revisiting the options backdating scandal 

 Amid all the attention being given to the current “subprime meltdown,” it might be easy to forget that only a year ago “options backdating” was the hot topic. Options backdating may now even seem passé, but several considerations, including large settlements and new lawsuits, suggest that options backdating-related litigation should not be forgotten and that we still have a long way to go before we can put the scandal completely behind us. 

“Backdating” occurs when a company grants an executive stock options at an exercise or “strike” price below the actual closing price of the shares on the day of the grant, thus permitting executives to pocket more compensation than they otherwise were entitled to receive. The strike price frequently corresponded with the date of the lowest closing price during the fiscal quarter of the grant. In 2006, a Harvard Law School professor released research into the backdating practice and concluded that there were 19,000 stock option awards that occurred on the date with the lowest price between 1996 and 2005. In fact, it was surmised that 12% of all CEO’s option grants were “lucky grants”— a grant with a strike price set on a prior date which happened to coincide with the stock’s lowest closing price. One expert has opined that the odds that such grants were random or by luck are lower than winning the lottery. Following such studies, scores of cases were brought against companies that had seemingly engaged in options backdating to its executives.

The majority of the backdating cases that were filed between 2005 through 2007 are now concluding. Ten of the 36 cases filed before 2008 have been dismissed while 12 have reached significant settlements, sparking a new interest in backdating-related litigation. The 12 settlements total $1.3 billion, for an average of over $109 million. In July 2008, United Health settled its securities backdating class action case for $895 million and the ERISA case against the company based on the same backdating allegations settled for $17 million. This represents the largest settlement in a backdating case to-date. A number of other companies have recently settled options backdating cases for varying amounts ranging from $435,000 to almost $900 million. Such companies include high-profile names, such as Mercury Interactive, Meade Instruments, Brocade Communications, Rambus, Dean Foods, Cyberonics, Tyson Foods and Marvell Technologies. These options backdating cases have had serious repercussions to corporations nationwide, with an estimated cost to companies of $10.3 billion. Additionally, over 40 executives have lost their jobs due to options backdating, while criminal charges, Senate and SEC investigations have been overwhelming.

Although many of the backdating cases filed two years ago are now closed or reaching a conclusion, it is important to remember that backdating-related lawsuits continue to be filed in 2008. As recently as July 8, 2008, a backdating lawsuit was filed against MRV Communications. Maxim Integrated Products also faces a similar lawsuit that was filed earlier this year. Investors must continue to monitor newly filed options backdating cases, as well as the cases that have recently been settled, to ensure they are receiving their rightful share of the final recovery.

Source : Scott+Scott August 2008 Newsletter