Finally, the poised ax has fallen. After months of warning that up to 80 companies are being investigated for manipulating employee stock options, Federal prosecutors in July charged former officers of technology group Brocade Communications Systems with securities fraud in the first court action. Former chief executive Gregory Reyes, human resources vp Stephanie Jensen and CFO Antonio Canova are accused of using practices known as "spring-loading" and "backdating." The three were also hit with related civil charges. From 2000 to 2004, authorities allege, Brocade hid millions of dollars in expenses from investors and overstated its income by falsifying employee stock-option grant records. Authorities, which also include the Department of Justice, are trying to determine if the former employees finagled the grant dates of stock options to boost profits available to corporate executives. However, no charges were brought against Brocade itself, a San Jose firm that makes hardware for networking storage. In "backdating," option-grant dates are retroactively set to precede a rally in the underlying shares, locking in risk-free profits for recipients; in "spring-loading," grant dates are scheduled for just before a positive announcement or just after a negative one, anticipating a stock price rally and anticipating higher profits for recipients. Both practices are not illegal, but must be properly disclosed in regulatory filings, taxed and reported on the accounting ledger. Criminal securities fraud carries a maximum sentence of up to 20 years in prison and a fine of up to $5 million.
SEC officials declined to say whether any banks are among the 80 companies being investigated, but other non-sector firms recently announced they had received subpoenas or SEC request for documents: optical-switch maker Sycamore Networks, high-tech firm Rambus, Quest Software, UnitedHealthGroup, Caremark Rx, Juniper Networks, Affiliated Computer Services, OpenWave Systems, Vitesse Semiconductor Corp., McAfee and drug firm Sepracor. "For some time now it's been abundantly clear that these were not episodic instances," SEC chairman Christopher Cox said after the announcement. "But, rather, there were widespread problems, certainly during the 1990s." Two finance professors who produced research leading to the probes said nearly 30 percent of companies in the past two decades, mostly in the '90s, had manipulated stock-option grants to top executives. Officials say the Sarbanes-Oxley law of 2002 effectively halted options backdating, since it cut from 30 days to two business days the time that company insiders are required to report their options grants to the SEC. And some company officials will be paying, though observers say shareholders will be picking up the tab in the form of higher directors' and officers' insurance, which shields executives and board members from personal losses for the decisions made on the job.
Banks that oppose more competition from the likes of nonbank players like Wal-Mart and Home Depot have renewed hope for stricter legislation in two proposed bills in Congress. One by Rep. Jim Leach, the Iowa Republican, would place industrial-loan corporation holding companies (status that both firms are requesting) under the supervision of the Federal Reserve via the Bank Holding Company Act; prohibit ILC ownership by commercial firms; and require commercial companies that own ILCs to divest them within five years. The other bill, by Ohio Republican Rep. Paul Gillmor and Massachusetts Democrat Rep. Barney Frank, would prohibit commercial firms from forming or acquiring ILCs after June 1, 2006, give the Federal Deposit Insurance Corp. supervisory authority over companies that own ILCs, and limit activities of ILCs acquired by commercial companies between October 1, 2003 and June 1, 2006. And there's more good news: In late July, the FDIC imposed a moratorium until January 31 on agency actions involving ILC charters.
