Stock Option Woes Widen

CNET will restate three years' worth of earnings, and Take-Two's grant practices have drawn SEC scrutiny. The difference? Investors' response

Fallout over the way companies reward executives with stock options spread further across the tech landscape on July 10. Media publisher CNET Networks (CNET) said it would restate results for 2003, 2004, and 2005 to account for a practice of allowing employees to buy stock at monthly lows. Take-Two Interactive Software (TTWO), maker of the Grand Theft Auto game series, said the U.S. Securities & Exchange Commission had begun an investigation of its stock option grants.

The announcements are further evidence of heightened scrutiny of what had become standard operating compensation procedure for technology companies in recent years. In the case of at least 60 companies, regulators or corporate directors are probing instances of possible backdating of options, where the timing of an options grant is changed to coincide with a trough in the stock price. The practice lets employees own stock that's virtually guaranteed to increase in value, calling into question whether a company is providing incentives for employees to work hard (see, 6/2/06, "A Primer on the Option-Grant Scandal").

But there's a divergence in the way investors are responding to the option grant mess at each company. By the end of the trading day, CNET's shares rose about 3%. By contrast, Take-Two shares dropped 7.5%. At least for now, investors are refraining from hammering companies they perceive as tackling the matter head-on. "Here we have a board saying we are going to have to restate earnings for these years, and then we are going to move forward," Beth Young, a senior research associate at The Corporate Library, says of CNET.

Some analysts also gave Apple (APPL) the benefit of the doubt after it said on June 29 that it had found "irregularities" related to certain stock options and that it had alerted the SEC (see, 6/29/06, "Apple's 'Irregular' Options"). "We view Apple's actions to take the matter seriously, work with the SEC, and hire an independent counsel to investigate further as positive and the appropriate response," Standard & Poor's analyst Megan Graham-Hackett wrote in a June 30 note.


  There's also a sense CNET may be putting the worst of the matter behind it, says Safa Rashtchy, an analyst at Piper Jaffray. "In a way, [investors] are saying that this is the worst of it, I suppose," he says. The company's stock took a hit, falling 2.8%, after the news broke that it had been subpoenaed by the grand jury for the U.S. Attorney of the Northern District of California related to stock options. "The market is going to move at the first bit of news," said Ann Yerger, executive director of the Council of Institutional Investors.

Take-Two's announcement is the latest in a string of disclosures that have shaken investors' confidence in the company's management. The software maker is already being investigated by the New York County District Attorney's office regarding a hidden sex scene in its video game Grand Theft Auto: San Andreas, as well as a host of other accounting matters (see, 6/28/06, "Take-Two Takes More Lumps"). The DA probe was announced just weeks after Take-Two reached a settlement with the Federal Trade Commission on charges arising from the matter, and it followed a $7.5 million settlement of a separate SEC investigation.

"I think what you are finding is investors are responding to restatements based on whether or not they have faith in the long-term sustainability of the firm and whether they can trust the firm in general," says Laura Hartman, professor of business ethics at DePaul University's College of Commerce. "The investment community is responding to firms…saying 'Now I can trust you into the future because you have been honest with me today,' or 'Now I can't trust you with anything.'"

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