Legal issues with backdating stock options

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.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 discovery of past backdating practices may raise issues as to the adequacy of the company’s internal controls and disclosure controls and procedures.It could also lead to delays in filing financial statements while the magnitude of the problem is determined.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.But if these conditions are not met, a number of negative consequences can result, depending on the individual circumstances of the practice at issue.An option granted at less than fair market value will also not qualify as “performance based compensation” and thus must count toward the

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.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 discovery of past backdating practices may raise issues as to the adequacy of the company’s internal controls and disclosure controls and procedures.It could also lead to delays in filing financial statements while the magnitude of the problem is determined.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.But if these conditions are not met, a number of negative consequences can result, depending on the individual circumstances of the practice at issue.An option granted at less than fair market value will also not qualify as “performance based compensation” and thus must count toward the $1 million executive compensation deduction cap under Section 162(m) of the Internal Revenue Code.Finally, an option granted at less than fair market value that either vests in whole or in part after December 31, 2004 or granted or modified after October 3, 2004 raises issues under the new deferred compensation rules set forth in Section 409A of the Code.

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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.

million executive compensation deduction cap under Section 162(m) of the Internal Revenue Code.Finally, an option granted at less than fair market value that either vests in whole or in part after December 31, 2004 or granted or modified after October 3, 2004 raises issues under the new deferred compensation rules set forth in Section 409A of the Code.

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This problem occurs most often when boards or committees act by unanimous written consent but there is a delay in the receipt of all of the signed consents.Options that are granted at less than fair market value result in higher levels of compensation expense.Before FAS 123R, generally only options granted below fair market value resulted in any compensation expense.After 123R, the “fair value” of discounted options will be greater than the “fair value” of comparable undiscounted options, resulting in higher compensation expenses.If the compensation expense is not properly reflected in earnings, the company’s financial statements will be inaccurate and restatement of the financials may be required.

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