TAKE TWO Completes Preliminary Option Investigation

Video Game Law Blog

January 08, 2007

Take-Two Interactive Software, Inc. (NASDAQ TTWO) ('Take Two"?) has completed its preliminary independent investigation of its stock option grant practice which we reported on last summer and it has found a number of irregularities in its stock option grant practice. Accordingly, Take Two will have to restate its financials all the way back to 1997. The investigation cleared its current CEO and CFO of any wrongdoing.

Moreover, Take Two is the subject of a SEC investigation of its stock option grant practice, which will publish its findings later this year.

Options are granted as a form of future compensation to motivate employees. The idea is to grant an option to an employee, typical a senior officer, to purchase a share of the issuer at a future date at the current trading price of the issuer. This will provide the optionee with an incentive to increase the value of the issuer.

The TSX rules provides that stock options must be granted at an exercise price at no less than the trading price at the date of the grant. The TSX Venture Exchange rules provides that the exercise must not be less than the trading at the date of the grant less a discount of 15%-25% depending on the trading price of the issuer. Otherwise, investors expect that the exercise price is equal to the trading price of the issuer at the time of grant.

The major issues that the SEC has been looking at is backdating of options. Backdating can occur in a number of ways; one way is where the board declares a stock option without setting an exercise price. At a subsequent board meeting, the board sets the exercise price which will be equal to the lowest level in the period. Another way of backdating occurs when the board substitutes the actual grant date with a grant date where the stock price is lower.

Another issue of concern is springloading which means that the issuer grants options prior to the issuer releasing positive information. After the release of the positive information, the stock price will go up and the option will be in the money.

The investigations of stock option practices have mostly been aimed at issuer listed in the US. This does not mean that there are no problems with backdated options for Canadian listed issuers. Canadian listed issuers may be the subject of similar investigations in the future as Canadian listed issuers also have similar or better opportunities to backdate than US listed issuers. The Canadian rules with respect to disclosure of stock option grants are similar to those in the US prior to the implementation of the Sarbanes-Oxley Act which went into force in 2002. Under the Sarbanes-Oxley Act, stock option grants must be disclosed within two days of the grant. It is interesting that most of the irregularities in the US have occurred prior to Sarbanes-Oxley Act came into force.

A TSX listed issuer must report any grant of options to the TSX no later than 10 days after the end of the month in which the grant was made. Moreover, any grant of options to insiders must be filed by the insider no later than 10 days after the grant. This gives a TSX listed company certain room to backdate options.

A TSX Venture Exchange listed issuer has less room to backdate options as it must issue a press release each time it grants options to its directors and officers.

It will be interesting to see how widespread the problem of backdating is in Canada. Research In Motion Limited (TSX RIM) is subject to such an investigation at the moment but it is spearheaded from the SEC as the RIM stock is dually listed at NASDAQ.

Coverage         www.gamasutra.com/php-bin/news_index.php?story=12275
Take Two        www.take2games.com