Backdating of Executive Stock Option (ESO) Grants. The number of shares subject to option was , and the exercise price was $30 (the trough in the stock price graph below.) Given a year-end price of $85, the intrinsic value of the options at the end of the year was ($$30) x . One study showed that backdating stock options added approximately $, to the average executive’s pay at 48 companies between and , but the market value decline in those companies since the investigations into the practice began has been approximately $ million, or more than $10 per share, on average (Eric Dash, “Report Estimates the Costs of a Stock Options Scandal,” . Options backdating occurs when a company issues stock options on one date, but reports in its financials an earlier issue date to create a “strike” or exercise price equal to .
Fifty-two companies currently under criminal investigation. Two indictments. Multiple guilty pleas. All stemming from the practice known as "options backdating.
Stock options backdating, the company avoids having to expense the options as current compensation, Stock options backdating, thus increasing earnings in the near term. The backdating problem was first highlighted by Professor Erik Lie of the University of Stock options backdating, who published his initial study in Professor Lie concluded that the robust profitability of so many options was statistically impossible absent some artificial influence such as backdating.
The SEC brought no backdating cases prior to The practice of options backdating, apparently widespread from throughis widely believed to have been short-circuited by the enactment of Sarbanes-Oxley in Although backdating had not yet Stock options backdating recognized as a problem, the provisions of Sarbanes-Oxley requiring that insiders report the acquisition of securities, including options, within two days of receipt greatly hindered the ability of corporations to backdate options.
Under previous regulations, corporations could wait 45 days or, in some cases, over a year to report options, thus providing ample time for backdating. Other similar practices are being reviewed by government officials as well.
With its attendant investigation, Stock options backdating, legal actions and executive fallout, the practice of options backdating is expected to have a short shelf life, Stock options backdating.
But while options backdating may have a truncated life expectancy, its current impact is robust. The SEC is investigating many companies, Stock options backdating, ranging from small to Fortune companies, for options irregularities. Similarly, the FBI has reported that it has Stock options backdating companies under Stock options backdating investigation. Two indictments have been issued and multiple guilty pleas have been entered in the most egregious cases.
In addition to the governmental investigations, more than companies have completed, or are conducting, internal investigations — either because they want the comfort of knowing that they have not engaged in options backdating or they have an inkling that they did and want to be proactive in addressing the problem. The problem is indeed widespread. In a follow-up study to his earlier work, Professor Lie estimated that 29 percent of 7, companies he surveyed backdated option grants to executives between and That is almost 2, companies.
What are the consequences of options backdating? To a public corporation, the potential consequences of engaging in options backdating are manifold and can range from none whatsoever to having founders and CEOs going to prison. In general, the U. Department of Justice has said it will bring criminal charges where defendants falsify corporate books and records; issue false financial statements; lie to boards of directors, auditors or the SEC; or file false reports. Likewise, in a case involving Comverse Technology Inc.
Options were also backdated for new employees to dates prior to the date employment actually commenced. Not surprisingly, the defendants themselves earned millions of dollars from backdated options. Another troublesome outcome for a corporation is that the SEC will bring civil fraud charges stemming from options backdating in all cases where criminal charges have been filed.
But even if no criminal charges are filed, the SEC still can bring a civil fraud action in federal court. 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 Stock options backdating 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, Stock options backdating.
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 Stock options backdating 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 Stock options backdating options backdating, substantial doubt exists as to the viability of shareholder claims, Stock options backdating. Shareholder derivative claims, which are more common, are brought directly against Stock options backdating officers and directors on behalf of the corporation.
Recovery in derivative suits inure to the benefit of the corporation, Stock options backdating. 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, Stock options backdating. In addition, Stock options backdating, 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, Stock options backdating. Indeed, the high costs of running internal investigations, coping with SEC investigations, Stock options backdating, and defending strike suits may have a major economic Stock options backdating 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 Stock options backdating of civil suits, Stock options backdating.
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Stock option backdating occurs when an employer corporation purports to grant a stock option at a date earlier than the actual grant date. A corporation may do this in an effort to provide the optionee with a reduced exercise price, selecting an effective grant date on which the FMV of the stock is low. Backdating of Executive Stock Option (ESO) Grants. The number of shares subject to option was , and the exercise price was $30 (the trough in the stock price graph below.) Given a year-end price of $85, the intrinsic value of the options at the end of the year was ($$30) x . Options backdating occurs when a company issues stock options on one date, but reports in its financials an earlier issue date to create a “strike” or exercise price equal to .