Backdating of US share options | Practical Law

Several companies have expressed their intent to restate financial statements due to option timing issues, and opportunistic attorneys have already filed derivative and class action lawsuits. Use the arrows to arrange content. Download pages as a. No attorney-client relationship attaches as a result of any exchange of information, including emails that are sent to the Firm. Please do not send us confidential information or sensitive materials. Unsolicited information that you send to us will not be regarded as confidential unless we have agreed to represent you. If you send this email, you confirm that you have read and understand this notice. Legal Alert Jul 10, What Are Backdated Options? Companies have considerable discretion in determining the timing of stock option awards.

Best Practices for Option Grants by Venture-Backed Companies

With the U. The practice involves stock options. A company promises a worker the right to buy a share of of stock at a specific price, called the strike price. The strike price is typically tied to the value of the stock on a certain date—the hiring date for an employee, for example. That option is currently worth nothing.

Backdating options involves looking for past low points for a stock, then pretending the options were granted on those favorable dates.

New research finds that despite regulations, CEOs control information release and may do so for their own financial gain. Stock options are often used to align the interests of stakeholders and CEOs, as both benefit when share price rises. New research shows, however, that companies release more negative news during the period immediately before stock options are granted to their CEOs, which financially benefits the CEOs. CEOs, who control the release and tenor of the information, see higher future gains when options are granted while the share price is lower.

The researchers examined 1, grant dates representing CEOs across large U. For the year before each grant, they examined press releases issued by the firm to examine the positive or negative tone of each release, over a total of 49, releases.

Corporate Law Alert: Backdating Stock Options

What is backdating? Backdating is the practice of marking a document with a date that precedes the actual date. What is the benefit of backdating ESO grants? ESOs are usually granted at-the-money, i. Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.

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Before Lehman Brothers imploded, before Bernard L. Karatz, the former chief executive of KB Home , to five years of probation. His case is likely to be the last criminal trial relating to backdating, a scandal that ensnared dozens of executives over allegations that the dates of stock-option awards had been manipulated to enrich recipients. When the first cases emerged in , they looked like low-hanging fruit for federal prosecutors.

The Securities and Exchange Commission and the Justice Department investigated more than companies. Internal investigations by companies led to scores of financial restatements and dozens of executive dismissals. But on the criminal front, the government had mixed results, winning several trials but also losing a number of prominent cases.

On the Timing of CEO Stock Option Awards

Scholars, regulators, and practitioners have long struggled with challenges emanating from the separation of ownership and control of modern corporations. Agency theory typically prescribes the use of stock options, or other outcome-based contractual arrangements, to overcome the critical issue of information asymmetry.

We theorize that this arrangement, which leaves information asymmetry in place, provides CEOs an informational advantage that can be used, via impression management techniques, to circumvent some of the intended benefits of option grants. Specifically, we argue that the period leading up to an option grant creates a scenario where CEOs are incentivized to reduce the stock price of their firm for personal gain. Our results suggest that CEOs respond to this incentive by adjusting the tenor of releases from the firm during the pregrant period, providing CEOs a substantial economic gain.

With Apple facing a federal investigation into its stock option backdating of California confirming that it’s investigating Apple’s backdating of stock options, Post that Jobs didn’t directly benefit from exercising those options.

This article also appeared in the Bloomberg Corporate Law Journal and can be accessed by clicking the pdf link above. Employee option grants have long been a staple of the recruitment and compensation of employees at venture-backed companies. However, changes in the regulatory and enforcement environment in recent years have made the option grant process more complicated and often more perilous than it has been in the past.

This article reviews the primary regulatory issues that companies should consider when granting options and suggests some best practices for doing so. The determination of the correct fair market value is crucial for both tax and accounting reasons. On the tax side, use of the correct fair market value is necessary to ensure an option is a valid incentive stock option, and more importantly, to ensure that the option is exempt from the onerous provisions of Section A of the Internal Revenue Code the Code.

Section A accelerates the taxation of options to time of vesting and imposes penalty taxes on the income recognized, unless the option has an exercise price not less than the fair market value of the underlying shares or unless certain other exceptions apply—which is not usually the case for options granted by venture-backed companies. This becomes particularly important at the time of an initial public offering IPO , because the Securities and Exchange Commission SEC will review the compensation charges taken for options granted in the month period prior to the IPO.

If the SEC challenges the valuation used by the company, the IPO process could be slowed and, in the worst case, the company could miss its window to go public. In light of the importance of correctly valuing the stock underlying option grants, many companies now hire independent valuation consultants to determine the fair market value of their stock. The use of an independent valuation by a qualified appraiser offers the protection of a safe harbor exemption from Section A.

Once a company makes the decision to use independent valuations, the next issue is how often the valuation should be updated. The Section A safe harbor provides that the valuation can be relied upon for 12 months, unless its later use is grossly unreasonable. No guidance yet exists on how to apply this standard.


Options backdating is the process of granting an employee stock option ESO that is dated before its actual issuance. In this way, the exercise strike price of the granted option can be set at a lower price than that of the company’s stock price at the granting date. This process makes the granted option ” in the money ” ITM and therefore of greater value to the holder. The practice of backdating options has been considered unethical and is now the subject of regulatory scrutiny, making it far less widespread in recent years.

Who would be so arrogant to be still backdating their options? Instead, stock prices rise after option grants between 5%-8%.[6] Also stock.

