Senator Charles Grassley (R-Iowa) is targeting “all the actors” involved in stock options backdating scandals. That includes accountants, lawyers, and compensation consultants who advised executives to backdate options, and board members who “blessed [backdating] or looked the other way.”
The senator made his remarks at the close of a Senate Finance Committee hearing on executive compensation, held on Wednesday. Grassley, who chairs the committee, said he intends to write to several major corporations involved in backdating investigations to obtain board minutes regarding the decision to backdate options, “as well as any and all material from advisors . . . who assisted in these efforts.” He stopped short of calling his letter writing campaign an official congressional probe, but did add that he aims to “bring enforcement action against all the actors who were involved with this abusive scandal.”
Grassley had questioned witnesses about whether a cottage industry had emerged during the tech boom to provide the questionable advice about backdating, similar to the way promoters and designers of illegal tax shelters bubbled up in the 1980s and 1990s. But witnesses, including Linda Thomsen, the director of the Securities and Exchange Commission’s Enforcement Division, and Paul McNulty, Deputy Attorney General at the Department of Justice, said the collusion among executives and board members to backdate options was usually done within a small internal group of individuals.
Backdating has largely remained an internal process, said Thomsen, because it is much less complicated than, say, drawing up tax shelter transactions, which requires extensive participation by legal and tax advisors.
Still, Thomsen pointed out that backdating scandals have already moved beyond just the CEO and CFO. Indeed, she noted that in one of the two backdating cases being prosecuted as a criminal offense, an internal attorney was charged. On August 9, the SEC and DOJ announced civil and criminal charges against three former executives from Comverse Technologies. The former CEO and CFO were charged, as well as William Sorin, Comverse’s former general and senior general counsel.
Another witness, governance advocate Nell Minow of The Corporate Library, emphasized that while backdating is a symptom of poor governance, the underlying problem is a “pay-for-pulse” compensation system supported by a 1993 tax rule that, while well intended, is broken.
“Movie stars, athletes, and rock stars are paid-for performance,” asserted Minow, who notes that Tom Cruise’s financial cut of a movie decreases when ticket sales sink. Yet, in the most egregious cases, corporate executives receive bonuses for “just showing up” to work. That’s because, argues Minow, executive pay packages are approved by management-controlled boards.
In addition, Minow — and every other witness, including IRS Commissioner Mark Everson and several academics — as well as Grassley and ranking committee Democrat Max Baucus (Montana), pointed to Section 162(m) of the tax code as responsible for spawning the backdating boom. Federal tax code Section 162(m), which went into effect in 1993, limits the tax deductibility of the pay awarded to certain top executives to $1 million. The cap doesn’t apply to stock options and other performance-based compensation.
One remedy, which may not be politically practical, but is on Minow’s governance wish list, is to deny the compensation tax deduction unless the company adopts a majority voting provision. That way, shareholders would have the power to vote out directors that award pay packages that hurt investors. Another, more practical cure, says Minow, is to tie pay to specific company performance, rather than stock market movement.