Options backdating is the practice of granting an employee stock option that is dated prior to the date that the company actually granted the option. This practice raises a number of legal and accounting issues. The practice of backdating itself is not illegal, nor is granting of discounted stock options. What is illegal is the improper disclosures, both in financial records and in filings with the United States Securities and Exchange Commission (SEC).

In 1992 the SEC imposed a rule requiring companies to report executive stock options in detail. Even after the rule, some executives could legally delay reporting option grants for so long that it was virtually impossible to figure out whether any individual grant had been backdated.

Since the Enron scandal, the U.S. Congress enacted Section 409A of the Internal Revenue Code to deal with such non-qualified deferred compensation. Backdated stock options would be considered discounted stock options triggering additional taxes and penalties at vesting or exercise. Most of the legal issues arising from backdating are a result of the grantor falsifying documents submitted to investors and regulators in an effort to conceal the backdating.

Research history

In 1995, New York University finance professor David Yermack studied data that companies were obligated to publish, under a 1992 SEC decree, in connection with the exact dates of options grants in proxy statements. Previously, dates were disclosed within often ignored filings. Yermack found a pattern that the stock prices often declined in value just prior to the time of the grant of the options, and rose thereafter. He theorized that the executives were timing the awards of the options so that the issuances would precede good news and would follow bad news. In 1997, his findings were published in the Journal of Finance.

Accounting professors David Aboody of UCLA and Ron Kasznik of Stanford followed with a study of companies that grant options at the same time every year. Aboody and Kasznik found a similar pattern. Their evidence suggests that company executives time the release of news. The findings of Aboody and Kasznik were published in the Journal of Accounting Economicsin 2000.

In 2004 Finance professor Erik Lie of the University of Iowa asserted that many options grants were timed to exploit marketwide price depressions that nobody, including insiders, could predict — leading to the conclusion that at least some of the grants must have been retroactive.

In 2007, Mark Maremont, Charles Forelle and James Bandler of the Wall Street Journal won a Pulitzer prize for their investigative series on stock options backdating.

Terminology

• bullet dodging - delaying an options grant until just after bad news
• spring-loading - timing an options grant to precede good news
• symmetric spring-loading - where members of the board who approve the grant are aware of the forthcoming good news
• asymmetric spring-loading - where members of the board who approve the grant are unaware of the forthcoming good news