Options Spark Global Concern
By Ted Allen, Director of Publications

The U.S. stock options timing scandal is attracting the interest of pension funds in Europe and Australia, which along with U.S. pension funds and other investors have filed more than 70 lawsuits against at least 25 firms.

Darren Robbins, a partner with the law firm of Lerach Coughlin Stoia Geller Rudman & Robbins in San Diego, told the Associated Press that the pension funds are "completely beside themselves and outraged over the self-dealing that has gone on."

Robbins said he is bringing 34 cases on behalf of 350 to 400 pension funds. "The damages total in the tens of billions of dollars," Robbins told Red Herring, a technology industry magazine, noting that he would seek to recover for the market value that investors have lost after companies disclosed option probes.

As part of any settlement, Robbins said his pension fund clients are going to seek the replacement of directors who allowed the backdating of grants as well as the ouster of executives who profited from those options. "That's their position," he told Red Herring. "They're just not going to accept it. These companies are owned by investors, primarily pension funds. These people are owners and not the employees."

Among the investor plaintiffs are the New South Wales Treasury, which filed a lawsuit against American Tower in Massachusetts.

More than 50 firms had disclosed internal, regulatory, or criminal probes into whether the timing of option grants was manipulated to maximize executive compensation. This week, Delta Petroleum said it received a subpoena from federal prosecutors for records on its option grants since 1996. In addition, Progress Software delayed filing quarterly results as it completes an internal review of option grants. On June 21, Altera announced that it will restate 10 years of earnings. Nine other companies have said they will restate results to account for option grants, according to Bloomberg News.

Around the world, investors and regulators are taking a closer look at corporate option grants and other executive compensation practices. David Tweedie, chairman of the International Accounting Standards Board, said European securities regulators are looking at the option timing issue. "We're looking very closely at what's happening here, and we'll also have to do something about it too," he said in an interview with Bloomberg News. "We've got exactly the same problem."

In Australia, mining firm Oxiana disclosed on June 20 that it had mistakenly undervalued options granted to executives and directors by about A$1 million, The Australian newspaper reported. Oxiana's chairman agreed to review the company's options after its remuneration report received a 46 percent "no" vote in April. Most reports have received less than 10 percent opposition since Australian firms started submitting their remuneration reports to non-binding shareholder votes in 2005.

In France, securities regulators are probing stock sales by senior executives at EADS, which occurred before its Airbus unit announced jumbo jet production delays that caused the company's shares to fall.

Questions at Home Depot, Microsoft
Back in the United States, two industry leaders have acknowledged irregularities in how they used to date option grants. On June 16, The Wall Street Journal reported that Microsoft awarded stock grants to employees at monthly lows from 1992 to 1999. A spokesman for the software giant said the practice was legal and did not constitute backdating because the grant prices were set at the lowest price in the 30 days after the grants. Microsoft disclosed in 1999 that it was ending that practice and took a $217 million charge. According to the Journal, Microsoft's practice may have violated accounting standards then in place that required companies to book expenses for "in-the-money" options.

Also on June 16, Home Depot disclosed three instances before December 2000 where executives received stock options with exercise prices that were below the market price on the day they were approved. The company has faced recent investor criticism over the pay received by CEO Robert Nardelli. Ten directors received "withhold votes" of more than 30 percent at the home improvement retailer's May 25 annual meeting.

"It's very disturbing," Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, told Bloomberg News. "It's a particularly damaging disclosure vis-à-vis their relationship with shareholders."

Another concern is that shareholders may end up paying the taxes and penalties owed by executives who received improperly timed options. In a June 15 filing, Brocade Communications said it will pay $3.32 million to executives and employees who received options that are under scrutiny. The company said it has offered to cancel the options or to raise their exercise price, and then pay the employees the difference in cash. One executive will receive a $581,812 payment, Bloomberg reported.

"Were the options designed as an incentive or a reward?'" Elson told Bloomberg News. "If they were designed as an incentive, there is no sense in reimbursing'" employees and executives for taxes due.

Earlier this month, the California Public Employees Retirement System urged 24 companies to fully disclose their option grants and "to refrain from using any company resources to satisfy the tax and legal liability for executives implicated for wrongdoing related to the backdating of options."

Meanwhile, a new survey by consulting firm Watson Wyatt shows that large majorities of both directors and institutional investors want U.S. firms to move toward the greater use of equity incentives that vest only after performance goals are met. More than four out of five corporate directors and two-thirds of institutional investors surveyed by Watson Wyatt said they would prefer performance vesting, but they disagree on what performance metrics should be used.

"Directors and institutional investors want to see performance vesting, rather than time vesting, on both options and shares,'" Ira Kay, Watson Wyatt's global director of compensation consulting, told Bloomberg News. "They're much harder to earn because there's a greater likelihood of forfeiture."

The Watson Wyatt survey included 50 institutional investors and 50 directors. While they differed on how to determine severance payments, 79 percent of directors and 85 percent of investors agreed that the U.S. compensation model has hurt corporate America's image. For more on that survey, click here.