There is a five-year statute of limitations for securities fraud, and under the Sarbanes-Oxley Act of 2002, option grants to senior management must be reported within two days of the grant date.
This all but eliminated the opportunity for senior management to engage any meaningful options backdating.
Options backdating may still occur under the new reporting regulations, but Sarbanes-Oxley compliant backdating is far less likely to be used for dishonest reasons due to the short time frame that is allowed for reporting.
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.
To avoid having to pay higher taxes, many companies adopted a policy of issuing “at the money” stock options in lieu of additional income, with the idea that the executive or employee would benefit through the option by working to increase the value of the company without exceeding the one million dollar deductibility cap for executive income.
When company executives discovered that they had the ability to backdate stock option grants, thus making them both tax deductible and “in the money” on the date of actual issuance, the common practice of stock option backdating for financial gain began on a widespread level.
However, in late 2005 and early 2006, the issue of stock options backdating gained a wider audience.
Many companies' stock option plans provide that stock options must be granted at an exercise price no lower than fair market value on the date of the option grant.
While this conclusion is logical in cases of options backdating in which executives knowingly participated in the criminal actions, options backdating can be a result of normal accounting or corporate policies that are not criminal in nature, and is a legal practice as long as the backdated contract is appropriately reported for tax purposes.
Academic researchers had long been aware of the pattern, exhibited by some companies, of share prices rising dramatically in the days following grants of stock options to senior management.
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.
Additionally, companies can use backdating to produce greater executive incomes without having to report higher expenses to their shareholders, which can lower company earnings and/or cause the company to fall short of earnings predictions and public expectations.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.