Sickened by Stock Options

Like many, I've followed the stock options scandal, first with amazement at the audacity of what I thought were a select few, then with growing disgust as the circle widened to encompass some of Wall Street's brightest and most well-respected names. Companies such as Broadcom (Nasdaq: BRCM  ) , UnitedHealth (NYSE: UNH  ) , (Nasdaq: MNST  ) , and even Home Depot (NYSE: HD  ) were all among more than 120 companies that now occupy The Wall Street Journal's stock-option backdating naughty list.

It seems like every day brings a new ugly fact to light, further staining corporate America's reputation for transparency and responsibility. Recently, Home Depot revealed that it had been backdating options for nearly 20 years. Heck, Comverse's (Nasdaq: CMVT  ) CEO fled the U.S for Namibia, rather than face arrest by U.S authorities. Broadcom also announced that it would be taking a $1.5 billion dollar charge for options backdating, and that it was further reviewing possible tax implications. Amazingly, the company had only $5.5 billion in revenues from 1998-2003, the key period covered by the restatement; its noncash charge amounted to roughly 27% of those revenues over that time period.

It makes me sick.

Malfeasant managers
Sure, I've read arguments that boards of directors and executives were backdating options to firm up the size of the pay package. In other words, why hand the new CEO or CFO a fuzzy pay package that may not match up to peers, or may even exceed industry pay scales? Let's pin down the dates on the options, so we have a far better idea of how much the whole shebang is worth. Now we've quantified this thorny issue of compensation a bit better.

Hogwash. Stock-option backdating is pure, unadulterated greed. A select group of directors from companies such as Juniper (Nasdaq: JNPR  ) and Novellus Systems (Nasdaq: NVLS  ) may have even spread the word to fellow directors. Indeed, research from the Corporate Library shows that 40% of the companies under scrutiny share common directors. While there is no evidence to prove these theories correct just yet, intuitionally, the speculation makes sense. After all, how is it otherwise possible that more than 100 companies in varied industries all individually did the same thing?

It's not all in my head; the Wharton Business School recently did a similar study, concluding that CEOs who were linked to directors on the compensation committee received substantially larger paychecks than their nonlinked brethren.

Do as I say, not as I do
The hypocrisy here stinks, especially when many of the firms caught in the options backdating scandal adamantly opposed expensing of stock options in the first place. It took more than a decade to get options expensed. Lobbies like the American Electronics Association (AEA), made up of serial option offenders such as Cisco, Intel, Apple, and Applied Materials, pushed the party line that if stocks options were expensed, it would hurt the little guys (i.e. the employees) most of all. Never mind that this bankrupt argument ignored shareholders, or that in many cases, a select group of top managers in repeatedly received the lion's share of options grants every year. Even Congress was involved, briefly pushing an inane bill that would force only the top five executives' options grants to be expensed. Thankfully, wiser (or more Foolish!) heads prevailed.

Now, the latest from The Wall Street Journal makes the bile rise in my throat anew. Not only were these stock options magically dated at the low points of the year, or at multiyear lows, to ensure massive gains for top management, but they were also potentially dated to ensure a lower tax bill.

How does this work? Per the WSJ, it all depends on the exercise date of the option. Typically, many managers sell their exercised shares immediately upon vesting, but some, for whatever reason, elect to hold onto their shares. Perhaps that's because after a year, the capital gains rate drops to 15%. Given a $10 strike price, if the option can be dated to have an exercise price of $15, yet still get sold at $20, the recipient reaps an identical gain with a smaller tax bill.

Greed isn't good
Many of America's most innovative and admired corporations are in a sorry state nowadays, and the disgust they've drawn is richly deserved. Shareholders are understandably revolted, and they're showing CEOs and top management the door. For this Fool, the firings often can't come fast enough.

Gordon Gekko (of Wall Street fame) may have stated that "Greed, for lack of a better word, is good." But he was referring to greed as a motivating factor in the pursuit of good works. In this case, I submit that the greed is bad; as far as I can see, this backdating scandal is nothing more than outright theft from the true owners of the company: the shareholders.

UnitedHealth is a Stock Advisor and Inside Value pick, while Home Depot also made the cut at Inside Value. Follow the preceding links to try either newsletter free for 30 days.

Fool contributor Stephen Ellis does not own shares in any companies mentioned. You can view the stocks he owns and check out his 99th percentile ranking in Motley Fool CAPS, the Fool's new stock-rating community. The Motley Fool has a disclosure policy.

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