Stock options backdating issue
Inaccurate reporting of a stock option grant date could be alleged to be a violation of the securities laws. Many stock option plans require that stock options be granted with an exercise price no lower than fair market value or a specified percentage thereof (generally 85%) on the date of grant.If an improperly dated option grant results in an exercise price lower than that permitted by the plan, the grant might violate the terms of the plan unless it were characterized as a grant outside of the plan or as a de facto amendment of the plan, either of which could violate the rules of the stock exchange upon which the stock is listed. Where the possibility of irregularities is suggested, federal and state authorities and the stock exchanges can be expected to vigorously investigate.Because compensation expense is recorded over the vesting period of the option (generally four years), a single occurrence of improper dating could result in the restatement of several years of financial statements.In addition, irregularities in option grant practices could reflect material weaknesses in internal controls. Publicly-traded companies are required to disclose executive officers compensation in their proxy statements.In November 2005, a publicly-traded company announced the resignation of three of its top executive officers following an SEC investigation into the backdating of stock option grants.
In addition, if the stock option was intended to be an incentive stock option, improper dating could disqualify the option from the favorable tax treatment ordinarily accorded that type of option. Under Section 16 of the Securities Exchange Act of 1934, executive officers are required to report the grants of stock options on forms they file with the SEC.
Backdating refers to the intentional setting of a grant date that precedes the actual date of the corporate action that effected the grant, in order to achieve a lower option exercise price and hence a higher value to the recipient.
Backdating results in an option already being in the money at the time of the grant.
These agencies have a broad array of enforcement powers and resources to punish unlawful actions.
In several cases to date, investigations by the SEC or the Department of Justice are reported to have led to resignations or firings of senior management. Companies facing suspicions about their option grant practices can expect shareholder lawsuits, most likely in the form of derivative claims and/or class actions under the federal securities laws. Because every company has a different history and set of corporate practices, no one series of actions is necessarily appropriate for all.