LOS ANGELES — KB Home’s former chief executive officer “secretly padded his pay” by about $11 million when he backdated his own stock options without the knowledge of others at the company, including its in-house lawyers, a federal prosecutor alleged during opening statements in the criminal trial against Bruce Karatz.
Assistant U.S. Attorney Alex Bustamante, speaking on Thursday before a federal jury in Los Angeles, painted a picture of a chief executive who lied about the backdating to everyone, both inside and outside the company.
Of the $11 million that he stood to gain as extra compensation through the backdating, Karatz, 64, eventually pocketed more than $6.5 million from 1999 to 2005, when he resigned from KB Home.
“The defendant was looking back and picking the stock option price for himself and for other executives and managers,” Bustamante told the jury. “He was the one who stood to benefit the most from the backdating.”
Karatz’s attorney, John Keker of San Francisco’s Keker & Van Nest, outlined a less nefarious grant process in his opening statement to the jury. “The evidence in this case is going to show that with respect to the stock option process, everybody thought they were playing by the rules,” he said.
Karatz and human resources chief Gary Ray relied on the company’s lawyers, specifically chief legal officer Ben Hirst, in determining that “look backs” of a few days in setting option grant dates were not considered backdating under the law and therefore didn’t have to be divulged to the public.
Karatz, who was KB Home’s CEO for 20 years, was indicted last year on seven counts of mail fraud, five counts of wire fraud, three counts of securities fraud, four counts of making false statements in filings with the U.S. Securities and Exchange Commission and one count of lying to accountants. If convicted of all charges, he would face a maximum sentence of 415 years in federal prison.
The KB Home case is especially important for the U.S. Attorney’s Office for the Central District of California, which lost a significant backdating case against two former executives of Broadcom Corp. in December. In that case, a federal judge in Santa Ana, Calif., dismissed the charges after concluding that prosecutors had inappropriately influenced and intimidated witnesses and “distorted the truth-finding process.”
On Thursday, before U.S. District Judge Otis Wright, Bustamante told the jury that Karatz, who holds a law degree from the University of Southern California Gould School of Law, backdated options to obtain compensation unavailable to shareholders. “That means every time, the executive or manager will have an advantage over shareholders,” Bustamante said.
The alleged backdating scheme began in 1997, he said, when KB Home’s compensation committee rejected a plan that would have given Karatz 1 million options priced at $1 each. At that time, Karatz was making $750,000 in salary and the company’s stock price was $26, he said.
For six years, Karatz and Ray picked the as the grant date the day with the lowest stock price following the compensation committee’s meeting in October, Bustamante told the jury. Karatz never told the compensation committee what he was doing, he said; neither did he tell anyone in the legal department — in particular, Kimberly King, associate general counsel in charge of securities.
In 2006, when reports of backdating throughout the country began to put pressure on companies to investigate their own grant practices, Karatz told Ray that they would “have to keep a lid on this,” Bustamante told the jury.
When interviewed that year by Hirst, Karatz denied that he had looked back to price the options and blamed any appearance of backdating on administrative problems, Bustamante said. The matter remerged when an outside law firm, Munger, Tolles & Olson of Los Angeles, and a new associate general counsel, Charlie Carroll, continued to look into potential backdating at KB Home.
In 2007, KB was forced to restate its earnings to reflect more than $36 million in compensation expenses due to options that were backdated from 1999 to 2005, according to the indictment.
Keker told the jury that no one at the company, including Karatz, thought they were doing anything improper or wrong.
“They honestly believed that what they were doing was proper and legal,” he said.
Keker added that others, including Ray, Hirst, King and members of the compensation committee, were involved in the granting of stock options. They often had to select a date that was different from the date on which the compensation committee decided to award the grants as a way to be fair to the hundreds of employees receiving options, who were spread throughout various divisions and offices around the country, he said.
The setting of dates was an “open, above board, not covered up process,” he said. “That Bruce Karatz and Gary Ray picked the grant date was no secret to anyone.”
Keker cast doubt on the credibility of Ray, the government’s key witness. He asked the jury to consider why Ray, who had at first denied the existence of backdating at KB Home, reversed his position after meeting 17 times with government officials.
“Mr. Ray’s story has changed since when he first came in, and changed significantly,” Keker said. “His story has changed from day to night.”
Amanda Bronstad can be contacted at email@example.com.