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The stock plans of many public companies prohibit the granting of below-market options; other companies disclose in their SEC reports that stock options are granted at market and prepare their financial statements on that basis.The term “backdating” refers to a number of option granting practices in which the reported grant date is different from the date on which the option is actually awarded, resulting in an option that is already “in-the-money” at the time of the grant.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.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.State law and bylaw provisions as to the time of effectiveness of unanimous consents may be helpful in evaluating these issues. It is important to note that most of these practices are not inherently illegal.The practice of granting options in advance of the disclosure of positive news does not involve option backdating, but it is often discussed in the context of backdating and is also under scrutiny. If no documents are forged, and if practices are properly approved and disclosed, appropriately accounted for, properly treated for tax purposes and in accordance with the terms of the option plan, most option granting practices should fall safely within the law.
Companies and individuals could face monetary penalties, restitution and disgorgement under the securities laws and the Internal Revenue Code.
The practice of “backdating” stock option grants has recently captured the attention of regulators, prosecutors, the plaintiffs’ bar, shareholders and the media.
The SEC’s Enforcement Division and the offices of the United States Attorney are investigating the option granting practices of dozens of companies and actions taken by their executives.
Options granted at less than fair market value or without proper board or committee approvals may violate the terms of the applicable option plan, with the result that options could be invalid.
Exceeding the authority set forth in a shareholder-approved plan may also run afoul of stock exchange rules requiring shareholder approval of equity-based compensation.
Options granted as of the date of employment acceptance are also troublesome if the plan does not permit grants to non-employees or if the additional tax and accounting issues relating to grants to non-employees are not adequately addressed.