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Updates
Stock Options Backdating Controversy May Have Scope and Sanctions Far Beyond What Most Companies Expect
August 29, 2006
The US Department of Justice and the US Securities & Exchange Commission continue to scrutinize corporate stock option practices at public companies. 60+ public companies have received government subpoenas or information requests and derivative lawsuits. Many of these companies, on their own initiative or at the government's prompting, have begun independent internal investigations into the stock option granting process. Senior executives at two public companies have been criminally charged with intentionally backdating stock option grants to historically low prices. However, even in the absence of intentional manipulative acts, options issues may arise due to inadequate internal controls or poorly documented procedures.
US public companies should recognize that the backdating controversy can have a far-reaching impact. Senior executives, officers and directors must show their commitment to honesty and corporate compliance, assuring shareholders they have not run afoul of the law’s complexities.
For companies who feel they are not at risk from current backdating controversies, the following developments should be carefully considered:
A new statistical study of options granted by 7,774 companies between 1996 and 2005 suggests that 2,270 of those companies (nearly one-third of the total) made options grant decisions that could be construed as backdating. *
Options grant strategies that were standard practice, especially at technology companies, are now subject to criminal investigation.
There are potentially significant financial and legal problems for companies and their executives and officers who in good faith participated in option programs that are now being questioned. Options worth millions of dollars may be invalidated, or given accounting treatment that hits the issuer's prior year and current profits heavily. Substantial restatements of prior period financial statements might be required. Under recently adopted Section 409 of the Internal Revenue Code, these options could produce millions of dollars of immediate taxable income to the affected individuals. Depending on the circumstances, financial, accounting, legal and human resource executives who helped draft relevant documents could be targets of SEC enforcement actions.
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* “Study Finds Backdating of Options Widespread,” New York Times (7/16/06)
