Some CEOs reap millions by landing stock options when they
are most valuable. Luck -- or something else?
By Charles Forelle and James Bandler
Saturday, March 18, 2006
On a summer day in 2002, shares of Affiliated Computer
Services Inc. sank to their lowest level in a year. Oddly,
that was good news for Chief Executive Jeffrey Rich.
His annual grant of stock options was dated that day,
entitling him to buy stock at that price for years. Had
they been dated a week later, when the stock was 27% higher,
they'd have been far less rewarding. It was the same
through much of Mr. Rich's tenure: In a striking pattern,
all six of his stock-option grants from 1995 to 2002 were
dated just before a rise in the stock price, often at the
bottom of a steep drop.
Just lucky? A Wall Street Journal analysis suggests the
odds of this happening by chance are extraordinarily remote
-- around one in 300 billion. The odds of winning the
multistate Powerball lottery with a $1 ticket are one in 146
Suspecting such patterns aren't due to chance, the
Securities and Exchange Commission is examining whether some
option grants carry favorable grant dates for a different
reason: They were backdated. The SEC is understood to be
looking at about a dozen companies' option grants with this
The Journal's analysis of grant dates and stock movements
suggests the problem may be broader. It identified several
companies with wildly improbable option-grant patterns.
While this doesn't prove chicanery, it shows something very
odd: Year after year, some companies' top executives
received options on unusually propitious dates.
The analysis bolsters recent academic work suggesting that
backdating was widespread, particularly from the start of
the tech-stock boom in the 1990s through the Sarbanes-Oxley
corporate reform act of 2002. If so, it was another way
some executives enriched themselves during the boom at
shareholders' expense. And because options grants are
long-lived, some executives holding backdated grants from
the late 1990s could still profit from them today.
Mr. Rich called his repeated favorable option-grant dates at
ACS "blind luck." He said there was no backdating, a
practice he termed "absolutely wrong." A spokeswoman for
ACS, Lesley Pool, disputed the Journal's analysis of the
likelihood of Mr. Rich's grants all falling on such
favorable dates. But Ms. Pool added that the timing wasn't
purely happenstance: "We did grant options when there was a
natural dip in the stock price," she said. On March 6, ACS
said that the SEC is examining its option grants.
Stock options give recipients a right to buy company stock
at a set price, called the exercise price or strike price.
The right usually doesn't vest for a year or more, but then
it continues for several years. The exercise price is
usually the stock's 4 p.m. price on the date of the grant,
an average of the day's high and low, or the 4 p.m. price
the day before. Naturally, the lower it is, the more money
the recipient can potentially make someday by exercising the
Which day's price the options carry makes a big difference.
Suppose an executive gets 100,000 options on a day when the
stock is at $30. Exercising them after it has reached $50
would bring a profit of $20 times 100,000, or $2 million.
But if the grant date was a month earlier and the stock then
was at, say, $20, the options would bring in an extra $1
A key purpose of stock options is to give recipients an
incentive to improve their employer's performance, including
its stock price. No stock gain, no profit on the options.
Backdating them so they carry a lower price would run
counter to this goal, by giving the recipient a paper gain
right from the start.
Companies have a right to give executives lavish
compensation if they choose to, but they can't mislead
shareholders about it. Granting an option at a price below
the current market value, while not illegal in itself, could
result in false disclosure. That's because companies grant
their options under a shareholder-approved "option plan" on
file with the SEC. The plans typically say options will
carry the stock price of the day the company awards them or
the day before. If it turns out they carry some other
price, the company could be in violation of its options
plan, and potentially vulnerable to an allegation of
It could even face accounting issues. Options priced below
the stock's fair market value when they're awarded bring the
recipient an instant paper gain. Under accounting rules,
that's equivalent to extra pay and thus is a cost to the
company. A company that failed to include such a cost in
its books may have overstated its profits, and might need to
restate past financial results.
The Journal's analysis raises questions about one of the
most lucrative stock-option grants ever. On Oct. 13, 1999,
William W. McGuire, CEO of giant insurer UnitedHealth Group
Inc., got an enormous grant in three parts that -- after
adjustment for later stock splits -- came to 14.6 million
options. So far, he has exercised about 5% of them, for a
profit of about $39 million. As of late February he had
13.87 million unexercised options left from the October 1999
tranche. His profit on those, if he exercised them today,
would be about $717 million more.
