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A federal investigation into improperly backdated executive stock options has swept up four New Jersey companies and has spurred a grand jury subpoena and a civil suit against one of them. The inquiries are part of a nationwide probe by the Securities and Exchange Commission, and in some cases by the Justice Department and Internal Revenue Service, into allegations that more than 100 companies changed stock option grant dates to make them more valuable. The SEC has asked Medarex Inc. of Princeton, Kos Pharmaceuticals Inc. of Cranbury, Ulticom Inc., a Mount Laurel software provider, and DRS Technologies Inc., a Parsippany military product and service provider, for stock-option-plan data. Ulticom and DRS say actions by affiliates drew them into the probe. All four businesses say they are cooperating with authorities, and Kos claims it started its own investigation before hearing from the SEC. Last month, Medarex announced plans to restate its financial statements from the beginning of 2000 through the quarter ended March 31, 2006, to account for the stock options. But Medarex is already in court, answering a subpoena by the U.S. Attorney’s Office for documents relating to backdated options and defending against a shareholders’ suit. The suit, in Mercer County, charges that CEO Donald Drakeman, directors and certain officers breached fiduciary duties and violated the shareholder-approved stock plan by backdating stock options granted to them and company officers. As a result, the plaintiffs claim, Medarex has suffered millions of dollars in damages, including additional compensation expenses and tax liability, plus costs related to the SEC investigation and the restated financials. Strike down A stock option generally gives a holder the right to buy shares at a specified price for a set period. Generally, this price – known as a strike, or exercise price – is equal to the stock’s price the day the option is created. If the stock price subsequently goes up, the person holding the option makes money. But if the price falls below the exercise price, the stock option is worthless. That is where backdating comes in. To increase the value of stock options, some companies went back and reduced the strike price of the grant by resetting the creation date to one on which the stock traded at a lower price. This meant the stock option had a built-in gain. SEC Chairman Christopher Cox has called backdating a deceptive and poisonous practice. “In order for our system of public ownership to work, the interests of shareholders, and not the personal interests of the company’s management or its directors, must be paramount,” he said at a news conference in July. “The proper use of options for compensation can be an important tool for companies that produces tangible benefits for shareholders. But options backdating strikes at the heart of investor confidence in our capital markets. It deceives investors and the market as a whole about the financial health of companies that cheat in this way. “It understates a company’s compensation expenses and overstates the company’s income. In many cases, it makes a hash of the financial statements. It is poisonous to an efficient marketplace,” he continued. The Medarex shareholders’ suit says the company’s backdating of options violated generally accepted accounting principles. At the time of the alleged scheme, said to have run from 1996 to 2002, companies could issue stock options without immediately recording a charge to compensation expense, as long as the strike price was not lower than the current market price. Since 2004 though, the Financial Accounting Standards Board has generally required companies to expense the value of stock option-based compensation. Under the old accounting rules, when Medarex’s stock options were backdated and priced to produce an immediate gain, the company should have recognized the additional compensation expense, the plaintiffs say. By hiding the backdating, the defendants violated accounting principles and were responsible for the production and dissemination of false financial statements, the suit charges. While there is nothing inherently wrong with backdating options, certain standards must be met for it to be legal. “Backdating must be approved by authorized individuals,” such as the corporate board’s compensation committee, says William Greenbaum, a partner in the employment services department of WolfBlock Brach Eichler in Roseland, who is not involved in the Medarex suit. “Also, any effect on the company’s earnings must be properly reflected in the business’ financial statements, the effects of the transaction must be properly reflected in the company’s tax filings [and in compensation reported to the recipient], and the backdating itself must be clearly communicated to shareholders.” Case in point All of those issues appear to have been in play in a civil suit the SEC filed on Aug. 9 against Teaneck resident David Kreinberg, former CFO of Comverse Technology Inc., a New York software and systems company that was the major shareholder of Mount Laurel’s Ulticom. Comverse’s former CEO, Jacob Alexander, and former general counsel, William Sorin, were also named in the suit, SEC v. Alexander, Kreinberg and Sorin, 06-CV-3844 (E.D.N.Y.). The complaint alleges that from 1991 through 2001 Alexander and Sorin, and from 1998 through 2002 Kreinberg, backdated Comverse stock options improperly. It alleges Alexander and Kreinberg created records that falsely indicated that Comverse’s board had approved the backdating scheme, and then took steps to hide it from the company’s auditors. The suit further alleges that because the backdated options should have been recognized as an expense on Comverse’s books, but were not, the company overstated its net income and earnings per share between 1991 and at least 2002. And the suit alleges that beginning in 2000, Kreinberg, with Sorin’s knowledge, initiated a similar backdating strategy at Ulticom, in which Comverse was the major shareholder. The SEC says the undisclosed backdating activity caused Ulticom to issue false and misleading financial statements and to make false and misleading disclosures about options grants in its SEC filings. In April, Ulticom announced that it expected to record noncash charges for stock-based compensation expense incurred in prior periods. The company also says it will need to restate financial statements for fiscal years 2002 through 2005. The SEC has asked Cranbury’s Kos Pharmaceutical to provide documents relating to the grant and exercise of stock options from 1997 through 2006. The company did not respond to calls seeking information about outside legal counsel. Ulticom has not been advised of any formal SEC investigation, says spokesman Chris Tunard. He says that the New York firm Weil, Gotshal & Manges usually represents the company. DRS Technologies has been advised that the SEC is investigating the options backdating practices of Engineered Support Systems Inc., a company it acquired in January, says Pat Williamson, DRS’ vice president of corporate communications. She says DRS itself is not under any kind of cloud since the alleged backdating took place before ESSI was acquired by DRS. Williamson, who declines to name the company’s outside counsel, says DRS may be called as a witness by the SEC. The Medarex case is a consolidation of separate suits by Schiffrin & Barroway of Radnor, Pa., and another by Danziger Shapiro & Leavitt of Philadelphia. The liaison counsel, Lisa Rodriguez of Haddonfield’s Trujillo Rodriguez & Richards, was away from her office and unavailable for comment last week.

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