Backdating fraud

Options backdating is the practice of altering the date a stock option was granted, to a usually earlier (but sometimes later) date at which the underlying stock price was lower.This is a way of repricing options to make them valuable or more valuable when the option "strike price" (the fixed price at which the owner of the option can purchase stock) is fixed to the stock price at the date the option was granted.However, if the company granted options with an exercise price below fair market value, there would be a compensation expense that had to be recognized under applicable accounting rules.If a company backdated its stock options, but failed to recognize a compensation expense, then the company's accounting may not be correct, and its quarterly and annual financial reports to investors may be misleading.However, in late 2005 and early 2006, the issue of stock options backdating gained a wider audience.Numerous financial analysts replicated and expanded upon the prior academic research, developing lists of companies whose stock price performance immediately after options grants to senior management (the purported dates of which can be ascertained by inspecting a company's Form 4 filings, generally available online at the SEC's website) was suspicious.There is a five-year statute of limitations for securities fraud, and under the Sarbanes-Oxley Act of 2002, option grants to senior management must be reported within two days of the grant date.

In 1972, a new revision (APB 25) in accounting rules resulted in the ability of any company to avoid having to report executive incomes as an expense to their shareholders if the income resulted from an issuance of “at the money” stock options.

The SEC’s opinions regarding backdating and fraud were primarily due to the various tax rules that apply when issuing “in the money” stock options versus the much different – and more financially beneficial – tax rules that apply when issuing “at the money” or "out of the money" stock options.

Additionally, companies can use backdating to produce greater executive incomes without having to report higher expenses to their shareholders, which can lower company earnings and/or cause the company to fall short of earnings predictions and public expectations.

If a company grants options on June 1 (when the stock price is 0), but backdates the options to May 15 (when the price was ) in order to make the option grants more favorable to the grantees, the fact remains that the grants were actually made on June 1, and if the exercise price of the granted options is , not 0, it is below fair market value.

Thus, backdating can be misleading to shareholders in the sense that it results in option grants that are more favorable than the shareholders approved in adopting the stock option plan.

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