By Falsifying Stock Sale Dates, They Earned Up to 20 Million Dollars

Between 200 and 250 companies, including Apple, are suspected of having bought the loyalty of their management structures through stock falsification over the past five to six years. It is believed that this practice has gradually developed since the 1950s.

Written by: Vinka Drezga

American economics professors Randall Heron and Erik Lie have overnight become the most hated names in American business circles. After years of research, they found that some American businessmen falsified their own company’s stocks and pocketed the profits. The forgery consisted of backdating the sale of stock packages to the company’s management establishment. Thanks to seemingly harmless manipulation of the stock sale date to employees within the company, some directors earned up to 20 million dollars additionally. Between 200 and 250 companies are currently suspected of having bought the loyalty of their management structures in this way over the past five to six years. Economic experts believe that the latest research has only confirmed suspicions about a practice that has gradually developed since the 1950s.

The pattern is simple: the company’s board of directors would grant a stock package, the so-called favorable stock option – from several thousand to several hundred thousand and even millions of shares – to their director at a low price of, for example, 10 dollars. Soon after, usually after a month or two, the stock value would rise significantly to, for example, 17 dollars. For a thousand shares, this represents an immediate profit of 7,000 dollars. However, intentional falsification of stock values can have far-reaching negative consequences in the broader business community: the company falsely reduces its expenses and (again falsely) increases its revenues. This, in turn, misrepresents the company’s tax obligations and defrauds the state budget, while misleading investors, as false data leads them to potentially poor investment moves.

Decisions at Non-Existent Meetings

The practice of granting stock options below market value has become particularly popular in recent decades in America. It is intended for all employees, but it was invented specifically for directors. Favorable stocks serve as additional motivation for directors to put in their maximum effort and thus increase the company’s overall profit. More favorable conditions mean that the director buys the stock package at the end of the year, but at the price from April, when it is significantly lower, for example. Such a practice is entirely legal as long as the company regularly reports this to its shareholders and operates transparently. However, the trend of sudden stock value increases in a number of companies, particularly after granting stock options to directors, prompted scientists Heron and Lie, professors at Indiana and Iowa universities, respectively, to suspect the business ethics of certain corporate empires.

Their research showed that the meeting dates of many boards of directors, where stock options were supposedly decided upon, were entirely fabricated. Some directors, after all, later publicly admitted that they received stocks outside of any meetings, i.e., that the meetings where these decisions were supposedly made were falsely recorded in the boards’ agendas. This was acknowledged, for example, by Steve Jobs, one of the directors and founders of the widely known Apple, the computer giant from Silicon Valley. Jobs admitted before the state prosecutor that in December 2001, he was given the opportunity to buy a package of 7.5 million shares of his own company at a below-market price. This decision from late 2001 was attributed to a never-held board meeting from October of the same year. Thanks to this ‘small intervention’, Jobs instantly earned more than 20 million dollars at that time.

An internal investigation, as well as the state prosecutor’s investigation, confirmed several other cases in which Apple falsified data about its stocks. As for Jobs, he emerged from the scandal practically unscathed. Given that he is one of Apple’s founders and that he transformed it into a powerful business empire over time, the company’s management decided not to take any special measures against him. However, due to similar forgeries, three directors of Mercury Interactive lost their jobs two years ago. Their business failure represented a significant blow to the company’s reputation from which Mercury Interactive has not recovered.

Despite Everything – The Old Way

The two mentioned companies are just an illustration of a very widespread practice. The research results, in fact, surprised the authors themselves. The trend of manipulating stock values for internal needs turned out to be far more common than expected; 19 percent of companies have at least once falsely represented the granting of stock options. The value of stocks, on average, increased by seven percent just one month after their sale to directors. At first glance, this may not seem like much, but on a large stock package, they calculated, this implies an average additional profit of several million dollars.

These discoveries were so shocking to the editors of the most prestigious American scientific journals that they all refused to publish the scientific work of Heron and Lie. The editors’ reactions were almost the same: ‘Why hasn’t this been published somewhere already?’ Discouraged by such a reception from the academic community, the scientific duo decided to offer their material to the Wall Street Journal. The editors there eagerly accepted their thesis with only one question about how many companies are engaged in this date manipulation. Since journalists could not discover this themselves, Heron and Lie taught them how to read annual business reports and what to pay special attention to. The academic-journalistic collaboration led to the publication of a series of journalistic articles about stock manipulations, which in turn prompted internal investigations in many companies.

Many directors fear for their positions. Soon, two more Apple directors could find themselves in court. Although regulations have since been enacted to prevent similar manipulations, Heron and Lie stated that many companies continue to operate the old way. Until recently, companies were only required to compile a report on the granting of stock options at the end of the year. Recently, however, the law mandates that companies must document the granting of these favorable stock packages within two days. However, few companies adhere to this regulation. And there are no additional measures to compel them to do so. The legislator, in fact, does not want to put too much pressure on the corporate sector, as excessive state interference in the economy is not typical of the American model of capitalism.