How to Clean Up a Scandal

ACS and several other companies caught in the options backdating scandal are firing executives and winning back investor confidence

by Sonja Ryst

On Nov. 27, Affiliated Computer Services (ACS) reported the results of an internal probe into the backdating of option grants at the Dallas technology services company. That, in and of itself, isn't so unusual. More than 200 companies have been touched by the scandal, including Apple Computer (AAPL), Barnes & Noble (BKS), and Gap (GPS). What was surprising is that ACS's stock surged 6% on the news, to $53.60, before retreating to close at $50.25 as the whole stock market plunged on Nov. 27 (see BusinessWeek.com, 11/27/06, "ACS Shares Higher after Execs Resign").

What got investors' attention was the extent of the company's housecleaning. ACS provided loads of detail on its internal investigation, which was conducted by the law firm Bracewell & Giuliani and included interviews with 40 current and former directors and employees. More dramatically, the company replaced Mark King, its chief executive officer, and Warren Edwards, the chief financial officer, saying that they "violated the company's code of ethics for senior financial officers." Both men have denied any wrongdoing through their attorneys.

Experts say ACS's actions sent a clear and much-needed signal to investors: that the board was serious about cleaning up the backdating mess. "I think firing people is necessary in some cases," says Erik Lie, an associate professor of finance at the University of Iowa who conducted the original research that uncovered widespread options backdating. "You want shareholders to see that you're addressing the issues."

Not All Backdating Is the Same

The backdating scandal involves companies that issued stock option grants to executives at favorable prices. Typically, the companies picked a date in the past when their shares were trading at a particularly low price, so the price at which executives could exercise, or acquire, shares was lower than the current market price.

Of course, the situations at the companies involved in the backdating scandal are all different and the circumstances don't always require the firing of top executives. The backdating may have been accidental or it may have been handled by a limited number of people.

Still, ACS is one of several companies that are now demonstrating how executives and boards caught up in the scandal can rebuild their reputations with customers, employees, and investors. Others include KB Home (KBH), Shaw Group (SGR), and Mercury Interactive, which has been acquired by Hewlett-Packard (HPQ). Launching an internal probe is a necessary first step, if there's any suspicion of wrongdoing. "You want to do that before the [Securities & Exchange Commission] begins an inquiry," says Paul Hodgson, a senior research associate at the Corporate Library, which does research on governance and compensation issues.

If any problems are uncovered, it's important to address them with the utmost speed. "You want to restate your financials quickly," says Lie. "You want to pay any additional taxes quickly."