If the compensation expense is not properly reflected in earnings, the company’s financial statements will be inaccurate and restatement of the financials may be required.
The discovery of past backdating practices may raise issues as to the adequacy of the company’s internal controls and disclosure controls and procedures.
Options granted as of the date of employment acceptance are also troublesome if the plan does not permit grants to non-employees or if the additional tax and accounting issues relating to grants to non-employees are not adequately addressed.
The practice of “backdating” stock option grants has recently captured the attention of regulators, prosecutors, the plaintiffs’ bar, shareholders and the media.
The SEC’s Enforcement Division and the offices of the United States Attorney are investigating the option granting practices of dozens of companies and actions taken by their executives.
Another scenario involves the allocation of grants to employees from an authorized pool.
If the exercise price is set when the pool is authorized by the board or committee but the allocation and actual grants occur later (when the stock price has increased), backdating issues may arise.
SEC Chairman Christopher Cox recently stated that the proposed SEC rules on disclosure of executive compensation will “almost certainly address options backdating explicitly.” I. Companies have considerable discretion in determining the timing of stock option awards.