It's not often that a mild-mannered finance professor can prompt one of the most widespread investigations into allegations of corporate wrongdoing in U.S. history. But Erik Lie at the University of Iowa has managed to do just that.
The 38-year-old professor's research into the backdating of stock options has prompted the Securities and Exchange Commission to investigate stock option granting practices at roughly 140 companies. Some executives have been dismissed and a couple have even pleaded guilty to criminal charges. In addition to working with the SEC, Prof. Lie has testified before the U.S. Congress on the issue and acted as a consultant on several shareholder lawsuits, including one filed against Research In Motion Ltd.
“At this point I am surprised,” Prof. Lie said Monday from his office in Iowa City when asked about the reaction to his work. “I think any researcher is hoping that his or her research will have some impact. So, yeah, I am very happy to have seen that kind of an impact.”
Prof. Lie said he stumbled across the issue of backdating a few years ago when he was looking into stock options in general. At first, he was examining how stock options were granted and whether that had any impact on company decision making. “Particularly with regard to payout policy, capital structure and all that kind of stuff,” he said.
That work led him to start looking at the return patterns at some companies. In many cases, he noted, options were granted at remarkably opportune times for the recipients.
Normally options are granted at the price of the company's stock that day.
That means the options only have value if the share price climbs in the future. Many companies don't allow executives to cash out options right away, often making them wait several years.
Companies involved in backdating look back and choose a date when their share price was low, then price the options as if they were granted on that date. That makes the options far more valuable to the recipient, and the practice can be illegal if it is not disclosed properly.
“In he beginning, I was just looking, looking, looking and coming up with one hypothesis after another, and finally it got down to the backdating possibility,” Prof. Lie said Monday.
In May, 2005, he published a paper summarizing his findings, which showed a pattern of remarkably well-timed option grants across dozens of U.S. companies. He concluded that the grants could not have been mere chance, but that some kind of manipulation was occurring.
Prof. Lie also found a striking pattern of stocks dropping sharply just before the date of option grants, then rising immediately afterward. A second study with his colleague Randall Heron of Indiana University's business school found that the pattern virtually ended in 2002 when U.S. regulators introduced stiffer reporting requirements for stock options.
No one took much notice of the papers until a small California company faced allegations of backdating. After The Wall Street Journal ran a story on that case, Prof. Lie called up the paper and said: “There's a lot more there if you are looking for it.” Within months, the Journal ran several stories on the issue and before long the SEC had launched dozens of probes.
Prof. Lie has become involved in many cases including a lawsuit against RIM. He recently filed an affidavit in an Ontario court in support of a legal action launched by the Ironworkers Ontario Pension Fund, which owns 13,200 RIM shares. In it, he concluded that based on his review of RIM's stock option granting practices, “I believe that backdating has taken place here.”
Jim Balsillie, RIM's co-chief executive, acknowledged Monday that backdating had occurred at the company, but insisted it was not intentional and that the company had followed procedures it thought were correct based on outside advice. RIM is taking all appropriate steps to improve its corporate governance structure and option granting process, he added.
So far, RIM is the only major Canadian-based company to be ensnared in the backdating issue.
Neil Brisley, an accounting professor at the University of Western Ontario researching option backdating, said Canadian regulators have been slower than U.S. regulators to uncover the problem. U.S. regulators were guided to backdating cases in part by extensive academic research and media reports.
“I think the [Canadian] authorities have preferred to be forward-looking rather than backward-looking. The authorities are now closing the stable door, and saying, ‘Just make sure your house is in order going forward, and we will react to any tip-offs or information we get on the past.' But I think the authorities don't really have the resources to discover in a systematic way if this has been happening.”
Prof. Lie declined to comment on the RIM case Monday, but he said he believes the Canadian reporting rules, which have been tighter for several years, may mean there is less of a problem in this country.
“Having just glanced at some of the studies in Canada, it doesn't look like it was a pronounced as U.S. companies,” he said.
Prof. Lie added that while he is still working on some backdating cases, he has moved on. “It has started to heat up in terms of competition; too many people working on it. I feel like I've done my share.”
As for his own growing media profile, Prof. Lie laughed and said he still works out of the same small university office. “There are two worlds out there. One is sort of the narrow financial world and then we have the rest of the world, and very few people know about the financial world. So, you know, when I'm here in Iowa City, no one knows who I am,” he said.
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