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KB Home ex-CEO Bruce Karatz accused of stock option fraud

A federal grand jury indictment alleges that Karatz, who resigned under fire in 2006, orchestrated the backdating of options to his own benefit.

March 06, 2009|William Heisel

Bruce Karatz, who rode the housing boom to become one of the highest-paid executives in the country, was indicted by a federal grand jury Thursday on charges of manipulating stock options -- becoming one of the few executives to face criminal charges in the nation's options backdating scandal.

Karatz, 63, served as chairman and chief executive of Westwood-based KB Home from 1986 to 2006, when he resigned under fire. Over a three-year period ending in 2005, Karatz garnered more than $232 million in compensation.

"This investigation painted a picture of avarice and dishonesty at its core," said Salvador Hernandez, who heads the FBI office in Los Angeles.

Karatz's lawyer said his client did nothing wrong and was being unfairly prosecuted.

"We are disappointed that during this economic collapse the government chooses to waste its resources on backdated options, an issue that has long ago been fixed at KB Home and generally in the corporate world," attorney John Keker said in a prepared statement.

Karatz, who has already been forced to pay $20 million to the company and the federal government in connection with the case, faces up to 415 years in prison if convicted on all 20 counts of the indictment, which includes charges of fraud and making false statements.

The indictment said Karatz orchestrated the backdating of stock options from 1999 to 2006. Stock options typically are granted to employees with an exercise price tied to the date of the grant. Companies can legally backdate stock options to a date when the stock price was lower -- insuring an immediate paper gain -- but they must account for it properly, pay taxes accordingly and report the backdating to shareholders.

In the KB Home case, the backdating was not disclosed until nearly a decade after it began. The company was forced to adjust its financial statements by $70 million when the backdating of options held by Karatz and other shareholders was finally disclosed in 2008.

In Karatz's case, the backdating made his stock options worth $1.63 to $4.56 more per share, according to the indictment -- a fact that should have been disclosed to other shareholders, it said.

The indictment does not say exactly how much Karatz gained as a result, but KB Home required Karatz to pay back $13 million in backdating gains when he left the company in 2006. And the SEC agreed to a settlement of $7.2 million with Karatz in 2008 to cover what it reckoned were his gains.

Karatz has long been a target of shareholder activists and labor unions, who accused him of taking more than his fair share of company profit. In 2005, the year before he stepped down, Karatz had take-home pay of $6.3 million, but he received an additional $150 million, mostly from exercising stock options.

"For the whole backdating scandal, he was one of the biggest poster CEOs," said Patrick McGurn, a special counsel for New York-based Risk Metrics Group who specializes in executive compensation. "He had to hand back more of his gains than almost anyone else."

The indictment accuses Karatz of concealing the practice from KB's board of directors and compensation committee as well as from shareholders.

It alleges that when KB undertook an internal investigation into the stock-option grants in May 2006, Karatz falsely denied his orchestration of the backdating scheme and caused a false report of KB's options practices to be submitted to the company's auditors, resulting in improper disclosures in filings with the Securities and Exchange Commission.

The SEC and other agencies have investigated more than 250 companies for backdating improprieties since 2005, and there have been some large settlements. In December 2007, United Healthcare CEO William W. McGuire agreed to pay $458 million to settle a civil case with the SEC over backdating.

The KB Home case produced one of only a handful of criminal indictments under which executives might lose more than money.

The case also stands apart because of how much Karatz himself allegedly benefited. In most of the backdating cases, including the case of Broadcom founders Henry T. Nicholas III and Henry Samueli, the companies and executives are accused of using backdating to attract and keep employees.

"Companies can say they were using these options to equalize the pay among employees who entered at different times," said Michael Lemmon, a University of Utah finance professor who has studied backdating. "It becomes a much harder story to sell when you have the CEO benefiting personally."

Karatz's resignation in November 2006 surprised Wall Street analysts who had watched him, since he took over as CEO in 1986, expand the company from its Los Angeles roots into one of the country's largest home builders.

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