A company grants a senior employee 10, stock options. Backdating is considered to be unethical, since option recipients are being given the opportunity to acquire shares at the lowest possible price, which puts them at an advantage over other shareholders.
It also results in less cash being received by the issuer when the option holder exercises an option. Thus, backdating harms not just other investors, but also the issuing company. Backdating is found by comparing the board of directors meeting date when the options were approved to the date stated on the stock options. If there is a difference, then option backdating has occurred. This task is typically performed by an internal auditor or external auditor.
Books Listed by Title. Articles Topics Index Site Archive. About Contact Environmental Commitment. What is Option Backdating? This sort of case can be brought against the corporation and its officers and directors and can result in the disgorgement of profits, stiff monetary penalties, and prohibitions against officers and directors serving any public company in those capacities in the future.
As in other enforcement areas, the SEC has a penchant for pursuing through civil actions matters that involve blatant and intentional misconduct. Of course, the imposition of an officer and director bar against those who are intimately involved with the backdating process can result in a corporation losing its founder or other key management personnel. And in addition to officer and director bars imposed by government authorities, internal investigations have led to numerous officer resignations from at least 25 companies including Quest Software, KB Homes, United Health Group, Inc.
Even Apple Computer CEO Steve Jobs was implicated by an internal investigation into backdating, although he apparently did not receive, or otherwise benefit from, the backdated grants. The Internal Revenue Service has also joined a number of investigations due to the tax implications of options backdating, both with respect to the individuals who received the backdated options as well as the corporations that failed to account properly for the options when they were granted.
Of course, disparity between a reported grant date and the actual grant date is not always intentional. Public announcements that a company or the SEC is investigating possible backdating issues have spawned a rash of civil suits. Such cases are brought under the guise of both class actions and shareholder derivative proceedings.
Class actions ostensibly are brought on behalf of the shareholders of the company who have been impacted by the option grants. Shareholder claims typically are grounded in some allegation of misrepresentation. However, the fact of the option grants, their strike price and their eventual profitable exercise are in most instances disclosed. Thus, in the context of options backdating, substantial doubt exists as to the viability of shareholder claims. Shareholder derivative claims, which are more common, are brought directly against the officers and directors on behalf of the corporation.
Recovery in derivative suits inure to the benefit of the corporation. As of press time, reported decisions construing the metes and bounds of these particular type of suits are just beginning to be issued. Illogical perhaps, but not illegal. However, other than seeking disgorgement from individual option grantees of improper option profits, it is difficult to predict precisely what damage theories plaintiffs can pursue in either a derivative or class-action setting that would make their claims viable.
In addition, to the extent that plaintiffs pursue their cases on an unjust enrichment theory against beneficiaries of improper options backdating, they encounter the problem that such disgorgement is considered disgorgement of an ill-gotten gain and thus is not covered by directors and officers liability insurance policies. In addition, if a civil case is conducted parallel to an SEC enforcement action, there is the question of whether the benefiting officer or other person can be made to disgorge purported ill-gotten gains twice — once to the government and once to private plaintiffs for the benefit of the corporation.
Of course, all these down-the-road theoretical difficulties that could be encountered by plaintiffs are cold comfort to a company that is sued and must endure the years of uncertainty and high defense costs that inevitably accompany such suits. Indeed, the high costs of running internal investigations, coping with SEC investigations, and defending strike suits may have a major economic impact on companies with backdating issues. In addition to generating significant professional fees, a backdating problem can divert management and cause a corporation to lose focus.
The Wall Street Journal has kept a backdating scorecard and, as of December 31, , companies had been impacted by backdating, with a majority of those companies being investigated by the government and being sued by shareholders. Given that most responsible companies hopefully have internally reviewed their options-grant practices, it is expected that this scandal will eventually taper off. However, as there is no statute of limitations that totally bans the SEC from suing companies, it may be difficult to determine with certainty when the risk has finally passed.
Options Backdating Fifty-two companies currently under criminal investigation. More than companies have announced internal investigations, and the SEC is investigating many of them as well. The involved companies range from small to Fortune companies. Private Litigation Public announcements that a company or the SEC is investigating possible backdating issues have spawned a rash of civil suits. Gifford , No.
Reyes , No. Alexander , No. Atkins, July 26, , sec.
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The exercise price is usually the market price of the shares on the date when the options were awarded. Backdating occurs when the date at which the option price is set is shifted backward to that date on which the market price of the stock was the lowest. By doing so, those awarded stock options can now buy the shares at a lower exercise price, so that they reap larger profits when they sell the shares.
Stock option backdating can be detected by examining the date of the board of directors minutes to see when the options were authorized, and then tracing this date back to when the options documentation was completed. A disparity between the dates indicates that backdating has occurred. Books Listed by Title. Articles Topics Index Site Archive. About Contact Environmental Commitment. What is Stock Option Backdating?
Second, the Sarbanes-Oxley Act of required companies to report stock option grants within two days. The University of Michigan found that nearly a quarter of stock options were still reported late, often to the financial benefit of the options grantee. Finally, the U. So: the U. In June , Apple announced that an internal probe had found some irregularities in some option grants issued between and Among those irregularities—a grant to its CEO, Jobs.
We are focused on resolving these issues as quickly as possible. Four months later, Apple said a special committee had found irregularities in 15 of the grants made between and —6 percent of the total grants issued in that period. The answer may be in a Wall Street Journal report from earlier this month. According to the Journal , regulators are looking into a falsely dated grant of 7. What will help or hurt any company enmeshed in a backdating probe is how its actions look to the government and to shareholders.
It really depends on how improper backdating is perceived—was it maliciously done and something done to hide it? The public typically sits up and takes notice of improper backdating when it begins to understand the financial impact that practice had, Dina added. You have to wait until it becomes real to people losing money. The shares split, and last March, Jobs was eligible to exercise his now million options.
Whether this argument will hold up under regulatory and public scrutiny remains to be seen. Paul Hodgson, a compensation expert with The Corporate Library, is skeptical.
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