Stock option backdating illegal

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The backdating problem was first highlighted by Professor Erik Lie of the University of Iowa, who published his initial study in 2004.

Professor Lie concluded that the robust profitability of so many options was statistically impossible absent some artificial influence such as backdating.

It was the pseudo-scandal launched by the Wall Street Journal's investigative unit, after its reporters began following up on an academic report that demonstrated many executive stock options awards were too well-timed to be plausible.

The basic idea was that many companies seemed to award stock options on days when their stocks were at low-points, which increased the value of the options when the stock increased and made the stock cheaper to buy for the executives.

Under previous regulations, corporations could wait 45 days or, in some cases, over a year to report options, thus providing ample time for backdating.

Other similar practices are being reviewed by government officials as well.

Last week the Do J brought criminal charges against two Brocade Communications Systems executives, while the SEC filed a civil suit against the same two and the CFO.

The companies were awarding the options later but then marking the awards to earlier dates, when the stock's price was low.

A quick examination of the cases against Brocade clearly identifies why backdating is synonymous with fraud, even though no U. The practice involves using hindsight to assign a stock-option contract an earlier date than its actual grant date.

By pushing the date into the past, to a time when the underlying stock traded at a lower price than it did the day the grant was issued, the option holder is, in effect, being given the promise of cash.

At first glance, call options represent the perfect way to tie an executive's level of compensation to the company's performance because as the company's share price increases, so does the payoff the executive will receive.

However, this concept is not perfect and there are ways that executives can take advantage of the way that options are granted in order to earn money.

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