Aladdin Beckons the Options-Repricing Genie

Many companies were caught changing the dates of stock options
during the backdating scandals. If that was improper, if not illegal,
why isn't changing the options’ price similarly abhorrent?

Aladdin Knowledge Systems (Nasdaq: ALDN)
issued a press release late Friday night. You know a company is trying
to avoid publicity when it makes an announcement at 7 p.m. the night
before a weekend. In this case, Aladdin announced that some 430,000 stock options
that had previously been issued at a price of $19.85 when its stock was
flying high were being repriced to $8.82 now that the shares have been
laid low.

The backdating scandal snared dozens of companies and executives,
and a few of them are serving jail terms as a result. Before stepping
down, the former CEO of UnitedHealth (NYSE: UNH) voluntarily repriced higher
the nearly $2 billion in options he was granted when it was discovered
that the health-care giant had improperly backdated options. Steve Jobs
recently dodged a bullet at Apple (Nasdaq: AAPL)
for his role in that company's backdating scandal, though its CFO was
not so lucky, and the general counsel and one of her associates are
still facing charges. Nice of them to take one for the boss.

Also not so lucky was the head of Brocade Communications (Nasdaq: BRCD), who's doing time for his role in that company's backdating mess.

In every case, the executives were caught with their hands in the
cookie jar, trying to give executives guaranteed profits using a form
of compensation that was supposed to be aligning the interests of
management with those of shareholders. By backdating
the options to a time when the share price was even more advantageous
to the executive, they gave that executive an even greater benefit from
the stock's appreciation in value – and we saw that stock options were
simply a wealth transfer system.

Still, the stocks at the center of the backdating scandals did in
fact increase in value, meaning outside shareholders also enjoyed that
increase -- though perhaps not to the same degree.

How much more insidious is it, then, to change the price of the
option so that only management benefits, while outside shareholders are
left to feel the pain of a fallen stock price?

Moreover, because repriced stock options receive special accounting
treatment under SEC rules, earnings take a hit each and every year the
stock price moves up until the repriced options are exercised,
forfeited, or canceled. And the greater the rise in price, the greater
the hit to earnings. So while executives are enjoying the benefits of
higher future share prices, the company and outside shareholders suffer
from the impact of reduced earnings.

Aladdin, a Motley Fool Hidden Gems recommendation, isn't the only company that's repriced "underwater" stock options -- it’s merely the latest. Tenet Healthcare (NYSE: THC), Hovnanian (NYSE: HOV), and Toll Brothers (NYSE: TOL) have all recently received or sought shareholder approval to reprice options. It's a time-honored tradition on Wall Street.

Management may describe repricing in terms of retention and
motivation of employees, but in reality, it’s rewarding them for poor
performance. Keeping the options priced at their issue level would be a
true incentive to improve the company's profitability, and thus its
price. Changing the rules -- and the price -- mid-game simply means
some insiders will benefit at the expense of all outside shareholders.