WSJ.com - Mercury Interactive Executives Resign in Wake of Probe

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By REBECCA BUCKMAN, MARK MAREMONT and KAREN RICHARDSON
Staff Reporters of THE WALL STREET JOURNAL
November 3, 2005; Page A7

Three top executives of Silicon Valley software company Mercury Interactive Corp. resigned amid disclosures about improper pricing of employee stock options, an issue under increased scrutiny lately by the Securities and Exchange Commission.

The management shakeup, which included the resignations of Mercury's chief executive and chief financial officer, caused shares of the Mountain View, Calif., company to plunge 27% in 4 p.m. composite trading on the Nasdaq Stock Market.

Mercury, a supplier of software for monitoring Web-based business applications, also said its shares could be delisted from Nasdaq if it can't file restated financial reports by the end of this month. The company was due to release third-quarter earnings yesterday but said it couldn't because of the possible financial ramifications of the stock-option pricing. The disclosures at Mercury come as the SEC is examining whether some companies -- particularly high-tech outfits, many of which rely on stock options as a significant form of employee compensation -- are manipulating the timing of stock-option grants to lift the compensation of employees. The practice could cast questions over some companies' reported earnings, as the alleged manipulation could affect stock-option expenses and even tax liabilities.

CONFERENCE CALL

See a transcript² of Mercury's Wednesday conference call, provided by Thomson StreetEvents (www.streetevents.com³). (Adobe Acrobat Required⁴.)

Mercury said yesterday that an internal investigation had uncovered 49 cases in which the reported date of a Mercury stock-option grant differed from the date on which the option appears to have been actually granted. The practice applied to "the overwhelming majority" of grants issued between January 1996 and April 2002, according to a report Mercury filed yesterday with the SEC. That likely allowed executives and employees to make more money on their options because it set a lower "strike price" at which the options could be exercised, allowing employees to take fatter profits when the stock price later rose.

In almost every case of misdating, the price of Mercury shares on the reported option-grant date was lower than the share price on the actual day the options were issued, the SEC filing said. However, "intentional selection of a favorable price for option grants appears to have ended in or about April 2002," after which the company improved its internal controls and procedures, the filing said.

Chief Executive Amnon Landan, Finance Chief Douglas Smith and General Counsel Susan Skaer were aware of the misdating and "benefited personally from the practices," which were contrary to proper accounting, according to the company's SEC filing. The company said each of the three "knew or should have known" that the practices were improper. All three of those executives resigned yesterday, and weren't available for comment. The company wasn't more specific in explaining the reasons for their departure. Mercury also disclosed yesterday that on at least three occasions, exercise dates for options exercised by Mr. Landan seemed to be incorrectly reported and may have reduced his income -- meaning the company could face penalties for failing to pay withholding taxes.

Mercury said it launched an internal investigation into the issue in June in response to an inquiry initiated by the SEC in November 2004.

Since 1995, Mr. Landan paid $5.5 million to exercise 813,000 options in Mercury, and sold 1.04 million shares for a total of $73.6 million, according to Thomson Financial. Because the purchases and disposals were at a variety of times, it isn't clear what profit he made on the sales. Ms. Skaer reaped a gain of $1.1 million from exercising 65,170 options and selling the shares, while Mr. Smith reaped a gain of $2.7 million from exercising 120,000 options and selling the same number of shares, according to Thomson Financial.

A stock option can give the holder the right to buy a stock at a certain price in the future. Typically, companies set that price at the same time their directors approve an option grant, with an exercise price -- also known as the strike price -- usually set at the closing price of the stock that day, the closing price the night before or by computing an average of the high and low prices on the day of the vote. In prior regulatory filings, Mercury has said that since at least 1999 it had been granting stock options to employees at the "fair market value on the date of grant," an assertion that now appears wrong.

By manipulating the grant dates, Mercury "was able to provide employees with the lowest possible exercise price," says Robert Willens, an accounting and tax analyst with Lehman Brothers in New York. "The lower the exercise price, the better off you are as an employee, so you'd want to cherry pick the dates on which the prices would be set," he says.

Mercury said Mr. Landan would be succeeded as CEO by Anthony Zingale, who had been the company's president and chief operating officer. David Murphy, Mercury's former senior vice president for corporate development, has been named finance chief, and Giora Yaron, a Mercury board member since 1996, has been elected chairman. Mr. Landan had been CEO and chairman.

In an interview, Mr. Zingale said that he is still confident about Mercury's business and that his aim is to keep the company independent. He said he couldn't elaborate on details of the reporting of option-grant dates beyond what was in the company's SEC filing. But generally, "the company needs to be an example of best practices going forward, and the right tone has to be set at the top," he said. He added that he believed 30 to 40 other Silicon Valley companies had received inquiries about their option-accounting practices from the SEC.

In May, data-storage outfit Brocade Communications Systems Inc. said that the SEC and the Justice Department were looking into its stock-option accounting and that it would restate financial results for fiscal years 2002 through 2004. Brocade first said in January that an internal committee had completed a review of its stock-option accounting; on that same day in January, the company also said it had replaced its chief executive, Greg Reyes. A Brocade spokeswoman said yesterday that she couldn't comment about whether the accounting matter and the installation of a new CEO were related.

Nyfix Inc., a Stamford, Conn., provider of electronic-trading technology, said earlier this year that it would restate several years of financial statements after reviewing its accounting for past stock-option grants. The review came after an SEC inquiry, the company said. Last week the company said it had been delisted from the Nasdaq stock market and said its outside auditor, Deloitte & Touche LLP, resigned after telling Nyfix's audit committee that it was no longer willing to "rely on the representations of management." A Nyfix spokesman said the company wouldn't comment beyond its prior news releases.



	November 3, 2005