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More than 100 firms probably backdated options
Number of companies discovered to have used controversial practice could double, expert says.
By Amanda Cantrell, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- The list of companies being investigated in the stock-options saga grows longer by the day and could easily climb much higher, according to the professor whose research brought the issue to light.

More than 50 companies are being investigated by the Securities and Exchange Commission and federal prosecutors over whether they "backdated" or otherwise manipulated the dates they granted stock options to employees to make the options more lucrative, according to Reuters.

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And the number of companies that engaged in the practice could climb into the hundreds once more research is carried out, according to Erik Lie, an associate professor of finance at the University of Iowa.

It was Lie's research that attracted media and regulatory attention to the problem when he published a study in the journal Management Science noting that the granting of options to executives at several companies preceded big run-ups in the stock price.

"I am confident that the number of companies who have done this is much higher" than the number currently being investigated, said Lie, who plans to release new research in the coming weeks.

The controversy over options comes amid a growing outcry over how top executives are paid in the United States.

"There's a negative ring to the term 'back-dating,' and poll after poll shows Americans are fed up with how high executive compensation is," said Michael Koenig, an attorney in the Washington office of law firm Dewey Ballantine LLP.

Koenig noted the controversy comes with executive pay under scrutiny, not only by ordinary Americans but also by SEC Chairman Christopher Cox, who has made made disclosure about how executives are paid one of his top priorities.

A harsh spotlight

"You've got the perfect storm that makes this a very populist issue," said Koenig. "The government's investigative spotlight is burning more intensely with each passing day. This could mean rough roads ahead for the companies, their boards and investors."

But Koenig noted it's possible that some companies that "backdated" did not break the law.

Stock options give executives and employees the right to buy shares at a certain price, and if the stock rises after the options are granted, profits can be fat.

No criminal charges have been filed in connection with the investigations so far, but certain companies have ousted some executives, and state prosecutors are also on the hunt. Some companies have already said they will have to restate several years' worth of financial results.

The list of companies embroiled in the saga now includes well-known Internet companies like CNET (Charts), which said this week it was among the companies needing to restate earnings over multiple years, while Take-Two Interactive Software (Charts), publisher of the popular "Grand Theft Auto" video game series, announced the SEC is investigating option grants made from 1997 to the present.

Lie said some companies have engaged in backdating in a way that makes wrongdoing harder to detect. For example, many companies may have backdated options to coincide with the second-lowest stock price in a given period, rather than the lowest, to deflect regulators' attention.

"That makes it easier for companies to say, 'if we were back-dating, wouldn't we have used the lowest price?'" he said in a phone interview.

Some options-granting practices under fire could be considered ethically dodgy but not illegal, while others could prove to be illegal, despite what the companies issuing them at the time may have thought. Still others could have resulted from honest mistakes. (For more on the practices under fire, click here.)

'Spring-loading' also eyed

Also being discussed is "spring-loading" options, or issuing options before news that's likely to boost a company's shares.

"You really have to look at the facts of the specific case," said Koenig. "Certainly if it's disclosed it may not be illegal." If what the company actually did differs from what it told investors, "that is arguably securities fraud," he added.

"Whether you are talking about spring-loading or backdating, if it's done with material, non-public information, you are opening the door to classic insider trading," said Koenig.

While the practice of backdating got harder in 2002 with the passage of the Sarbanes-Oxley Act, which gave companies two days after granting options to employees to report those grants to the SEC, regulators and prosecutors are pursuing investigations into past practices and will likely continue to do so.

Sycamore Networks (Charts) was the latest to be named, as a former employee, Stephen Landry, said in a lawsuit that the maker of network gear fired him for complaining about the company's stock-options practices.

A copy of the complaint filed by Landry includes a memo that he claims came from Sycamore. The memo appears to instruct human resources employees at Sycamore to change the start dates for some workers to jibe with options grants and indicates that the author knew the practice could be construed as illegal.

Sycamore spokesman Scott Larson declined to comment, citing the company's policy of not publicly discussing pending litigation, but the company said in an SEC filing that it believes it has "meritorious defenses to the complaint" and "intends to vigorously contest this action and intends to file counterclaims, as appropriate."

Some companies, like Apple Computer (Charts), have started their own internal investigations into their options-granting practices before waiting for regulators to step in, and Koenig said it would behoove other companies to follow suit.

"What a company has done to clean itself up is a major factor that the SEC and prosecutors will look at," he said.

Related: Sycamore memo points to back-dating Top of page

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