EDS shares drop as SEC probe deepens

Electronic Data Systems says a U.S. Securities and Exchange Commission inquiry into its stock-hedging efforts has become a formal investigation.

Ed Frauenheim Former Staff Writer, News
Ed Frauenheim covers employment trends, specializing in outsourcing, training and pay issues.
Ed Frauenheim
2 min read
Electronic Data Systems' stock fell by nearly 10 percent Tuesday on news that a U.S. Securities and Exchange Commission probe into the company has grown more serious.

Late Friday, the computer services giant said the SEC's informal inquiry into its stock-hedging efforts has become a formal investigation. The SEC is also investigating the events leading up to the company's dramatically reduced earnings forecast presented in September. EDS said it will continue to cooperate with the regulatory body in the matter. A company representative on Tuesday declined to provide further details.

The inquiry, first revealed in October, concerns the $225 million EDS paid in September to settle contracts related to its stock-based employee compensation program. EDS had entered the contracts as a way to buy back stock to keep those compensation programs from diluting its earnings per share--a practice known as hedging stocks. The move essentially locked in a future price for EDS stock, with the company betting its share price would rise above the price set in the contract. But the share price fell below a certain level, forcing EDS to settle the contracts, which it did by taking out short-term debt, the representative said.

In mid-September, the company chopped its third-quarter earnings guidance from 74 cents per share to a range of 12 cents to 15 cents. The company blamed the reduction on several factors, including lower revenue, increased costs related to business pursuits, and asset writedowns associated with the US Airways bankruptcy in August.

A Merrill Lynch analyst later downgraded EDS shares from "neutral" to "sell," and questioned whether the company's stock-hedging strategy would hinder it from pursuing large information technology services deals by limiting its financial flexibility.

The company issued a statement that same day defending its financial strength, saying it still had the ability to pursue "mega deals."

In December, EDS signed a $4.5 billion, 10-year contract to revamp and manage Bank of America's voice and data networks. Rival IBM, however, landed billion-dollar deals in December with J.P. Morgan and Deutsche Bank.

Plano, Texas-based EDS' annual revenue was $21.5 billion in 2001. The company's shares closed Tuesday at $16.95, down 9.94 percent from Friday.