Define backdating stock options
Although researchers may have been puzzled by this phenomenon, jurists are not. Significant changes to internal controls subsequent to the most recent evaluation have been disclosed, including any corrective action. The legal complaint alleged that from to , the former CEO and the former chief accounting officer directed the company to engage in schemes to provide undisclosed compensation to executives and certain employees. In the modern business world, the Sarbanes-Oxley Act has all but eliminated fraudulent options backdating by requiring companies to report all options issuances within 2 days of the date of issue. Indeed, the coverup is often worse than the crime. Huson, Parrino, and Starks found that Since , accounting principles for awards of stock-based compensation to employees have required a fair-value method of accounting for employee stock options under SFAS R.
The CEO and the CFO are responsible for disclosure controls and procedures, and have reviewed those procedures within the 90 days preceding the report filing date. 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. The IRS filed charges of aiding and abetting personal income tax evasion related to stock options from to Indirect costs from correcting accounting problems and financial restatements will also be significant. As of 17 November , backdating has been identified at more than companies, and led to the firing or resignation of more than 50 top executives and directors of those companies. However, if the exercise price is below the market price so that the options are in the money, then the compensation will not be performance based, as the options would have intrinsic value immediately. From an accounting perspective, backdating practices that involve the concealed award of in-the-money stock options result in misleading financial statements because employee-compensation expenses are hidden. The problem with this practice, according to the SEC, was that stock option backdating, while difficult to prove, could be considered a criminal act. He states that, under paragraph 10 b of APB Opinion 25, the measurement date for determining the compensation cost of a stock option is the first date on which both of the following are known: Based on their knowledge, the financial statements fairly present, in all material respects, the financial position, results of operations, and cash flows. At one extreme, where it is clear that top management was guilty of conscious wrongdoing in backdating, attempted to conceal the backdating by falsifying documents, and where the backdating resulted in a substantial overstatement of the company's profitability, SEC enforcement actions and even criminal charges have resulted. SOX addresses financial accounting problems and reporting issues exposed by corporate scandals such as Enron and WorldCom. Brocade executives were charged with concealing millions of dollars in employee compensation expense from investors. Significant changes to internal controls subsequent to the most recent evaluation have been disclosed, including any corrective action. Because at-the-money stock options have no intrinsic value when measurement and grant dates are identical, there is no employee compensation cost to be recognized under APB Opinion In some cases, backdating can be considered an act of fraud and an SEC investigation may result. Exposure for Investors Investors should expect backdating problems to be expensive for affected companies. Based on their knowledge, the report is truthful and does not omit material information. Although many companies have been identified as having problems with backdating, the severity of the problem, and the consequences, fall along a broad spectrum. As an economic and practical matter, backdating and cherry-picking dates with the lowest market price of the underlying stock may be evidence that the options granted were not reasonable compensation, because the grant of the options would not be performance based. Enforcement of Options Backdating Restrictions After the two-day reporting rule went into effect, the SEC found numerous companies were still backdating options in violation of the legislation. Options backdating defeats the purpose of linking an executive's compensation to the company's performance, because the bearer of the options will already have experienced a gain. In such cases, backdating can invalidate an option award. In the current environment, however, the change has outraged both commentators and legislators, who perceive it to be a relaxation of disclosure rules at a time when corporate officers appear to need more, not less, oversight. An option's strike price is usually chosen by taking the stock's closing price on the day that the option was granted, calculating an average of the day's high and low prices or by taking the closing price from the previous day's trading. Is Backdating the New Corporate Scandal? This all but eliminated the opportunity for senior management to engage any meaningful options backdating.
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