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Beating up Broadcom

Its alleged backdating of options hurt no one, defenders say. But healthy markets need transparency.

May 16, 2008

The Securities and Exchange Commission's lawsuit against top executives at Orange County chip maker Broadcom led their defenders to raise an existential question: If there's no obvious harm, can there be a foul?

Billionaire co-founders Henry T. Nicholas III, who stepped down as chief executive in 2003, and Henry Samueli, who resigned Wednesday as chairman after the lawsuit was filed, are accused along with two other top-ranking Broadcom officers of surreptitiously backdating up to 88 grants comprising 232 million stock options from 1998 to 2003. That put the options "in the money" by setting their price below the current market value. By creating fake paper trails to conceal the backdating, the company avoided accounting charges that could have made a huge difference to its bottom line, the government alleges. For example, the SEC claims that proper accounting for options in 2000 would have increased Broadcom's losses almost 40% -- on paper, at least.

Broadcom's leaders have denied any wrongdoing, and critics of the government's crackdown note that the company's investors don't seem to have been affected by the executives' maneuvers. Broadcom's share price :symbol=brcm;range=my;indicator=volume;charttype=line;crosshair=on;oh lcvalues=0;logscale=on;source=undefined has risen fitfully since the dot-com crash, with announcements related to the backdating scandal (including a massive $2.2-billion restatement of earnings in January 2007) barely registering. Many of the options granted lost their value before they could be exercised. And Nicholas and Samueli aren't accused of granting themselves in-the-money options; instead, they allegedly used the options to attract or retain employees who had accepted below-market salaries. In other words, the options were designed to improve the performance of the company and its shares, helping all investors.

Still, the evil being alleged isn't the creation of in-the-money options -- it's the deception. Under the law, companies have to disclose when they backdate options, and they have to treat the resulting discount in price as a compensation expense even if the options aren't exercised. That's inconvenient and not necessarily revealing, which is why Wall Street analysts typically ignore such noncash charges when evaluating companies. But it's the law. Besides, honest disclosures are vital to the health of the financial markets. Nicholas and company may show that the government's allegations are false or that its rules were too opaque to follow, but they can't say surreptitious backdating is a victimless crime.

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