Backdating employee stock options
Any person who willfully violates ' any provision' of the Securities Act or the Exchange Act and ' any rule or regulation thereunder' commits a criminal offense, and could be subject to substantial fines as well as imprisonment. Two of these new regulations may give rise to liability, but only for backdating that occurred after August 29, 2002, the effective date of the amendments. Section 302 requires the principal executive and financial officers of publicly-traded corporations to certify each annual or quarterly report filed with the SEC. The officers also certify that they are responsible for establishing and maintaining internal corporate controls to ensure the proper disclosure of all material information. In addition, regardless of the GAAP accounting method the company used, the company must have recorded some sort of compensation expense for the discounted options. Additional Liabilities Under Sarbanes-Oxley When Congress and the SEC approved the Sarbanes-Oxley Act to amend the Exchange Act, they created additional financial regulations for publicly-owned corporations. Section 403 significantly shortened the time companies are permitted to wait before disclosing transactions involving management or principal stockholders, including option grants. This shortened time frame essentially removes the significant benefits of backdating because the limited volatility most stocks experience over the course of two days narrows the potential discount margin between the market price on the grant date and the strike price. This certification represents that the officers reviewed the company's financial data, and that it presents the financial condition of the company in all material respects. Certain 'performance-based' compensation payments are not counted toward the cap, including stock options that are granted with an exercise price equal to or greater than the FMV of the companies' shares on the date of the grant. In addition, discounted options that do not have a fixed exercise date are subject to an additional twenty percent penalty tax. Therefore, any executive who failed to account for backdated options under 409A and/or failed to pay the penalty tax for options lacking a fixed exercise date could be criminally liable for willfully failing to pay taxes, see, e.g., I. C.7202, or providing fraudulent and false statements in a tax return, see, e.g. Options backdating is the process of granting an option that is dated prior to the actual issuances of the option.In this way, the exercise price of the granted option can be set at a lower price than that of the company's stock at the granting date.Whether executives will be criminally liable depends on whether they were consciously trying to cover up the practice of backdating. Like securities fraud, the criminal tax fraud statutes require an intent element. Securities Fraud The primary source of criminal liability for backdating are the federal securities acts, which regulate the sale of securities by publicly traded companies.
For example, the SEC filed a civil lawsuit in 2010 against Trident Microsystems and two former senior executives from the company for stock option backdating violations.Disordered, untimely paperwork was cited as the cause in some cases of unintentional backdating.Initially, lax enforcement of the reporting rule was also blamed for allowing many companies to sidestep the rule adjustment that stemmed from Sarbanes-Oxley. Wire And/Or Mail Fraud Finally, improper backdating practices could also subject an executive to criminal liability for violations of the federal mail and wire fraud statutes, which prohibit the use of mail or wire communication in furtherance of a 'scheme or artifice to defraud' or to 'obtain money or property by means of false or fraudulent pretenses, representations, or promises.' 18 U. Two GAAP approaches, Accounting for Stock Issued to Employees , Accounting Principles Bd. Section 409A would apply only to options granted since its enactment in 2004. Under either statute, the penalties are the same and a conviction can result in substantial fines plus up to 20 years imprisonment.