Maybe it's scandal fatigue, but investors no longer seem to care about stock-option backdating misdeeds. If the judge's comments in the trial of former Brocade
The backdating battle broke open in earnest last year, following a Wall Street Journal story detailing the "perfect payday" executives at companies including Affiliated Computer Services
Stock options give the recipient the right -- but not the obligation -- to buy a stock in the future, presumably when it sits at a price higher than when it was granted. The idea is to align the interests of management and shareholders. If managers do well, the company succeeds, and the stock price rises. Everyone benefits, giving managers an incentive to do the right thing.
Backdating an option subverts that process. While it's not necessarily illegal, rolling an option's price back to an earlier date when the share price was lower gives the options holder an immediate paper gain unavailable to regular shareholders. It's like going back in time and betting on the Kentucky Derby winner. With backdated options, the incentive to keep executive and shareholder interests aligned grows ever smaller.
Executives ran into trouble with their backdating schemes by undermining shareholder disclosure rules. Most companies have an options-granting plan in effect, specifying that options are typically granted on the day they're awarded, or perhaps the day before. Changing those dates -- sometimes, the executives even went so far as to change the minutes of the board meetings -- is illegal. It not only violates its own options plan, but potentially breaks securities fraud rules, too.
Or so we thought. While companies that initially announced they might have backdating problems saw their stocks take an immediate hit, they often recovered just as quickly. Today, those shares trade higher (many times higher) than they did before the announcement, even though internal and external investigations are still under way. The scandal would eventually ensnare some 200 companies, three quarters of which would come under some kind of regulatory scrutiny, including companies as large as Home Depot
Perhaps investors first thought that options backdating would become akin to the accounting scandals that brought down Enron and Worldcom. Perhaps they were getting caught up in a media-generated feeding frenzy. For a while there last summer, it was a regular perp-walk of executives announcing their companies were undertaking an internal review of their options-granting practices. Better to get it out in the open before the SEC comes knocking at your door.
These days, no one much cares. Backdating options is so last year. Maybe we've decided to believe the executives who say they didn't realize they were doing wrong. Apologists for Steve Jobs at Apple
That may just be the case in the Brocade trial, where the judge is considering dismissing the charges against Reyes because he may not have fully understood options-accounting rules. There was testimony, however, alleging that the CEO said backdating was "illegal," and that he supposedly falsified meeting minutes to cover up the deed.
To a certain extent, the frenzy around the scandal served a purpose -- and I do think it was scandalous of executives to give themselves such instantaneous profits, even if only on paper, considering how much they're already paid. Many companies either curtailed the use of stock options or, like UnitedHealth, stopped granting them altogether. Slightly better forms of compensation were substituted, like shares of restricted stock.
Yet when we tolerate criminality, when we excuse executive excess in the companies we own because everyone else is doing it, it's not long before we find ourselves hip deep again in a truly scandalous quagmire -- all because we didn't do enough to thwart the greed early. If we're weary now, will we have the strength then?
Home Depot and UnitedHealth are recommendations of Motley Fool Inside Value. UnitedHealth is also a recommendation of Motley Fool Stock Advisor.
Fool contributor Rich Duprey owns shares of Digital River, but does not have a financial position in any of the other stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
