It is the scandal Wall Street can no longer dismiss as "a few bad apples". In what amounts to systematic corruption, dozens of American companies stand accused of manipulating share options to inflate executive pay artificially, and then lying to shareholders about it.
As many as 2,000 companies may be involved. So far, 85 have publicly admitted they are under investigation. Directors from nine companies have quit in disgrace. Six executives from two firms are facing criminal charges. Angry shareholders are lining up their lawsuits.
And now we have the extraordinary possibility that shares in Apple Computer might be thrown off Nasdaq, and that Steve Jobs, the iPod maker's visionary leader, could be questioned by the Securities and Exchange Commission, the Wall Street regulator.
The scale of the scandal is breathtaking and the anger felt among shareholders is palpable. Tobias Levkovich, chief equity strategist at Citigroup, said the affair will radicalise shareholders. Already we are in an age in which activist investors and hedge funds appear on shareholder registers to agitate for change; they may find more willing support from traditional shareholders.
Share options give an executive the right to buy company shares at a fixed price - typically the price on the day they were granted - for several years into the future. The greater the share price rise before they are exercised, the greater the profit.
But getting a company's share price up is hard work for directors. A much easier way to increase the profit on options is to pretend they were granted at a lower price than they really were. With disclosure rules lax before the Sarbanes-Oxley reforms of 2002, and plenty of time allowed before the grant had to be revealed to shareholders, there was ample temptation to wait and to pick the date at which the share price was at its lowest.
In many ways, the tale of its discovery is a classic detective story. It was maverick academics who first smelt something fishy and pursued their hunch, in the face of an establishment that dismissed them or was slow to respond. Only in recent months have they finally been hailed as heroes.
In 1997, David Yermack, now a professor of finance at New York University, planted the first germs of suspicion by noting the lucky timing of the average executive options grant, which appeared to come just before a strong rally in a company's share price.
And as options grants became a more central plank of executive pay during the dot.com years, these coincidences became more frequent and striking. By the time Erik Lie, associate professor at the University of Iowa, compiled statistics on the subject in 2003, he could come up with only one conclusion.
"The odds of executives being able to predict a rally in the share price over the next few days after a grant were simply astronomical. I thought it was clear they were cherry-picking dates from the past."
But Mr Lie struggled to find a publisher for the work. At this point, not a single company had been accused of backdating options, and the editors thought it unlikely that this was what was happening.
It was only in 2004 that the SEC stumbled across backdating at Mercury, and Mr Lie sent his research to the regulator. The SEC has since worked with him and other academics in its search for new companies where there are suspicions of fraud.
His latest studies continue to provide astonishing new evidence of systematic corruption. At 2,000 of the 8,000 companies examined, there were significant grounds for believing that options dates were chosen after the fact to maximise executive profit. And the introduction of Sarbanes-Oxley rules did not stamp out the practice. Although companies are required to disclose options within two days of granting them, many have simply not complied with the rules and filed the information late. Even since 2002, one in eight grants still has the whiff of suspicion over them, Mr Lie says.
"I believe that only a minority of firms that have engaged in backdating of option grants will be caught. In other words, we will never see the full iceberg," he said.
http://news.independent.co.uk/business/analysis_and_features/article1219345.ece
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