By doing so, the executive will be required to pay taxes on the value between the option's strike price and price of the stock when it was excercised.
Currently, this capital gains tax rate can be as high as 35%.
As a result, numerous companies are conducting internal investigations to determine if, when, and how backdating occurred, and are filing amended earnings statements and tax forms to show the issuance of “in the money” options in place of the “at the money” options that were previously reported.
This is not always the case, according to a ruling by federal judge William Alsup of the U. District Court for the Northern District of California.
According to a study by Erik Lie, a finance professor at the University of Iowa, more than 2,000 companies used options backdating in some form to reward their senior executives between 19.
The SEC’s opinions regarding backdating and fraud were primarily due to the various tax rules that apply when issuing “in the money” stock options versus the much different – and more financially beneficial – tax rules that apply when issuing “at the money” or "out of the money" stock options.
In the modern business world, the Sarbanes-Oxley Act has all but eliminated fraudulent options backdating by requiring companies to report all options issuances within 2 days of the date of issue.
The practice of options backdating has landed many companies into the hotseat.The SEC constantly investigates possible instances where high level executives have been issued options at a past point in time (or backdating) where the underlying stock's price was at a low.This way the executive would be granted options with a very low strike price, so that they are quite often already deep in the money.One of the larger backdating scandals occurred at Brocade Communications, a data storage company.It was forced to restate earnings by recognizing a stock-based expense increase of 3 million between 19, after allegedly manipulating its stock options grants for the benefit of its senior executives.
For example, suppose that yesterday an executive backdated some options to when the underlying stock was $5.00 (the low for the last 1.5 years ).