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May 23, 2006 1:15 am

Scrutiny of options comes from Iowa, via Norway

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It cannot be often that US authorities are prompted to scrutinise the accounting practices of scores of large US companies as a result of research by a Norwegian academic in the corn-growing state of Iowa.

But that appears to have been the effect Erik Lie has had on the Securities and Exchange Commission, not to mention the US attorney for the southern district of New York.

Mr Lie’s research at the University of Iowa into stock options has prompted a widening probe into the possibility that companies may have back-dated the granting of stock options to senior executives. His research has shown that an unusually high number of executives benefited from the grant of options at the lowest possible strike price just before a surge in their companies’ share prices.

“It’s good to get some recognition for some academic research,” says Mr Lie, speaking from his office at the University of Iowa.

He says he “bumped into this price pattern” while researching in 2002 how the granting of stock options affected the financial policies of companies.

He ended up wading through the financial statements of 6,868 companies – including all those in the S&P 1,500 index.

In 2004, he handed his research to the SEC, which was investigating the timing of stock option grants.

But the agency was not focused on the possibility of back-dating, he says. “I didn’t feel like the SEC was on the right track. I sent my stuff to them and said ‘you might want to take a look at this stuff’’.”

Michael Moran of Goldman Sachs says the outcome of the investigations “could result in restatements of GAAP financials, tax penalties and fines, securities law violations and/or the departure of key executives and board members. Some companies could be penalised by investors on the basis of perceived poor corporate governance”.

One focus of investor concern that executives may have inappropriately enriched themselves by timing the issue of stock options is sure to be Silicon Valley, the spiritual home of the options compensation culture.

Because stock options are only valuable if a company's shares rise above a certain “strike price”, they have long been viewed as the performance incentive of choice among Silicon Valley’s many fast-growing startups.

For a time in the late 1990s, employers showered huge numbers of stock options on managers and employees alike. In recent years, however, the coming of Sarbanes-Oxley and new rules that require companies to take the expense of stock options into account in their corporate reports have diminished options’ appeal.

Henry Hu, a professor at the University of Texas who specializes in stock options and other financial instruments, draws a line between Silicon Valley’s staunch opposition to the new options expensing rules and the unfolding backdating mystery.

“Silicon Valley was very forceful in trying to fend off the expensing of stock options,” he says. “The argument was that stock options provide incentives for people and if you have to expense them, there’s going to be more reluctance to grant them [on the part of shareholders], which would therefore hurt the company’s ability to recruit the best and the brightest.”

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