Erik Lie, the University of Iowa Business School professor whose research is widely credited with unlocking the emerging options backdating scandal, has published a new research paper concluding that practice of options backdating was far more widespread than current media reports suggest. According to Lie’s July 14, 2006 paper, written with Associate Professor Randall Heron of the University of Indiana Business School, “the alleged incidents of backdating that have surfaced in the media appear to represent merely the tip of the iceberg.”

The paper’s authors examined a sample of 39,888 stock option grants made to 7,774 companies’ CEOs, Presidents and Chairmen of the Board, using information from the Thompson Financial Insider Filing database and insider transactions reported to the SEC. The study analyzed whether or not there were “abnormal [investment] returns around option grants.” The authors’ assumption is that, without manipulation, half the returns should be positive and half should be negative, but in fact the distribution was shifted upward. The authors used this analysis to infer the number of grants that were backdated or otherwise manipulated.

According to the authors, 13.6% of the grants studied were backdated or manipulated. Because grants that are scheduled to take place at the same time every year are more difficult to backdate or otherwise manipulate, the authors focused their attention on unscheduled grants that were in-the-money or at-the money. (Grants that were out-of-the-money, that is, with the exercise price below the share price on the grant date, presumptively were not the subject of manipulation.). The authors concluded that 18.9% of the unscheduled, in-the-money or at-the money option grants were backdated or otherwise manipulated. The authors also concluded that the practice was more widespread before August 29,2002, when the SEC implemented new rules requiring option grants to be filed within two days. The authors concluded that 23% of the unscheduled at-the-money grants between January 1, 1996 and August 29, 2002, and 10% of the unscheduled grants after August 29, 2002, were backdated or otherwise manipulated.

The number of backdated or otherwise manipulated grants is different from the number of firms that engaged in backdating. The authors compared expected and average actual options returns for the 7,774 companies in their data population to estimate that 29.2% of companies (or 2,270 companies) engaged in backdating or similar manipulation of grants to top executives at some point between 1996 and 2002. The authors also estimate that 16.1% of companies in the study engaged in backdating between August 29, 2002 and December 1, 2005.

The authors’ finding of continued backdating after the SEC’s August 29, 2002 implementation of the new filing rule may be partially understood by some companies’ apparent disregard for the new filing rules. The authors found that while 10% of the unscheduled at-the-money grants after August 29, 2002 were backdated or otherwise manipulated, the incidence was 19.9% for companies that filed their grants late, but only 7% for companies that filed within the required two business days.

The study also found that the incidence of unscheduled at-the-money grants that are backdated or otherwise manipulated is 20.1% among low tech firms but 32% among high tech firms; 23.1% among small firms (market capitalization within 20 days before the grant < $100 million), 27% among medium-sized firms ($100 million $1 billion); and 13.6% among the firms with the lowest one-third of share price volatility, 26.2% among the firms with the middle third level of share price volatility, and 29% among firms with the one-third highest level of volatility.

The study also concludes that smaller auditors (i.e., those other than the big five) are associated with more companies that backdated after August 29, 2002. Among the big five firms, PwC and KPMG are associated with less backdating before August 29, 2002, and PwC with less after August 29, 2002. However, the authors note that care should be taken in interpreting the backdating differences among the auditors, as the differences might reflect characteristics of the audited companies.

The New York Times July 17, 2005 article reporting on the new study quotes Professor Lie as saying that the widespread nature of options backdating is “pretty scary and quite surprising to me.” The Times article also reports that Professor Lie said the findings were so surprising that he asked several colleagues to check his numbers, and they concluded that the numbers probably erred on the low side.

The D & O Diary notes that because the study is limited to analysis of grants made to the most senior company officials, the study necessarily omits companies that engaged in options timing practices for grants to other persons. For example, another option timing practice that has been the subject of scrutiny is the award of hiring-related options grants, whereby new hires or potential new hires were offered grants backdated to a date prior to their hire date, when the company’s share price was trading at a higher price. The backdating potentially made the options grant more attractive to potential new hires. Hiring-related options grants was the subject of a prior D & O Diary post, which may be found here.

Professor Lie’s Options Backdating website may be found here.

Options Backdating Criminal Charges Coming? An article in the July 14, 2006 issue of The Recorder predicts that Gregory Reyes, the ex-CEO of Brocade Communcations may be the first executive indicted in the options backdating scandal. Brocade was one of the first companies implicated in the scandal, as it restated its financials due to options related issues in January 2005. According to this February 13, 2006 Business Week article, Reyes blames one of the most prominent lawyers in Silicon Valley, Larry Sonsini of the Wilson Sonsini Goodrich & Rosati firm and a former member of Brocade’s board, for the company’s options problems. According to Reyes, Sonsini suggested a compensation structure in which Reyes sat as a “committee of one” and those could aware stock options at will. When stock options questions arose, Reyes said, Sonsini argued for him to resign. Sonsini is named as a defendant in the Consolidated Amended Complaint filed in the civil securites fraud class actions that has been filed against Brocade Communications. A WSJ.Com Law Blog post on the anticipated indictment can be found here.

According to a July 17, 2006 article on, after the first indictment, which is anticpated this week, “at least 12 more cases will probably follow.” The article also quotes sources as saying that in the enforcement action this week, the SEC will probably file a civil case in tandem with criminal charges by the Justice Department. The article also notes that the June 2003 criminal complaint filed against Peregrine Systems encompassed a wide variety of charges including stock-option violations. The SEC’s June 2003 complaint against Peregrine Systems can be found here (the stock options allegations are in paragraph 29).

Jupiter Networks Sued in Options Backdating Securities Class Action: According to a July 17, 2006 press release, Jupiter Networks has been named in a securities class action lawsuit based on allegations of improper options backdating. This brings the number of companies sued in securities class action lawsuit based on allegations of improper options backdating to nine. Prior D & O Diary post tallying the other eight lawsuits and identifying the companies previously sued can be found here and here and here.

Options Backdating Link: Readers interested in more regular servings of options backdating news may want to check out the Vangal blog, which may be found here. Tip of the hat to Adam Savett at the Lies, Damn Lies blog for the Vangal link. The Vangal blog apparently is affiliated with Vangal Strategy and Business Consulting, whose website describes the company as “the leading strategy consulting firm for high-velocity companies who are facing a crisis with Stock Options Backdating [and] and Spring-loading grants.” A June 24, 2006 article in the San Jose Mercury News describing Vangal and other blogs discussing options backdating can be found here.