In The Valley, Scars That Could Last A Long Time

In Silicon Valley, stock options are the coin of the realm, used to seal the deal with prized recruits and say ``thanks'' to executives for a boffo year. But lately options fever has a new meaning in the Valley. Not a day seems to pass without an announcement that a company has dug up options bookkeeping misdeeds and is firing top executives and restating financials.

So far, 18 executives, at companies such as online publisher CNET Networks and software maker McAfee Inc. (MFE ), have been ousted. Former executives at Apple Corp. and chipmaker Altera Corp. (ALTR ) have been implicated. And the party is just getting started: Over 40 Valley companies face government scrutiny. ``More and more companies are trying to work with the authorities and get out ahead of this,'' says Joe A. Grundfest, a former commissioner at the Securities & Exchange Commission who is now director of the Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford University.

Yet even when the backdating wave recedes, it may leave long-lasting scars. This is the first time tech companies have faced such a broad-based threat of prosecution. On the plus side, boards are paying far closer attention to the details of corporate governance. Even minor transgressions that once might have been excused in the cause of doing business the fast-paced Valley way are no longer acceptable. But many techies worry that directors are spending more time staying out of trouble than finding the Next Big Thing. ``The level of anxiety is way higher, and people are getting paranoid about everything,'' says Joseph B. Costello, a software vet who sits on three boards. ``My fear is that Silicon Valley is like a beautiful racing yacht that has just accumulated a big pile of barnacles...that will slow down the pace of innovation.''

The purge began after news reports showed that many companies seemed to have cherry-picked dates when stock prices were low to grant options and ensure the biggest payoff -- without reflecting these ``in-the-money'' grants as expenses, as required by accounting rules. When federal regulators and law enforcement agencies stepped in, many boards launched their own probes. Now, results in hand, they are rushing to crack down before the feds do it for them.

Once a special board committee is set up to investigate the books, companies are in many ways governed by outside experts who step in. Executives may have to hand over their computer hard drives, while lawyers and forensic accountants search through crates of old paperwork and interview underlings. What starts out as an options probe can broaden if the hired experts come to doubt management's integrity in other areas. That happened at Mercury Interactive Corp. (MERQ ), where Costello has been a director since early this year. Mercury fired its former CEO and CFO after an investigation turned up 49 instances of backdating. The SEC is considering bringing charges against three long-standing directors. But Costello figures that more than two-thirds of the $70 million spent on outside investigators went to make sure Mercury was properly booking its sales, paying commissions, and examining other non-options-related issues.

A complaint that's often heard, sotto voce, in the Valley is that the crackdown has tumbled out of proportion. Executives and experts alike note that most backdating was done by fast-growing young companies desperate to hire and retain top talent and lacking in the internal processes to properly account for options granted below the stock price on a given day. ``A lot of good companies are being run through the wringer,'' says the CEO of a company that restated earnings.

But others say that smacks of rationalization. Willem P. Roelandts, CEO of chipmaker Xilinx Inc., says he is dismayed by peers who argue they didn't realize backdating was illegal. ``I'm sorry, but I don't buy that -- because we knew it wasn't right, and we didn't do it.'' Xilinx spent a ``few million'' on an investigation this summer; it uncovered only small administrative problems, no fraud. Says Roelandts: ``It was a waste of money, but we had to do it to clear our name.''

By Peter Burrows

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