Watchdog Grundfest on options and corporate fraud
Joseph Grundfest made himself known to investors when he took a strong laissez-faire stance as one of the five Securities and Exchange commissioners trying to pick up the pieces after the 1987 stock crash. Arguing that well-informed investors regulate markets best, he opposed attempts to rein in program trading, raise the amount investors had to put up to buy stock on margin, and put limits on how much a stock price could change each day. He supported efforts to make hostile takeovers easier.
Now Grundfest, who holds a law degree and a doctorate in economics from Stanford, is back as a professor at his alma mater. From this perch, he has become one of the keenest observers of the investors' rights battleground. He runs a comprehensive website tracking shareholder litigation: securities.stanford.edu. It is one of the few sites that investors can check to see if any of their holdings have settled investor fraud cases and thus owe them reimbursements. Grundfest says the number of private lawsuits alleging that companies have cheated shareholders has dropped dramatically: from 235 in 2004 to 182 in 2005 and just 62 in the first six months of 2006. Senior Writer Kim Clark met up with him in Palo Alto, Calif.
Does the decline in the number of private securities lawsuits mean companies are being more honest, and investors can relax?
Investors can never relax. Obviously, we have new concerns about [stock] option dating issues.
The 2002 Sarbanes-Oxley law says companies have to report option grants within two days of the decision, but they are allowed to decide to give options dated days or weeks ago, as long as they report that decision within two days, so it seems backdating might be legal.
You are allowed to grant options that are in the money. There is nothing illegal about saying, "Gee, our stock is currently $20 a share, and we want to grant executives options at $18 a share." As long as you disclose it clearly, and account for it properly, and as long as your option plan permits you to do it, then there is nothing illegal. Now, there is a separate question as to whether it is good governance.
Many people are oversimplifying this backdating debate. Everything is being described as time-travel backdating. It's not. My bet is that only a small fraction of the cases involved illegal intent. A much larger percentage will be complicated questions of corporate hygiene, cases where management decides in a way entirely consistent with policies, and approved by a board, that it is going to give you an option grant dated today. Management starts the paperwork for the compensation committee of the board to approve it. But suppose one of the directors is off on a walking tour and doesn't come back for three weeks? During that time the stock price has gone up. What is the date of the grant for purposes of accounting measurement? That's a big piece of the problem. It's not a lot of people running around trying to commit fraud.
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