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Tech Industry

Options backdating trips up whiz kids

The worst may be over, but executive-search veteran Stephen P. Mader says the fallout from the options backdating scandal will haunt Silicon Valley.

    Is it possible that what started as a way to lure talent to tech start-ups may end as the hammer that quashed innovation?

    The Securities and Exchange Commission probes into stock-options backdating practices at 140 companies have raised that specter for many.

    Public reactions to the backdating scandal have ranged between two extremes. At one end, some see the backdating practices as a flat-out violation of the law. At the other end are those who advance the argument that "everybody did it" and it was a necessary way to attract scarce talent in an incredibly competitive market.

    So, is Apple CEO Steve Jobs the poster boy for innovation or ethics violations? I believe, at the end of the day, he'll remain an icon for technical innovation, an exemplar of a particular kind of tech visionary who sets out to change the world and gets rich doing so.

    The "everybody was doing it" argument--while not an excuse--is worth reviewing to understand the business climate start-up techs have operated in. Stock options started as a method for luring scarce technical talent to take a chance on the future rewards from a risky start-up. As the tech boom mounted, talent became even scarcer, prompting companies to look for ways to increase the value of the reward. Backdating options became the solution.

    These individuals are rule-breakers to start with. They think and behave outside the box.

    We should note that most of these companies had attorneys and CFOs advising them on the legalities of these practices. Backdating became institutionalized and was practiced fairly openly. Notice, for example, that memos and e-mails documenting the practice haven't been hard to come by.

    Throw in one other variable: the nature of the tech leader. These individuals are rule-breakers to start with. They think and behave outside the box. They care little for structure or the details of running a business.

    As I say, this is not to excuse the practice or the behavior; it is just to give a context for the discussion. In my view, the penalties should be severe. In a high-risk culture of tech innovators, nothing will change if they don't get hit hard.

    Much of the responsibility for reining in the tech culture lies with boards of directors who need to get more attentive and more cautious. And I believe they will. They're taking it on the chin, and they won't want to go through this experience again. The disruption and damage to reputations has had enormous costs.

    In-house counsels will take some well-deserved licks as well. They exist to keep companies safe, and some of them didn't deliver.

    The SEC investigation and resulting scandal is having an impact, but investors remain primarily focused on business performance. Christian & Timbers recently asked 313 senior executives: "Which issue would make you less likely to invest in a company: financial performance or options backdating issues with the SEC?" While one-third of the sample said that options backdating issues would outweigh corporate performance in their investment decisions, the overwhelming majority continue to make business performance the priority.

    Wall Street cares about financial performance but expects those in charge to control ethics issues. Apple's board has remained fully supportive of Jobs in his potential backdating involvement. The Street will continue to invest in Apple.

    We'll continue to see fallout from the backdating scandal for some time, however. In a worst-case scenario, institutional investors may start pulling out of tech sector stocks if backdating scandals aren't cleaned up. At the same time, the value of going public or remaining public can be marginal. For slower growing companies with existing capital structures, the shareholder focus on compensation may be an incentive to go or stay private.

    Instead, I hope and expect that the SEC's investigations will nudge the system and players to police themselves better. The best outcome will be if innovators continue to innovate, but everyone gains a stronger sense of the value of governance and boards--even in the Wild West tech climate.