Stock option backdating illegal

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The cascading litany of alleged charges is not likely to stop with the Brocade case.

Indeed, with more than 80 companies being reviewed by the SEC for potential illegal backdating practices, and one academic study claiming that more than 2,000 companies have engaged in the practice, civil and criminal charges will probably mushroom in the next few months. The purpose of backdating is straightforward: it gives options holders an immediate paper gain, and a real gain once the option is exercised.

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ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.

Backdating does not violate shareholder-approved option plans.

Most shareholder approved option plans prohibit in-the-money option grants (and thus, backdating to create in-the-money grants) by requiring that option exercise prices must be no less than the fair market value of the stock on the date when the grant decision is made. For example, because backdating is used to choose a grant date with a lower price than on the actual decision date, the options are effectively in-the-money on the decision date, and the reported earnings should be reduced for the fiscal year of the grant.

An example illustrates the potential benefit of backdating to the recipient.

The Wall Street Journal (see discussion of article below) pointed out a CEO option grant dated October 1998.

He attributed most of this pattern to grant timing, whereby executives would be granted options before predicted price increases.

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