It could also lead to delays in filing financial statements while the magnitude of the problem is determined.Adverse tax consequences may result from option backdating practices.
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.
Finally, an option granted at less than fair market value that either vests in whole or in part after December 31, 2004 or granted or modified after October 3, 2004 raises issues under the new deferred compensation rules set forth in Section 409A of the Code.
Under Section 409A, the recipient could be subject to acceleration of taxable income and additional taxes and penalties, and the company could be subject to special tax withholding and reporting requirements.
In its most basic form, backdating can range from the blatant falsification of a document to take advantage of a lower stock price to allowing executives to select a grant date during a specified period, for example during the 30 days after the grant is approved by the board or committee.
Although these practices involve different types of conduct, both create problems because the date when the exercise price is set is not the same as the date on which the option is awarded.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.The author of the academic study who is credited with focusing regulators on this issue estimates that at least 10% of “at-the-money” grants of options to CEOs between 19—before Sarbanes-Oxley shortened the reporting period for option grants—were backdated.This problem occurs most often when boards or committees act by unanimous written consent but there is a delay in the receipt of all of the signed consents.Even though no documents are backdated and there may be no intent to select a lower exercise price, backdating issues may arise if the stock price increases before the corporate formalities have been completed.Another scenario involves the allocation of grants to employees from an authorized pool.