Washington, D. McGuire, M. The settlement is the first with an individual under the “clawback” provision Section of the Sarbanes-Oxley Act to deprive corporate executives of their stock sale profits and bonuses earned while their companies were misleading investors. The Commission’s complaint alleges that during a year period, McGuire repeatedly caused the company to grant undisclosed, in-the-money stock options to himself and other UnitedHealth officers and employees without recording in the company’s books and disclosing to shareholders material amounts of compensation expenses as required by applicable accounting rules.

McGuire’s misconduct. The Commission’s complaint alleges that from at least through , McGuire looked back over a window of time and picked grant dates for UnitedHealth options that coincided with dates of historically low quarterly closing prices for the company’s common stock, resulting in grants of in-the-money options. According to the complaint, McGuire signed and approved backdated documents falsely indicating that the options had actually been granted on these earlier dates when UnitedHealth’s stock price was at or near these low points.

These inaccurate documents caused the company to understate compensation expenses for stock options, and were routinely provided to the company’s external auditors in connection with their audits and reviews of UnitedHealth’s financial statements.

Companies Say Backdating Used In Days After 9/11

Many corporate managers, with the aid of the board of directors, discovered that they could provide themselves with guaranteed or excessive compensation by manipulating the terms of stock option grants that were included in their compensation packages. This paper seeks to examine the legal, tax, and accounting issues that have evolved because of these suspect illegal activities. The author then examines regulations, judicial theory, and court cases to determine the current legal status of backdating, spring loading, or bullet dodging of executive stock option grants.

The current legal environment has made it difficult for executives to continue the practice of manipulating stock option grants without falling under the ire of regulators and shareholders. However, a question remains whether executives that manipulated stock option grants in the past will be found criminally liable for their acts. The paper’s review of the discourse on the legality of corporate executives enhancing their compensation packages shows the complexity of detecting and regulating this type of suspect activity.

malfeasance in the form of stock option backdating. 2 This paper after the listed grant date, and backdated so it appears that the options were.

This brings the number the number of companies sued in securities fraud class action lawsuits based on options timing allegations to eight. Background on the other seven companies previously named can be found on prior D …. With the addition of the Brooks Automation lawsuit, the number of companies named in securities fraud class …. The recent media coverage surrounding stock option practices primarily has been focused on options backdating , and to a lesser extent on options springloading.

A new wave of media attention has drawn scrutiny of another options compensation practice — the allegedly improper use of stock options grants in connection with hiring and recruiting of …. Options backdating involves retroactively dating the grant and exercise price of an options issue to a ….

Forward dating stock options

Options backdating? Who would be so arrogant to be still backdating their options? We decided to find out. We find that despite all the reforms enacted in response to the backdating scandal of , manipulation of stock options as a form of incentive compensation is once again alive and well. Backdating an option refers to the practice of fraudulently picking a date in the past when the stock price was lower than today as the grant date of the option.

They’re valuable only if the stock price rises after you get them. The companies involved in the recent scandal were backdating options to a.

Related Content. This chapter concerns the issue of backdating of US share options, including: the potential difficulties that this practice may cause and the penalties that may be incurred; steps that companies can take to avoid falling foul of this practice; the implications for non-US companies; and the likely further developments in this area. In the past few years, the practice of granting share options has come under heightened scrutiny in the US and the US Securities and Exchange Commission SEC has been investigating hundreds of publicly traded companies to determine whether they “backdated” share option grants.

Backdating occurs when an option’s grant date is recorded as occurring in the past, typically on a date when the company’s share price and therefore the option’s exercise price, which is usually fixed as that day’s fair market value was lower. The opportunities for backdating have waned in recent years due to the enactment of several pieces of legislation, which led to an increased stringency in required disclosure reports, and tax penalties imposed on certain deferred compensation.

However, different agencies in the US continue to audit, investigate and impose civil and criminal penalties on listed companies for breach of the backdating rules. This chapter gives an overview of the most important issues relating to backdating, including:. An overview of the current position, including:. Implications of backdating, including implications relating to:. The likely further developments occurring in the issue of backdating. The issue of backdating has to be seen in the context of the increased popularity of the growth of equity-based compensation in the s see box, The growth of equity-based compensation.

How Jobs dodged the stock option backdating bullet

Predating a document or instrument prior to the date it was actually drawn. The negotiability of an instrument is not affected by the fact that it is backdated. Backdating Predating a document or instrument prior to the date it was actually drawn. Mentioned in?

patterns around declared option grant dates. It fur- ther captures any tendency for firms to simply grant options after stock price declines. However, the empir-.

Tobak’s take on Steve Jobs’ role in the stock options backdating scandal at Apple. The allegations of illicit sex, drugs, and rock and roll reminded me of the 60s Funny, I can’t remember. While the story was enthralling, I didn’t understand what any of it had to do with a federal investigation into stock option backdating. But how does that relate to hiring prostitutes and drugging customers without their knowledge? Said another way, do the feds really need to dig that deep to find enough rope to hang executives with?

After all, stock option backdating is all the rage these days. You’d think they’d be up to their eyeballs in rope. I count no fewer than 38 top executives at 19 high-tech companies that have bit the dust over this stuff. And we’re just getting started. That’s serious fallout considering that options backdating is legit as long as the company reports it and accounts for it accurately. You see, if you backdate stock options to a date when the price of the stock was lower, then the options are “in-the-money” when granted.

That means the company incurs an expense equal to the difference in the share price between the two dates. If you cover it up and fail to report that expense, the way Apple’s folks allegedly did, well, that amounts to accounting fraud.

Earnings Date is it a Good Technique to Make Money?

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