Stock Option Probe Biggest Since Abusive Fund Trading Cases

Bloomberg reports that at least 22 companies are being investigated by the Justice Department, the Securities and Exchange Commission (SEC), or the Internal Revenue Service (IRS) over stock option grants. US attorneys in New York and California issued grand jury subpoenas to 14 of those companies. Sixteen of the 22 companies said they are under investigation by the SEC.

The probe is to determine whether the firms may have defrauded investors by deliberately backdating option grants to coincide with low stock prices, according to Bloomberg. The lower the price, the more an executive stands to make by exercising the options when the shares rise.

The options inquiry is “the biggest pervasive financial scandal in capital markets” since the fund probe targeted more than two dozen companies, said James Cox, a law professor at Duke University, in the news report. The probe coincides with the SEC’s call for more transparency in executive compensation reporting (See SEC Unveils Proposed Exec. Comp. Disclosures Mandate ).

Prosecutors and regulators have not filed any charges against the companies in connection with the current investigation. However, since November, executives at four companies including New York-based Comverse Technology Inc. and Vitesse Semiconductor Corp. (See Executives Fired over Stock Option Dating Issue ) have resigned, been fired or put on leave in connection with internal or regulatory reviews of stock option grants.

The potential consequences for companies include criminal fraud charges, earnings restatements, penalties for violating rules on corporate disclosure, additional tax expenses and civil lawsuits by shareholders seeking damages, said John Freeman, a professor of business ethics at the University of South Carolina Law School in Columbia and a special counsel to the SEC in the 1970s, according to Bloomberg. Backdating may be considered legal if the change was not made deliberately to reduce the exercise price of the stock option or if it was disclosed publicly.

Seven public pension funds have already filed suit against UnitedHealth relating to options backdating (See UnitedHealth Sued Again Over Option Dating Allegations ).

Most of the subpoenas and document requests are for information dating back to before 2002. The Sarbanes-Oxley Act, passed in 2002, shortened the reporting period for stock option grants to make backdating almost impossible.

All of the companies under investigation are in either the technology or health-care industries. Those companies, according to the news report, are:  

• Mercury Interactive
• Affiliated Computer
• Jabil Circuit
• Comverse 
• UnitedHealth
• Brooks Automation
• Caremark
• SafeNet
• Vitesse
• AmericanTower
• Nyfix
• RSA Security
• F5 Networks
• Juniper
• Semtech
• Openwave
• Sycamore Networks
• KLA-Tencor
• Medarex
• CNET Networks
• Analog Devices
• Power Integrations