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US: Questions Raised on Another Chief's Stock Options

by Barnaby J. FederThe New York Times
June 9th, 2006

New accusations of corporate stock option abuse were leveled yesterday, this time against Cyberonics, a medical device maker that is no stranger to controversy.

The company's board approved stock option grants for top executives one evening in June 2004, a few hours after receiving positive news about the regulatory prospects for a promising product. When trading began the next morning, Cyberonics shares soared, and along with them, the value of the options.

Yesterday, Cyberonics shares plunged nearly 16 percent when trading began, after Amit Hazan, a device industry analyst for SunTrust Robinson Humphrey, published an investor advisory about his concerns over the timing of those stock options, which were granted to Robert P. Cummins, Cyberonics' chairman and chief executive, and two of his lieutenants.

The analyst's report criticized the option grant, saying it gave Mr. Cummins an instant paper profit of $2.3 million, and profit of $150,000 each for the other two executives, but did nothing for other shareholders.

Mr. Cummins and the company countered that because the option grant had been immediately reported to the public and that he and the other men had not yet exercised any of the options, there was no cause for controversy. By the end of regular trading yesterday, the stock had regained most of its losses, closing down 20 cents at $23.59.

Mr. Hazan did not accuse Cyberonics of backdating the options to a day when prices were particularly low — a practice that has recently been reported among more than 30 companies and has become the subject of a Justice Department investigation. But, he wrote, "the effect was exactly the same."

A number of technology companies, most recently McAfee, which makes antivirus software, have announced the departures of senior executives as a result of questions about options dating. The Securities and Exchange Commission has been investigating issues surrounding dating for more than a year.

Mr. Hazan, who said he was surveying all the companies he follows for potential backdating issues, focused on Cyberonics options that were granted at a special board meeting on the evening of June 15, 2004. That was only hours after a Food and Drug Administration advisory panel recommended that the agency approve Cyberonics's request to market its implantable nerve stimulator as a treatment for severe chronic depression.

Mr. Cummins received options on 150,000 shares at an exercise price of $19.58, the closing price the day before the F.D.A. panel's recommendation. The chief medical officer, Dr. Richard L. Rudolph, and the vice president for regulatory affairs, Alan D. Totah, who played pivotal roles in winning the panel's backing, each received options on 10,000 shares at that price.

The shares soared when trading resumed the next day, June 16, closing at $34.81, as investors bet that Cyberonics might soon be selling a new approach to treating the most severe forms of depression, a condition that affects millions of Americans annually.

"The board acted on an event before investors were able to do so," Mr. Hazan said yesterday in an interview. "It's a perfect example of an abusive option. Options are supposed to be an incentive to align executives' interests with shareholders. This was just a reward."

Mr. Hazan said that because the options were priced below what would become the market value the instant that trading resumed, they should have been accounted for as compensation in that quarter. Because the company did not do so, it might have to restate its earnings for that fiscal year, he said.

Mr. Cummins, an imposing and combative executive already known for prickly relations with critical analysts and skeptical investors, e-mailed Mr. Hazan yesterday, sarcastically thanking him for "a completely uninformed note" about "a nonissue," Mr. Hazan said.

Mr. Cummins said in a telephone interview that all the options had been legally priced, properly reported and approved by the company's auditors and lawyers. He acknowledged that the options had been a reward but said that they had been designed to conserve the company's cash and to serve as an incentive because they vested over a five-year period. The only way to benefit from them, Mr. Cummins said, would be to "create and sustain value over time."

Mr. Hazan said that the company's response did nothing to change his attitude. "My problem is the timing of when they did this," Mr. Hazan said. "The fact that it doesn't vest immediately doesn't mean it was ethical, and I haven't heard from one institutional investor today who disagrees with me."

The options granted to the executives in June 2004 are now 38 percent vested. At yesterday's closing price for Cyberonics, the value of the vested options was $601,500 to Mr. Cummins and $40,100 each to the others.

Mr. Cummins and the company said he exercised options on 350,000 shares in February 2005 and sold them at prices ranging from $40 to $45, but those options had been granted earlier: in October 1997, March 1999 and June 2001. He has been chief executive of Cyberonics since 1995.

As it turned out, Cyberonics's price began falling soon after the June advisory panel meeting and plunged to $14.36 that August, the day after the F.D.A. took the unusual step of ignoring the panel's recommendation and refusing to approve the application.

Cyberonics' implant, a battery-powered, pacemakerlike device that stimulates the vagus nerve just below the neck, has been used widely since 1997 as an F.D.A.-approved treatment for epilepsy. But the clinical trial data the F.D.A. considered in 2004 did not show conclusively that VNS Therapy, as the treatment is called, was effective for severe depression when compared with patients who had a device implanted but no power turned on.

Mr. Cummins bitterly criticized the agency at the time. Through a combination of lobbying and additional data, Cyberonics got the F.D.A. to reverse its stance, with conditions, in February 2005. It received final approval last July to market VNS Therapy for depression, but not before the controversy led to an inquiry by the Senate Finance Committee into the tangled process.

Since then, Mr. Cummins has spent much of his time battling insurers who label the therapy experimental and who are hesitant to pay for it as a depression treatment.

By the end of April, 1,100 patients had VNS implants for depression, and 1,200 more were appealing for insurance coverage, Cyberonics said.

Mr. Hazan, the analyst, said that he was optimistic about the long-term prospects for VNS but that resistance from insurers was another factor in his decision to downgrade his rating on Cyberonics yesterday to neutral from buy.

The company recently reported that it lost $5.2 million, or 21 cents a share, on revenue of $123.4 million in the fiscal year that ended April 28.

Cyberonics and analysts who favor the stock say much of the insurers' resistance stems from the focus of the original clinical trials on three-month results, too short a period to demonstrate an advantage. But more data, they say, has shown that the rates of remission of depression symptoms in VNS patients remain high in two-year follow-up data, while those receiving other treatments suffer relapses.

Data presented last month at a scientific meeting in Toronto also suggested that rates of suicide and hospitalization drop steadily for patients on VNS Therapy for two years.

The pro-VNS argument received an indirect boost yesterday with the publication in The Journal of Clinical Psychiatry of research documenting the high failure rate of conventional drug and electroconvulsive therapies for patients suffering recurrent bouts of severe depression.





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