On The Cusp of a New Phase in Option Backdating

Includes: CLX, MOLX
by: Belvedere

Thinking about the option backdating dust-up (of course), it occurred to me that we may have run through the “shock and awe” phase from around March through the present - “shock and awe” being the effect on investors of the announcement of an investigation being launched by a company’s management, the SEC or the US Attorney General.

(And maybe “shlock and awww” being the reaction of managers whose option grant practices have been sleuthed by outsiders using circumstantial evidence.)

The pace of regulatory investigations seems to have slowed down a bit lately, and investors seem to be pretty tired of talking about the subject. (Anecdotal evidence only, for sure, but it seems there’s more talk on op-ed pages about backdating than actual chatter among investors and analysts.)

What I think we might see happening next is the “steady drone” phase of the option backdating chapter in the annals of accounting’s effects on investing. Yesterday, Molex (NASDAQ:MOLX) reported earnings - and also reported that it had examined its option grants back to 1995 for “misdating.” While the company noted that any adjustment for properly recording compensation would be immaterial, it will be requiring certain officers to repay $685,000 of gains related to misdated options. The company also mentioned that it had informed the SEC of its review.

Separately, Clorox (NYSE:CLX) reported earnings - and also reported a $25 million (pretax) catch-up adjustment for option compensation-related issues. Of the total charge, “$15 million in equity compensation expense related to the determination of the appropriate measurement date for certain stock option grants, of which $2 million relates to certain stock options granted to officers … The remaining $10 million in pretax charges results primarily from the requirement to use variable (i.e., mark to market) accounting with respect to certain options granted to officers due to existence of documented approval of the options within six months of the repurchase in 2001 of stock options from the same officers.”

What else do these two companies have in common besides releasing earnings and news about option dating issues on the same day? Just this: prior to yesterday, neither of them were in the news for their own investigation of “misdated” options (I think a new buzzword is developing, too) or for being in the crosshairs of a regulator looking for the same. Their announcements are the result of their own investigations conducted without the world looking over their shoulders.

Note that yesterday’s post about the GAO’s restatement study showed that the majority of restatements were initiated by the restaters themselves. Also recall the post about the PCAOB’s “audit alert” regarding backdating: auditors are now more sensitive about backdating issues that may have existed in previous audits and may prod some restatements, too. So we might be heading for the “steady drone” period, where companies are doing their own overdue homework and releasing news of catch-up adjustment after catch-up adjustment. Or restatement after restatement. If companies are really looking inward, they may not have gotten their self-exams under way until after a substantial number of other companies’ subpoenas/investigations were in the news. For instance, Clorox said their investigation began in June. So, the drone might get pretty loud in the third quarter earnings season.