How two firms tackled scrutiny of their stock options.

At least one Los Angeles company appears to be bucking the trend by striving for more transparency in the backdating of stock options--a scheme that has drawn the attention of regulators and a growing number of shareholder lawsuits, including one targeting KB Home.

Pasadena-based Tetra Tech Inc., a provider of consulting and engineering services, launched a "voluntary" internal investigation into its own stock options in July after an accounting board made recommendations about stock options.

Tetra Tech did not receive a notice of inquiry from the Securities and Exchange Commission and is not the target of shareholders lawsuits. By contrast, KB Home announced last week that it has launched an internal investigation into the granting of stock options to its Chairman and Chief Executive Bruce Karatz only after the lawsuit and press inquiries.

"The (Public Company Accounting Oversight Board) put out their memo in July and we decided to initiate our own voluntary review," said Tetra Tech's director of investor relations Jorge Casado.

The Accounting Oversight Board memo told independent auditors to be on the lookout for potential options-timing issues, including the granting of options to executives ahead of market-moving news.

After a review of stock options from 1998 to 2006, Tetra Tech's audit committee announced in an SEC filing that the company "did not engage in intentional or fraudulent misconduct in the granting of stock options."

Rather, the committee stated that "due to unintentional errors," the tracking system used for roughly 500,000 options that were given to more than 600 employees in fiscal 1999 had used dates for certain option grants that differed from their actual grant dates.

The errors--which the company labeled as such--"were not material" and did not require a restatement of past earnings. Moreover, none of the options in question were those that had been given to Tetra Tech's founder and chairman emeritus Li-San Hwang, Casado said.

Greg Regan, a manager of the forensic accounting practice at Hemming Morse Inc. in San Francisco, said only a handful of companies have made such disclosures about stock options without being prodded either by shareholder lawsuits or by an SEC inquiry. "They're really stepping up to the plate here," Regan said of Tetra Tech. "This is an example of best practices--something every company should be doing."

The SEC first became interested in the back dating of stock options when academics found that the shares prices of scores of companies had dropped dramatically just prior to the granting of options. Options typically are set at the market price on the day the option is granted. With backdating, a company can wait weeks or even months to set the date at a stock's low price to maximize the potential return when an executive exercises the option.

Regan said a major issue going forward in the investigations is that the SEC doesn't have the manpower to investigate so many companies. "They're really going to rely on the companies themselves," he said. "They're going to rely on the audit committees and the lawyers."

For Tetra Tech, it helped that the company's audit committee is headed by Hugh Grant, a business consultant who is a former vice chairman and regional managing partner for the Western region at Ernst & Young LLP. Grant also serves as chairman of the audit committee of IndyMac Bancorp Inc., in Pasadena.

Tetra Tech announced Aug. 23 that it would take a $3.2 million pre-tax, non-cash charge for stock options granted before 2004. Tetra Tech's stock, which actually rose in the days following its initial Aug. 11 disclosure of its internal probe, closed Aug. 23 at $16.31, down 5.5 percent.

KB Home

KB Home began its internal investigation only after being prompted by questions from a reporter for the Wall Street Journal.

Caroline Shaw, a spokeswoman for KB Home, said in a statement that the company "has been reviewing these grants with the assistance of outside counsel." She added she would not comment on the issue "because they are the subject of pending litigation."

The Journal inquiry itself followed a shareholder lawsuit that was filed in Los Angeles County Superior Court last month against Karatz and other KB Home officers and directors, alleging manipulation of stock option grant dates. Then last week, the company announced the SEC had begun an informal probe into its stock option practices.

JP Morgan Securities analyst Michael Rehaut downgraded shares of KB Home last week adding that a lawsuit "will create an overhang on the stock and lead to relative underperformance."

Shares of KB Home fell 6 percent Aug. 23 to $40.53 a share on the news of the review.

The Journal has stated that four grants to Karatz between 1998 and 2001 were dated at unusually low points for the company's stock price, including at least one grant that was dated at the stock's 52-week low.

If in fact the grants dates were manipulated, that would in itself not constitute an illegal act. It was only after Aug. 29, 2002, that the Securities and Exchange Commission first required under the Sarbanes-Oxley Act that stock option grants be disclosed within two days of the grant. However, the SEC is investigating whether shareholder disclosure or other regulations were violated by companies in the process.

So far, nearly a dozen companies in Southern California are among the more than 80 investigations under way into possible manipulation of companies' grant dates of stock options. The Justice Department has also set up a task force in Northern California to examine possible criminal charges against companies, and the Internal Revenue Service is investigating roughly 40 companies.

Camarillo-based Vitesse Semiconductor Corp. may be one of the hardest-hit by the options scandal. The company fired three executives, including its chief executive and chief financial officer, in May after discovering accounting irregularities. The chip supplier then ran into a liquidity crisis, its shares have tanked to under $I a share and it is now in a dispute with its trustee, U.S. Bank.

Video game makers Activision Inc. and rival THQ Inc., both received letters from the SEC requesting documents, and are conducting internal reviews.

Calabasas Hills-based Cheesecake Factory announced an internal probe of stock options in July, which is still underway. The restaurant chain has delayed filing quarterly financial reports for a second time, and is being threatened with delisting by the Nasdaq Stock Market.

And El Segundo-based Computer Sciences Corp. has been sued by several shareholder groups after receiving an inquiry from the SEC in June.

In a study released last week, Glass Lewis & Co. said 138 companies with market capitalizations above $75 million reported their quarterly filings would be late. The market research firm said that was a record number of late filings for larger U.S. corporations, blamed the options-timing scandal which has prompted companies to review past option grants.