Options Backdating: Unethical Practice and Regulatory Enforcement
Options backdating is a controversial practice in which employee stock options (ESOs) are granted with a retroactive date, allowing the exercise price to be set lower than the current stock price at the time of grant. This manipulation makes the options more valuable to the recipient.
Options Backdating: Key Takeaways
- Options backdating involves granting ESOs with a date earlier than the actual issuance, setting the exercise price lower than the stock price at the granting date.
- Backdating options has been widely regarded as unethical or illegal and has faced increased regulatory scrutiny since the enactment of the Sarbanes-Oxley Act of 2002.
- Reporting requirements under Sarbanes-Oxley have made options backdating more challenging, as companies must now report option grants to the SEC within two business days.
Understanding Options Backdating Options backdating originally gained popularity when companies were only obligated to report stock option issuances to the SEC within two months. Companies would wait for a period during which their stock price hit a low and then rebounded, and they would grant options with retroactive dates near the lowest point.
However, with the introduction of Sarbanes-Oxley in 2002, the reporting window was shortened to two business days, making options backdating more difficult to execute.
Enforcement of Options Backdating Restrictions Even after the implementation of the two-day reporting rule, the SEC discovered that some companies continued to backdate options, either intentionally or due to administrative errors. In some cases, companies used fraudulent and deceptive schemes to backdate options.
The SEC took action against Trident Microsystems and two former senior executives in 2010, filing a civil lawsuit for stock option backdating violations. The complaint alleged that the CEO and chief accounting officer engaged in undisclosed compensation schemes from 1993 to 2006, involving backdating stock option documents. The backdating benefited officers, employees, and directors, and the company’s financial reports failed to disclose the compensation costs resulting from the backdating incidents.
Trident Microsystems and its former executives settled the case without admitting or denying the allegations in the SEC’s complaint.
Resources:
Websites and Online Resources:
- Securities and Exchange Commission (SEC): SEC v. Trident Microsystems, Inc., Frank C. Lin, and Peter Y. Jen, Civil Action No. 1:10-CV-01202 (JDB)(D.D.C.)
Books:
- “Options, Futures, and Other Derivatives” by John C. Hull
- “Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports” by Howard Schilit and Jeremy Perler
Academic Journals and Research Papers:
- EY (Ernst & Young). “Options Backdating: A Canadian Perspective.” (Available through academic databases)
Reports and Studies:
- The National Bureau of Economic Research (NBER). “Backdating: A Canadian Study.” (Available through academic databases)
Professional Organizations and Associations:
- American Institute of Certified Public Accountants (AICPA)
- Financial Executives International (FEI)