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Wall Street Journal, January 20, 2007 article


The Wall Street Journal  

January 20, 2007


Executives Get Bonuses
As Firms Reprice Options

Aim Is to Offset Losses
As Backdating Is Fixed;
Mr. Deason's Windfall
January 20, 2007; Page A1


The stock-options backdating scandal has prompted dozens of companies to fire top executives, take charges totaling billions of dollars against earnings and tell shareholders that they misrepresented how options were awarded.

Now, a number of companies are taking one more step: making special payments to executives or directors who received backdated options. Companies say the payments will compensate executives and directors who weren't involved in options wrongdoing, yet saw their potential profit reduced when their options were adjusted to reflect the actual dates they were issued. Several of the companies describe the payments as bonuses in regulatory filings.



 The Situation: Some companies that backdated stock options are fixing them -- then paying "bonuses" to executives to make up for lost value.

 Why Investors Should Care: Critics say shareholders shouldn't pay for backdating. Companies often say bonus recipients weren't involved in wrongful conduct and shouldn't be punished.

 The Bottom Line: Executives who get the bonus payments may make out better than if backdating weren't exposed, because they swap risky options for riskless cash.

But the practice has given critics more fodder for attacks on ballooning executive pay levels and special perks.

Federal authorities are scrutinizing the options practices of nearly 140 companies, and scores more companies are conducting internal reviews. A stock option typically gives its holder the right to buy a set amount of stock at some future time, at its price at the time the option was granted. The idea is to give recipients an incentive to help boost the company's share price. But a number of companies and executives changed the date on their grants to make them appear they had been granted at a time when the price was even lower, making them worth more to their holders.

Many companies that have acknowledged options-dating troubles are adopting the position that misdated options -- particularly those granted to top executives -- should be fixed without taking more out of shareholders' pockets. For instance, Sehat Sutardja, chief executive officer of microchip maker Marvell Technology Group Ltd., recently reimbursed his employer $5,355,001 for wrongly dated stock options he already had cashed in. He also agreed to forgo another $5.4 million from the value of options he still holds.

But some companies are taking another course. At KLA-Tencor Corp., for instance, Chief Executive Richard Wallace is in line for an options-related "special cash bonus," according to a securities filing.

The semiconductor-equipment maker is adjusting some of Mr. Wallace's options to carry the share prices that correspond to the dates the options were awarded, rather than the wrong ones achieved through backdating. The adjustments shaved $368,618.36 from the value of those grants. According to the filing, Mr. Wallace will have that amount paid to him in cash.

In effect, Mr. Wallace may come out ahead now that backdating has been exposed, since he is swapping unrealized, potential profit -- which could evaporate if KLA-Tencor shares fall -- for cash. By keeping the repriced options, he retains the chance to profit from them if shares rise higher.

In most cases, the companies making the payments say the executives in question aren't the ones responsible for the options troubles. KLA-Tencor has said in filings that Mr. Wallace, a 19-year company veteran who became CEO last year, had "no involvement" in the improper options granting, which it says occurred primarily from July 1997 through June 2002, a period when Mr. Wallace was a lower-level executive.

KLA-Tencor has said it intends to cancel improper options held by former CEO Kenneth Schroeder, and it will reprice -- without compensatory payment -- improper options held by Ken Levy, its former chairman. Mr. Schroeder, a longtime executive who had taken an advisory role, was fired and Mr. Levy left in the wake of KLA-Tencor backdating revelations last year.

A KLA-Tencor spokeswoman, Kyra Whitten, says the bonuses are being paid to Mr. Wallace and two other officials because the company doesn't want employees not involved with the options trouble to be "adversely impacted." She said the company hasn't yet decided how it will treat backdated options held by nonexecutive employees.

With readjusted prices, most of Mr. Wallace's options are still "in the money" -- meaning their price is below the current market price. But a portion aren't -- meaning they wouldn't be profitable if cashed out. KLA-Tencor will pay Mr. Wallace $84,332.69 for that portion, according to the company's securities filings, meaning Mr. Wallace will be making money from so-called underwater options that otherwise wouldn't yield profit for him at all. The payment is due in January 2008.

The bonuses don't sit well with shareholder activists. "To do this in the context of the outrage over the practice [of backdating] is just shocking," says Ann Yerger, the executive director of the Council of Institutional Investors, who said she was stunned when informed of the payments. "It is a sign that something remains rotten in corporate America with regard to executive pay."

