223.html

›Executives Receive Unusual Awards During Negotiations in Spate of Large Mergers

OCTOBER 12, 2009
By MARK MAREMONT

Numerous companies have awarded stock options to their top executives while engaged in negotiations to be acquired, according to academic research and a Wall Street Journal review of company filings.

The practice, which experts say appears to be legal under federal law, typically results in the target firm's executives receiving a bigger payout when the takeover is later announced.

An examination of securities filings found unusual pre-deal options grants in a half-dozen large mergers since 2007. The companies generally say the options awards weren't timed to take advantage of the merger talks, but instead were routine or stemmed from unrelated one-time events.

For shareholders, such grants can cut two ways. Critics say that insiders at some companies are unfairly benefiting from nonpublic information, and that issuing extra shares to executives dilutes the value of existing shares. On the other hand, such options could provide further incentive to executives to entertain takeover bids, benefiting all shareholders.

Top executives at Omniture Inc. exchanged some old options for lower-priced new ones in June 2009, weeks after the software firm received takeover feelers from Adobe Systems Inc., according to regulatory filings. The talks ended last month with Adobe agreeing to buy Omniture in a $1.8 billion cash deal, handing the executives paper profits of $9.7 million on their 1.1 million newly minted options.

Omniture says the options exchange had been discussed by its board for many months and was unconnected to the takeover talks, which at that stage were very preliminary. Filings show Omniture's CEO will be able to cash in 75% of his options when the deal closes, but other executives will have to wait to do so, unless they leave the merged firm under certain circumstances.

As previously reported, Marvel Entertainment Inc. Chief Executive Isaac Perlmutter stands to reap more than $34 million from options he was granted in the weeks after a subordinate opened discussions with Walt Disney Co. that ultimately led to a merger agreement. Marvel has said some of the options were an annual grant and the rest were connected to a new employment agreement with Mr. Perlmutter.

"It's very selfish behavior by these CEOs," argues Eliezer Fich, an associate professor of finance at Drexel University's LeBow business school and co-author of a research paper on the topic with Jie Cai and Anh L. Tran. "They want to get the last nickel from the company, regardless of what's in the best interests of shareholders."

Their paper, which has been presented at academic conferences but not yet published, examined 110 deals between 1999 and 2006 in which target company CEOs were given unscheduled stock-option grants while takeover discussions had started but hadn't yet been made public. The authors defined unscheduled grants as those awarded more than two weeks away from the anniversary of any grant in the prior three years.

The researchers concluded that the grants were "systematically timed" to benefit the CEOs, and that companies that engaged in the practice on average got lower takeover premiums than those that didn't. The average CEO received an extra $5.7 million from these grants, the researchers said.

A key form of compensation at many firms, stock options typically give executives the right to buy their company's stock for a decade, at a "strike price" usually equal to the market price on the day of issuance. Executives can reap profits if the shares rise. Options often can be immediately cashed in for a profit if a company is acquired, although sometimes executives who stay at the merged firm get equivalent replacement options.

Issuing premerger options is related to a controversial practice known as "springloading," in which a company grants options just ahead of releasing good news that is expected to buoy its stock price.

After internal debate, the Securities and Exchange Commission last year declined to take enforcement action against a company that engaged in the practice. [That figures—the SEC is a joke.] But the agency issued a rule requiring companies to disclose in their annual proxy statements whether they had engaged in such options timing [LOL].

Alan L. Dye, a securities lawyer at Hogan & Hartson LLP in Washington, says premerger options grants likely would escape disclosure under the new rules. The target company usually gets swallowed by its new parent before any annual proxy filing is required. Usually, the only way shareholders can discover that a company has awarded options amid takeover talks is by piecing together information in multiple regulatory filings.

Steven N. Kaplan, a University of Chicago finance professor, says one argument for issuing unscheduled pre-deal options would be if a CEO has such a small equity stake that he would rather hold on to his job than listen to a reasonable takeover offer. He says a well-designed pay plan should previously have provided incentive for a CEO to consider a sale, and shareholders should "ask a lot of questions" about why new options are needed.

Late this month, shareholders of Teppco Partners LP, a publicly traded oil-and-gas pipeline concern based in Houston, are scheduled to vote on an all-stock bid by a related company, Enterprise Products Partners LP, initially valued at $3.3 billion. According to a regulatory filing, talks started Feb. 17, 2009.

Teppco traditionally grants options in May, and indeed did so this year. But it also granted an extra batch on Feb. 23, the same day merger talks reached the point that a confidentiality agreement was signed. Six top executives received a total of 154,000 options.

The companies first disclosed the talks in April, and in late June announced an all-stock deal that initially valued Teppco at 48% above the strike price of the February options. Based on Teppco's closing price on Friday, the executives currently have a collective paper profit of $2.3 million on those options.

Rick Rainey, a Teppco spokesman, says the timing of its options awards is "discretionary," and Feb. 23 happened to be the date of a quarterly board-committee meeting. He says it was "purely coincidental" the confidentiality agreement was struck on the same day. [Uh huh.].

Mr. Rainey also says the executives' options will convert to Enterprise options and vest four years after being awarded.

Often top executives can cash out their newly issued options when deals close. That was the case at Birmingham, Ala.-based Compass Bancshares Inc., which was purchased for $9.6 billion two years ago by Spain's Banco Bilbao Vizcaya Argentaria SA.

According to Compass's filings, its then-CEO, D. Paul Jones Jr., traveled to Spain for initial discussions in mid-January 2007. On Jan. 23, he was awarded 188,000 new options at $59.80, less than eight months after his prior grant. Nine other Compass executives were granted options. The deal was announced in mid-February. When it closed, Mr. Jones received $68.11 per share in cash, or $1.6 million, for his new options, filings show, while other Compass executives received a total of $2.2 million.

A BBVA Compass spokesman, Ed Bilek, says takeover discussions were very preliminary at the time of the options grants. "You don't stop doing what you're doing because you might be in talks," he says. Mr. Bilek says the company had no set time for issuing options, but grants in January weren't unique in the prior 25 years.

Electronic Data Systems Corp. issued its CEO a large options grant early last year, during negotiations that led to its $13.25 billion takeover by Hewlett-Packard Co. According to EDS's filings, the talks started in late December 2007, and in early February 2008 the firms entered into a confidentiality agreement. On Feb. 13, 2008, EDS issued two million new options at $18.30 to its recently named CEO, Ronald A. Rittenmeyer, and a total of one million more to other top executives.

"We didn't issue options because we were in merger talks," says Mr. Rittenmeyer. He says EDS already had planned to move up its normal option-award date by a month to closely follow the annual earnings release, and had no idea whether the talks would lead to a deal [LOL].

In its March 2008 proxy, EDS said that the object of awarding options was "to motivate executives to achieve long-term goals designed to create sustainable shareholder value and reward them to the extent they achieve such goals."

When the $25-per-share cash deal was announced in May 2008, Mr. Rittenmeyer was sitting on a $13.4 million profit on his three-month-old options. He received the cash when the deal closed that August. "I did my job," says Mr. Rittenmeyer, "and I did the right thing for shareholders."‹