Alan Reynolds

Until 1992, the Securities and Exchange Commission (SEC) did not even bother to ask firms to report what date they put on stock options, because no sensible investor gives a hoot about that. What investors care about is how many options were granted at what price -- information that has always been readily available in every annual report.

Since Aug. 29, 2002, companies have been required to report new option grants within two days, which does not leave much opportunity for changing the date. So the alleged "backdating scandal" -- an artifact of capricious changes in tax and accounting regulations between 1992 and 2002 -- is ancient history by now.

The Wall Street Journal almost single-handedly created the "backdating" crusade, with the admirable exception of Holman Jenkins. That paper's latest article says: "Amid the stock-market swoon that followed the Sept. 11, 2001, terrorist attacks, dozens of companies granted stock options to top executives or other employees. Now, some of those companies are saying the grants were in fact made weeks later -- and backdated. The disclosures are the latest wrinkle in a backdating scandal that involves more than 140 companies."

To say the investigation "involves" more than 140 companies does not mean any have been proven guilty of anything. The Wall Street Journal's list is closer to 120, including some who have been cleared, such as Altera, Asyst, Chordiant, Equnix, Intuit, Macrovision and Xilinix. Only three former CEOs have been charged with criminal violations and only one plead guilty.

Because federal investigations impose huge legal costs on firms, some have tried to placate regulatory sharks by tossing their best executives overboard. Their stock then falls for two reasons -- loss of executive talent and legal bills. The ritualistic restatement of past earnings is irrelevant: Investors do not invest in past earnings.

The Journal article shows graphs for nine NASDAQ companies that "granted options dated soon after Sept. 11, 2001." The NASDAQ stock index fell to 1,423.2 by Sept. 22, but bottomed a year later at 1241.9 in October 2002. Yet the Journal quotes Harvey Pitt, former chairman of the SEC, who finds it "offensive for companies to capitalize on the market panic caused by 9-11."

Offensive to whom? There were only two parties involved -- not companies, but stockholders and employees. If the 2001 stock options had been dated Sept. 10, rather than Oct. 1, that might have been less offensive to shareholders, but it would be hugely unfair to employees. If the options had been dated a year later, in October 2002 rather than October 2001, that would have been a much better deal for employees but apparently less offensive to Pitt.

All such mindless moralizing about backdating starts with two key misunderstandings. One is that this overblown and costly accounting issue affects only top executives rather than millions of U.S. families. Among semiconductor firms, who dominate the backdating list, David Walker of Boston University found that "13.8 percent of the shares covered by options granted by backdating firms each year went to the top five senior executives."

Another key myth is that there is something inherently unfair about receiving stock options "in the money" (priced below some later market price). This is particularly absurd considering the halo reporters have placed on restricted stock, which is the ultimate in-the-money option with an exercise price of zero. In November 2005, the lead author of the latest Journal article, Mark Maremont, wrote that "by tying strike prices to earlier, more favorable dates, executives granted options can instantly lock in a paper gain."

But a lower strike price does not "lock in" any gain at all because options cannot be exercised until they are vested, typically after three or four years. And the issue mainly concerns non-executives.

Whenever you read about some new "scandal" in business or finance, you can be sure the story is not about any criminal acts because those are called "crimes." Business journalists rely too heavily on the word "scandal" to describe complex activities they do not fully understand.


Alan Reynolds

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