The 1999 grant was dated the very day UnitedHealth stock hit
its low for the year. Grants to Dr. McGuire in 1997 and
2000 were also dated on the day with those years' single
lowest closing price. A grant in 2001 came near the bottom
of a sharp stock dip. In all, the odds of such a favorable
pattern occurring by chance would be one in 200 million or
greater. Odds such as those are "astronomical," said David
Yermack, an associate professor of finance at New York
University, who reviewed the Journal's methodology and has
studied options-timing issues.
Options grants are made by directors, with details often
handled by a compensation committee. Many companies make
their grants at the same time each year, a policy that
limits the potential for date fudging. But no law requires
Until last year, UnitedHealth had a very unusual policy: It
let Dr. McGuire choose the day of his own option grants.
According to his 1999 employment agreement, he is supposed
to choose dates by giving "oral notification" to the
chairman of the company's compensation committee. The
agreement says the exercise price shall be the stock's
closing price on the date the grants are issued.
Arthur Meyers, an executive-compensation attorney with
Seyfarth Shaw LLP in Boston, said a contract such as that
sounded "like a thinly disguised attempt to pick the lowest
grant price possible." Mr. Meyers said such a pact could
pose several legal issues, possibly violating Internal
Revenue Service and stock-exchange listing rules that
require directors to set a CEO's compensation. "If he picks
the date of his grant, he has arguably set a portion of his
pay. It's just not good corporate governance."
UnitedHealth called the process by which its grants were
awarded "appropriate." It declined to answer specific
questions about grant dates but noted that on all but two of
them, grants were made to a broad group of employees.
William Spears, a member of UnitedHealth's compensation
committee, said the October 1999 grant wasn't backdated but
was awarded concurrently with the signing of Dr. McGuire's
employment contract. Mr. Spears said a depressed stock
price spurred directors to wrap up negotiations and get
options to management. The board revised terms of the
employment contract last year and will start making
stock-option grants at a regular time each year, Mr. Spears
The SEC's look at options timing was largely prompted by
academic research that examined thousands of companies and
found odd patterns of stock movement around the dates of
grants. One study was by Erik Lie of the University of
Iowa. He found that share prices generally fell before
option grants and rose afterward, with the result that
recipients got options at favorable times. He concluded
this was so unlikely to happen by chance that at least some
grant dates had to have been filled in retroactively.
Another possible explanation for big rises in stock prices
following grants is that executives knew favorable company
news was coming and timed the grants just before it. But
academics think timing for company news is a less likely
explanation for the patterns, given the consistency of the
stock climbs after grant dates. Also, for many of the
companies the Journal examined, no obvious company news
followed closely upon the option grants.
It's also possible companies sometimes award options after
their stock has taken a fall and seems to them to be
undervalued. In point of fact, the companies can't possibly
know what the stock will do next, but that doesn't mean they
might not feel confident enough about a recovery to think
they are hitting a favorable time to grant options.
The use of stock options surged in the late 1990s as young
firms that had bright prospects but little revenue used them
to attract and pay executives. As dot-com and telecom
shares exploded, stock options became a source of vast
They also grew controversial. Critics worried that big
options grants tempted executives to do whatever it took to
get the stock price up, at least long enough to cash in
their options. At the same time, during a general bull
market, the options sometimes richly rewarded executives for
stock buoyancy that had little to do with their own efforts.
Mercury Interactive Corp., a Mountain View, Calif.,
software maker, the chief executive and two others resigned
late last year. Mercury said an internal probe found 49
cases where the reported date of options grants differed
from the date when the options appeared to have been
awarded. The company said it will have to restate financial
results. The SEC is still looking at Mercury, said someone
familiar with the situation.
Analog Devices Inc. says it reached a tentative
settlement with the SEC last fall. It neither admitted nor
denied that it had misdated options or had made grants just
before releasing good news that would tend to push up the
stock. The Norwood, Mass., computer-chip maker tentatively
agreed to pay a $3 million civil penalty and re-price some
options. CEO Jerald Fishman tentatively agreed to pay a $1
million penalty and disgorge some profits. Analog didn't
make him available for comment. The company said it will
not restate its financial records.
