What is option backdating?
Option backdating is the process of granting a employee stock option (ESO) whose date is prior to its actual issue. In this way the strike price (exercise) of the option granted may be set at a price lower than that of the company’s share price on the date of grant. This process makes the granted option “in the money” (ITM) and therefore of greater value to the holder.
The practice of backdating options has been deemed unethical and is now under regulatory scrutiny, making it much less common in recent years.
Key points to remember
- Option backdating is a practice in which a company issuing stock options to employees uses a date that is earlier than the actual issue date in order to set a lower strike price, which makes the options more precious.
- Backdating options were considered an unethical or illegal practice, and are now subject to legal and regulatory enforcement since the Sarbanes-Oxley Act of 2002.
- Backdating options has become much more difficult since the introduction of Sarbanes-Oxley, as companies are now required to report option grants to the SEC within two business days.
Understanding backdating options
The practice of option backdating first arose when companies were only required to report the issuance of stock options to the SEC within two months of the original grant date. Companies would simply wait during this period to identify a particular date when the company’s stock price fell to a low and then rose during those two months. The company would then grant the option, but date it at or near that low point. This backdating would become the official granted option that would be reported to the SEC.
The options deed the antedate became much more difficult after companies were required to report option grants to the SEC within two business days. This adjustment to the filing window came with the Sarbanes-Oxley legislation in 2002.
Enforce option backdating restrictions
After the two-day reporting rule went into effect, the SEC found that many companies were still backdating options in violation of the law. Messy and untimely paperwork has been cited as the cause in some cases of unintentional backdating. Initially, the reporting rule’s lax enforcement was also blamed for allowing many companies to circumvent the rule adjustment that stemmed from Sarbanes-Oxley.
The SECOND would continue to investigate and prosecute companies and related parties who allegedly backdated options, in some cases through fraudulent and deceptive schemes. For example, the SEC filed a civil lawsuit in 2010 against Trident Microsystems and two former senior executives of the company for violating stock option backdating. The legal complaint alleged that from 1993 to 2006, the former CEO and former chief accounting officer directed the company to engage in schemes to provide undisclosed compensation to executives and certain employees.
CEO Frank C. Lin has been accused of backdating stock option documents to make it appear that the options were granted on dates prior to those issued. This scheme would have been used for the benefit of the officers and employees of the company as well as its directors. This included the backdating options presented in offer letters to new hires. The annual and quarterly reports filed by the company did not include compensation costs arising from the option backdating incidents. Trident and its former executives have agreed to settle the matter without admitting or denying the allegations contained in the SEC’s complaint.