Friday, August 25, 2006

New York Times Editorial - Phantom of the options

New York Times Editorial - Phantom of the options
Copyright by The New York Times
Published: August 24, 2006

The corporate scandal in the United States over rigged stock options continues to expand. More than 100 companies are now either under investigation by the U.S. government or performing their own internal investigations. Companies are restating earnings and preparing for new tax bills, and in extreme cases, executives are facing criminal charges.

Fiddling with the dates of stock options doesn't sound that nefarious. And unlike in the Enron case, with its spectacular implosion and shattered retirement accounts, the victims are a lot less obvious.

But just because the victims are harder to spot doesn't mean that secretly backdating or otherwise manipulating the timing of an options grant is a victimless crime. Rigging the timing of option grants hurts both the company and its shareholders, usually for the greater enrichment of top executives.

Stock options allow employees to buy the company's stock in the future at the price on the day they were granted. If the company's shares rise in the meantime, the employee can profit from the difference by exercising the options. It all sounds very abstract, if not downright abracadabra, as if the shares don't have to come from somewhere.

But the stock can't just materialize out of thin air. When employees decide to exercise their options, the company has to buy back shares at the new higher price to offset the awards. The company is selling low and buying high. It's that or dilute the value of all outstanding shares by issuing even more of them. Either way, the money is indirectly coming out of shareholders' pockets.

Gaming the system by picking an artificially low starting point siphons off even more money. It also tricks investors into thinking that compensation packages are smaller than they actually are. In the case of Brocade Communications Systems, the problems made the company look profitable when it was operating at a sizable loss. Two executives there now face criminal charges.

Investigations are revealing outright skulduggery. At Comverse Technology, three former executives have been charged with mail, securities and wire fraud for allegedly managing a secret options slush fund using fictitious employees. The former chief executive, Jacob Alexander, is a fugitive from justice; he wired $57 million to an account in Israel and is believed to have fled there.

The deeper prosecutors dig, the worse this latest scandal looks.


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