The anti-dating of the option focuses on the date of grant of the stock option. For corporate and tax purposes, the date on which the option is granted is generally the date on which the board of directors (or other authorized committees or persons) took all necessary steps to grant the stock option. In many cases, the award date is the date of the meeting of the board of directors or the compensation committee. (We note that FASB Declaration 123(R) [“FAS 123(R)”] defines the date of award for accounting purposes as the date on which the employer and employee reach a mutual understanding of the key terms of the scholarship.) Options only have value if the price of the underlying share is higher than the strike price, allowing executives to buy the stock at a discount. Companies that face backdating wait for stock prices to rise, and then give executives options that are dated earlier when prices were lower. Executives can make immediate profits, and they and the company can avoid some of the negative consequences typically associated with options in the currency. Fifty-two companies are currently under criminal investigation. Two counts. Several confessions of guilt. It all comes from the practice known as “anti-time options”.
Publicity around the backing of stock option allocations has focused on listed companies. Pillsbury Winthrop Shaw Pittman and its Stock Option Task Force are actively involved in representing corporations and boards of directors on these issues. But even private companies should learn from the questionable practices that have been uncovered and use procedures that avoid these concerns. In this disclaimer, we identify some of the practices that have caused problems, explain why they are important even for private companies, and suggest best practices to avoid problems. What are the best practices for granting stock options to avoid problems? On July 20, 2006, the Department of Justice and the Securities Exchange Commission filed criminal and civil proceedings against former executives of Brocade Communications Systems, Inc., one of more than eighty companies currently under investigation for stock option dating. One of the executives indicted in the Brocade litigation is the former vice president of human resources. If convicted on both criminal and civil charges, former leaders could have to pay hefty fines and could face jail time. The Department of Justice (the “DOJ”) and the Securities Exchange Commission (the “SEC”) have proposed that executives of other companies be charged in the same way. In most jurisdictions, a private company that sets the strike price below the fair value of the shares at the time of the award, whether as a result of a draw or for other reasons, should not consider that there are securities concerns. However, a stock option that is intended to qualify under California securities laws generally cannot be granted at an exercise price of less than 85% of the market value or 100% of the general market value in the case of a stock option granted to a 10% shareholder. Failure to comply with this substantive requirement in California or a similar requirement in any other jurisdiction could result in the loss of the exemption.
Section 162(m) of the Internal Revenue Code limits the deduction of the compensation of publicly traded companies for amounts paid to certain officers to $1 million per year. Certain performance-related compensation will not be considered when applying the $1 million limit, including options granted at an exercise price equal to or greater than the fair value of the underlying share at the time of the award (provided that the other requirements of paragraph 162(m) are met). If the option has been backdated to manipulate the strike price, it is unlikely that the option will be considered performance-based compensation. In this case, the ordinary income recorded by the option holder cannot be deductible in the corporation`s corporate tax return. If the corporation has already recognized the deduction, it may be required to file amended tax returns and restate its tax liability in its audited financial statements. Regulators recognize that due to innocent administrative delays, there may be legitimate discrepancies between the date an option is granted and the date it is completed. However, companies must report their option allocations within two days of their issuance and record all stock options as expenses. To avoid backdating issues, make sure your option granting practices are consistent and well documented. Backdating may be allowed if it is transparent. However, incorrect backdating may require profit reprocessing. And publicly traded companies guilty of backdating can violate federal securities disclosure and reporting requirements and expose themselves to regulatory or criminal investigations and securities fraud disputes.
If you decide to give backdated stock options, contact us to find out how to do it correctly. Given that most responsible companies have hopefully reviewed their option granting practices internally, it is expected that this scandal will eventually subside. However, since there is no statute of limitations that the SEC completely prohibits from suing companies, it can be difficult to determine with certainty when the risk is finally over. In any case, the secrecy of backdating and other accounting issues raised by incorrectly backdated options is grist to the plaintiffs` mill. However, aside from seeking a recovery of inappropriate option gains from individual option beneficiaries, it is difficult to predict exactly which damage theories plaintiffs may pursue in a derivative dispute or class action that would make their claims viable. .