In some instances, backdating wouldn't be possible without
inattentive directors, securities lawyers say. At one
company the SEC is looking at, lawyers say, it appears that
someone picked a favorable past date for an option grant and
gave it to directors for retroactive approval, perhaps
counting on them not to notice. In another case, the lawyers
say, a space for the grant date appears to have been left
blank on paperwork approved by directors, or dates were
Until 2002, companies didn't have to report option grants
until months later. The Sarbanes-Oxley law, by forcing them
to report grants within two days, left less leeway to
retroactively date a grant.
The new rule reduced stock patterns suggestive of
backdating, but didn't eliminate these altogether, according
to a study by M.P. Narayanan and H. Nejat Seyhun of the
University of Michigan. They found that companies report
about a quarter of option grants later than the two-day
deadline -- and that such delayed reporting is associated
with big price gains after the grant dates. It is a pattern
Mr. Narayanan calls "consistent with backdating."
Before the stricter rules,
Brooks Automation Inc., a semiconductor-equipment maker
in Chelmsford, Mass., gave 233,000 options to its CEO,
Robert Therrien, in 2000. The stated grant date was May
31. That was a great day to have options priced. Brooks's
stock plunged over 20% that day, to $39.75. And the very
next day it surged more than 30%.
A June 7 Brooks report to the SEC covering Mr. Therrien's
May options activity made no mention of his having gotten a
grant on May 31, even though the report -- which Mr.
Therrien signed -- did cite other options-related actions he
took on May 31. Not until August was the May 31 grant
reported to the SEC.
It wasn't the only well-timed option grant he got. One in
October 2001 came at Brooks stock's lowest closing price
that year, once again at the nadir of a sharp plunge. The
Journal analysis puts the odds of such a consistent pattern
occurring by chance at about 1 in nine million.
Mr. Therrien, who stepped down as CEO in 2004 and retired as
chairman this month, didn't return messages seeking
comment. Chief Financial Officer Robert Woodbury said
Brooks is "in the process of revamping" practices so grants
come at about the same time each year. Mr. Woodbury, who
joined in 2003, said no one at Brooks would be able to
explain the timing of Mr. Therrien's grants.
The highly favorable 2000 grant also benefited two others at
Brooks -- the compensation-committee members who oversaw the
CEO's grants. Although Brooks directors typically got
options only in July, that year a special grant was awarded
just to these two directors, Roger Emerick and Amin J.
Khoury. Each got 20,000 options at the low $39.75 price.
By the time of their regular July option-grant date, the
stock was way up to $61.75, a price far less favorable to
Mr. Emerick, a retired CEO of Lam Research Corp., declined
to be interviewed. Mr. Khoury, the CEO of BE Aerospace Inc.
in Wellington, Fla., didn't return messages left at his
Comverse Technology Inc., said Tuesday that its board
had started a review of its past stock-option practices,
including "the accuracy of the stated dates of options
grants," following questions about the dates from the
Journal. The announcement reversed a prior Comverse
statement -- given a week earlier in response to Journal
inquiries -- saying all grants were made in accordance with
applicable laws and regulations.
The Journal's analysis spotlighted an unusual pattern of
grants to Kobi Alexander, chief executive of the New York
maker of telecom systems and software. One grant was dated
July 15, 1996, and carried an exercise price of $7.9167,
adjusted for stock splits. It was priced at the bottom of a
sharp one-day drop in the stock, which fell 13% the day of
the grant and then rebounded 13% the next day.
Another grant, on Oct. 22, 2001, caught the second-lowest
closing price of 2001. Others also corresponded to price
dips. The odds of such a pattern occurring by chance are
around 1 in six billion, according to the Journal's
Before Comverse announced its internal probe, John Friedman,
a member of the board's compensation committee, said
directors had noticed the scattered nature of the grants --
eight between 1994 and 2001 fell in six different months --
but management assured them there were valid reasons. Mr.
Alexander, the CEO, didn't return phone calls.
This week, Comverse said that, as a result of the board's
review of its options grants, it expects it will need to
restate past financial results.
