Tech's Backdating Blues

Stock options are a big part of the culture of Silicon Valley, and tech companies have been far more dependent on them than companies in most other sectors. The tech sector fought tooth and nail against a recent accounting rule requiring companies to recognize options costs in their income statements, often using specious arguments to do so.

More recently, many companies -- particularly in tech -- have been accused of suspiciously playing with the assumptions they use to calculate the value of options, allegedly to reduce their recorded options expense.

"It's certainly possible that those people would have played the same game with backdating," says Lynn Turner, former chief accountant at the Securities and Exchange Commission and the managing director of research at Glass Lewis, a proxy advisory firm.

Companies hit by the backdating scandal so far have seen their stocks singed. Shares of RSA Security (RSAS), for instance, are off nearly 10% since the company announced it was being investigated. Shares of KLAC are down about 12% since its own revelation.

But investors say the revelations to date -- and the fear that there will be more to come -- are weighing on the entire technology sector. How much is hard to say, given the sector's many areas of concern: rising interest rates, inflation, and worries about slowing growth.

"Anything that erodes the credibility of the marketplace -- which this clearly does -- adds to the discount rate," says Ken Broad, a portfolio manager at Delaware Investments. "This is one more negative that absolutely has to weigh, in general, on investors' minds, and particularly in the technology sector."

The scandal is already playing a role in the anonymous portfolio manager's investment decisions. The investor sold off Comverse (CMVT) and Vitesse (VTSS) after they revealed that they were being investigated. And the investor is trying to steer clear of other companies that could potentially have problems, particularly those flagged in research reports.

"Some of this is once bitten, twice shy," says the portfolio manager, adding that it's hard to know how long to take that stance. Right now, "this stuff seems to keep coming out of the woodwork."

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