KB HOME, THE INDUSTRY'S FIFTH-largest builder, accepted the retirement of its CEO and chairman, Bruce Karatz, after an investigation conducted by members of KB's board of directors concluded that he and two other senior-level officials were involved in a scheme to backdate stock option grants to increase Karatz's compensation.

Karatz, 61, had been with Los Angeles–based KB for 34 years. His retirement took effect Nov. 12, as did the resignation of Richard Hirst, the builder's chief legal officer; and the firing of Gary Ray, who headed KB's human resources department.

The board appointed Jeffrey Mezger, 51, KB's COO and a 12-year company veteran, to replace Karatz as the builder's president and CEO. The company also launched a search for an independent non-executive chairman, a new position. Meanwhile, board member Kenneth Jastrow II, CEO of building products supplier Temple-Inland, will serve as KB's lead director. Jastrow told BUILDER that the board has expressed its “full confidence” in Mezger and KB's business plan, known internally as “KBnxt.” He also pointed to the independent chairman slot, as well as newly created positions of Chief Compliance Officer and Risk Assessment Officer, as evidence of how the builder is addressing concerns about the integrity of its corporate governance.

KB spokesman Ray Gomez said the company wouldn't comment beyond its prepared statement, which asserted that the backdating scheme was confined to the three executives named. Spokespeople for New York–based accounting firm FTI Consulting and Century City, Calif.–based law firm Irell & Manella, which KB retained to help conduct the investigation, also declined comment.

KB's evaluation of its backdating practices found that Karatz and Ray had been selecting option grant dates that were to Karatz's advantage. The Wall Street Journal, which triggered this probe when it questioned the convenient timing of KB's grants last summer, traces this backdating scheme to 1998, when Karatz received 450,000 options, or more than four times what he had been granted in each of several previous years.

Indeed, much of Karatz's compensation in recent years came from stock options he exercised. KB's proxy statement for fiscal 2005 reported that his compensation included $1,091,667 in salary, a $5 million cash bonus, and restricted stock valued at $27,913,496. At the end of that year Karatz controlled a total of 4.5 million shares through options, of which he had exercised about half for a profit of $118.4 million. Karatz agreed to return an estimated $13 million to KB for mispriced options, and the company will use new measurement dates to re-price any remaining options he's been granted.

KB is still under investigation by the SEC and said it might need to restate its earnings as far back as 1998. New charges to correct its accounting for backdating could reach $50 million. Bloomberg News reports KB is one of 176 companies that have disclosed internal or federal probes into their options practices, 73 of which have said they must restate earnings because of option-related errors.

Housing analysts greeted KB's backdating audit and subsequent management shakeup positively. “It does remove some uncertainty as a result of the outcome,” says Carl Reichardt of Wachovia Securities. He and other analysts, though, wonder who will emerge as the builder's next strategic architect. Stephen East of Susquehanna Financial Group sees Karatz's departure as a “mixed blessing,” because it helps put the “options scandal fiasco” behind the company, but also deprives KB of a leader with “a tremendous amount of experience and vision that has actually served KB very well. The longer-term question is whether the positive change of pace witnessed over the last 10 years will continue. [W]e are optimistic that it will.”

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