Some F5 options show pattern
Seattle Times business reporters
For three years in a row, F5 Networks' stock-option grants were particularly well timed — some would say suspiciously so.
As the company's stock price zigzagged through highs and lows in the early part of the decade, executives repeatedly received options at relatively low prices, boosting their potential value.
Now, the timing of those option grants has brought the Seattle company a grand jury subpoena and an inquiry by the Securities and Exchange Commission.
F5, which makes hardware and software for managing Internet traffic, is among some two-dozen companies — including Mercury Interactive, CNET Networks and Juniper Networks — whose options programs are being investigated by federal authorities.
The widening probe threatens to become the latest in a series of scandals that have shaken public confidence in corporate America.
In F5's case, it's not known specifically what the SEC and the grand jury are looking at.
However, analysis of the company's financial reports and stock-price history shows several instances in which options were granted on the same day the stock was at a two-month low. Such coincidences may have raised investigators' suspicions.
It's not clear whether F5 has broken any laws, and the company says it is cooperating with both inquiries. The company would not respond to questions for this article, citing the ongoing investigations.
Stock options were a common, and lucrative, form of compensation over the past decade, especially among fast-growing technology companies. Options allow someone to buy a stock at a set price, typically the price on the date the option is granted.
If the stock has risen in the interim, the option holder can profit from the difference.
But by "backdating" an option — changing the date it supposedly was granted to a date when the stock price was particularly low — a company can lock in a no-risk profit for the recipient. It's like being able to bet on a horse after the race is run.
"Stakeholders in the American economy have had their faith in the management of these companies shaken pretty badly," said Paul Hodgson, senior research associate at The Corporate Library, an institutional advisory firm in Portland, Maine.
If companies are found to have backdated options, he said, "we find ourselves once again in a situation where executives have been, in effect, cheating."
In the wider investigation, the Securities and Exchange Commission, the Justice Department and the IRS are believed to be looking into several related issues:
• Whether corporate managers backdated options or otherwise timed their grants so that executives could take advantage of sharp moves up or down in the stock price.
• Whether the value of option grants was properly accounted for in company financial statements and publicly disclosed.
• Whether, if any of the above is true, companies or their executives owe federal income tax.
Without access to internal corporate records, such as minutes of board meetings, it's not possible to determine definitively whether a company deliberately manipulated its options grants to guarantee a big payday for its executives.
However, a pattern of grants whose dates coincide with low points in the stock price, or that precede sharp price increases, could suggest there was more than good luck at work.
"Statistically to happen to make a single year's grant on a 20-day low might just be good luck, but it's highly unlikely it would happen more than once," said Fred Whittlesey, a principal at Compensation Venture Group, a Seattle firm that advises companies on compensation.
With F5, it happened four times from 2000 to 2002. At least three other option grants in that period were made at significant dips or before a price run-up.
For example, in its public filings, F5 has said Chief Executive John McAdam received three options grants in 2001: 100,000 options on Jan. 1; 375,000 on March 16; and 270,000 on April 27.
The first grant was on the stock's lowest day within a two-month period; the second came after a steep fall in the share price; the third shortly after F5 stock began what turned out to be a long rise.
And on May 6, 2002, F5 granted McAdam and four other top executives 480,000 options. On that date, F5 shares were at their lowest point in seven months.
Until the Sarbanes-Oxley reforms of 2002, company executives could wait as long as 30 days to report buying or selling stock or receiving or exercising options, said Lynn Turner, former chief accountant at the SEC and now managing director of research at Glass Lewis, a proxy advisory firm based in San Francisco.
Within that 30-day window, companies theoretically could backdate an option without publicly disclosing the fact.
Practices such as backdating, if substantiated, are harmful for several reasons, Turner said.
Stock options are meant to reward executives and employees when their work leads to a rise in the stock price. But by removing the risk from options, Turner said, backdating destroys any incentive value they might have: "By the time you've gotten the option, you already know you're in the money."
In addition, he said, options are supposed to align management's interests with shareholders. But executives with options that have been pre-set to pay off are in a far superior position to ordinary investors who buy stock without knowing when, or whether, it will go up in value.
Finally, Turner said, options that let executives buy stock at artificially low prices cheat companies — and, ultimately, shareholders — out of money they're entitled to.
"In essence," he said, "you've got a senior executive who's intentionally taking money out of the pockets of the shareholders they're supposed to be working for."
Backdating, said compensation expert Whittlesey, "involves breaking law and it involves a whole stream of false information about the nature of those grants."
Given how many companies relied on stock options, Whittlesey said, the federal net could spread much wider: "I think it might be a lot more than the 20 companies we're looking at now."
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