KB Home ex-CEO tried to keep stock option scheme secret, an executive testifies

Home chief Bruce Karatz engineered a massive stock
option scheme that made him millions of dollars and then fought to keep
it secret from investigators, a longtime company executive testified
Wednesday.

Gary Ray, who served as KB's human resources director
from 1996 to 2006, told a federal jury in Los Angeles that he and Karatz
backdated stock options to make them more valuable to themselves and
employees and then concealed it from company shareholders and the
Securities and Exchange Commission.

When the company launched an
internal investigation in 2006, he said Karatz told him "to put the best
interests of the company ahead of the truth," and deny that they had
carefully selected dates when the stock price was low to make options
more valuable. The scheme had enabled Karatz to make more than $6
million in additional profit from his options, prosecutors say.

Ray,
52, is at the center of the government's prosecution of Karatz, who
faces 20 felony charges including securities fraud and making false
statements about the stock option program to regulators. Ray pleaded
guilty last year to conspiring to obstruct justice and agreed to testify
against Karatz. In exchange for his testimony, prosecutors have agreed
to recommend leniency when Ray is sentenced.

Ray said Karatz
instructed him to backdate employee stock options from 1999 to 2005,
carefully choosing dates when the stock price was low so that the
options would be more valuable. He said Karatz lied to the company's
chief legal officer about the backdating in the hopes they could fend
off regulators.

"He specifically said, 'We don't look back.
We've never looked back. It's not something we do in this company,' "
Ray said. "It was Mr. Karatz's belief we had to make sure we keep this
within the company."

Ray said Karatz was so concerned about
avoiding scrutiny of the company's options plan that he asked him to
fire a company lawyer who had questioned the backdating. KB did not fire
the lawyer because of concern he might be protected as a
whistle-blower, Ray said.

Karatz, who is free on bond, has
pleaded not guilty and denied any wrongdoing. Defense lawyer John Keker
told jurors in his opening statement that neither Karatz nor Ray
knowingly broke any laws, saying they handled options the same way that
many other companies did. He said Ray had agreed to plead guilty because
he was afraid of a possible prison sentence.

The defense lawyer
also said Ray changed his story about the way the company handled
options during 17 meetings with prosecutors before the trial, initially
denying wrongdoing and now describing a scheme that he said violated
federal law. Keker is scheduled to begin cross-examination of Ray on
Thursday morning.

Despite his insistence that he did nothing
improper, Karatz paid $7.2 million in 2008 to settle a lawsuit filed
against him by the SEC. Of that amount, more than $6 million was
returned to KB for what the SEC determined were ill-gotten profits from
the backdated options.

By taking the witness stand, Ray
completed a surprising transformation from being one of Karatz's top
confidants to his chief accuser. Karatz recruited Ray from PepsiCo Inc.,
put him in charge of the company's stock option plan and invited him to
exclusive employee compensation meetings in California at resort hotels
in Pebble Beach and Carlsbad.

Stock options are a form of
compensation that allows employees to buy a set amount of stock at a set
price -- usually the closing price on the date they're granted. If the
stock price increases over time, employees can exercise their option to
buy at the lower price and sell at the higher price for a profit.

If
a company handpicks an option date when the stock price was low,
employees can make even bigger profits.

Backdating is not illegal
as long as companies account for it in public filings. KB Home did not
acknowledge the practice until 2007, when it acknowledged $70 million in
previously unreported option liabilities from 1998 through 2005.

Karatz,
indicted by a grand jury last year, was one of several high-priced
executives the government accused of options-related malfeasance. By
that time, Ray had already pleaded guilty and agreed to testify as a
prosecution witness.

Under questioning from Assistant U.S. Atty.
Alexander A. Bustamante, Ray said he had made "the biggest mistake of
my career, if not the biggest mistake of my life," by trying to conceal
the backdating of stock options.

"I have not forgiven myself for
that mistake," Ray said, his voice trembling. "It caused a great deal
of pain for my family."

Ray, who is due to be sentenced July 12,
has paid $1 million to settle a lawsuit KB filed against him about the
backdating scheme. He also agreed to give up retirement and deferred
compensation benefits.

stuart.pfeifer@latimes.com

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