Propitious option timing can help build fortunes even at
companies where the stock doesn't steadily rise. Shares of
Vitesse Semiconductor Corp., although they zoomed in the
late 1990s, now rest at about the level of a decade ago.
But Louis R. Tomasetta, chief executive of the Camarillo,
Calif., chip maker, reaped tens of millions of dollars from
Mr. Tomasetta got a grant in March 1997 that, adjusted for
later stock splits, gave him the right to buy 600,000 shares
at $5.625 each. The date they were priced coincided with a
steep fall in Vitesse's stock, to what turned out to be its
low for the year. He pocketed $23.1 million in profit when
he exercised most of these options between 1998 and 2001.
Had the grant come 10 days earlier, when the stock price was
much stronger, he would have made $1.4 million less.
In eight of Mr. Tomasetta's nine option grants from 1994 to
2001, the grants were dated just before double-digit price
surges in the next 20 trading days. The odds of such a
pattern occurring by chance are about one in 26 billion.
Alex Daly, a member of the Vitesse board's compensation
committee, said a review of the grants found "nothing
extraordinary" about their timing, and "absolutely no grants
have been made to anyone, least of all the CEO, that are out
of sequence with our normal grant policy." Vitesse's
finance chief, Yatin Mody, said the grants were "reviewed
and approved" by the compensation committee, "and the
exercise price set as of the date of the approval, as
documented by the related minutes." He declined to provide
a copy of those minutes. Mr. Tomasetta said the grants were
"approved by the board and the price set at the close of the
day of approval."
At ACS in Dallas, Mr. Rich helped turn a small technology
firm into one with more than $4.4 billion in annual revenue
and about 55,000 employees. ACS handles paperwork,
accounting and data for businesses and government agencies.
It is a major outsourcer, relying on global labor. "It is a
pretty boring business," Mr. Rich told the University of
Michigan business school in 2004, "but there is a lot of
money in boring."
While most of Mr. Rich's stock-option gains were due to
rises in ACS stock, the exceptional timing of grants
enhanced his take. If his grants from 1995 through 2002 had
come at each year's average share price, rather than the
favorable dates, he'd have made about 15% less.
An especially well-timed grant, in which Mr. Rich received
500,000 options at $11.53, adjusted for stock splits, was
dated Oct. 8, 1998. This happened to be the bottom of a
steep plunge in the price. The shares fell 28% in the 20
trading days prior to Oct. 8, and rose 60% in the succeeding
20 trading days.
ACS's Ms. Pool said the grant was for Mr. Rich's promotion
to CEO. He wasn't promoted until February 1999. Ms. Pool
said there was a "six-month transition plan," and the Oct. 8
option grant was "in anticipation" of his promotion.
Mr. Rich would have fared far worse had his grant come on
the day ACS announced his promotion. The stock by then was
more than twice as high. The grant wasn't reported to the
SEC until 10 months after the stated grant date. Ms. Pool
said that was proper under regulations in place at the time.
A special board committee oversaw Mr. Rich's grants. Most
years, its sole members were directors Frank Rossi and
Joseph O'Neill. Mr. Rossi declined to comment. Mr. O'Neill
said, "We had ups and downs in our stock price like any
publicly traded stock. If there were perceived low points,
would we grant options at that point? Yes."
Mr. Rich said grants were made on the day the compensation
committee authorized them, or within a day or so of that.
He said he or Chairman Darwin Deason made recommendations to
the special board committee about option dates.
Mr. Rich, who is 45 years old, resigned abruptly as ACS's
chief executive on a Thursday in September to "pursue other
business interests." Again, his timing was advantageous.
In an unusual separation agreement, the company agreed to
make a special payment of $18.4 million, which was equal to
the difference between the exercise price of 610,000 of his
outstanding stock options and the closing ACS stock price on
the day of his resignation.
But the company didn't announce the resignation that day.
On the news the next Monday that its CEO was departing
suddenly, the stock fell 6%. Mr. Rich netted an extra $2
million by cashing in the options before the announcement,
rather than on the day of it.
Mr. Rich said ACS signed his separation agreement on Friday,
using Thursday's price for the options payout. He said it
waited till Monday to release the news because it didn't
want to seem "evasive" by putting the news out late Friday.
contributed to this article.
Write to Charles Forelle at
email@example.com and James Bandler at