The Politics of Options

Posted by: Peter Burrows on September 9, 2006

Just when it seemed the news flow on the stock options scandal had eased to a slow boil, it’s now heating up again. The news is emanating from the halls of Congress, where the Senate’s Finance Committee is holding hearings. One idea: a law that would decrease tax advantages tied to options. But wait a minute: I didn’t think this scandal was about options per se, but about the bad apple’s that broke options accounting laws? I’m not arguing for or against options as a compensation practice, mind you. But I do hope any new laws will be based on finding the best tax policy to foster innovation and growth—and not, as many in Silicon Valley fear, by the desire of lawmakers to win votes.

More after the break.

I also wonder about the timing of all this--because unless I'm wrong, the evidence suggests that fraudulent, illegal backdating isn't nearly as popular as it was during the Boom. Given the requirements of Sarbanes Oxley, new FASB rules and the scandal itself, I'd bet such schemes are pretty much non-existent these days. It would take a pretty inveterate--and stupid--crook to try their luck in the face of all that, no? My hunch is that the white collar bad guys have long since moved on to safer hunting grounds, a point my colleague David Henry makes in his story about Broadcom's $1.5 billion restatement.

Then there's the cost of this options scandal. So far, almost all of the focus has been on the amounts made off with by crooked executives. But a new study from the University of Michigan says stocks of company's that are facing government scrutiny are down by $500 million. I haven't spoken with the authors or read the full study, but clearly the vast majority of that is not based on actual wrongdoing. After all, there hasn't been a single perp walk yet.

Rather, the reason the stocks are down is mostly the scandal itself. It's created a herd mentality on Wall Street, whereby every new inquiry leads investors to worry that there company will be the one with the truly disgraceful behavior, which will lead to huge tax liabilities, the ouster of key execs, or worse. But then, everyone seems to agree that only a tiny percentage of these 80-plus companies are going to be found guilty of outright fraud. (I'd be surprised if some smart hedge fund guy hasn't created a fund just for options-implicated companies, so they can cash in when the bulk of them report that they're books are clean.) As one Silicon Valley executive wondered a few weeks back, isn't the SEC supposed to be making investors feel more confident?

On the other hand, shareholders are paying for the scandal in another way that involves an outflow of real, hold-in-your-hands greenbacks. I'm talking about the millions (tens of millions? Hundreds of millions?) of dollars that tech companies are paying to forensic accountants and outside lawyers to run their independent investigations (ironically, in many cases to the same lawyers and accountants that gave the boom-era advice that helped spawn the scandal in the first place).

I spoke with the CEO of a $100 million-plus start-up that spent $.5 million on its investigation. That's not huge, to be sure. But when you add it to the big money that companies like Apple and United Health are doling out (not to mention the Intel's and Cisco's and other companies that are not implicated, but surely have spent some dough just to make sure their books were spic-n-span), you end up with a big number. And the money isn't the only cost. This CEO says there's a cost in management focus. Rather than trying to grow his company, he's got to spend more time quelling investor's concerns, convincing new hires that it is in fact safe to come aboard, or even assuaging the fears of his kid, who read on a message board that Dad was going to be indicted within the week.

Now, I'm clearly ticking off some of the arguments of the companies that are on the wrong end of this scandal. But, of course, it's healthy that companies are cleaning up their accounting and restating their financial statements. And I have no doubt the government will have great cases to bring. There are undoubtedly people who abused the law and made off with millions in ill-gotten gains without paying their fair taxes, and they should be prosecuted to the full extent of the law. But there are these other sides to this scandal that should also be considered by our lawmakers in the days ahead.

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