The Stock Option Scam

    See, i just can't tear myself away from keeping you'all informed...I read this article several times yesterday and managed to keep from posting, so i could keep a promise to myself to finish a pile of other work...but...I digress.

    Yesterday's Wall Street Journal had an amazing article, co-written by Mark Maremont, who I worked with some years ago at Business Week (yes, I toiled away in the belly of the capitalist publishing beast...it beat unemployment). Maremont and his co-writer Charles Forelle wrote a very long article digging into the abuse of stock options. Because this piece is for subscribers only, I'll try to give you a flavor:

Eugene Isenberg is the little-known chief executive of a modest-sized oil-services company in Houston. But he stands out in one way: He is among the highest-paid corporate executives in history. In the past 19 years, he has pocketed more than $450 million.

The key to this wealth: stock options, in abundance. His employer, Nabors Industries Ltd., has lavished more than 25 million options on him over the years.

They became lucrative partly because of Nabors's generally rising stock price, but also because of some controversial moves that gave the options more punch. When Nabors's stock fell below the price at which the options could be exercised, temporarily making them worthless, Nabors let him trade in some of his options for new ones with lower exercise prices. And when Mr. Isenberg cashed some options in, Nabors "reloaded" him, replacing those he'd exercised with the same number of new ones.

Stock options were hailed two decades ago as a remedy for runaway executive pay. Academics, politicians and investors, tired of seeing CEOs pocket big money for a so-so job, pushed to have stock options become a primary method of compensating executives. Options -- granting the right to buy stock tomorrow at today's price -- would pay off only if the company's stock went up. To advocates they were the ideal carrot, an incentive for good work that aligned executives' interests with those of shareholders.

That happened -- sometimes. But at many companies, options morphed into the biggest executive bonanza yet, pouring out cash like a stuck ATM, and sorely disappointing those who thought options would moderate executive pay.

Instead of replacing big bonuses, options became an additional form of pay slathered on top of already-generous packages. Employers doled out options in ever-growing numbers, in part because, until recently, accounting rules meant companies didn't have to treat this largess to executives as an expense. And like Nabors, some used repricing, reloading and other tactics that made it even easier for executives to score huge hauls.

    Essentially, Isenberg and others gamed the system.

    There is a chart that goes along with the article that is truly mindboggling (if you click on the chart, you can get a bigger, more readable, version). It looks at the 25 executives who cashed in the highest profits in stock options from 1992-2005. Some of them are recognizable names like Oracle's Larry Ellison and Dell's Michael Dell. But, others are probably people you never heard of like Dwight Shar of NVR and William Greehey of Valero Energy. What all these people have in common is a complaint board of directors willing to shower these executives with compensation without question. Here's some more perspective from the Journal's writers:

The backdating scandal at scores of companies shows one way stock options, once seen as an executive-pay reform, have often been distorted by corporate officials and their consultants. Nell Minow, a longtime corporate-governance advocate, calls backdating "just another in an endless and unstoppable series of mechanisms to subvert the purpose of stock options." A vocal proponent of options in the early 1990s, Ms. Minow now regrets that stance. "Options became completely disconnected from shareholder interests," she says. "I grossly underestimated the capacity of corporate boards and corporate managers to circumvent the principles we established."

From 1992 to 2001, the average value of option grants to CEOs of S&P 500 companies soared nearly tenfold, according to data compiled by Kevin J. Murphy of the University of Southern California. The result was that options, which in 1992 made up less than a quarter of the average CEO's pay, by 2001 provided more than half of pay packages -- packages that were much larger. Companies have started doling out fewer options in the past few years, but grants remain far more generous than a decade ago.

In 1985, Miami financier Victor Posner pulled down $12.7 million, putting him atop lists of best-paid CEOs that year. Last year, 393 executives earned more than that, thanks largely to gains from exercising options, according to Standard & Poor's ExecuComp, which tracks executive pay at about 1,800 public companies. The top 2005 earner was Barry Diller of IAC/InterActiveCorp., with $295 million, nearly all from options.

    So, those top 25 executives in the graphic above pocketed $9.6 billion--just from money reaped from stock options. Twenty-five people.

    In Isenberg's' instance, he benefitted from something called "reloading':

In the late '80s and early '90s, companies found another way to goose stock-option grants: "Reload" them.

Normally, options disappear when exercised. But with a reload plan, a person who exercises options automatically gets replacements. Typically the replacements number fewer than the options exercised. They carry the same expiration date but a different exercise price -- the current market price.

Reload plans are supposed to encourage executives to hold stock in their company, says Mr. Cook, the pay consultant, who invented them. To get a reload, executives exercising options generally must do so not with cash, but with stock. That is, they must hand in existing shares whose value equals the cost of exercising the options. Since executives can't do that unless they own shares, they have an incentive to be shareholders of the company and to hold onto new shares obtained when they exercise options.

Critics decried reloads as abusive, a kind of option replication machine that enriched top managers -- while diluting other stockholders' ownership as the number of shares outstanding rose.

    By giving Isenberg a "reload," and he cashed those in 2000 (reloaded, repriced and repriced) for a nice cool $54 million. There is also a suspicion that the company backdated the options--pricing the options earlier than they really were given, at doing so at a price that was more favorable to the CEO. That would be illegal. The Journal article says that 60 executives and director of public companies have been ousted because of the growing backdating scandal. We will see what happens with Mr. Isenberg.

Comments

[Stephen Diamond]

One thing to keep in mind about stock options: some so-called "progressive" corporate law types, like Nell Minow, supported them! (To her credit, Minow now admits she was wrong.) Options were viewed as a solution of the gap between managerial capitalists and finance capitalists. This was all part of the myth of responsible capitalism that so many on the liberal left propagate. Of course, like all forms of fictitious capital options instead opened up new opportunities for manipulation and abuse by insiders of "other people's money" - largely the retirement assets of America's workers.

[Jack Payne]

Reloading is hard to understand. Couldn't the inventors of this abhorrent practice see, in the beginning, all of the horrors that would result from this? Backdating is invited, and apparently, got out of hand.

On the other hand the hi-tech boom of the 1990s created another type of scam, the rollover into brokerage accaunts in preference to cash-outs.

Which came first? The cart or the horse? Chicken or the egg?
Sidewinder or the victim of the rattlesnake bite?

--Jack Payne

[jim byrnes]

unentitled entitlement, poor excuses for the human race......

[Credit Repair Services]

reloading and other tactics that made it even easier for executives to score huge hauls,very useful information.

[credit repair company]

Thanks for the info. Anyone can repair their own credit, but some people like to have a professional do the work for them.

[Dave]

I work for a company that was bought by Boeing in Sept. 2008. In the years leading up to the purchase stock I was issued in two forms: incentive and performance. I rec'd both - but never got paid some of the performance grants...the award waa linked to performance on a project that was funded with Airforce Research lab money. As it turns out the CEO stated that we were not going to perform only spoon feed the project as it locked up the IP from our competitors - using taxpayer dollars to create a competitive advantage...in the end he cnacelled my options without any notice - yet gave friends and family large amounts of free stock in the days leading up to the buy out...and some friends and family had their performance goals changed so they could realize all of their individual awards. Without giving too nuch more detail - who do I contact to see these guys fry? I have all of the e-mail trails to prove the point!!!