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Sarbanes oxley backdating options
Options backdating is the practice of altering the date a stock option was granted, to a usually earlier (but sometimes later) date at which the underlying stock price was lower.
This is a way of repricing options to make them valuable or more valuable when the option "strike price" (the fixed price at which the owner of the option can purchase stock) is fixed to the stock price at the date the option was granted.
The SEC’s opinions regarding backdating and fraud were primarily due to the various tax rules that apply when issuing “in the money” stock options versus the much different – and more financially beneficial – tax rules that apply when issuing “at the money” or "out of the money" stock options.
Additionally, companies can use backdating to produce greater executive incomes without having to report higher expenses to their shareholders, which can lower company earnings and/or cause the company to fall short of earnings predictions and public expectations.
Corporations, however, have defended the practice of stock option backdating with their legal right to issue options that are already in the money as they see fit, as well as the frequent occurrence in which a lengthy approval process is required.
In 1972, a new revision (APB 25) in accounting rules resulted in the ability of any company to avoid having to report executive incomes as an expense to their shareholders if the income resulted from an issuance of “at the money” stock options.
In essence, the revision enabled companies to increase executive compensation without informing their shareholders if the compensation was in the form of stock options contracts that would only become valuable if the underlying stock price were to increase at a later time.
In 1994, a new tax code (162 M) provision declared all executive income levels over one million dollars to be “unreasonable” in order to increase taxes on all applicable salaries by removing them from their previous tax-deductible status.To avoid having to pay higher taxes, many companies adopted a policy of issuing “at the money” stock options in lieu of additional income, with the idea that the executive or employee would benefit through the option by working to increase the value of the company without exceeding the one million dollar deductibility cap for executive income.When company executives discovered that they had the ability to backdate stock option grants, thus making them both tax deductible and “in the money” on the date of actual issuance, the common practice of stock option backdating for financial gain began on a widespread level.The problem with this practice, according to the SEC, was that stock option backdating, while difficult to prove, could be considered a criminal act.One of the larger backdating scandals occurred at Brocade Communications, a data storage company.It was forced to restate earnings by recognizing a stock-based expense increase of 3 million between 19, after allegedly manipulating its stock options grants for the benefit of its senior executives.It allegedly failed to inform investors, or account for the options expense(s) properly.Since the advent of stock option backdating, corporate policies have moved first toward a posture of encouraging backdating as a standard business practice, but then toward a posture of avoidance as public scandals emerged and investigations into fraudulent or dishonest business practices increased despite a commonly held belief that backdating was an acceptable and legal practice.In the modern business world, the Sarbanes-Oxley Act has all but eliminated fraudulent options backdating by requiring companies to report all options issuances within 2 days of the date of issue.Options backdating may still occur under the new reporting regulations, but Sarbanes-Oxley compliant backdating is far less likely to be used for dishonest reasons due to the short time frame that is allowed for reporting.As a result, numerous companies are conducting internal investigations to determine if, when, and how backdating occurred, and are filing amended earnings statements and tax forms to show the issuance of “in the money” options in place of the “at the money” options that were previously reported.