In the mids, an investigation by the Securities and "Stock options backdating scandal" Commission resulted in the resignations of more than 50 senior executives and CEO s at firms across the spectrum from restaurant chains and recruiters to home builders and health care. What was it all about? Read on to find out how the scandal emerged, what brought it to and end and what you can learn from it now. Backdating Scandal Returns to the Forefront.
The roots of the scandal date back towhen an accounting rule was put in place permitting companies to avoid recording executive compensation as an expense on their income statements so long as the income was in the form of stock options that were granted at a rate equal to "Stock options backdating scandal" market price on the day of the grant, often referred to as an at-the-money grant. This enabled companies to issue enormous compensation packages to senior executives without notifying shareholders.
Although this practice gave the senior executives significant stock holdings, since the grant was issued at-the-money, the share price had to appreciate before the executives would actually earn a profit.
A amendment to the tax code created an incentive for executives and their employers to work together to break the law. Performance-based compensation, on the other hand, was deductible.
Since at-the-money options require a firm's share price to appreciate in order for the executives to profit, meet the criteria for performance based-compensation and therefore qualify as a tax deduction.
By faking the issue date, they could guarantee themselves in-the-money options and instant profits. They could also cheat the IRS twice, once for themselves, since capital gains are taxed at a lower rate than ordinary income, and once for their employers since the cost of the options would qualify as a corporate tax write-off.
A series of academic Stock options backdating scandal was responsible for bringing the backdating scandal to light. The study, published inidentified a strange pattern of extremely profitable option grants, seemingly perfectly timed to coincide with dates on which the shares were trading at a low.
A series of two follow-up studies by professors elsewhere suggested that the uncanny ability to time options grants could only have happened if the granters knew the prices in advance.
As a result, firms restated earningsfines were paid and executives lost their jobs—and their credibility. Betting on stock prices when you already know the answer is dishonest.
A business run without integrity is a scary proposition. From a consumer's perspective, customers rely on companies to provide goods and services. When those firms have no ethical boundaries, their wares become suspect. From a shareholder's perspective, nobody likes to be lied to when providing the financing and paying the salaries.
The Dangers of Options Backdating. In the early s, new accounting provisions were enacted that required companies to report their option grants within two days of their issue and also required that all stock options be listed as expenses.
These changes reduced the likelihood of future backdating incidents. Check out Investopedia Academy's Options for Beginners course. With over 4 hours of video content and interactive exercises, you'll learn the fundamentals of options trading and how to employ effective strategies within the options market.
A Scandal Comes to Light A series of academic studies was responsible for bringing the backdating scandal to light. The Bottom Line Betting on stock Stock options backdating scandal when you already know the answer is dishonest. No thanks, I prefer not making money. Option Backdating scandal and the new, resultant SEC regulations The Stock- Option Backdating scandal, like the other scandals before it, has its own. SEC Charges Trident Microsystems, Inc.
and its Former CEO and Former CAO with Stock Options Backdating (SEC v.