He's Making Hay As CEOs Squirm

Erik Lie loves academic life. The University of Iowa associate finance professor is free to research whatever topic intrigues him, and his $160,000-plus income goes a nice long way in Iowa City. Summers off mean that Lie (rhymes with "key"), his wife, and two kids can travel back to his parents' vacation home in Norway. During the rest of the year, he's free to take off after class for a run or some cross-country skiing. "Life as a professor is good," says the lanky 38-year-old.

It's particularly good now that Lie's research is having a major impact on Corporate America. His mid-2005 research first suggested that hundreds of companies may have routinely manipulated stock- option accounting rules to sweeten top executives' paydays. A later study done with his research partner, Indiana University associate professor Randall Heron, puts the number at 2,000, or 29% of all public corporations. Five executives face criminal indictments for such alleged backdating, more than 100 companies face civil charges and shareholder suits, and hundreds more are neck-deep in comprehensive investigations of their books to try to make sure the Feds don't add them to the list.

The scandal is creating a financial windfall for Lie. He and Heron have created a limited partnership now that the initial crush of calls from reporters has given way to people willing to actually pay for their insights. Lie says he has earned around $100,000 from hedge funds and other investors, who pay him to handicap whether a company's options irregularities are harmless paperwork errors or the kinds of fraud that lead to CEO ousters and big civil penalties. He'll probably draw $400 an hour or more doing consulting work for law firms, and still more as an expert witness. He's now a senior adviser at the Brattle Group, a consultancy in Washington. All told, Lie figures he could make $250,000 before the options scandal fades from memory.

Lie may be underestimating his prospects. An elite business prof can make tens of thousands for a one-day consulting gig. Notre Dame University professor Paul H. Schultz, who in the mid-1990s discovered that NASDAQ market makers were skimming pennies from investors on stock trades, says he earned $250,000 over three years, charging $250 an hour to work with plaintiffs' attorneys. "But Erik can do quite a bit better, if he wants to," Schultz says. "There are more lawsuits, and he should be charging a higher rate."


Rarely has an academic had such an outsize, real-time impact on the business world. Academics had long known that companies tended to grant options with remarkable acuity--just before big rises that gave those options immediate value, at least on paper. But Lie and Heron were first to suggest that this could only have happened with the help of hindsight. That's because those favorable trading patterns appeared only in cases where companies had delayed their options paperwork for months, giving them the ability to look back and cherry-pick the most lucrative grant dates. That's a violation of federal law--and of many corporate options plans--if not properly disclosed.

Lie helped make sure the scandal exploded, notifying the Securities & Exchange Commission of his work and showing The Wall Street Journal how to interpret a particular company's options records, although he insists he never I.D.'d companies himself. He's clearly proud of his work's resonance but insists the attendant financial opportunities are a low priority. He limits his consulting time, he says, to less than one day a week. "I did not start this line of research for the money, and I am still not in this for the money," Lie says.

Now he's turning away many opportunities, he says--particularly from plaintiffs' lawyers who would like to tailor his findings to suit their cases. But he is helping "less pushy" plaintiffs' attorneys prepare potential cases against three dozen companies, diving into details of specific transactions. Indeed, he says he'll probably take the stand as an expert witness in some high-profile cases. He won't name any names, in part because it's too early to know which companies will settle rather than make it into court, but does say that he "may become involved in litigations" against Apple Computer (AAPL).

Lie is also open to working with defendants facing options-related allegations, although none have taken him up on the offer. "People tend to think I'm against all companies," he says, "but I think some of the companies identified in the media are innocent"--perhaps a dozen or so of the 200 companies that have announced options irregularities. He says some guiltless CEOs are likely to lose their jobs simply because they were at the helm when mistakes were made by others. Still, "it's one of those necessary evils; a small price to pay to get more transparency into the system. How much is good governance worth to the economy? I don't know, but it's billions and billions."

Lie grew up the son of left-leaning parents in southern Norway. His father, Rolf, a retired construction engineer, thinks Lie is imbued with the economic egalitarianism they taught him. "Erik doesn't like that people have gotten money they didn't deserve," says the elder Lie. The son briefly considered a career in law but later caught the academic bug while doing a finance research project at the University of Oregon.


When he began researching stock options as a young professor in 2002, it wasn't to find a scandal. "Shareholders were giving executives options so they'd work harder to change corporate behavior," he says. "I just wanted to see how it manifested itself"--say, by companies repurchasing more shares. Even after Lie began to suspect backdating, it took a while for anyone to listen. An initial paper in 2004 was slammed by a reviewer who said that Lie was "overreaching" and that his conclusions "made little economic sense." After Sarbanes-Oxley regulations were imposed, however, all option grants had to be reported to the SEC within two days. By comparing the new grants with pre-SarbOx grants, Lie and Heron were able to document a disappearance of the windfall obtained by execs at companies that had taken months to file in the past.

Defense lawyers dismiss Lie's analysis because it doesn't consider legitimate explanations for how options may have been granted at low stock prices. For example, CEOs during the boom routinely granted options on days when their stocks were down because of unfounded rumors. That way, they could provide some extra incentive to employees before cranking up their investor relations efforts to refute the rumor. "His analysis is simplistic," says Richard Marmaro of Skadden, Arps, Slate, Meagher & Flom, who is representing indicted former Brocade Communications Systems (BRCD) CEO Greg Reyes. "There are people whose job it is to grant options, who are expert in understanding what they perceived to be low prices."

Lie says he's going into this next phase of the scandal with his eyes wide open, expecting to have his motives criticized, and ready for persuasive arguments about why a specific company, board, or executive did nothing wrong. He figures that the bulk of backdaters have yet to be identified, and that just 10% will ever be punished in any way. "I don't anticipate I'll be able to create something of this magnitude again," he says. "But it's not necessary for me that there is a consequence for every single firm. My research has already helped curb this behavior. That's the most important thing."

By Peter Burrows

The Epic Hack

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