Consequences of options backdating

If the compensation expense is not properly reflected in earnings, the company’s financial statements will be inaccurate and restatement of the financials may be required.

Before FAS 123R, generally only options granted below fair market value resulted in any compensation expense.

After 123R, the “fair value” of discounted options will be greater than the “fair value” of comparable undiscounted options, resulting in higher compensation expenses.

SEC Chairman Christopher Cox recently stated that the proposed SEC rules on disclosure of executive compensation will “almost certainly address options backdating explicitly.” I. Companies have considerable discretion in determining the timing of stock option awards.

Most employee stock options are, or purport to be, granted “at-the-money,” meaning that the exercise price of the option equals the market price of the underlying stock on the date of the grant.

Option grants to new employees have their own set of backdating issues.

A company may want to give a new employee the benefit of any increase in the stock price from the date of acceptance of the employment offer.State law and bylaw provisions as to the time of effectiveness of unanimous consents may be helpful in evaluating these issues. It is important to note that most of these practices are not inherently illegal.The practice of granting options in advance of the disclosure of positive news does not involve option backdating, but it is often discussed in the context of backdating and is also under scrutiny. If no documents are forged, and if practices are properly approved and disclosed, appropriately accounted for, properly treated for tax purposes and in accordance with the terms of the option plan, most option granting practices should fall safely within the law.The practice of “backdating” stock option grants has recently captured the attention of regulators, prosecutors, the plaintiffs’ bar, shareholders and the media.The SEC’s Enforcement Division and the offices of the United States Attorney are investigating the option granting practices of dozens of companies and actions taken by their executives.Grants to new employees based on inaccurate employment commencement dates are troublesome.

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