Monday, November 13, 2006

Options Backdating Scandal Hits KB Home

Way back in 1998, I had breakfast with Bruce Karatz, CEO of KB Home. At the time, the company was still called Kaufman & Broad. Karatz was extremely bullish about the home building industry and the prospects for his company. He turned out to be right. About a year later, I added the stock to the Special Situation Survey's recommendation list, and as everyone now knows by now, home building stocks went on a tear.

Of course, I didn't know at that time that Karatz was personally benefiting from backdating his own employee stock options. Harvey Pitt calls backdating fraud and explains why on my MoneyMasters video. There is no question that backdating is wrong. After all, it requires that you lie about when the options were actually issued. Instead of pricing them on the issuance date, you simply pick a more favorable date from the past.

Ironically, there was no reason for Karatz to backdate his options. After all, the Wall Street Journal reports that Standard & Poor's estimates that Karatz reaped $180 million from the exercise of stock options alone since 1992. In 2005, his total compensation, including options, amounted to $150 million. KB Home said backdating benefited Karatz to the tune of $13 million, which he will repay. Compared to his total compensation over the years, this is chump change. It won't make a dent in his bank account. Of course, by the time the SEC gets through with him, he may end up paying a whole lot more.

Karatz isn't the only one leaving the company. Richard Hirst, chief legal officer, and Gary Ray, head of Human Resources, are also leaving. But Ray is the only one being fired. Karatz and Hirst were allowed to resign. It seems they cooperated in the company's internal investigation while Ray refused.

Backdating is gearing up to be the next big corporate scandal. Karatz is the biggest name to fall so far, but it looks like there will be plenty more coming up in the near future.