THE BACKDATING OF STOCK OPTION GRANTS:
Accounting Practices Cases

Presented by:
Truth in Corporate Justice™ LLC of the Worldwide Tree Group™

POWER TO EMPOWER™

This Web site is for those who have lost money due to the backdating of stock options by directors and officers of many companies. These corporate directors and officers engaged in a scheme that enabled them to award stock option grants to themselves on specific dates corresponding to low stock price trade dates in the past. This ensured that these officers and directors would maximize the cash value of their option grants.

A stock option has traditionally been defined as an incentive given to officers and directors to purchase the company's stock at a lower price based on the actual trade price of the stock at the time the option is granted.

Since the compensation committee within a company's board of directors determines the fair market value of such options, they were backdated so as to ensure better profits for those who received them.

The Focus:

If you are trying to determine if a stock is the target of more trouble to come, look at the following:

1. Does the chief executive officer (CEO) receive most of his/her compensation in stock options?

2. Has the chief financial officer (CFO) resigned in the past six months?

3. Have there been signs of corporate governance problems that have led to public explanations by the company?

4. Is the company a technology or biotechnology company (sectors that tend to use stock options as compensation)?

5. Has the recipient of the backdated options included the money made as compensation—or has it been booked in another manner?

6. Has the backdating of options been previously disclosed in SEC public filings?

It is the opinion of Truth In Corporate Justice LLC ("TCJ") that the SEC will not allow the expensing of these options. If the option income is considered personal income, it is our opinion that the SEC will find no harm in the practice. TCJ's expressed opinion is solely based upon that which is available in the public domain.

More on Stock Options:

Joseph Hargett of Schaeffer's Investment Research wrote in "Backdating Options: Why All The Attention?" (June 26, 2006):

The objective of granting ESOs (employee stock options) is to more closely tie the interests of employees and the company's shareholders, thus creating an incentive for the employee to help the company to better perform. However, there are a couple drawbacks to this plan. If the stock drops, the ESO holder loses the opportunity for a bonus, but doesn't take the same hit as a stock owner. Furthermore, there is a raging debate going on regarding how to value an ESO, and whether or not they are an expense on the income statement.

This brings us to the topic at hand. During the 90s, when the practice of backdating options was all the rage, stock options were the compensation of choice for many up-and-coming CEOs and chairmen, especially during the dot-com boom. With little-to-no actual capital layout, an ESO holder could easily make a fortune by exercising their option and immediately selling it on the open market at a higher price. However, when the days of the dot-com bubble went the way of the dodo, these easy gains were hard to come by.

Enter Erik Lie of the University of Iowa. Lie did a study on the behavior of stock prices before and after option grants, looking at 5,977 option grants between 1992 and 2002. In his paper, he discovered that unless executives were truly clairvoyant in their market timing, they had to be backdating the grants. Essentially, companies were pricing options on days in which the firm's stock was trading at a low for the week, month, or quarter; thereby almost guaranteeing a large profit for the executives. Who wouldn't want to name their own price on a bonus or a stock? Unfortunately, the market isn't run by priceline.com, and the practice of backdating options lowered income levels, thus evading certain taxes and bilking company shareholders out of a considerable chunk of profit.