If a company disclosed that stock options were granted at the money, but in fact the options were granted on a date when the fair market value of the underlying stock would have resulted in the options being in the money, the disclosure may have been inaccurate. Under a relatively recent addition to the Internal Revenue Code, Section 409A, stock options that are treated as deferred compensation arrangements that do not comply with Section 409A can result in regular plus an additional 20% income tax to the option recipient on the date(s) of option vesting, rather than on the date(s) of option exercise or sale of the underlying stock, plus interest on any such tax that should have been paid.
The grant of an in the money stock option that is exercisable at any time following vesting may be treated as a non-compliant deferred compensation arrangement under this section of the IRC with these unfavorable tax consequences for the recipient.
However, if the exercise price was lower than the fair market value of the stock on the date of grant, then the company was required to record compensation expense equal to the difference between the exercise price and the fair market value at the date of grant.
As a result, the improper dating of options may require a company to restate its financial statements for prior years to reflect additional compensation expense.
In November 2005, a publicly-traded company announced the resignation of three of its top executive officers following an SEC investigation into the backdating of stock option grants.
Since then, more than 20 companies have announced the formation of independent committees to investigate option granting practices or the existence of a government investigation into their option grants.
Your investor relations department may be receiving calls from investors asking if you have a backdating problem.
There may be a natural tendency to respond, possibly without having done any investigation, that the company has no problems or is not aware of any problems.
Determine the Appropriate Response to Investor Inquiries.Backdating could be accomplished either at the time of the grant, by arbitrarily selecting an earlier date when the stocks price was lower, or after the grant has been made, by retroactively changing the grant date.Published reports have highlighted some instances in which a companys stock price increased substantially shortly after the reported grant date, suggesting that backdating may have occurred.We recommend, as a preliminary matter, that each company have a conversation with counsel to assess the general propriety of its option grant practices.You may be able to ascertain at that point the likelihood of potential irregularities.