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KB Home Executives Quit Over Stock Options Probe

By Martin H. Bosworth
ConsumerAffairs.com

November 13, 2006

KB Home • Consumer Complaints --- News • KB Home Executives Quit Over Stock Options Probe • Texas Court Invalidates KB Home's Forced Arbitration • KB Home Customers Find FTC Penalties Inadequate • KB Home to Pay $2 Million for Violating Home Warranty Agreement

KB Home finds itself at the center of yet another scandal. Its CEO, Bruce Karatz, and several officers resigned or were fired over an investigation into whether the company falsified its accounting for stock options.

In addition to Karatz, company human resources chief Gary Ray was fired, and chief legal officer Richard Hirst resigned. Karatz may have to pay back $13 million in improperly granted stock options once the company investigation correctly assesses the stock's actual worth.

Karatz is a 34-year-veteran of the Los Angeles-based homebuilding company, twenty years of which he spent as CEO. Karatz was credited as one of the highest paid CEOs in the country, having earned over $150 million dollars in 2005, mostly from exercising stock options.

Karatz is the latest CEO to fall victim to the temptations of stock option "backdating," the practice of pricing options when the stock price is abnormally low, thus reaping much higher gains when the stock improves.

Companies ranging from United Healthcare to Apple to CNet News have all seen major reporting restatements, and resignations in some cases, over the growing scandal.

Although industry insiders have often lavished praise on Karatz for guiding the company to record profits during the housing boom, KB Home has also weathered more than its fair share of its own scandals.

Critics have charged the company uses low-quality materials to build its homes, provides poor customer service, and forces its buyers into restrictive "mandatory binding arbitration" agreements that removed their rights to go to court.

The FTC fined KB Home $2 million last year for violating the terms of a previous 1979 agreement that banned the company from inserting binding arbitration clauses into its home contracts. The company was also required to extend its warranty coverage for certain homeowners.

A Texas district court judge ordered the company to stop mandating binding arbitration in May 200, after homeowners' groups claimed that KB Home was continuing to violate the terms of the second FTC settlement.

KB Home has been a target of frequent criticism from buyers, with many disgruntled owners launching Web sites and bulletin boards documenting the many problems with KB properties in exhaustive detail.

Bubble Trouble

What really signaled trouble for KB Home, however, was the sudden slowdown in the housing market.

Cancellations of contracts for new homes and a glut of inventory, as well as increased foreclosures, have all contributed to stagnant home sales and the increasing calls for deep price reductions.

In an interview with "CNN Money" two weeks before his resignation, Karatz stated that the current downturn was the "worst he had seen." Karatz predicted that it would be at least another year before homebuilders could move excess inventory and prices flattened out sufficiently for buyers.

KB Home's stock share price has tumbled by over 40 percent this year, due to investors' jitters over the moribund market.

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