Options Backdating is the New Overhang

By Dr. Duru written for One-Twenty

May 23, 2006

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Yesterday, I provided examples of cases where a general sell-off and/or bad news in a stock did generate a "buy on the despair" reaction from me. Each case involved alleged or essentially proven backdating of options - a method companies can use to generate out-sized financial rewards to management by retroactively timing the issuance of stock options. As I watch more and more headlines roll out the now familiar and terrifying refrain - "SEC informal inquiry" - about potential backdating of options, I am realizing that the stock market, and technology stocks in particular, will have a hard time lifting above all the other bad news that the market has suddenly chosen to care about. And I know I still cannot buy on most of this news. No sooner does the fraud balloon get lifted over the sweating head of another company, analysts and executives alike beat a warpath to the PR desk and Wall Street announcing that "there is nothing to see here folks! Please, move along." This scramble to reassure us is understandable. This growing scandal reminds us of the time soon after 9/11 when we not only had to deal with our fear of terrorism, but we also sat shell-shocked and aghast as we heard a litany of offenses and fradulent behavior being uncovered from the fog of the burst tech bubble. Imagine, there went our sons and daughters, mothers and fathers, marching off to Aghanistan and Iraq while back home, folks were looting the candy store and making loose with the rules of proper conduct and ethics in the boardroom. Now, we still have Afghanistan and Iraq, but we hate the President, think the economy stinks just as much as it did during the brief recession, and we are selling commodity stocks because we fear inflation. We thought we had heard the worst of the bad behavior during the mutual fund "backdating" fraud, but it seems Wall Street always has room for another creative scam.

Given that technology companies are particulary dependent on compensating employees with stock options, it now makes sense that the NASDAQ should lag the rest of the market so markedly. I will also submit to you that until some of these allegations start getting officially cleared up, technology stocks will continue to have a rough go of it. Who wants to buy a speculative technology stock when you might wake up one morning to find out the board of directors has been permitting the company's executives to enhance their compensation through fraud? And we have seen several cases where companies have admitted they will have to restate earnings going back as far as three years. And who knows what they will uncover once they go back three years?! The burst bubble perhaps continues to ripple through our collective monetary veins.

Note well. This is not to say that all hope is lost. You know from the way I started this year, I will never sink that low. It IS to say that the news flow has become thick with negativity, and you will be hard-pressed to swim against it right now. You can try to share all the faith, hope, and optimism that the defenders of accused backdaters seem to readily display, but if the stock keeps selling off, you might as well wait until the fresh cash turns tail and runs off into the sunset on the back of some "too little, too late" downgrades. I also cannot say that I will stay on top of the situation closely enough to generate some potential buying opportunities, so I encourage you to do your homework. I remain a "reluctant bull" on Google, and I figure they have not been a public copmany long enough to pull off backdating of options...right? Right. And the insiders have been too busy cashing in on options owned before going IPO to worry about timing new option grants during the few dips Google has had since then. Right? Right. In the meantime, I sure see a lot of potential shorts out there that just need a little lift first...

Be careful out there...!

DrDuru, 2006