There’s a sinking feeling among technology stock investors this summer–a feeling of history repeating.
At the start of 2002, the bear market had been raging for nearly two years. Then came a wave of scandals that showed the Enron Corp. debacle of late 2001 was no one-off affair.
As shares of Tyco International Ltd., Adelphia Communications Corp. and WorldCom Inc. all collapsed in the first half of 2002 amid allegations of massive financial fraud by their executives, demoralized investors wondered whether they could trust any number on corporate balance sheets and income statements.
The scandals helped fuel one last burst of panicked selling, driving the Standard & Poor’s 500 index down nearly 30 percent in the first nine months of 2002. The tech-dominated Nasdaq composite index plunged 40 percent in that period.
Now, investors’ faith in corporate accounting again is under siege. Over the last few months, more than 50 companies–most of them technology firms–have disclosed that they were under investigation by federal authorities for possibly manipulating executives’ stock-option grants to boost the potential payoffs.
It’s early in this scandal, if that’s what it indeed turns out to be. No charges have been filed, and we may well find that what some companies did with options was unethical but not illegal. It seems unlikely that this will amount to fraud on the scale of Enron and WorldCom.
Even so, stocks of many tech firms have taken steep hits in recent months as the probes have been reported. With memories of 2002 still fresh, some investors appear to be selling first and asking questions later.
Ann Yerger, executive director of the Council of Institutional Investors, a Washington-based group of major pension funds, said her members were blindsided by the large number of companies that have admitted they’re under investigation.
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“I think everyone has been surprised by how this has snowballed,” she said. “It’s another black eye for the corporate community.”
Options abound
The tech industry is at the center of this, of course, because stock options long have been the preferred type of compensation for tech executives. In the 1990s, shareholders were told over and over that even though their stakes faced continual dilution because of the huge volume of options grants, the awards were necessary to keep the industry’s entrepreneurial spirit alive.
At a time when excessive corporate compensation is a driving issue for shareholder activists, the option investigations also feed investors’ simmering anger about what some call wanton executive greed.
“There’s something so fundamental about this,” said Kevin Cameron, president of Glass, Lewis & Co., a shareholder advisory firm. Enron’s book-cooking, he said, was so complex that most on Wall Street admitted it was beyond their comprehension.
But in the case of option manipulation, “this is so straightforward and so wrong that every investor can understand it,” Cameron said.
A focus of the probes is whether firms routinely backdated option awards in the late 1990s and early in this decade so that executives were able to buy shares at the lowest possible prices in a given period.
Another focus: whether firms timed option grants to precede good news that would be expected to lift the share price.
Looking back
The possibility of widespread backdating of option awards was proposed by Erik Lie, an associate professor with the University of Iowa’s business college, in a May 2005 research paper. He looked at nearly 6,000 option awards from 1992 through 2002, using company disclosure reports filed with the Securities and Exchange Commission.
What he found was a pattern of abnormally large stock price gains immediately after unscheduled option grants–those that weren’t awarded at the same time each year, he said.
In an interview, Lie said he believed that many more companies were likely to be probed for backdating. “I’m quite confident we’re talking about hundreds of companies that have done this,” he said.
Investors fear what the investigations will cost the firms involved, and, therefore, shareholders.
Indeed, the bitter pill for investors is that they often lose twice when their companies are caught doing something wrong. The first hit is the slide in the stock on the disclosure. Later, the stocks may suffer again–or at least be held back–if the companies face heavy financial or regulatory penalties that impede their business prospects.
Paul Wick, a veteran technology investor who manages the $3.4 billion Seligman Communications and Information stock mutual fund, illustrates the uncomfortable position in which shareowners of many implicated tech companies now find themselves.
“Most institutional investors are disgusted that management of these companies would have been so brazen and unethical to undertake some of these practices,” he said.
At the same time, Wick said, the possibility of earnings restatements, fines, executive firings and management’s distraction from running the business could “end up hurting the people who were hurt the first time around: shareholders.”
As during the tail end of the last bear market, knee-jerk selling of tech stocks caught up in the option investigations may well wind up producing bargains for patient investors.
The damage this affair does to long-term investor confidence, however, is a cost that may be beyond measure.
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50 companies, most of them tech firms, disclosed over the past few months that they were under investigation for possibly manipulating executives’ stock-option grants.
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Tom Petruno is a columnist for the Los Angeles Times, a Tribune Co. newspaper.
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