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June 5, 2006 10:01 pm

Stock option scandal could widen

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Concerns that the questionable timing of stock options was not restricted mainly to technology companies were lent statistical support on Monday in a study suggesting the practice may have been spread across the entire S&P 500.

The study of the index’s constituents by Merrill Lynch showed that a stock in the S&P 500 derived a 2 per cent “excess return” in the 20-day trading period following the pricing and granting of stock options from January 1999 to December 2002. Merrill said this equated to an annualised 36 per cent excess return over the period, suggesting statistical significance.

More than 20 companies are being investigated by the Securities and Exchange Commission or are the subject of potentially criminal enquiries by the US attorney – or both – after revelations of questionable stock options practices in the five years up until 2002.

Investigations are focusing on the award of stock options to executives on dates that immediately precede a sharp rise in the companies’ share prices.

Before Sarbanes-Oxley legislation was enacted in 2002, companies had a 20-day window in which to report the award and pricing of a stock option to the SEC. Investigations are likely to look at whether companies, compensation committees and legal counsel used that window to backdate stock options and failed to account for them properly.

Shareholders in some of the companies have already issued lawsuits alleging that such failure occurred and that options that were immediately “in the money” as the result of a propitious award date were not reported as such, thus defrauding shareholders.

Merrill said that to establish the extent to which the performance of a stock subsequent to a stock options grant was “excessive”, it calculated how much performance post-grant dates diverged from the S&P’s average performance within a 20-day period after the grant dates.

The bank found that information technology companies showed an average
5 per cent excess return in the 20-day trading period following options issuance dates – more than twice the average for the S&P 500.

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