SEC Chairman Christopher Cox recently stated that the proposed SEC rules on disclosure of executive compensation will “almost certainly address options backdating explicitly.” I. Companies have considerable discretion in determining the timing of stock option awards.Most employee stock options are, or purport to be, granted “at-the-money,” meaning that the exercise price of the option equals the market price of the underlying stock on the date of the grant.Civil and criminal authorities are investigating the option granting practices of many companies.

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The stock plans of many public companies prohibit the granting of below-market options; other companies disclose in their SEC reports that stock options are granted at market and prepare their financial statements on that basis.

The term “backdating” refers to a number of option granting practices in which the reported grant date is different from the date on which the option is actually awarded, resulting in an option that is already “in-the-money” at the time of the grant.

State law and bylaw provisions as to the time of effectiveness of unanimous consents may be helpful in evaluating these issues. It is important to note that most of these practices are not inherently illegal.

The practice of granting options in advance of the disclosure of positive news does not involve option backdating, but it is often discussed in the context of backdating and is also under scrutiny. If no documents are forged, and if practices are properly approved and disclosed, appropriately accounted for, properly treated for tax purposes and in accordance with the terms of the option plan, most option granting practices should fall safely within the law.

But if these conditions are not met, a number of negative consequences can result, depending on the individual circumstances of the practice at issue.

Options that are granted at less than fair market value result in higher levels of compensation expense.

Option grants to new employees have their own set of backdating issues.

A company may want to give a new employee the benefit of any increase in the stock price from the date of acceptance of the employment offer.

Several companies have expressed their intent to restate financial statements due to option timing issues, and opportunistic attorneys have already filed derivative and class action lawsuits.

The author of the academic study who is credited with focusing regulators on this issue estimates that at least 10% of “at-the-money” grants of options to CEOs between 19—before Sarbanes-Oxley shortened the reporting period for option grants—were backdated.

The practice of “backdating” stock option grants has recently captured the attention of regulators, prosecutors, the plaintiffs’ bar, shareholders and the media.