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Union Urges Auditors to Dig Deeper for Exec Options Excesses

August 28, 2007
The AFL-CIO wants auditors to step up their reviews of corporate books and records in order to curb illegal stock option backdating.

In letters to the Big Four accounting firms, AFL-CIO treasurer Richard Trumka said independent auditors should dig deeper into corporate disclosures and stock option practices from the past five years—especially during the months surrounding passage of the Sarbanes-Oxley Act, which tightened disclosure rules for backdating.

Backdating and spring-loading—in which stock option grants are made before good news or after bad news—occurs mainly because the grants are made between senior management and the board of directors without any counter-party oversight, Trumka wrote.

“We are especially concerned because stock option abuses appear to have been endemic at U.S. corporations,” including Apple and UnitedHealthcare, Trumka wrote. “In order to properly deal with the manipulation of stock option grants, independent auditors need far broader access to senior management and the board of directors than they have typically been granted.”

Calls to the accounting firms—Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers—were not returned.

The union, which has met with accounting firms recently over the issue, suggested that auditors go back through old filings to search for illegal backdating, including filings 34 days before and 48 hours after Sarbanes-Oxley was enacted in 2002.

Trumka also suggested that auditors examine equity award plan documents and board minutes, including minutes from a company’s compensation committee meetings. Companies that have granted an “inordinately large” amount of stock options, especially to the CEO or senior executives, should warrant extra attention, he wrote. Companies that granted options during stock “blackout” periods and immediately preceding significant increase in stock price should be vetted heavily, he added.

The letters are a shot across the bow to corporations.

“It’s something [shareholders and union members] have already lost hundreds of millions of dollars on,” said Dan Pedrotty, director of the AFL-CIO office of investment, adding that auditors can face difficulties from stonewalling boards of directors and their law firms. “There are ways [to catch backdating] if auditors are more aggressive.”

More than 200 companies are reportedly being investigated by the Securities and Exchange Commission and the Department of Justice for alleged backdating. The stakes for top executives rose significantly this month when former Brocade CEO Gregory Reyes was convicted on 10 counts of fraud related to backdating, record manipulation and conspiracy. Mr. Reyes’ sentencing is scheduled for November.

Some research suggests that roughly 2,000 companies may have engaged in backdating, but have either not reported it or have not been snagged by the federal sweep into backdating and spring-loading.

The Delaware Chancery Court ruled earlier this year that companies could not rely on statutes of limitations to avoid shareholder lawsuits over backdating if the backdating was concealed from shareholders to begin with. Furthermore, the court’s rulings stated that intentional stock option backdating is a violation of a board director’s duty, and that directors are not granted liability immunity in such cases.

Filed by Nicholas Rummell of Financial Week, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.