Options Aftermath – Scandals Have Brought Policy Shifts; Installing Software, Tracking Sign-Offs

In the old days, some chief executives handed out stock options like candy.

Today, granting options is a little more like pulling teeth.

After a flurry of scandals and government investigations of options backdating in the past year, companies are taking pains to stick to new regulations and formalize the accounting of options.

Among the changes: adding software to organize old records, developing better ways to track options and formalizing approvals from the board.

The issue hits home in Orange County, home to the nation’s most costly options case.

Earlier this year, Irvine chipmaker Broadcom Corp. applied $2.2 billion in charges to restated financial results from 1998 to 2005 after a high-profile company inquiry that lasted more than a year.

Federal officials are considering filing criminal charges against the company’s former chief executive, Henry Nicholas, and ex-financial chief William Ruehle, for their role in the misdating of options.

By now, most companies with options issues are up to speed on their financial reporting, including charges to past earnings to reflect misdated options.

One notable exception is Aliso Viejo’s Quest Software Inc., which hasn’t reported full financial results for nearly a year.

In the wake of the scandals, companies have changed the way they give out options and firmed up accounting and approval of them, according to consultants.

Companies themselves aren’t saying much about it—several contacted for this story declined to comment on changes they’ve made to option granting practices.

Many have tapped consultants to help with what used to largely be an internal matter, according to John Mooers, chief executive of 3six0 Advisors Inc., a management consulting firm in Newport Beach.

“More companies are seeking our advice and direction as an unbiased third party regarding making final decisions and strategy,” he said. “They are willing to look at outside parties more than they have in the past.”

Mooers’ firm, which has done work for Conexant Systems Inc. and Microsoft Corp., has formed an advisory practice on corporate governance issues, he said.

The first step is admitting that there’s a problem with the status quo, according to Mooers.

“The whole options issue has become a wake-up call for the board regarding its governance responsibilities,” he said.

Companies are looking for help to set up more checks on compensation practices, according to auditors.

“There is a heightened awareness of options backdating now,” said Steve Milner, partner at Squar, Milner, Peterson, Miranda & Williamson LLP in Newport Beach. “There is now a great deal of focus during the course of an audit of the effect that options may have on the financial statements.”

Smaller companies also are concerned, said Ken Jones, executive managing director of Lyndon Group LLC, a financial consultancy in Newport Beach.

Options accounting is “of particular interest to small companies, because they are often less sophisticated and are run very lean,” he said. “But they still have to do all of the same things as the big companies.”

A common first step: getting software, such as E-Trade Financial Corp.’s Equity Edge, to clean up the books and get old records organized, Jones said.

“The fear is, ‘What have we done that we could get nailed for?’” he said. “We are helping clients to implement tracking software that will reconstruct their activities back from day one. Company records become more visible to the board and to management.”

Perhaps the biggest change has been to make sure options grants are in the light.

“The most typical thing is to really increase the visibility within the organization of option grants so that management and the board are fully aware of the transactions, when they are occurring and how pricing is being set so that there isn’t anything out of the ordinary,” said J. Scott Farber, partner-in-charge at Grant Thornton LLP in Irvine.

Companies are developing ways to track board member signoffs when options are granted, said John Poth, partner at Haskell & White LLP in Irvine.

“I’ve seen some changes for the good with regard to documentation that’s kept in the board minutes,” Poth said. “We’ve got a lot of educated board members trying to do the right thing.”

Poth is seeing companies use numbered tracking systems for options, similar to the old stock certificate program that assigned a serial number to shares, he said.

“It’s another means of getting their arms around it,” Poth said. “Anytime companies do a better job tracking options, it’s easier to audit.”

Some companies have lessened their reliance on stock options, which allow employees to buy shares at a future date at a certain price, in favor of grants, where an employer gives an employee actual shares.

“Companies have been more conservative toward the issuing of options and the initiative of stock compensation in general,” said Mooers of 3six0 Advisors.

Back in 2003 Microsoft Corp. said it would stop issuing options altogether. Other technology companies have rolled back their use of options to pay executives, including Costa Mesa’s Emulex Corp. and Aliso Viejo-based QLogic Corp.

“I haven’t seen any drastic moves yet, but (companies) are starting to think of other options for compensation,” Lyndon Group’s Jones said.

But options still remain a powerful tool for recruiting and keeping workers.

“For companies that have great potential but little cash, options are a great way to attract talent that wouldn’t come unless there is an upside,” Milner said. “They can still be done on a very legitimate basis.”