By Frank Ahrens
Washington Post Staff Writer
Thursday, October 12, 2006
The heads of three well-known technology companies lost their jobs this week as the result of a scandal sweeping through the business world over the improper backdating of stock options, a practice often designed to inflate the value of stock grants to employees.
Internet news publisher Cnet Networks Inc., security software firm McAfee Inc. and online recruitment service Monster Worldwide Inc. announced the resignation or retirement of their chief executives, all apparently over concerns about how the companies granted stock options.
The three are the latest of at least 135 companies to acknowledge or be investigated for backdating stock options, which typically involves picking dates for stock grants when the purchase price was low, so that when the stock is sold, the holder can make more money. The practice is not illegal as long as the options are properly accounted for on company earnings sheets and tax returns.
According to the Securities and Exchange Commission and the Justice Department, however, a number of companies have not followed the rules. Federal authorities have filed fraud charges against executives at two technology companies, and they continue to investigate many firms.
The investigations are sending shock waves through the tech community, where stock options have long been a key tool for luring talent to start-ups.
"The primary concern in [Silicon] Valley is how many CEOs will be fired, and how many will be indicted," said Kirk O. Hanson, executive director of the Markkula Center for Applied Ethics at Santa Clara University.
Though the scandal lacks Enron's hubris or Tyco's Saturnalian excess, the consequences are grave: Cnet founder Shelby W. Bonnie resigned yesterday as chief executive and apologized for his role in the backdating options. The company issued an internal report that said Cnet backdated options from 1996 through 2003 and partially blamed Bonnie.
Also yesterday, McAfee fired its president, Kevin Weiss, and announced that chief executive George Samenuk was retiring. Earlier in the week, Monster's chief executive, Andrew J. McKelvey, resigned. Last week, Apple Computer Inc. announced the resignation of board member Fred D. Anderson over stock option issues.
Though many of the higher-profile companies under scrutiny are tech firms in Silicon Valley, the SEC and Justice Department are casting their nets widely, investigating companies as varied as Home Depot Inc. and Cheesecake Factory Inc. The SEC said in testimony to Congress last month that it is investigating more than 100 companies for possible fraudulent reporting of option grants.
"As the use of options compensation has increased, however, so apparently has its abuse," SEC enforcement director Linda Thompson testified. "This practice benefits employees at the expense of shareholders."
Former Comverse Technology Inc. chief executive Kobi Alexander is awaiting extradition from Namibia on federal charges related to his company's options practices. Former Brocade Communications Systems Inc. chief executive Gregory L. Reyes also faces federal charges.
How does backdating work?
Companies have long issued stock options to their employees to motivate them. Options allow an employee to buy a certain number of company shares at a price set by management, usually the price the day the option is granted.
The employee makes the most profit by buying stock options at a low price and selling them when the stock market has pumped up the company's stock to a higher price. If a company backdates options, it typically allows the employee to buy options when the stock was at its lowest point, thereby increasing the profit when the stock is sold.
Options usually are granted to a company's highest executives as part of their compensation packages. Backdating has been criticized as a shady way for wealthy executives to get wealthier, even if the company performs poorly.
The process is not illegal if no company documents have been forged, if the other shareholders have been informed and if the backdated options are correctly accounted for in company earnings and tax returns.
It may be legal, but it's "slimy," said Nell Minow, co-founder of the Corporate Library, a corporate-governance watchdog. "It subverts the whole justification for options," she said.
Minow was in New York yesterday lecturing corporate directors on a number of topics, including backdated options.
"No one comes to you and says, 'Let's backdate our options,' " she said. A company's human resources department "will tell an employee, 'We have a great benefit with our options -- a 60-day look-back.' That doesn't sound quite so dirty."
Backdating has cost some companies more than their chief executives. Many have had to restate earnings and take charges on upcoming earnings to account for the improperly recorded options.
For example, in August, Clorox Co. said it took a $25 million pretax charge in its most recent quarter to account for "errors" in how the company accounted for options. Research in Motion Ltd., maker of the BlackBerry, said last month that a review of its options-accounting practices could reduce past earnings by as much as $45 million. Also last month, chipmaker Broadcom Corp. said it would restate earnings to take $1.5 billion worth of options expenses off its books.
Staff writers Sara Kehaulani Goo and Yuki Noguchi contributed to this report.
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