Feds ramp up Silicon Valley stock option probe

FBI, prosecutors form task force to look into backdating of stock options, which is illegal in some circumstances.

Declan McCullagh Former Senior Writer
Declan McCullagh is the chief political correspondent for CNET. You can e-mail him or follow him on Twitter as declanm. Declan previously was a reporter for Time and the Washington bureau chief for Wired and wrote the Taking Liberties section and Other People's Money column for CBS News' Web site.
Declan McCullagh
3 min read
The FBI and federal prosecutors in San Francisco said Thursday that they are escalating their investigation into possibly illegal stock option backdating by area companies.

U.S. Attorney Kevin Ryan announced that a new eight-person task force will try to determine whether Northern California companies retroactively changed the grant date of stock options with intent to defraud investors. It appears to be the only such task force in the nation.

"We will evaluate the facts of each case, and we will bring criminal charges when appropriate," Ryan said.

Allegations about stock option backdating, while not necessarily illegal, have ensnared dozens of companies and drawn the attention of securities regulators and plaintiffs' lawyers.

Stock option backdating

Some Bay Area companies have announced that they've been contacted by the U.S. Attorney's office in northern California. Typically the contact comes in the form of a grand jury subpoena. They include:

Applied Micro Circuits
Asyst Technologies
CNET Networks
Foundry Networks
Linear Technology
Marvell Technology Group
Maxim Integrated Products
Openwave Systems
Power Integrations
Redback Networks

Source: Wall Street Journal database

During a conference call with reporters, Ryan declined to say which companies are being targeted. At least 15 companies, though, have publicly said they have received grand jury subpoenas from Ryan's office (see related chart).

Ryan also said that the investigation would look into whether executives engaged in "spring-loading," the practice of awarding stock options before a positive announcement expected to boost share prices.

"Then you have both insider trading and you have an accounting issue," Ryan said. "An old-fashioned cooking-the-books fraud."

Stock options give the recipient the right to buy a share of a company's stock at a price called the strike price, the value of the stock on a certain date. If the strike price is $10 and the shares now trade at $15, each option would be worth $5. (The options would be worthless if the stock fell below $10.)

If an executive is able to change the grant date retroactively to when the stock was trading at a lower price, the options would become more lucrative.

That's precisely what federal investigators are looking into. Some academic research has suggested that many companies have engaged in the practice--which could be a securities fraud violation if the disclosures accompanying stock option grants were intentionally misleading. Tax laws could also be triggered because of different rates for deducting different types of stock options.

Erik Lie, a finance professor at the University of Iowa's business school, has evaluated thousands of option grants and found that for many companies, it was statistically improbable for them not to have been backdated. Lie estimates that at least 10 percent of option grants to chief executives between 1996 and August 2002 were backdated.

Lie said in an interview on Thursday that three company features contribute to backdating. "Small firms tend to do it more than large firms," he said. "Firms with higher stock price volatility tend to do it more than others. Tech firms tend to do it more than others."

Some technology companies including Apple Computer and CA (formerly Computer Associates International) have announced internal investigations of stock option grants. CNET Networks, the publisher of News.com, said in a statement this week that its own investigation is ongoing and it expects to restate earnings for 2003, 2004 and 2005.