FBI Says Stock Options Fraud Cases Aim for Level Playing Field

You’re at the track and the pony you bet on came up a winner. Your homework paid off—you knew the horse likes the mud and the inside post and has a family tree full of Triple Crown winners. You go to collect your winnings, and there you see another bettor—the horse’s trainer!—swagger up to the cashier, place a huge wager on the race that was just run and collect a windfall.

Sound ridiculous? The FBI says that’s essentially what happens when companies backdate corporate stock options for their executives. Options (the right to buy or sell stock at a set price) are only valuable when a company’s stock price rises—a grant of 100 options at $5 per share is more valuable than 100 options granted at $6. It’s a variation on the stock market’s golden “buy-low, sell-high” rule.

In options backdating, executives benefit from hindsight. Companies look back over their stock’s performance and cherry-pick a low point on the stock chart to set the options price, thereby boosting the value of the options—and the executive’s portfolio. When the practice isn’t documented in financial statements, it amounts to fraud, in the FBI’s eyes.

“More and more Americans are choosing to invest in the markets,” said James “Chip” Burrus, head of the FBI’s Criminal Investigative Division, which investigates these and other white-collar crimes. “These investors have willingly agreed to assume risk. They didn’t agree to be cheated. They expect honest jockeys, no horse doping, and nobody getting to bet on the race after it has already been run.”

Of the FBI’s 492 pending corporate fraud cases, 61 center on options backdating. Most corporate fraud cases involve accounting schemes designed to deceive investors and analysts about the true financial state of a company. Burrus said that while the number of those cases has remained fairly steady, options cases have spiked.

“Our agents who work these cases have a term they like to use to describe this conduct—stealing,” Burrus said.

The FBI investigates corporate fraud cases with the IRS, the Securities and Exchange Commission (SEC), the National Association of Securities Dealers (NASD), and the U.S. Postal Inspection Service. Some 261 FBI agents today are working corporate, securities, and investment fraud cases, including four supervisory special agents working with federal prosecutors on a special options backdating task force formed last July in the San Francisco area.

FBI cases led to 405 corporate/securities fraud convictions in the fiscal year that ended last September. Among the significant examples of backdating cases:

– Brocade Communications Systems: The company’s former CEO and head of human resources allegedly backdated stock option grants to give employees favorably priced options without recording the necessary compensation expenses.

– Comverse Technology Inc.: Three former executives were charged for their roles in a scheme to manipulate the grant of millions of stock options to themselves and to employees. Read the press release Two pleaded guilty. The CEO fled the country.

Options cases and corporate fraud are just a piece of the FBI’s battle against white-collar crime—there are more than 18,000 pending white-collar cases. But Burrus says their fallout is considerable: financial losses and damaged investor confidence.

“Our mission,” Burrus said, “is to try to keep the playing field level.”

Source: FBI