Watchdog warns listed companies of crackdown on stock options malpractice

FSA threatens fines and outing of manipulators
Directors' awards subject to 'market abuse' regime

Jill Treanor
Tuesday September 26, 2006
The Guardian


The Financial Services Authority is warning stock market-listed companies and directors that they face public sanction and unlimited fines if they try to manipulate stock options.
Spurred by official investigations into practices in the United States, the City regulator is reminding companies that options awards - used to motivate and reward directors - are subject to its "market abuse" regime.

The FSA has been prompted to address the issue of options grants after its US counterpart, the securities and exchange commission, began investigating whether American companies had manipulated the dates of grants to executives in an attempt to boost the profits that might be made.


Article continues

--------------------------------------------------------------------------------

--------------------------------------------------------------------------------

Professor Erik Lie, of the University of Iowa, has conducted research into 8,000 US companies. This appears to indicate that at least 1,000 had manipulated or backdated the granting of options.
No such data appears to be available in the UK. Even so, the FSA has used its Market Watch newsletter to outline its approach to any "spring-loading" and "bullet-dodging" of options grants. Spring-loading is when a company brings forward the timing of options grants to allow an executive to benefit from a rise in the share price, which might be caused by a positive news announcement, and bullet-dodging is the term used when a grant has been delayed until after share prices have fallen because of negative news. The FSA's newsletter makes it clear that the facts of each case will need to be analysed before it can conclude that market abuse has taken place. "But in any event the acquiring or granting of options would amount to 'dealing' [under the Financial Services and Markets Act]," said the FSA.

"So, if an employee, being an insider, acquires options on the basis of inside information they may be committing market abuse. Similarly, the person granting the option may well be committing market abuse."

The FSA gives the example of a director who is aware of an impending announcement disclosing the information to the person responsible for granting options to influence the timing of the award. Even information that is not technically "inside information" - market sensitive and likely to move the share price - but relevant and not generally available to the wider market could be classified as "misuse of information" and subject to the FSA's market-abuse regime.

Under this regime, directors and companies can be subjected to unlimited fines and unwanted publicity if they breach its rules.

The FSA also reminds companies that they would be breaching the listing rules - to which all stock market-listed companies must comply - if they allow directors to deal in options ahead of the release of inside information.

The newsletter, on market conduct and transaction-reporting issues, analyses new trading systems being used by major investor banks and hedge funds to push ideas for trades. It gives warning of the possibility that these could be used for insider trading.

Traditionally, bankers have picked up the phone to clients to suggest trading ideas but the FSA said there was now an "increasing move" to communicate electronically through what is known as an Alpha Capture System. These systems allow firms to communicate trading ideas to clients in a written electronic form with the rationale for the suggestion, the timescale on which they are making their forecast and a guide to the strength of their conviction about the idea.

"As with all forms of client communication, there is a risk that those inputting ideas may seek to pass on insider information or relevant information not generally available to clients," the FSA said.

It has conducted meetings with the six or so companies providing this service and though it has concluded that the system may actually reduce the transfer of inside information, it points out that insider dealing can still take place.

"There remains a risk that those inputting ideas may still do so on the basis of inside information, masking this by giving another seemingly plausible rationale," the FSA added.

How do you see the relevance to afn?