The options backdating story has unfolded in successive stages. First, there was the March 18, 2006 Wall Street Journal article (here, registration required) that drew attention to the issue and set off the media frenzy. Then there were the waves of announcements from companies stating that they or regulators were investigating their options practices. (According to the WSJ.com “Options Scorecard,” here, there are 115 companies under investigation one way or the other.)

The current stage seems to involve the slow but steady defenestration of numerous senior company officials.

An October 17, 2006 Philadephia Inquirer article entitled “Backdating -Who Has Been Ousted” (here), attempted to list all of the executives who have lost their jobs so far. Even thought the Inquirer list is only a couple of days old, it is already out of date, because it omits the recent departures from KLA-Tencor (here and here), Altera (here), Sapient (here) and SafeNet (here). By my count, more than 40 executives have lost their jobs so far.

More departures undoubtedly are on the way. These circumstances have to be uncomfortable for executives at companies undergoing options timing investigations. Both investors and the individuals themselves have to be wondering about the executives’ continued tenure. For example, the San Jose Mercury News ran an October 17, 2006 article entitled “Is Steve Jobs Safe?” (here, registration required) (short version: not enough information yet). Times have to be rough even for executives whose names are not in the papers every day.

There is a certain inevitability to this ritual bloodletting. The companies are, of course, taking great pains to repair their public image and to restore investor confidence. Companies also face pressure under the Thompson Memo to show full cooperation with regulators in order to avoid corporate criminal prosecution, which adds a particularly sharp edge of necessity for companies to cut individuals loose.

Given the number of companies that have not yet completed their investigations, the steady drumbeat of executive departures is likely to continue for some time.

There is some peculiarly American necessity to scapegoat and assign blame when dramatic, unexpected events occur, and consistent with that tradition it is to be expected that these company officials are being made to walk the plank. Perhaps few will shed tears for William McGuire, United Health Group’s recently departed CEO, who ended last year with $1.78 billion in unexercised stock options. But SafeNet’s October 18 announcement (here) of the resignation of two of its officials (including one of its founders) has a downright elegiac tone. The D & O Diary questions whether this forced exodus of the senior officials at so many companies is really in investors’ best interests –or in anyone’s best interest. This concern will only grow as the list of ousted officials lengthens in the weeks and months ahead.

Finally, if the current stage in the unfolding backdating story is the outster of senior officials, what is the next stage? Possibilties include additional criminal and regulatory enforecement actions and resolution of the pending civil litigation, undoubtedly followed by coverage disputes. Regardless of what lies ahead, this story has a very long way to go yet. We are still only in the opening chapters.

Options Backdating Litigation Update: Along with the steady stream of executive departures has been the continuing influx of new options backdating lawsuits. According to The D & O Diary’s latest tally (here), there have 20 securities fraud lawsuits and 89 shareholders’ derivative lawsuits based on allegations of options timing misconduct.

Harvey Pitt Interview: In an interview published in the San Jose Mercury News on October 17, 2006 (here, registration required), former SEC Chairman Harvey Pitt had a number of interesting observations about the unfolding options backdating story:

This may be just my own inherent bias, but I have very little sympathy for the companies that were engaged in real backdating. If you look at the Brocade and Comverse indictments, that conduct was raw. I grew up in Brooklyn, and we had a word for that. We called it fraud….

On the other hand, there are cases where people made mistakes, maybe cases where people did things inadvertently, maybe cases where companies backdated option grants but had poor procedures. That’s where the tension comes into play. It places a heavy premium on regulators and prosecutors to be balanced in their judgments. Just because there was backdating doesn’t mean it was a hanging offense. But if it was backdating with false documents and that sort of thing, I do think it’s a hanging offense….

Then you also need to look at what the company is doing — how does the company rectify the situation? If what you want is for companies to be law-abiding, then you have to give them credit when they take steps to bring themselves into compliance.

The SEC is showing a great amount of balance in how it approaches these issues. It’s not rushing to make headlines. It’s proceeding in a way that is thoughtful and appropriate. That is the hallmark of good regulation and good enforcement.

Pitt is right that a distinction needs to be drawn between companies that falsified documents and companies that made inadvertent mistakes due to poor procedures. All too frequently the media tar both kinds of companies with the same brush. I also hope he is right that the reason the SEC has been moving deliberately in its investigations of options backdating is that it is attempting to draw these kinds of distinctions.

Word Czech: While the word “defenestration” is generally meant to refer to the act of throwing someone out of the window, historically the word was meant to suggest politicial dissent.

Photobucket - Video and Image HostingThe historical reference derives from the “defenestrations of Prague,” particularly the Second Defenestration of Prague, which took place in 1618, during the Thirty Years War. Protestant aristocrats, angered by Catholic Church attempts to claim certain contested land rights, convicted several officials for violating the rights of religious expression and threw the officials from the windows of the Bohemian Chancellery. According to tradition, the officials landed in a pile of manure– and survived. With that historical background, readers may judge for themselves whether it is accurate to refer to the backdating-related ouster of corporate executives as defenestration.

According to Merriam-Webster (here), “defenestration” was one of their dictionary’s users’ favorite words of the year in 2004. By the way, the 2004 Word of the Year was “blog.” Now you know.