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Stock option shell game investigated

Posted: 29 May 2006 ?? ?Print Version ?Bookmark and Share

Keywords:stock option? Vitesse Semiconductor? delisting? Nasdaq? Altera?

Fallout over the way stock options were handed out to some electronics industry managers reached new heights recently, with the news that Vitesse Semiconductor Corp. was being investigated by both the U.S. Securities and Exchange Commission (SEC) and the U.S. Attorney's Office. Vitessewhich earlier dismissed its CEO and two lieutenantscould be delisted from the Nasdaq exchange as an indirect consequence of internal investigations into the options issue.

Two other prominent technology companies, Altera and Brooks Automation, also face the prospect of delisting.

Stock options have come under intense scrutiny of late. The controversy centers not on the options themselves, but on the practice of backdating them. A hangover from the boom years of the 1990s, backdating involves granting options dated retroactively to times when a company's stock price was relatively low (thus increasing the option holder's potential for profit), without notifying investors.

The practice raises tax issues, provokes shareholder unrest and may be a violation of the 2002 Sarbanes-Oxley financial-accountability act.

Published reports indicate that the SEC has been looking into the matter since at least 2004.

Companies that have failed to properly disclose the practice of backdating are likely to face SEC investigations, tax repercussions, restatement of quarterly financial statements, plunging stock prices and shareholder lawsuits, said Corey Rosen, executive director of the National Center for Employee Ownership, a nonprofit consultancy. "Are you going to go to jail over it? No," Rosen said. "Are you going to go to court? Yes."

Vitesse announced last May 17 that it had fired CEO Louis Tomasetta as well as its chief financial officer, Yatin Moday, and an executive vice president, Eugene Hovanec. Vitesse placed the three on leave on April 18 in connection with an internal investigation into stock options granting practices. Interim CEO Christopher R. Gardner, most recently general manager of Vitesse's Network Products Division, was named new chief executive.

The next day, the company disclosed it was also being investigated by both the SEC and the U.S. Attorney's office of the Southern District of New York. In the latter instance, Vitesse disclosed that it had received a grand jury subpoena "requesting documents from 1999 through the present referring to, relating to or involving the granting of stock options." For its part, the SEC's Division of Enforcement requested documents from Jan. 1, 1995, through the present, also relating to stock options.

Vitesse, programmable-logic heavyweight Altera Corp. and semiconductor fab automation provider Brooks Automation Inc. have all been notified by Nasdaq that their securities could be delisted for failure to file their most recent quarterly reports in a timely manner. All three companies have said they plan to hold off submitting the reports to the SEC pending internal investigations of how stock options were granted. Their stocks will remain listed on the Nasdaq pending individual hearings.

Questions about historical practices in the granting of options have hovered over the high-tech industry since the 1990s and recently bubbled to the surface in a case involving Analog Devices Inc. Last November, ADI settled with the SEC in a stock option investigation that was first disclosed in the company's Nov. 30, 2004, 10-K filing. That inquiry centered not only on backdating, but also on the granting of options to employees and directors prior to the release of favorable financial results. The settlement cost the company $3 million in civil fines, while the options granted in certain years to ADI's directors and its president and CEO, Jerald Fishman, had to be repriced. Fishman was also ordered to pay a $1 million civil penalty and had to make a disgorgement payment for options granted in certain years. He and the company settled without either admitting or denying the SEC's findings.

Questioned by EE Times about the current spate of investigations, a spokesman for the SEC said it is against agency policy to comment on the existence or nonexistence of any investigation. The spokesman said that whether options backdating at a particular company violated any laws or SEC regulations would depend on the circumstances of the individual case. The SEC, he said, has no statistics to indicate how widespread a problem backdating may be.

Vitesse, Altera and Brooks Automationalong with chip supplier Power Integrations Inc. and contract services manufacturer Jabil Circuit Inc.have all indicated that they variously are investigating their historical options practices internally, are being formally or informally investigated by the SEC, or both.

Altera chairman and CEO John Daane recently declined to say whether backdating was at issue for his company. He told EE Times that Altera would remain mum about the options-granting practices it is examining.

At least for a company's top five employees, backdating was banished under the Sarbanes-Oxley financial-accountability act of 2002, said Rosen of the National Center for Employee Ownership. The act requires companies to report the issuance of stock options grants for the top five employees within two days, he said.

Though backdating en masse may no longer be possible, the fact that stock options have historically been such a vital part of electronics executives' compensation has fueled speculation that other companies could be dragged into the controversy. But that's not necessarily so, said Charles Mulford, a professor of accounting and faculty director of the MBA program at Georgia Tech.

"My inclination is that those who are going to come forward have come forward," Mulford said. Because so much attention has been focused on this issue lately, and because options backdating is easy to recognize when people are looking for it, Mulford said, most companies have probably already determined whether they are at risk and decided to self-report. "I would be very surprised if, six months from now, a new one comes forward," he said.

But Rosen believes that more companies will soon be implicated, either through self-reporting or by regulatory investigation. "That is sort of the nature of things," Rosen said. "When people have an opportunity to be greedy, they'll take advantage of it."

Rosen added that although backdating is "not a common practice, to be sure," it is one that is fraught with risk. One of the criticisms, he said, is that backdating violates the spirit and intention of stock options: to provide executives with incentive to work harder to grow the value of a company's stock. Options, he said, are not intended to pad executives' guaranteed compensation.

The companies tarnished in the stock options scandal have already been punished by Wall Street. Since first publicly disclosing internal investigations on this matter, four of them have seen their share prices fall. As of the close of trading on May 18, Vitesse was down by 44 percent, Power Integrations by 26 percent, Altera by 14 percent, Jabil by 13 percent and Brooks Automation by 10 percent.

The companies have been hurt in other ways, too. Vitesse, Power Integrations and Brooks have all faced management shakeups in the wake of internal investigation announcements. Brooks said that it had accepted the resignations of two of its directors, including its chairman, in connection with the stock options inquiry.

Power Integrations' chairman and chief financial officer both resigned early this month. The company has acknowledged it may need to restate its historical financial statements for 1999 through 2004 and for the first three quarters of 2005.

Likewise, Brooks recently announced that it would restate its quarterly financial results for 28 consecutive quarters from fiscal 1999 through fiscal 2005, acknowledging that the restatement would account for "certain matters concerning stock options." Vitesse, which already faces a number of shareholder lawsuits, said last month that its fourth-quarter 2005 financial statement is not reliable and that other quarters' financial statements may well be off too.

Brooks Automation also may be compelled to pay off $175 million in outstanding convertible subordinated notes early. Holders of those notes, which are due in 2008, have notified the company that its failure to file its most recent quarterly report in a timely manner represents a breach of its obligations under the indenture governing the notes. If Brooks fails to file the report within 60 days, the note holders could demand payment sooner, according to the company. Brooks said it currently has $373 million in cash and marketable securities, more than enough to cover repayment of the notes.

Will shareholder outrage lead to other regulatory legislation in the mold of Sarbanes-Oxley? Not likely, according to Mulford of Georgia Tech, who suggested that the furor is just another symptom of the relaxed business practices that existed at many companies during the late 1990s and early part of this decade.

"I think this is more of a continuation of what we had seen that led up to Sarbanes-Oxley," Mulford said.

- Dylan McGrath
EE Times

Additional reporting by Mark LaPedus and Patrick Mannion

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