Evidence of Buyback-Option Shenanigans: The 9/11 Factor

In a major exposé of misused executive options, the Wall Street Journal ran a front page article on July 15, 2020, entitled:

Executive Pay: The 9/11 Factor; As stocks sank after the attacks, scores of companies rushed to issue options to top officials. Some reaped millions.”

Wall Street Journal research showed that:

Profit From A Tragedy?
Profit From A Tragedy?
  1. From September 17, 2020 to the end of that month, 10% of leading public companies issued stock options to 511 top executives;

  2. The number who received grants was 2.6 times greater than the same period of September 2000, and more than twice as many as in the like period in any other year between 1999 and 2003.

  3. Almost half of the companies issuing options during this period, did not normally issue stock options in September.

  4. Most grants were concentrated around September 21st, when the market reached its post-attack low.

The Wall Street Journal went on to say:

There’s nothing illegal about granting options after the market plunges. But acting so quickly after a national tragedy drove down stocks shows the eagerness of some companies to increase their executives’ potential wealth.

Stock options were originally designed to align executives’ incentives with the goals of shareholders, encouraging recipients to work hard to improve their companies’ stock price. When these options are granted at favorable prices, executives get some of their gain free — that is, they are buying at an unusual dip below the price most investors have paid.

Hypocrites Play on Patriotic Sentiment

Now it has often been observed that major bad news temporarily drives down stock prices, only to be followed weeks or months later by a recovery as information becomes available and investors adjust to new facts.

Famous investors, like Warren Buffett on CBS’s “60 Minutes”, advised the public not to panic and sell stocks after 9/11.

However, public companies went beyond this and stepped up stock buyback programs, as the Wall Street Journal article relates:

Companies lined up to invest [sic] in their own shares, often trumpeting their decisions in patriotic tones.

The SEC went along with this misleading of investors, granting even more safe harbors from manipulation for companies buying back their own stock in the wake of nine-eleven.

Why The WSJ Exposé Is Noteworthy

When the Center for Capital Flow Analysis was first published in October 2004, there were few articles in the press about buybacks, and even fewer linking buybacks and options with the word fraud.

This was unusual because for over twenty years the combination of stock buybacks, linked to executive options, and tax-deferred saving by unsophisticated investors that believed in the “Common Stock Legend“, had driven stock prices well above historical measures of intrinsic value.

This combination of buyers and sellers continues to drive the US equity markets today.

A persistence of this trend depends upon, among other things, the ability of Wall Street and corporate executives to continue to mislead the public.

As long as the public thinks that buyback-option schemes are just hunky-dory and believes in the “Common Stock Legend”, the game can go on for a while longer.

However, although both of these concepts are demonstratively false (as shown repeatedly on this site), it has been possible to deceive to public for a generation because of the almost total absence of contrary opinion in the financial press.

First Signs of a Changing Consensus

In 2006, this has begun to change and the press has begun to take notice:

  1. The volume of stock buybacks reached record levels in Q1 2006;

  2. The ethics of stock buybacks was challenged by Warren Buffett;

  3. Doubts were cast on the validity of the “Common Stock Legend” by Professor Jeremy Siegel, until recently a leading proponent;

  4. Corporations had begun to issue bonds to finance buybacks on a grand scale by Q1 2006;

  5. Moody’s, a leading bond rating agency, stated that issuing bonds to finance buybacks was not consistent with conservative financing;

  6. In a front page article, the Wall Street Journal acknowledged that the purpose of buybacks was to drive up stock prices;

  7. Hints of a possible link between short-selling and margin-buying by hedge funds with stock buybacks (and possible insider trading) began to appear;

  8. The SEC began to investigate improper back-dating of executive options.

This is still ‘early days’ and far from a consensus that corporations use options and buybacks to defraud long-term investors, but compared to discussions of this topic just a few years back, there is definitely a whiff of change in the air.

It is hard to say just when ‘option-buyback schemes are bad’ might become the prevailing opinion, or how fast such a change in consensus might occur.

However, if and when this should happen, holding a position in equity index funds may turn out to be a very bad place to be, indeed.

Stay tuned …

 
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