The New Corporate Reputation Crisis: The Backdating of Stock Options with Executives and Corporate Boards in Crisis

“Of 120 companies involved in the snowballing backdating scandal, more than 40 percent share directors with other implicated companies.” A corporate governance research firm, The Corporate Library, said in a recent report. According to the Associated Press, on tennis courts and golf courses, in bars and restaurants, at meetings and conventions, it seems corporate board members spread the word about a novel way to boost executive compensation – backdating options.

A study released last month suggested that the common link between companies that backdated options was a network of directors who sat on some of the same company boards. Now many of them, their companies and their chief executives are losing their jobs because of it.

Of 120 companies involved in the snowballing backdating scandal, more than 40 percent share directors with other implicated companies, The Corporate Library, a corporate governance research firm, said in a report Thursday. That proportion of interconnected boards is much higher than would be expected from a similar, randomly selected sample, the study found. “Director interlocking relationships are fast becoming what appear to be the most important characteristic and indicator of backdating problems,” the report said.

Options grants give the recipient a right to buy a stock at a fixed strike price, which is generally set at the stock’s market price the day of the grant. Generally, a company’s board or compensation committee must approve its options grants to top executives. Options holders benefit if the stock rises above the strike price because it enables them to buy stock at the lower price. In the backdating scandal, companies have dated option grants to days when the stock was at a low, enhancing the potential benefit.

The scandal was first reported in March by The Wall Street Journal, which calculated the tiny odds of companies randomly making grants on the days they chose, when the stock was at its lowest prices for the year or for the quarter. For instance, the Journal found the odds of one executive’s options being timed so well, without backdating, were about 200 million to one.

H. Nejat Seyhun, a finance professor at University of Michigan, said one of his studies found that “directors are often participants, as well as beneficiaries, of backdating”.

For instance, the odds that options grants to UnitedHealth Group Inc. director Richard T. Burke occurring randomly were more than a trillion to one, Seyhun found. In Burke’s 27 options grants, he got the best price available for a 91-day period five times.

Seyhun said the odds of some of Burke’s grants occurring randomly were even narrower than the odds of randomness for grants given to William McGuire, the company’s Chairman and CEO, who agreed Sunday to step down from both posts after an internal probe of the company’s option practices. The odds of his all of his grants occurring when they did were 45 billion to one against.

UnitedHealth spokesman Mark Lindsay said that during the time period in question, “Option awards were distributed broadly, and based on merit, to over 14,000 employees.”

At least 135 public companies have disclosed Justice Department, SEC or internal investigations of their option grants, according to an Associated Press review. So far, at least 39 executives and board directors at 19 companies have been fired or resigned.

Some of the directors on multiple boards of implicated companies include Millard S. Drexler, former chief executive and a director of retailer Gap Inc. also sits on the board of Apple Computer Inc. Both companies have uncovered troubles with options grants after internal reviews. Drexler left Gap in 2002 has been CEO of retailer J. Crew since 2003.

J. Crew and Apple representatives had no comment. Greg Rossiter, a spokesman for Gap, said that the company’s internal review had found no backdating or errors in options granted to executives at or above the vice president level and less than $5 million in errors related to options given to lower-level employees. He referred questions about Drexler to J. Crew.

A few comments from the Reputation Doctor regarding the growing corporate crisis of fraudulently backdating stock options:

WARNING TO CORPORATE EXECUTIVES: Keep it up, and you too will be caught!

Fraud is as old the origin of man. Why? Because we as humans are flawed. We need true accountability to stay on the path to truth, but rarely seek it. We are fearful of transparency and do all we can to try to protect our lies and deceit. We can not do it alone. We need help and reputation management counselors provide help when in these storms.

Denial is your enemy and honesty is always your best friend.

Doing the right thing is always difficult. It is the biggest challenge in my counsel of leaders and corporations with reputations in crisis. Learning that the truth always bubbles to the top is difficult for many to understand. Some truly believe hiding works. It never works for the long term. Still don’t believe me? How many examples of reputations in crisis do you have to read, hear or see in the news media to understand?

A message from clients who have learned the hard way: selling your soul, integrity and your good name is never, never worth the money!

Over the years, I have had the honor of counseling many top corporate clients. These clients have included CEOs and board members of global corporations. They have all shared the same advice to those still lying and stealing for money when they finally hit rock bottom: lying and stealing is never worth the money in the end. Selling your soul will take a toll on your mind and you will never be happy. The way my firm practices reputation management is like a 12-step program for your reputation. There is really no other way to truly help those with reputations in crisis. Most clients must hit rock bottom before they are truthful with themselves, and that is the first step in rebuilding their reputations. They must be honest with themselves before they can be fully honest and transparent with others. This is a valuable lesson for us all.

Remember, do the right thing when your reputation is in crisis and seek the counsel of an experienced reputation management expert. It will be a major challenge, but ultimately the rewards of repairing your reputation will be great. Why? Because Your Reputation Is Everything!™

backdating scandal, corporate crisis

• Share
•