SEC Targets 80 Companies in Stock Option Probe

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MELISSA BLOCK, host:

From NPR News, this is ALL THINGS CONSIDERED. I'm Melissa Block.

ROBERT SIEGEL, host:

And I'm Robert Siegel.

The chairman of the Securities and Exchange Commission tells the Wall Street Journal that more than 80 companies are under investigation for charges related to backdating executive stock options. Three present and former executives of one company, Brocade Communications, were indicted yesterday in San Francisco for securities fraud.

Stock options give executives or other workers the benefit of buying stock at the price it's sold for at one time - the exercise price - and then selling for a presumably higher price later on, thanks to the company's successes, which the executives or other workers presumably contributed to.

The question at stake here in the current investigation is how did the company decide the date of the exercise price and also who was told about it? John Coffee is professor of law and director of the Center on Corporate Governance at Columbia University Law School and joins us from New York. Welcome back to the program.

Mr. JOHN COFFEE (Director, Center on Corporate Governance, Columbia University Law School): My pleasure.

SIEGEL: First question, I can see how backdating a stock option to a time when a stock was at a historic low is beneficial to the person who receives it, but I gather that if it's all done right and the right papers are filed it's not necessarily illegal.

Mr. COFFEE: Well the question is who would be the victim? If the board of directors really wants to backdate the option and give the employee an option at below the then fair market value of the stock, they can do that. However, they would have to take an expense against the current year's income for the amount of that discount and if that reduction of their earnings were material, you would commit securities fraud if you publish your financial statements without taking a deduction that generally accepted accounting principals requires you to take.

In short, there are a number of different legal theories that could be used to reach backdating. And there's a likelihood that in any case you backdate there's going to be some falsification of books and records, which the SEC can bring an action against you for and prosecutors, if they want, can indict you for.

SIEGEL: Now, as I understand it, we know that backdating is quite common thanks to some researchers who found anomalies in how often the exercise price for stock options seem to be at or near a historic low. It's just too common to be coincidental.

Mr. COFFEE: That's right. I mean, it's statistically highly likely that something like 29 percent of all U.S. firms between 1996 and 2005 either backdated or manipulated their stock options in at least one or more cases. That in turn means that the scale of this particular scandal may be well beyond the ability of the Department of Justice to criminally prosecute.

SIEGEL: Yeah, that's well more than the number 80 of cases that Chairman Cox was quoted as talking about.

Mr. COFFEE: You're correct. And we don't that in all these cases actual backdating occurred. There are a variety of techniques that you can use to inflate the value of the options. One, for example, is to release negative news just before the option is awarded and then hold back and release positive news right afterwards. That, again, is manipulating and using selective disclosure, but it's much harder to prosecute. Only backdating has the clear, visible badge of fraud that federal prosecutors like and feel comfortable prosecuting.

SIEGEL: Now, among the three people who were indicted yesterday or whose indictments were announced in San Francisco, two of them hold positions you're accustomed to seeing people charged with in any kind of stock fraud cases - the CEO, I think the chief financial officer as well. But then there was the director of human resources for the company.

Mr. COFFEE: You're right and this is the first time we've seen someone outside of a financial role be the subject of federal criminal enforcement. If you think about Enron and WorldCom it was always the chief financial officer, the president and the chief executive officer.

But when you're dealing with stock options, usually the head of human resources is very much present at the scene, is working out the details and knows what promises may have been made, such as the promise to give you a stock option dated as of the low point for last year that was used to attract an employee.

And the message for corporate America is that anyone in any position who's involved in falsifying books or records that will be filed with the SEC is a potential candidate for criminal prosecution. And I think that will send a chill up the spine of many in corporate America.

SIEGEL: Jack Coffee, thanks a lot for talking with us once again.

Mr. COFFEE: My pleasure.

SIEGEL: Mr. Coffee is professor of law and director of the Center on Corporate Governance at Columbia University Law School in New York City.

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