Study of Stock Options Prompts Investigation
Erik Lie is not a whistle-blower, but his research into the obscure world of executive stock options has helped launch yet another nationwide investigation of corporate greed.
Lie, a University of Iowa associate professor of finance, said he never set out to uncover what's being called the next big scandal to shake corporate America. In 2003, he began hunting for a correlation between option grant dates and price movements of the underlying shares.
Instead, his findings suggest some companies were manipulating the timing of the stock options they granted to top executives. The result pumped up the executives' pay.
Lie reported his findings to the U.S. Securities and Exchange Commission in mid-2004. Now the agency and the U.S. attorney in New York have asked at least 20 companies to provide details on how they award stock options. And corporate governance experts predict the scandal will spread.
"When I first looked at the evidence, I thought it was pretty outrageous," Lie said.
A native of Norway the Scandinavian nation, not the eastern Iowa town Lie has taught in Iowa for two years. He said this week that he does not know whether information about any Iowa-based companies is included in the 6,000 corporate records reflected in his as-yet unpublished second study of options. He said many of the problems seem tied to young technology companies in California, where options often are a key component of executive pay.
But the options scandal has snared UnitedHealth Group, Iowa's second largest health care provider. Shareholders have sued the Minnesota-based company, which has suspended its stock option program and has seen its share price plummet 32 percent this year. Federal prosecutors and the Internal Revenue Service are investigating the company.
With proper disclosure and tax and accounting treatment, option backdating is not illegal, Lie said.
"Unfortunately, these conditions are rarely met," Lie wrote on his Web site, www.biz.uiowa.edu/faculty/elie.
What Lie suspects is that an unknown number of companies granted options to key executives on a particular date, but the timing of those options would later be recorded as the day the stock reached its low point of the year a practice known as backdating. If an option was granted at $40 on Dec. 31, but the stock had dipped to $30 sometime during the year, selecting the day of the low point automatically gave the executive a $10 per share profit.
The findings have shocked compensation experts.
"This is weird," said Steve Hall, a pay and benefits consultant in New York. "People should follow the rules and be honest."
Working with data from Lie and other academics who have studied options, the Wall Street Journal reported in March on six companies that granted options whose dates repeatedly coincided with share price low points. The newspaper estimated that all six option grants made to Jeffrey Rich, the former chief executive officer of Affiliated Computer Services Inc., came just before sharp runups in the price of the Dallas company's share price. The odds of that occurring were one in 300 billion. The odds of winning the Powerball lottery with a $1 ticket are estimated at one in 146 million.
Rich denied to the paper that any backdating occurred, and said the timing was a result of "blind luck."
After the Wall Street Journal report, the CEO and two top executives of Comverse Technology Inc., the nation's largest producer of voice mail software, resigned amidst an investigation by outside directors into possible timing irregularities of options. The company said it likely will restate earnings dating to 2001, and shareholders have sued.
Lie said he spoke with SEC investigators after sending them his report, but the details are confidential. John Heinie, a spokesman for the SEC, acknowledged that the agency is aware of Lie's work, but he declined to comment further.
Lie said he suspects many companies are involved in backdating. However, he and Hall said they believe much of the activity ended in 2002 with passage of the Sarbanes-Oxley Act, which reduced the time that companies could wait before reporting grants.
His findings are not universally accepted, he acknowledged, with some expressing doubt that backdating was widespread. David Aboody, an associate professor at UCLA, told the Journal that such an act is like stealing and questioned how many CEOs would resort to theft.
But Lie said that the results of his first study, of 1,500 companies, were so startling that he has teamed up with another professor, Randall Heron of Indiana University, to crunch data on the larger sampling. Early results from that have confirmed his suspicions.
"It's hard to explain this with anything other than backdating," he said.
Lie, 37, has found himself in demand as the scandal grows. He has appeared on National Public Radio and CNBC and in several publications.
Academics can labor for years, or even decades, on research projects that may or may not bring change, so this is a relatively quick turnaround. Lie said he is not troubled by his contacts with the SEC.
He said it's his hope that university-level research, often difficult to understand outside a small circle of fellow academics, can be distributed to the public.
"I consider myself a researcher," he said. "We try to expose corporate behavior all the time."