Investigations Expanded into Back-Dating Stock Options

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A growing list of publicly-held companies are being asked by the government to re-examine their stock options programs. One area of concern is the practice of back-dating, in which companies allow employees to buy stock at a lower, retro-active price and thereby maximize returns. NPR's Scott Simon talks to New York Times columnist Joe Nocera about the practice.

SCOTT SIMON, host:

This is WEEKEND EDITION from NPR News. I'm Scott Simon. Coming up: Mexican teachers prepare a lesson for their country's presidential candidates. But first, this week, Apple Computer, Inc. announced irregularities in the way the company awarded stock options to executives and employees from 1997 to 2001.

Apple joins a growing list of publicly held companies that have been obliged to re-examine their stock options programs. Now, no one as yet knows whether Apple engaged in backdating. That's a practice in which companies allow their executives and other employees to buy stock at a lower retroactive price and thereby maximize returns.

Back-dating is a kind of insider trading and it's prompted investigations by the Securities and Exchange Commission, the Justice Department, Congress and the Wall Street Journal.

Joe Nocera is our friend from the world of business and a columnist for the New York Times. Thanks for being with us, Joe.

Mr. JOE NOCERA (Columnist, New York Times): Thanks for having me, Scott.

SIMON: Now, I said insider trading, but to be blunt about it, is this just insider cashing in?

Mr. NOCERA: The practice at its worst is a situation where they wait for the date to pass when the stock hits bottom, so it's already on the way up, and they back-date the granting of the stock option to that bottom, so that the executive is automatically guaranteed a huge gain, you know, tens if not hundreds of millions of dollars of free money. So you know, it's a pretty smelly practice at its most venal.

SIMON: Now, I understand that somebody in the academic world decided this was worth looking into and established a pattern.

Mr. NOCERA: That's exactly right. It's a kind of a form of forensic economics, where an academic will do a study that will show a pattern that seems to be suspicious.

And so in this particular case, an academic named Erik Lie at the University of Iowa did a study last March where he, you know, showed this continued pattern of executives getting options at the exact low moment before the stock ran up. And he thought to himself, well, you know, there's one of two things going on here. Either these guys can really forecast the future, you know, or they're backdating the options.

And it's that study that caused both the SEC and the Wall Street Journal to get this out of the theoretical and put it in real terms with real companies, and that's what they've done.

SIMON: Many of the companies that have been named, either formally or informally, as being under SEC scrutiny are tech companies. Is that just coincidence, or is that where the money is or is there something about tech companies that make it more likely?

Mr. NOCERA: Well, the main thing about tech companies is that their compensation system has been heavily skewed to options for many years. So it's not a giant surprise that companies like Rambus, which makes - a semiconductor company, or Comverse Technologies or Vitesse Semiconductor, have been ensnared.

It makes sense. However, I should say, it's not entirely tech companies. One of the companies under the most scrutiny right now is United Health Group in Minneapolis, the big HMO, and you know, their CEO got a number of options that appear to be backdated, although the company has not said that and, indeed, is conducting its own internal investigation.

One of the great mysteries of this, Scott, is how did word spread about this? You know, is it water cooler stuff? Did CEO's just talk to each other and figure this out themselves? Nobody really knows, and therefore it's hard to know how many more companies - how much more widespread this is than it's already been.

SIMON: Part of the logic of stock options is that it gives a CEO or any executive a stake in the performance of the company. That gets created if what they're just going to do is shop around for the lowest price and then maximize the investment.

Mr. NOCERA: The point of options, originally, was to align the executives, and even the rank-and-file when they get stock options, with the shareholder, so that he is incented to try and make the share price go up, and you and I, who are shareholders, are rewarded, and he's rewarded.

So if you have a situation where, you know, he's rewarded from the very moment he gets the option - he has his reward, it's there - there's been no effort on his part, he's just handed free money. And then, by the way, it's not disclosed in the proxy that that's what they've done. That is, in my opinion, a form of securities fraud.

SIMON: Well, you anticipate my next question. How illegal is this? Are there any gray areas?

Mr. NOCERA: Oh, there are absolutely gradations here. In some cases executives have been fired, internal investigations are going on. I dare say, there'll likely be some prosecutions. It seems almost a sure thing. Although it's really, really too early to know, you know, how this is going to play out in the courts.

SIMON: Joe Nocera, our friend from the world of business and a columnist for the New York Times, speaking from New York. Joe, thanks very much.

Mr. NOCERA: Thanks for having me, Scott.

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