Peregrine Options Prosecution May Preview SEC, Criminal Cases
July 17 (Bloomberg) -- U.S. regulators first cracked down on stock-option backdating three years ago in a case that shows how government prosecutors may attack abusive pay practices now under investigation at more than 50 companies.
The Securities and Exchange Commission said in a 2003 lawsuit that San Diego-based Peregrine Systems Inc. committed fraud when the software maker awarded executives stock options and pretended they were granted on the day the company's stock touched its lowest price for the quarter. Since at least March, federal officials have been looking for evidence that companies from Apple Computer Inc. to Home Depot Inc. manipulated the dates of option grants to boost officers' pay.
Regulators this week plan to file criminal charges in the first enforcement case to emerge from the current options scandal, two people with direct knowledge of the matter said. At least 12 more cases probably will follow, said the people, who asked not to be identified because the probes aren't public.
``We are now starting to see that backdating was much more widespread than anybody had any previous indication,'' said Harvey Pitt, chief executive officer of Kalorama Partners LLC, a Washington consulting firm, and the SEC's chairman from August 2001 to February 2003. The Peregrine suit ``buttresses the observation that this conduct is neither new nor unique, nor uncovered by existing securities laws.''
More than 2,200 U.S. companies may have tampered with the timing of executive stock-option grants between 1996 and 2005, according to a study by researchers who helped set off the current wave of federal investigations.
Backdating Detailed
The study found 23 percent of all grants made from 1996 to August 2002, were at low share prices. The authors, Randall Heron at the Kelley School of Business at Indiana University and Erik Lie of the Henry B. Tippie College of Business at the University of Iowa, used the latter date as a cutoff because that's when the SEC tightened reporting rules for option grants.
The Peregrine complaint, filed in San Diego federal court in June 2003, details how a company backdated options.
Peregrine's directors approved stock-option grants at each quarterly board meeting. Instead of pricing the options on the day of the grant, meaning they couldn't be redeemed at a profit until after the stock appreciated, Peregrine waited until after the next board meeting.
The company's stock administrator then ``looked back at the market price of Peregrine's stock between the two quarterly board meetings, to find the lowest price at which Peregrine's stock had traded,'' the SEC said in its suit.
`Massive Fraud'
That's where Peregrine set the strike, or exercise, price of the options. The company failed to account for the ``positive difference in the stock price'' as a compensation cost and so understated expenses by about $90 million, according to the SEC.
At Peregrine, backdating was part of what the SEC alleged was a ``massive financial fraud'' that included inflating revenue and selling false invoices to banks. The stock-option violations are listed in a section of the SEC's 15-page complaint, and the agency didn't mention them in the statement it released on the Peregrine fraud.
``Given the train wreck Peregrine became, backdating was the least of their worries,'' said Thomas McNamara, a San Diego attorney who represented the software company. ``Now backdating is the crime du jour.''
The current probe into stock-option manipulation includes some of America's best-known companies, such as Cupertino, California-based Apple, maker of the iPod digital-music player, Atlanta's Home Depot, the world's biggest home-improvement retailer, and UnitedHealth Group Inc., the No. 2 U.S. health insurer, in Minnetonka, Minnesota.
SEC, Justice Department
Companies including software maker Mercury Interactive Corp., of Mountain View, California, and San Francisco-based Cnet Networks Inc., an online publisher of technology news and reviews, determined they granted options at below-market prices and didn't account for them properly. The crackdown has cost the jobs of at least 19 corporate officials, among them four chief executive officers.
In the enforcement action that may come as early as this week, the SEC probably will file a civil case in tandem with criminal charges by the Justice Department, the people familiar with the matter said.
Unlike the current investigation, the Peregrine case centered on widespread abuses of revenue-recognition rules in the software industry, Debra Patalkis, the SEC's lead trial lawyer in the 2003 case, said in an interview. Peregrine's auditor at the time, Arthur Andersen LLP, was aware of its option practices, the SEC said in its complaint.
Peregrine's proxy statements show CEO Stephen Gardner received options to purchase 1.2 million shares in April 1998 at the split-adjusted price of $4.56 each, coinciding with the lowest close for the company's stock during the fiscal year ended March 30, 1999.
Auditor Uncovered Fraud
The following year, Peregrine granted Gardner options on 291,750 shares at the lowest closing share prices in three fiscal quarters. At least four other executives also received grants that year priced on days that company shares hit quarterly lows.
Peregrine and new auditor KPMG LLP uncovered the fraud in the first half of 2002, triggering a $509 million reduction in previously reported revenue, at least 44 shareholder lawsuits, a bankruptcy filing in September of that year, and criminal charges against Gardner and 14 others.
Reid Figel, an attorney representing Gardner in his criminal case, didn't return calls seeking comment.
After cooperating with the SEC's subsequent investigation, Peregrine settled with the agency in 2003 without admitting guilt or paying a fine. The company was acquired by Palo Alto, California-based Hewlett-Packard Co. in December 2005.
The Peregrine fraud continues to haunt the perpetrators. Last week, Douglas Powanda, Peregrine's former vice president of worldwide sales, pleaded guilty to conspiracy to commit securities fraud.
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