Brian Foley, a compensation consultant in White Plains, N.Y., says, "it seems to me that it [reimbursement] would really stick in one's craw if it goes to the CEO, CFO, general counsel, or anyone who was in the know or should have been in the know."

Mr. Foley adds that the cash payments are "awkward," since it means people get paid for options they haven't yet -- and might never -- exercise.

At Affiliated Computer Services Inc., a Dallas outsourcer that last year ousted two top executives because of extensive backdating, several of those who remain are in line for special bonuses to compensate them for the loss of value on their wrongly dated grants. At the top of the list: Chairman Darwin Deason, who was head of the company's compensation committee and CEO for much of time when backdating occurred. Mr. Deason, who founded ACS and holds more than $400 million of company stock, will get a payment of $650,000, according to an ACS securities filing.

Michael Buckley, a spokesman for ACS, said Mr. Deason isn't being treated differently than any other employee.

Another ACS executive, Thomas Burlin, will get just over $100,000 thanks to the repricing of a misdated option grant that is presently out-of-the-money. Mr. Burlin's options aren't worth anything at ACS's current stock price.

Meanwhile, Fossil Inc. has said seven officers of the clothing-and-accessories maker could be up for a "cash bonus" if their options were repriced. And microchip maker Broadcom Corp. said a top sales executive may be up for a "special" payment of $525,870 next January to compensate him for lost option value.

Top executives of Sonus Networks Inc., a Massachusetts-based telecommunications-equipment maker, also may have a payday coming. The company has said it likely will reprice wrongly dated options, though it hasn't yet done so. Sonus says in a filing that upon repricing, it intends to pay certain executives and directors for any lost value.

Sonus's chairman and CEO, Hassan Ahmed, has some four million options covered by the payout agreement -- including one grant of 640,000 shares that is deeply under water. It now carries a grant date of April 3, 2001, with an exercise price of $13.875.

The stock was near a sharp low on that date, meaning a new price from a date even couple of days later would shrink Mr. Ahmed's potential profit. If the option is repriced to April 5, for example, the exercise price would change to $17.875 -- and Mr. Ahmed would be in line for a special payment of $2.6 million for an option that is otherwise very far from being profitable. (Sonus shares currently trade at $7.20.)

"All this really is is acknowledging a previous commitment" to grant an option at the originally agreed price, said Charlie Gray, Sonus's general counsel. He said Sonus hasn't determined whether the April 2001 grant carried an incorrect price, and he added that the company might seek to renegotiate the payment agreement in cases where the grant is well out of the money. He said Sonus's audit committee examined the granting practices and concluded that no current member of management, including Mr. Ahmed, did anything wrong.

The recent disclosures about the repricings come in large part thanks to a provision of Section 409A of the federal tax code. Section 409A slaps a 20% excise tax, along with other penalties, on certain "discount" stock options whose exercise price is below the level of the stock on the day the option was granted. Options backdated to a day with a low price are a type of discount option. By agreeing to reprice the options, an executive is saved from the big tax bill.

Executives who already have exercised backdated options may have to pay a penalty tax. But at least one company, j2 Global Communications Inc., a Los Angeles seller of telecom services, is relieving that burden. In a filing, the company says it "anticipates resolving the matter directly with the Internal Revenue Service on behalf of all such holders, including making any payments that are required." In addition to paying its executives' taxes, j2 Global also is offering a "compensating payment" to several because of repriced options. The company says in its filing that it had used "incorrect measurement dates" for some options but that "no willful backdating took place."

The bulk of companies that have admitted to options problems aren't being nearly so generous.

Every director and executive officer of chip maker Actel Corp. of Mountain View, Calif., for instance, will have wrongly dated options repriced with no reimbursement. Stephen Hemsley, who replaced William McGuire as CEO of UnitedHealth Group Inc. after Dr. McGuire's options-fueled ouster, is surrendering about $190 million in value, though the Minnetonka, Minn., insurer said it believes Mr. Hemsley did nothing wrong. (Dr. McGuire is forfeiting $200 million.) Boston Communications Group Inc. of Bedford, Mass., said in a filing that 13 current or former executives or directors are surrendering outright a total of more than 410,000 wrongly dated options, without compensation.

Write to Charles Forelle at charles.forelle@wsj.com1

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