Mercury responded to enquiries from the US Securities Exchange Commission (SEC) with an internal probe that discovered stock options granted to its CEO and others had been backdated to a point when the share price had been lower, essentially locking in a profit even if the share price did not rise further but stayed steady.
Stock options are financial instruments that give the right to exercise the option at some future time (under employment inducements, the time is usually not before an agreed date) and gain from any increase in the share price. The income received is the value of the share at the point of exercise minus the price of the share when the option was first issued (and at all times some multiple as options are sold in batches of hundreds or thousands).
For the privilege, the option purchaser pays a relatively small premium compared to the leveraged potential gain. Should the price fall, the option is not exercised, and only the premium is lost. Therefore, it should be clear that the date an option is issued has an important bearing on the final profit.
Employees (both low and C-level) are often given free stock options as part of an employment package. In start-up, cash-limited hi-tech companies vying to hit the market with a success, stock options are quite common – they only cost the firm the premium, and they reward the hard work that causes the company’s share price to rise. The only problem is that when share options are issued, they should reflect the issue date and should not be backdated to a time of lower share price.
In Mercury’s case, the options malpractice was compounded by tax evasions over the exercising of said options and a questionable large loan. The consequence was that Mercury became de-listed from the Nasdaq as it sought to correct its financial accounts to meet regulatory strictures, and thereby missed SEC filing dates.
The scandal has not harmed Mercury’s prospects in custom or share price. In the OTC market, since hitting a low of $25, its share price is currently trading at $37 – but there are increasing rumors of a takeover.
However, Mercury was not alone in backdating stock options and regulators are rooting out other cases under the tougher Sarbanes-Oxley regime. There is also research work being carried out in academia that is uncovering further irregularities, such as patterns of unscheduled stock option awards being timed to exploit announcements of bad and good company news to favor the option holder.
The scandal has also reached the mainstream press. The UK’s Sunday Times business section carried a story mentioning Caremark, McAfee, and Vitesse Semiconductors as under investigation. The article quotes Professor Erik Lie as stating, It’s been suggested that just about everybody in Silicon Valley was doing it. Computer Business Review also recently mentioned that SafeNet was implicated.
These investigations are throwing light into company practices that became prevalent, often through peer example that somehow made it seem acceptable. That peer comfort factor will evaporate as closer inspection of how some executives have handled stock options over the years – particularly during and since the hi-tech internet boom – will give rise to further SEC scalps.
Stock options are a perfectly sensible way to reward employees and often a useful strategy to induce motivation towards success. The problem has been that lax enforcement of rules within some companies has led to manipulations that have harmed the external shareholders, on top of the illegal internal transgressions. Therefore, today’s tighter regulations should lead to share prices that better reflect company performance.
Source: OpinionWire by Butler Group (www.butlergroup.com)
