Posted by: Robert Hutchinson
January 02, 2007

THE STOCK OPTION BACKDATING SCANDAL:THE HEADS I WIN TAILS YOU LOSE STRATEGY

Stock options came into favor for the reason that many thought greedy executives and chief executive officers were paying themselves too much. The idea was to instead give them stock options that are tied to the company's performance, and in that way, align their financial interest to the shareholders' interest. It wasn't long until that idea was twisted from using options to partially replace fat salaries to one of issuing options grants on top of fat salaries. In the ten years leading up to 2001, the average value of option grants to CEO's of S&P 500 companies has increased ten fold.

Now, incredibly, many have taken this idea one step further, to that of actually backdating options to guarantee that the options become valuable. As an example, say an option for 100,000 shares is granted with a strike price of $20 when the stock is worth $10, the idea is that management will be rewarded when and if the stock doubles. If that were to occur, then the grant's recipient would receive $1,000,000 upon exercise of the option. Obviously, if the stock goes nowhere, then the options are worthless.

What is poor management to do? Many have taken to granting themselves generous stock options after the stock hits a record or near record low, and gone up from that low. Of course, this requires a good measure of dishonesty on their part, because it means that they must back-date the options and pretend they were issued before the stock began going up. So if the stock skids to say $5 and then recovers to $12, then using this sort of scheme, a 100,000 option grant issued at a strike price of $7 magically becomes worth $500,000 despite management's so-so performance, which is now coupled with its outright dishonesty. Voila! Gone is the nettlesome problem of management actually having to perform well - heads they win, tails you (the shareholder) lose.

This scandal has become so widespread that the federal Securities and Exchange Commission is investigating a reported 130 U.S. corporations, according to the December 27, 2006 issue of the Wall Street Journal, and more that 60 executives and directors have lost their jobs, of which 17 are chief executive officers.

Think there's a health care crisis in this country? Consider this. UnitedHealth Group, Inc., this country's largest health care company by sales, according to the Wall Street Journal (same date), has issued to its now former CEO William Mc Guire options that are presently valued at $2.121 billion dollars. According to the Wall Street Journal, Mc Guire "had to resign" after "probable backdating was exposed." It was reported that he would give up $200 million in options, and that the company said it would have to restate earnings by as much as $1.7 billion. Separately, the Denver Post reported on December 27, 2006 that the Securities and Exchange Commission has opened a formal probe of the stock-options practice that led to McGuire's departure, which comes on the heels of its informal inquiry that began in April of this year

These facts show that there is no limit to greed and dishonesty. History teaches that those who perpetrate these schemes do not stop themselves. They must be stopped; the defrauded shareholders must be compensated, and those responsible must be held accountable.

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THE STOCK OPTION BACKDATING SCANDAL:THE HEADS I WIN TAILS YOU LOSE STRATEGY

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