Earlier this week the Wall Street Journal reported that a study from the University of Houston’s C.T. Bauer College of Business reveals as many as 141 companies that likely engaged in option backdating have never been investigated. The study joins a list of research projects going back to the mid-1990s that conclude option backdating occurs (or numerous companies are extraordinarily gifted at granting stock options when stock prices are at their lowest).
Stock Option backdating is the process of looking back over a prior time period and deeming employee stock options to have been granted on a date when the stock price was low. The practice has the effect of causing the options to be automatically “in the money” because they have been deemed to have been granted at the most advantageous time.
As is true of many compensatory schemes, the practice itself is not necessarily illegal, but failing to disclose it, account for it, and pay appropriate taxes is illegal. A host of potential illegal activity is involved, including (a) falsifying documents, (b) failing to properly account for option expenses which results in misrepresenting the company’s financial condition to investors, (c) misleading shareholders by granting options in violation of shareholder-approved stock option plans, and (d) improper tax treatment.
For a minimum of the past three years the SEC has actively pursued option backdating cases, and reports such as this new study are likely to continue to fuel enforcement.