San Jose, Calif. -- Bad behavior grabbed headlines this year, as the electronics industry hit what all must hope was its ethical nadir.
First there was the scandal at Hewlett-Packard Co., in which the top board member allegedly spied on other directors through a shady and illegal practice called pretexting. HP has since settled the case.
Then there is the continuing price-fixing probe of top DRAM makers by the U.S. Justice Department, an investigation that dates back to 2002. This year, Justice widened its probe to look into the SRAM and graphics chip sectors as well.
But the real shocker--and one of the biggest stories of 2006--has been the stock op- tion scandal that has rocked high-tech and other industries throughout the year, forcing state and federal regulators to react. Most of the allegations have centered on backdating--retroactively granting options on dates when a company's stock price was relatively low to maximize the potential profits for the option holder.
There is new and startling evidence that almost 30 percent of all companies "that granted options to top executives between 1996 and 2005 manipulated one or more of these grants in some fashion," according to a recent report from the University of Iowa.
Clearly, U.S. corporate governance, which is supposed to protect shareholders, is broken. "I believe that only a mi- nority of the firms that have engaged in backdating of op- tion grants will be caught," Erik Lie, associate professor at the Henry B. Tippie College of Business at the University of Iowa, said in the report. "In other words, we will never see the full iceberg."
At last count, the scandal involved nearly 150 public companies, including some high-profile brands from the who's who in business: Apple, Barnes & Noble, Costco, KB Homes, IBM and even the Cheesecake Factory. Home Depot has admitted to having backdated options for the past 26 years.
Dozens of high-tech companies have acknowledged that their past stock option grants are being investigated by the U.S. Securities and Exchange Commission, the U.S. Attorney's Office or both. Many either have restated earnings and incurred charges to correct for irregularities stemming from recording discrepancies, or they plan to do so.
Over the course of the year, the flap spread like wildfire, causing high-level executive resignations, criminal indictments and astronomical fines. Bottom line: The scandal has damaged public trust, investor confidence and employee morale.
U.S. agencies appear to have cracked down on offenders and ostensibly tightened the regulations. In September, SEC chairman Christopher Cox told a Senate panel his agency was investigating more than 100 companies for possible fraudulent reporting of stock option grants.
New accounting rules, Cox said at the time, have eliminated the incentive to grant "at the money" options--those that are immediately profitable because they are granted below a stock's current price. The rules will soon be complemented by more accounting guidance, Cox told lawmakers.
Is the problem fixed? Not by a long shot. Corporate executives may have found another avenue to manipulate their stock options by cheating on their taxes, a disclosure that could expand the scandal, according to a recent report in The Wall Street Journal, which cited the SEC.
Abuses of system
Questions about stock option programs have dogged tech companies since the 1990s, when options came into their own as a compensation tool. But abuses of the system quickly became widespread. According to one report, some 590 nontechnology companies and 130 tech firms appear to have manipulated stock options during a 10-year period ending in December 2005.
In one of the earliest cases, the SEC in 2004 began investigating historical options granted at Analog Devices Inc. That action led to a tentative settlement that imposed a $3 million fine as well as a $1 million civil penalty against CEO Jerald Fishman. Despite the settlement, ADI recently acknowledged it had been subpoenaed by the U.S. Attorney for the Southern District of New York to produce records dating to 2000 relating to the company's stock option program.
The long list of electronics companies implicated in 2006 includes Actel, ADI, Altera, AMCC, Amkor, Apple, Atmel, Asyst, Broadcom, Brooks Automation, Brocade, IBM, Integrated Silicon Solution, Jabil Circuit, KLA-Tencor, Keithley Instruments, Linear, Marvell, Maxim, Micrel, Microtune, MIPS, Molex, Nvidia, PMC-Sierra, Power Integrations, QuickLogic, Rambus, Sanmina-SCI, Semtech, Sycamore, Trident, VeriSign, Vitesse, Xilinx and Zoran.
Perhaps the highest-profile case was Brocade Communications Systems Inc. In August, two top executives--former president and CEO Gregory Reyes and former vice president of human resources Stephanie Jensen--were hit with a 12-count indictment for scheming to backdate option grants to give employees favorably priced options without recording necessary compensation expenses. The two pleaded not guilty in federal court.
In May, Vitesse Semiconductor Corp. said it had terminated three executives--including the CEO--amid a pending investigation at the troubled communications chip company.
At the same time, fab automation equipment provider Brooks Automation Inc. said it planned to restate earnings for 28 quarters from fiscal 1999 through fiscal 2005. The decision was the result of a continuing review by a special committee of Brooks' historical stock option-granting practices.
More disclosures emerged in the summer and fall. In September, Broadcom Corp. said it would restate finances for 2000 through 2005 and for the first quarter of 2006. The company set a dubious record for the highest penalty: It expects to realize additional noncash stock-based compensation expenses of about $1.5 billion. Last week, Broadcom revealed it is being investigated by the SEC over its handling of stock options.
Troubled chip vendor Applied Micro Circuits Corp. (AMCC) said it expects to take a charge of $200 million resulting from stock option problems.
October was another bad month for chip makers. High-flying Marvell Tech- nology said financial statements issued around the time of its initial public offering in June 2000 should no longer be relied upon. During the same month, Altera Corp. said it expected to take a charge of $47.6 million as a result of its historical stock option practices.
Rambus Inc. joined the chorus, saying it would likely take stock-based compensation charges of more than $200 million as a result of an options probe. Atmel Corp. , citing familiar reasons, said its financial statements for 2003 through 2005, plus the first quarter of 2006, were no longer reliable.
On the equipment side, metrology giant KLA-Tencor Corp. said it expected that the total noncash charges for stock-based compensation expenses "will not" exceed $400 million. As part of its stock option investigation, the company terminated its relationship with former CEO Kenneth Schroeder. Founder and chairman Kenneth Levy retired.
In the same month, semiconductor test and assembly services provider Amkor Technology Inc. said it would restate its financial results for 2003 through 2005 and the first quarter of 2006. The restatements contain additional stock-based compensation charges totaling $106 million.
And if all that wasn't bad enough, Apple Computer Inc. in October said an internal probe revealed that CEO Steve Jobs knew about some backdating of stock options but did not benefit from the practice. Apple's special committee of outside directors, an independent counsel and accountants recently found that stock option grants made on 15 dates between 1997 and 2002 appeared to have dates that preceded the approval of the grants. Apple said this month that it will again delay filing its financial statements and must restate earnings to account for backdated grants.
Last month, Nvidia Corp. said it was restating six years of earnings as a result of an internal investigation into stock option backdating. Nvidia will take a total of $190.2 million in previously unreported charges for compensation expenses and $9.4 million in compensation taxes for fiscal 2000 through 2006.
In a rare piece of good news for the industry, Xilinx Inc. in November said the SEC formally notified it that an investigation of its stock option practices had been terminated and that no enforcement action would be recommended.
The SEC and state officials have meanwhile promised to crack down further on stock option backdating. The threat may prompt other companies to come clean and restate previous earnings that reflected questionable option awards.
Observers say the coming year is likely to provide more revelations.