Feb. 23 (Bloomberg) -- KB Home, the fifth-largest U.S. homebuilder, is under criminal investigation by federal prosecutors over stock-options backdating that led to the resignation of the company's chief executive officer, people familiar with the matter said.

The investigation is being conducted by the U.S. Attorney's Office in Los Angeles, the people said. Los Angeles-based KB Home has said former CEO Bruce Karatz and ex-human resources chief Gary Ray used ``hindsight'' to ensure favorable exercise prices. Karatz resigned in November and Ray was fired.

KB Home, which is also being investigated by securities regulators, joins more than 50 other companies, including Apple Inc., that face federal criminal probes in the widening options scandal, according to data compiled by Bloomberg.

``The U.S. attorney doesn't get involved unless it's a very egregious situation,'' said Jason Lee, a San Francisco attorney who worked for the Securities and Exchange Commission's enforcement division. ``They are looking at whether there's evidence that individual executives went out to accrue benefits for themselves at the expense of shareholders.''

Backdating options can involve criminal conduct if executives intentionally misled regulators or investors by falsifying documents, hiding backdating from auditors or other deceptive practices.

KB Home Associate General Counsel David Simons declined to comment. Assistant U.S. Attorney Alex Bustamante in Los Angeles also declined to comment.

`Bump in the Road'

Billionaire Eli Broad, co-founder and former chief executive of Kaufman & Broad Inc., which became KB Home, said the company would get past its backdating issues.

``This is a bump in the road they'll get over,'' Broad told Bloomberg Television today. Broad, 73, who founded Kaufman & Broad with Don Kaufman in 1957, said he is no longer involved in the company.

More than 200 companies have disclosed federal or internal probes into misdated options. The investigations have led to earnings restatements exceeding $9.5 billion to account for the additional costs, according to Bloomberg data. More than 75 executives have resigned or been fired over options manipulation.

John Keker, an attorney for Karatz who represented former Credit Suisse Group banker Frank Quattrone in an obstruction-of justice case that prosecutors agreed to drop, declined to comment. A working phone number for Gary Ray couldn't immediately be located.

Obstruction of Justice

``The thing prosecutors are likely to focus on is evidence of obstruction of justice,'' said Bruce Vanyo, a lawyer with KattenMuchinRosenman in Los Angeles. ``The cases where there's some indication that entries have been falsified are the ones that attract the attention of the justice department.''

Stock options allow holders to buy shares at a later date, usually at the market price the day they were granted. Backdating options to days with low prices inflates their value, allowing holders to profit by purchasing stock at a lower price and selling it at higher one.

If not properly disclosed, the practice may break laws because it hides costs from shareholders and regulators.

Backdating History

KB Home last week reported its first quarterly loss in about a decade after incurring $343 million in expenses to write down land and abandon property contracts. The fourth-quarter net loss was $49.6 million, or 64 cents a share, compared with net income of $304.4 million, or $3.44 a share, a year earlier.

KB Home shares fell 96 cents or almost 2 percent, to $51.60 in New York Stock Exchange composite trading. They have fallen 26 percent in the past year, valuing the company at $4.6 billion.

``The stock has absorbed pretty much the whole story,'' said James F. Wilson, an analyst at JMP Securities in San Francisco who has a ``market outperform'' rating on KB Home shares and doesn't own them.

KB Home said in a regulatory filing Feb. 13 that an internal review showed ``hindsight was used to secure favorable exercise prices'' in several years since 1998, including in 1999, 2000 and 2001, when awards were dated to coincide with the lowest closing stock price during the month they were granted. Stock-based compensation expenses were understated by $36.3 million from 1999 to 2005, according to the filing.

No Safeguards

Karatz, who became CEO in 1986, and Ray picked the dates for grants to themselves and other senior executives and employees, KB Home said in the filing. Current senior management wasn't involved, and the company lacked safeguards to monitor how Karatz and Ray were selecting dates, KB Home said.

Stock-based compensation and the related impact of income tax reduced KB Home's net income by $41.1 million for 1999 through 2005, according to the filing.

KB Home said Jan. 26 that an SEC inquiry begun in August had become a formal civil investigation. That means the Washington- based agency may subpoena documents and compel testimony because it believes it's likely there was a violation of its rules. KB Home said it was cooperating with the investigation.

Karatz agreed to repay $13 million to cover gains on options he shouldn't have received, KB Home said when he left. Karatz received $43 million including option grants in 2005, making him the highest-paid homebuilding executive in the U.S. that year.

To contact the reporters about this story: Karen Gullo in San Francisco at kgullo@bloomberg.net and Edvard Pettersson in Los Angeles at epettersson@bloomberg.net

Last Updated: February 23, 2007 16:06 EST