Question regarding the legality of options backdating

Several articles and books I’ve read refer to backdating as fraudulent. The wikipedia article (below) states:
“While options backdating is not always illegal,[2] many options in corporations are granted to upper management”.

My question is to what extent are they legal and when are they deemed illegal?
I look forward to your feedback
davidmich

http://en.wikipedia.org/wiki/Options_backdating
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. Cases of backdating employee stock options have drawn public and media attention.[1]
While options backdating is not always illegal,[2] many options in corporations are granted to upper management. Backdating has been called “cheating the corporation in order to give the CEO more money than was authorized.”[3] and a way of “rewarding managers when stock prices fall”.[4] According to a study by Erik Lie, a finance professor at the University of Iowa, more than 2,000 companies used options backdating in some form to reward their senior executives between 1996 and 2002.[5] In an “uncanny number of cases,” the “companies granted stock options to executives right before a sharp increase in their stocks.”[1]

I suspect (though I do not know for sure) that the illegality would depend on the jurisdiction in which the corporation is formed, not the specific nature of the backdating. Your question seems to imply that it might be ok to backdate an option one week, say, but not one month.
The issue is that when a corporation issues stock (as I think it does when it satisfies employee options), it should benefit the corporation, not individuals. When it issues an option at the current strike price, it supposedly gives that person an incentive to work harder so that the stock price will go up, benefitting the corporation. Backdated options are often cashed in immediately (or a soon as possible), so no such incentive exists. Furthermore, the corporation has lost some money it might have gained simply by issuing that stock.
Different jurisdictions view this transaction differently, or, more likely, some just agree to overlook it.

There is another reason. If an in-the-money option is granted, that is one for which the strike price is less than the current stock price, then that difference is taxable income to the grantee at the time of the grant. If the strike price is at or above the current stock price, then there is no table income then and, in fact, there is no taxable income until the stock that is acquired from exercising the option is eventually sold.

I do not believe it is illegal per se to “back date” the option (in the company can set any strike price it wants for the option regardless of the prevailing stock price). There are financial consequences of issuing an option with a strike below the current stock price. Back dating may allow the company to claim it met this target.

I think there is no problem with back dating an option if the strike is at or above the current stock price.

I suspect the issue also involves this: (IANAAccountat)
If you pay an executive in cash, he pays income tax.
If you give him stock , he pays income tax on the value of the stock at the time, or gets options to buy at a price - then exercises the option and sells the shares at thew new price, thus making a capital gains. Capital gains is taxed much lower than pay, so effectivly you are turning payroll into capital gains to escape paying ful taxes. Backdating is cheating - claiming the sale price is lower than fair market value.
Tthere are also the implications that you are “redistributing” pay, by changing the accounting period it was allegedly paid.

Plus, if the disclosure is not correct on the corporate statements, presumably you are providing the SEC with false documents.

As others have mentioned, the payout must be authorized by the board and possibly the shareholders. backdating may violate these authorizations.

All in all, you are basically lying in a business where truth and full disclosure to the SEC, the IRS, shareholders, etc are a legal requirement.

you can’t do: “I will pay you minimum wage, but sell you this box of gold coins at $35/oz for the gold, as a bonus.” You have to value the payment at fair market value.

davidmich, I just want to ask a question.

The last four threads you’ve started in GQ have been in some way concerning the markets/economics. I went back and checked and you’ve started somewhere around 125-130 threads over the last 18 months and more than 10% of them - 15-25 depending on how one counts - have been market and econ related.

Now, I’m not speaking as a moderator here, but your market questions - about which I know a bit - are on technical issues that 95%+ of investors will never use. Is this for a class or what? If it’s not, perhaps some coursework in econ/markets is in order? I think it’s safe to say that most of us are glad to answer questions but such a focus - and such a number - seems like a greater depth of knowledge is desired.

Still, all love and such.

IANAL, and I’m just guessing, but frankly, a company can just outright give its stock away if it wants to, so backdating isn’t like stealing*. It’s really just changing the terms of a deal after the fact, in a way acceptable to both parties.

To the extent that it’s done to circumvent taxes or disclosure laws, or not done with the agreement of the company’s board of directors (or whoever has the power to give away stock, grant options, or whatever), then of course it would be illegal, but for specific reasons and not just because changing the terms of a deal is “bad”.

  • Giving away stock in ways that increases the quantity of outstanding shares “steals” from the stockholders by diminishing the value of their shares, of course. This is why the board has to be involved, as representatives of the stockholders. There is no shortage of laws governing issuance of shares, but you might be surprised what a company can do that’s perfectly legal in this regard.

Are options positions numerous to the extent that options strategies are?

Online and in textbooks I usually see anywhere from four to eight. But I’m pretty sure there are many many more.

I look forward to your feedback
davidmich

http://www.macroption.com/call-put-long-short-bull-bear/

http://help.tradestation.com/09_00/tradestationhelp/options_positions/about_long_and_short_positions.htm

http://www.voptions.com/bearish_strategies_synthetic_long_put.htm