2007Public Service

As Companies Probe Backdating, More Top Officials Take a Fall

Some CEOs reap millions by landing stock options when they are most valuable.
Luck -- or something else?
By: 
Charles Forelle and James Bandler
October 12, 2006

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Five senior officers at two well-known Silicon Valley companies became the latest corporate casualties of the stock-options backdating scandal, adding to a toll that is likely to continue to rise as companies wrap up probes of their internal practices.

In the latest actions, Shelby Bonnie, founder and chief executive officer of Web publisher CNET Networks Inc., and George Samenuk, chairman and CEO of computer-security vendor McAfee Inc., stepped down following internal probes that found use of options backdating. So far, some two dozen executives or directors have been fired or suspended or have resigned amid options probes. Among them are top officials of Apple Computer Inc., Web-site operator Monster Worldwide Inc. and software maker Comverse Technology Inc., whose former CEO is facing extradition proceedings in Namibia.

Experts said more departures are likely. More than 100 companies are under investigation for options backdating, and scores of them are still conducting internal probes. Many would like to finish them in time to make disclosures during quarterly earnings reporting, which will be heavy in the next several weeks. The companies face pressure to finish because they may not be able to tally their earnings without knowing whether they will need to record charges for any improper options discovered by the probes.

Many companies have already said they won't meet securities-filing deadlines for the quarter, leaving them at risk of delisting, costly fights with bondholders entitled to timely financial statements, and potentially greater liability in any options-related civil actions by shareholders.

Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, said he believes more people will lose their jobs. "It is a fundamental breach of trust to your investors," he said.

Backdating amounts to pretending that an option was granted earlier than it actually was, at a beneficial time when the share was trading at a low price. Since options entitle their recipients to profit from a rise in price, claiming the grant occurred at a time of low prices could give the recipient a running start to extra profit.

At a minimum, backdating generally involves accounting and disclosure violations. It can also constitute fraud. U.S. attorneys in more than a half-dozen jurisdictions are probing at least 50 companies. Five former executives of two companies are facing federal criminal charges for their alleged participation in backdating schemes.

Firing an executive doesn't necessarily get a company off the hook with regulators or litigious shareholders, but can be held up as a sign of good faith. The actions at CNET and McAfee underscore how seriously some corporate boards are taking options manipulation. Taken with other recent dismissals, they are establishing a precedent that separating executives from the company is a prudent response to options problems.

Getting rid of someone can be a double-edged sword, though. "The SEC [Securities and Exchange Commission] and the Department of Justice expect crisp remedial measures, so termination of a wrongdoing executive typically helps the company in the eyes of those regulators," says Michael Young, a lawyer at Willkie Farr & Gallagher. "Unfortunately, it can hurt in the defense of subsequent class-action litigation to the extent that plaintiff's lawyers infer that the departed executive did something wrong."

The McAfee departures suggest also that some boards, guided by outside lawyers conducting the probes, are taking a stern view of responsibility. Mr. Samenuk joined McAfee in January 2001, long after manipulations there apparently started. President Kevin Weiss, whose firing was announced yesterday, joined the company in October 2002.

In a statement, Mr. Samenuk expressed "regret" that some of the problems "occurred on my watch." Mr. Weiss couldn't be reached. Exactly what Messrs. Samenuk and Weiss did that precipitated their departures isn't known; a McAfee spokeswoman said the men were "implicated in the options backdating" but declined to elaborate.

Exactly who will go and who will stay at the scores of companies being investigated is difficult to discern. An executive's fate, of course, depends strongly on what evidence a review finds. But how that evidence is treated can vary from company to company.

Apple Computer threaded the needle last week when it discussed superstar CEO Steve Jobs's role in backdating at the company. Apple's disclosure said Mr. Jobs knew some grants were backdated; earlier, the company said he received a problematic grant. But Apple also said last week that Mr. Jobs wasn't aware of the accounting implications of backdating and didn't get any grants he knew were backdated, implying that any troublesome grant he received was manipulated for his benefit but was backdated without his knowledge. Apple's relatively terse disclosure didn't spell out exactly who did what.

Mr. Jobs apologized and remains with the company, which laid the blame on two unnamed former executives. Apple director Fred Anderson, a former finance chief, resigned from the board.

Bed Bath & Beyond Inc., the specialty retailer, said Tuesday that its review had found rampant backdating, concluding that "almost all annual grant dates" for several years were likely selected "with some hindsight." At a time when many corporate disclosures about backdating are opaquely written, the company's statement was frank and detailed, laying out how many grants the company believed were backdated and giving a sketch of how the process worked.

What's more, Bed Bath & Beyond said, the co-chairmen and chief executive had responsibility for picking the dates; the men themselves benefited from the low prices. But the board committee probing the options offenses concluded that no one had "engaged in willful misconduct." No top executives have departed Bed Bath & Beyond because of options misdeeds.

Mr. Young, the Willkie Farr attorney, says that in investigations of matters like options backdating, board committees try to probe deeply an executive's state of mind. "When somebody is deliberately doing something wrong, and misrepresenting the consequences, then you've got dishonesty in the ranks," says Mr. Young. That, he says, is dealt with harshly. What to do can be a tough call, he says, with "those whose involvement was gray."

San Francisco-based CNET said its review, conducted by law firm Davis Polk & Wardwell and led by a special committee of directors, found "instances of backdating" from the company's initial public offering in 1996 through "at least 2003." Even though CNET said its review didn't conclude that any of these people "engaged in intentional wrongdoing," Mr. Bonnie, General Counsel Sharon Le Duy and human-resources head Heather McGaughey all "bear varying degrees of responsibility." They all resigned and agreed to have any improper options repriced so that they wouldn't continue to benefit from the backdating.

CNET also said directors will reprice improper options; a company spokeswoman says the repricing affects "all members of the board of directors, to varying degrees depending on their length of service."

It isn't clear exactly which grants were backdated, though some raise suspicion. In 2000, CNET granted options to Mr. Bonnie and two other top executives with purported dates that coincided with the stock's lowest closing price in April. Other executives got options dated at October's low price. One received both favorable dates.

Melinda Haag, a lawyer for Ms. Le Duy, said her client neither knew about nor participated in any intentional misdating of options. "Sharon has always acted with integrity with regard to CNET's stock-option grant process and in all other regards," Ms. Haag said. "Given that she was a senior officer for part of the time at issue, however, Sharon recognized that her resignation would best help the company move forward."

An attorney for Mr. Bonnie couldn't be reached for comment.

Ms. McGaughey, a former Time Inc. manager, joined CNET in 1998 as vice president of human resources. She became senior vice president in 2000. "Ms. McGaughey is deeply saddened by the events that have happened at CNET," said her lawyer, Leigh A. Kirmsse. "She believes that in the end her name will be completely cleared of any wrongdoing whatsoever."

Kirk Hanson, executive director of the Markkula Center for Applied Ethics at Santa Clara University, said companies are operating in a climate that places great weight on the integrity of senior-most executives.

Mr. Hanson said he believes a senior executive who initiated or authorized backdating should leave his position.

"If a CEO who is tainted remains in place, a very unfortunate signal is given to the organization that irregular practices will be tolerated or even applauded," Mr. Hanson said. "This is not a question of whether the CEO is indictable; it is a question of whether the CEO is a credible leader of integrity."

Public Service 2007