3/6/2009 Department of Justice Press Release via the FBI Website:

LOS ANGELES – A former CEO and chairman of the board of KB Home was named today in a 20-count indictment that charges him in a scheme to defraud KB and its shareholders by awarding himself and other KB executives millions of dollars in undisclosed stock-based compensation in connection with the backdating of stock options over a seven-year period.

Bruce E. Karatz, 63, of Bel Air Estates, was charged with seven counts of mail fraud, five counts of wire, three counts of securities fraud, four counts of making false statements in reports filed with the Securities and Exchange Commission, and one count of lying to KB’s accountants.

This scheme alleged in the indictment involves Karatz’s use of hindsight pricing to inflate the value of stock options granted to him and other KB executives, as well as Karatz’s ongoing concealment of this practice from KB’s board of directors, Compensation Committee and shareholders. Furthermore, the indictment alleges, when an internal investigation into stock-option backdating was initiated at KB in May 2006, Karatz falsely denied his orchestration of the stock-option backdating scheme and caused a false report of KB’s historical option-granting practices to be submitted to KB’s Audit Committee and outside auditor, which impeded the timely and accurate disclosure of this matter in filings with the Securities and Exchange Commission.

In a related case, a former senior vice president of KB and head of Human Resources, Gary A. Ray, pleaded guilty on February 6 to conspiring with Karatz to obstruct justice. By pleading guilty, Ray admitted that he and Karatz collaborated in causing a false and misleading report on KB’s historical option-granting practices to be submitted to KB’s Audit Committee and other KB managers for the purpose of warding off a contemplated SEC probe into backdating at KB (see: http://www.usdoj.gov/usao/cac/pressroom/pr2008/154.html).

According to the indictment returned this afternoon by a federal grand jury in Los Angeles, Karatz engaged in a fraudulent scheme to disguise and conceal from KB and its shareholders the nature and value of stock-based compensation KB was actually awarding to Karatz and other KB executives through its stock-option granting practices. Karatz allegedly caused below-market exercise prices to be selected for stock options granted to him and other KB executives by using hindsight to backdate the grant date of these options to the date with the lowest price point for KB’s stock.

In furtherance of the scheme, the indictment alleges, Karatz concealed his use of hindsight pricing from KB’s board of directors, Compensation Committee and shareholders. In various public filings made by KB, Karatz made it appear that KB’s option grants were made “as of” the date that had been selected. Karatz allegedly caused false statements to issued that claimed that all employee stock options granted under KB’s compensation plans had an exercise price equal to the fair market value of KB’s stock on the date of the grant. This representation created the false impression that KB was granting at-the-money stock options to KB executives, for which the recording of a compensation expense was not required, when in fact KB was granting discounted, in-the-money stock options, a large portion of which were awarded to Karatz himself.

As a result of these fraudulent practices, Karatz caused KB to grant millions of backdated, in-the-money options to himself and to other KB executives without publicly reporting the compensation and without taking the required compensation expense on KB’s financial statements. As a result, the indictment alleges, Karatz was able to misappropriate millions of dollars in KB’s funds when he exercised his options, while maintaining the pretense that these gains were solely the result of the appreciation of the market value of KB’s stock.

After KB commenced an internal investigation into its option-granting practice in May 2006, Karatz continued to conceal that he had backdated KB’s stock option grants during the preceding seven years. Among other things, Karatz caused a false and misleading internal report to be presented to KB’s Audit Committee and outside auditors that represented there was “no evidence of the backdating of options or other manipulation by management.” KB’s Audit Committee and other members of KB’s management relied on this false and misleading internal report in deciding to file KB’s Form-10Q for the three month period ending May 31, 2006, without disclosing any irregularities in KB’s past option-granting practices.

After KB discovered irregularities in its reporting, KB was unable to timely file its third quarter 10Q in October 2006. When KB ultimately filed its 2006 3rd quarter Form-10Q and its 2006 Form-10K in February 2007, the company was forced to recognize, for the first time, more than $36 million in additional stock-based compensation expenses and a total increase of more than $70 million in accrued liabilities arising from adjustments required to address the backdated stock options.

Karatz is expected to make his initial court appearance on March 26 in federal court in Los Angeles. If convicted of all the charges, Karatz faces a statutory maximum sentence of 415 years in federal prison.

An indictment contains allegations that a defendant has committed a crime. Every defendant is presumed innocent until and unless proven guilty.

“Top executives of publicly traded companies have a duty to adhere to all the rules imposed on them by company directors and members of the public who invest their hard-earned money,” said United States Attorney Thomas P. O’Brien. “Mr. Karatz allegedly broke the rules, and then lied about it, to line his pockets and then to conceal his windfall from his company and the trading public. Efforts to manipulate a company’s compensation process, and then to impede the oversight function of the SEC, seriously compromise the integrity of our entire system.”

“This investigation painted a picture of avarice and dishonesty at its core,” said Salvador Hernandez, Assistant Director in Charge of the FBI in Los Angeles.  “The FBI is committed to devoting resources to the continuing crisis involving corporate figures who abdicate their responsibility in order to enrich themselves.”

This case was investigated by the Federal Bureau of Investigation.