Options backdating

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This article documents a current event.
Information may change rapidly as the event progresses.

Options backdating is the potentially illegal (depending on the country) practice of the grant of restricted Employee stock options at an exercise price equal to the value on the date that the grant is apparently made. However, the date chosen for the grant date is cherry picked to select an earlier date, one when the price of the underlying stock was lower. This results in a value of the option most favorable to the employee receiving it. This practice reduces the risk of share price going down for the year.

Backdating of stock options is not necessarily illegal. If the grantor of the stock options properly discloses the backdating at the actual time of grant, no fraud has taken place. It would only mean that it would not qualify for the favorable tax statutes carved out to encourage employee stock options like SARs or Stock Appreciation Right and ISOs or incentive stock options. Also since the Enron scandal, Congress enacted Section 409A of the Internal Revenue Code to deal with such non-qualified deferred compensation.

Most of the legal issues arising from backdating are a result of the grantor falsifying documents submitted to investors and regulators in an effort to conceal the backdating. This practice is a hot-button issue with investors all over the world and is currently being investigated/debated by the United States Securities and Exchange Commission.

[edit] Impact of options backdating in the United States

As of November 17th, 2006, backdating has been identified at more than 130 companies, and led to the firing or resignation of more than 50 top executives and directors of those companies. [1] Notable companies empbroiled in the scandal include UnitedHealth Group and Comverse Technology.

[edit] United States income tax issues

According to Section 83 of the Code, employees who receive property from the employer must recognize (reduce to) income in the year in which that property vests (is free from restrictions and other risks of forfeiture). Stock options granted which exercise price below the then current fair market value has intrinsic value equal to the difference betwen the market price and the strike price. Such backdating may be construed as illegally avoiding income recognition by falsely under-reporting the market price of such stocks so as to create no value in excess of the strike price at the time the option is granted.