As a consequence, the option is immediately profitable, or “in the money,” to the option holder.
With its attendant investigation, legal actions and executive fallout, the practice of options backdating is expected to have a short shelf life.Even Apple Computer CEO Steve Jobs was implicated by an internal investigation into backdating, although he apparently did not receive, or otherwise benefit from, the backdated grants.The Internal Revenue Service has also joined a number of investigations due to the tax implications of options backdating, both with respect to the individuals who received the backdated options as well as the corporations that failed to account properly for the options when they were granted.Another troublesome outcome for a corporation is that the SEC will bring civil fraud charges stemming from options backdating in all cases where criminal charges have been filed.But even if no criminal charges are filed, the SEC still can bring a civil fraud action in federal court.In that case, corporate officers inserted backdated option grant dates into board of directors’ unanimous written consents that were transmitted to the compensation committee.
Options were also backdated for new employees to dates prior to the date employment actually commenced.
Similarly, the FBI has reported that it has 52 companies under criminal investigation. Department of Justice has said it will bring criminal charges where defendants falsify corporate books and records; issue false financial statements; lie to boards of directors, auditors or the SEC; or file false reports.
Two indictments have been issued and multiple guilty pleas have been entered in the most egregious cases. To a public corporation, the potential consequences of engaging in options backdating are manifold and can range from none whatsoever to having founders and CEOs going to prison. For example, in the case involving Brocade Communications, the SEC charged the former CEO and the former Vice President of Human Resources with criminally violating the securities laws.
Professor Lie concluded that the robust profitability of so many options was statistically impossible absent some artificial influence such as backdating.
Subsequently, the Securities and Exchange Commission (SEC) took an interest, followed by the securities plaintiffs’ bar and many corporations. The practice of options backdating, apparently widespread from 1996 through 2002, is widely believed to have been short-circuited by the enactment of Sarbanes-Oxley in 2002.
In addition to the governmental investigations, more than 200 companies have completed, or are conducting, internal investigations — either because they want the comfort of knowing that they have not engaged in options backdating or they have an inkling that they did and want to be proactive in addressing the problem. In a follow-up study to his earlier work, Professor Lie estimated that 29 percent of 7,774 companies he surveyed backdated option grants to executives between 19. The facts of that case as set forth in the indictment were egregious.