All stemming from the practice known as “options backdating.” Options backdating occurs when a company issues stock options on one date, but reports in its financials an earlier issue date to create a “strike” or exercise price equal to the earlier date’s lower price.
Another consequence is that the company underrepresents the real nature of an executive’s compensation, perpetuating the myth that options are performance-based incentive compensation.
Subsequently, the Securities and Exchange Commission (SEC) took an interest, followed by the securities plaintiffs’ bar and many corporations. The practice of options backdating, apparently widespread from 1996 through 2002, is widely believed to have been short-circuited by the enactment of Sarbanes-Oxley in 2002.
Although backdating had not yet been recognized as a problem, the provisions of Sarbanes-Oxley requiring that insiders report the acquisition of securities, including options, within two days of receipt greatly hindered the ability of corporations to backdate options.
The idea is that when the shares go up in value on the markets, the employee can buy shares from the company at the strike price and then sell them at the market price and make a profit.
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.
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The Mossack Fonseca law firm, at the center of the Panama Papers storm, says its document backdating for high net worth clients setting up offshore shells is not intended “to cover up or hide unlawful acts.” Backdating is back.