What began as a trickle and has turned into a steady stream will soon become a deluge, I believe. I'm referring to the constant march of companies to the confessional, baring their sins of backdating the stock options they granted to executives and other senior managers. The latest domino to fall is KLA-Tencor (NASDAQ:KLAC), which submitted an 8-K to the Securities and Exchange Commission after the market's close on Friday, heading into the long holiday weekend.
While the semiconductor equipment manufacturer has been under scrutiny already for its option practices, its announcement this weekend was that the special committee of directors it had formed to look into the issue had found that there did appear to be some irregularities. Although the committee hasn't completed its investigation, I'd be willing to wager that what they found is going to be significant. Waiting for the long weekend to spill the beans can then allow the company to try to minimize the effect, since they can always claim the issue is old news when they tell investors just how large of a hit to earnings they will have to take.
What surprises me the most is that there weren't actually more companies filing similar reports this weekend. Despite the markets being open on Monday, most companies will have minimal staffing the day before the holiday, and probably even fewer investors will be bothering to read the filings that day. It's a great time for a company to release some bad news and ugly truths.
The news that KLA-Tencor has options backdating problems is not new, really. It was one of the companies whose executives The Wall Street Journalrevealed had extremely good fortune in the dates their stock options were granted. UnitedHealth (NYSE:UNH), Brocade Communications (NASDAQ:BRCD), and Comverse Technology (NASDAQ:CMVT) are among a dozen or so that the Journal found had incredibly fortunate option-granting dates.
KLA-Tencor's chairman received two option grants on especially propitious days. The chances of that occurring randomly are estimated at 1 in 20 million. The SEC is also investigating the company's option-granting policies.
Is this much ado about nothing, though? Is the practice of backdating options really so evil? Putting aside the fact that overcompensating executives who are already richly rewarded is simply taking money from shareholders (there is a cost to options, after all), when it is publicly disclosed and done in accordance with company-established guidelines, then no, there isn't a real issue. The problem -- and possible criminal prosecution -- comes about when executives and directors conspire to enrich themselves further by changing the option grant dates without telling shareholders or in contravention of company policy.
A stock option is the right to purchase a stock at a predetermined price at some time in the future. Generally, if the fortunes of the company rise, the stock price will, too, and the option will become more valuable. That's why proponents of options say they align the interests of management and shareholders, since an executive will strive to have the company improve to make his or her options more valuable.
Backdating, on the other hand, is simply a technique to enrich the option holder. Instead of the option being priced when it is issued, executives and companies are charged with going back and changing the date of the grant to one where the stock price was even lower. But this creates an expense for the company that was never recorded at the time the option was granted, and that's why we're seeing so many companies having to go back and restate their financials. As I noted last week, Altera (NASDAQ:ALTR) will be restating 10 years' worth of financial statements.
More companies every day are revealing stock option backdating problems. Last week, Apple (NASDAQ:AAPL) and Computer Associates (NYSE:CA) admitted they were investigating the potential backdating of options granted, and we can be assured that the drumbeat will grow louder as companies try to beat regulators and prosecutors to the punch.
Considering the number of options that KLA-Tencor has issued, and the fact that it's admitted on a holiday weekend that it has found irregularities, suggests to me that the ultimate cost to the company and the amount of restating that will have to take place will be significant. Whether the current executives will be able to do penance sufficient to placate the shareholders, however, remains to be seen.
For related Foolishness on the options backdating issue, check out these articles:
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
