Options Run Out at Comverse

When Richard Nixon bugged the Democratic campaign headquarters at the Watergate complex, the irony was that it was completely unnecessary. He went on to win in an electoral landslide. Likewise, when decorating diva Martha Stewart sold her ImClone (NASDAQ:IMCL) stock based on insider information, the irony is that this multimillionaire realized a paltry gain of $68,000. Her manicure probably costs more than that.

And now yesterday, the former CFO of telecom-software maker Comverse Technology (NASDAQ:CMVT) pleaded guilty to a single count of securities fraud and another count of conspiracy to commit securities fraud over his role in the company's stock-option backdating scandal. He, along with former fugitive CEO Kobi Alexander and the company's general counsel, made about $8 million by repricing their stock options to the lowest stock price at the time. The irony is, had they not backdated their options, they still would have legally made around $150 million in profits. Their greed did them in.

While David Kreinberg, the fallen CFO, becomes the first executive to plead guilty in a backdating case, he and his cohorts at Comverse were actually not the first charged. That dubious distinction went to executives at Brocade Communications (NASDAQ:BRCD), where three top executives also face criminal charges. Even so, some 15 executives have lost their jobs to date as the backdating scandal in general broadens and takes in more companies. So far, more than 120 companies are probing or are being probed as to whether they have any stock-option skeletons in their closet.

The past few weeks have been a veritable perp walk of executives leaving the front office in the wake of backdating scandals. UnitedHealth's (NYSE:UNH) CEO, William McGuire, left under a cloud of controversy for his role in that company's stock-option repricing scheme; the upper echelon at information security provider SafeNet (NASDAQ:SFNT) found themselves without a safety net; and business consultant Sapient consulted with its CEO and CFO and ushered them out the door.

Backdating is the practice of changing the date on which a stock option is granted so that the stock price is lower than it otherwise would have been. It serves as a way to give the executive an immediate profit on the options and undermines their purpose of aligning shareholder and management interests.

While there's a pretty diverse universe of companies that are accused of backdating, not all are facing the shareholder equivalent of the electric chair. Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT), for example, have admitted they backdated options, but they did so as company policy to date the options at the lowest price of the month in which they were issued. That's not necessarily a great defense, but it is nowhere near as nefarious as what occurred at Comverse.

According to prosecutors, Kreinberg and Alexander used fictitious names to generate stock options and then created a "secret slush fund" to evade the company's written plan on issuing them. Alexander then personally doled out the options, with Kreinberg's advice and consent, to the employees he favored. Compounding the scheme were the misleading statements made about the options in the company's public filings, including its proxy statements and annual reports. The general counsel, who was also in on the scheme, drafted and signed off on the reports.

And then there's the rub of why Comverse's backdating scandal is criminal and the revelations at Apple and Microsoft are greeted with a collective yawn. The difference is that the latter companies had no intention of misleading employees, shareholders, or regulators, nor were their actions exactly illegal. So long as a company didn't say one thing but do another, it seems as if it will simply have to restate its financial reports and have a finger shaken at it in admonishment. Comverse's CFO, on the other hand, will be cooling his heels for up to 15 years in Cell Block D.

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Fool contributor Rich Duprey does not own stock in any of the companies mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.