Accounting & Tax

Backdaters Get Clocked

Why are CFOs being blamed for options backdating?
Alix StuartJuly 7, 2006

Charges of backdating stock options have swelled, with more than three dozen companies reporting investigations by the Securities and Exchange Commission for suspicious options-grant dates. At press time, the Department of Justice had served at least 10 issuers with subpoenas related to backdating.

CFOs at companies involved are feeling the sting. So far, five current or former CFOs — Comverse Technology’s David Kreinberg, Mercury Interactive’s Douglas Smith, Power Integrations’s John Cobb, and Vitesse Semiconductor’s Yatin Mody and Eugene Hovanec — have lost their jobs over the scandals.

The question at many companies, though, is whether the CFO is really to blame. For one thing, options were not expensed when most of the backdating allegedly occurred, and thus were not accounting items. “As a CFO, I had little to do with the stock option–granting process,” says Chuck Noski, former CFO of AT&T and current board member at Microsoft and Morgan Stanley. Since the granting of stock options didn’t trigger any financial consequence except for a footnote disclosure, he says, HR generally handled the details of the grant and recordkeeping. For a CFO to later fudge the date would be “a big violation,” says Bruce Ellig, an executive-compensation consultant.

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Backdating options alone isn’t necessarily illegal. What gets companies in trouble is if their plan explicitly states that grants must be dated as of their board’s decision. Options that start in-the-money, as they often did in these cases, also raise tax issues.

It is telling that so far CFOs at the majority of companies under investigation have not been incriminated, even when the CEOs have been. One class-action attorney who filed a suit against Vitesse’s CFO even admitted he was not able to say what level of involvement the CFO may have had with the backdating. “Who knows if he was just a sacrificial lamb?” says the attorney.

However, CFOs are clearly expected to be watchdogs in such cases, regardless of explicit duties. Any breach of internal controls is likely “lethal” to a CFO, says Noski. Mercury Interactive forced out its CFO, Douglas Smith; the CEO; and general counsel, because they “knew or should have known” about the alleged backdating and “personally benefited” from it, according to a company press release.

Will the widening probes lead to more finance firings? Stay tuned. At least one study, by finance professors M.P. Narayanan and H. Nejat Seyhun at the University of Michigan’s Ross School of Business, shows evidence that backdating practices persist, so CFOs may remain in the crosshairs.

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Companies under investigation for options backdating*

American Tower
UnitedHealth Group
Juniper Networks
Monster Worldwide

*Partial list of companies that have received subpoenas from the Department of Justice