01:00 AM EDT on Sunday, July 2, 2006

BY JEFF BROWN

In one of the Back to the Future movies, Biff the villain got rich betting on sports after retrieving a record book from the future.

Read the stock market results on any given day and you might wish you, too, could travel in time to bet on sure things.

Now it looks like executives at dozens of companies may have found a way to do just that -- by backdating stock options.

The Securities and Exchange Commission, and federal prosecutors in New York, Massachusetts and California, are investigating more than 30 companies over possible backdating.

What's wrong with this practice and what's to be done about it?

A typical corporate stock option gives its owner the right to buy a share of the company's stock at a set "strike" price during a 10-year period. If the strike price is $10 a share and the stock rises to $30 after the option is granted, the option owner can "exercise" the option to buy the shares at the lower price.

In effect, that means paying $10 and simultaneously selling for $30, pocketing a $20 profit per share.

In theory, options help motivate employees to help the company prosper and raise its stock price, which is good for the ordinary shareholders.

The strike price is what the shares are trading at on the day the option is granted. Backdating involves ways of changing the grant date to increase the options recipient's profit.

Suppose the stock is trading at $10 a share when the company's board of directors approved the options grant today, but that it was trading at $9 two weeks ago. If the board recorded the grant as being made on the earlier date, the employee could make an extra dollar per share on the options.

But this extra dollar comes from shareholders' pockets because the company is selling the shares to the employee for $9 rather than $10. Multiply this by millions of options granted over a number of years and we're talking about big money.

Also, backdating makes it more likely the options will be profitable even if the company doesn't do very well, undermining the incentive they are supposed to provide.

Executives get the most options and have the most to gain from backdating, so it is likely they are behind the practice in most cases. Boards of directors that go along are violating their duty to put shareholders' interests first.

Many of the cases being investigated predate the passage of the Sarbanes-Oxley law in 2002, a post-Enron reform said to have made backdating more difficult by tightening options reporting. If the current investigations result in real penalties for executives and directors, backdating will be further discouraged.

And the SEC is expected to vote this summer on a proposal to improve corporate disclosure of options grants and other elements of executive pay, again making backdating harder. That proposal should be approved.

But that's not enough. Regulators and legislators should enact some simple rule changes, such as standardizing grant dates to the first day of every month or quarter. That would make it far harder for directors to play with timing.

Ultimately, options backdating, like soaring executive pay and other anti-shareholder practices, is more evidence of the fundamental flaw in corporate governance: too many directors are too cozy with the executives they are supposed to oversee.

That will not be fixed until Washington reforms the corporate elections system, which typically offers only one nominee per available board seat -- a person chosen by the board itself.

Angry shareholders can vote against the board's nominees, but this has little effect since most companies simply seat the candidate who gets the most "yes" votes. When there's only one candidate, he is assured of winning even if a majority of shareholders vote against him.

Washington should eliminate the obstacles that make it virtually impossible for shareholders to field their own candidates. And it should insist that, to win, a board nominee must receive a majority of votes cast.

Jeff Brown is a business writer for The Philadelphia Inquirer and can be e-mailed at brownj@phillynews.com.