Option backdating example

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Granting stock options to employees is a generally accepted and perfectly legal form of compensating employees. Critics of backdating argue that the practice is difficult to detect and thus encourages boards and executives to use it to synthesize more creative compensation packages.

In our example, backdating the options is the same as giving John Doe a check for ,000 -- without recording that ,000 on the within two business days.

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 Alsup’s reasoning and subsequent ruling, it is improper to infer fraudulent activity based solely on the occurrence of options backdating – further facts must be present and proven before the act can be considered to be fraudulent.

grants to one that is earlier than the actual grant date in order to place a lower exercise price on the options and thus enhance the potential profits from the exercise of those stock options.

The practice sometimes also occurs in the insurance industry, whereby policy issuers make the effective date of a policy (or claim) earlier than the application date in order to obtain a lower premium for the customer (or obtain better claim results). When he was hired, the Company XYZ board of directors offered John an attractive salary as well as an annual grant of 1,000 Company XYZ stock options.

Cases of backdating employee stock options have drawn public and media attention.

In 1972, a new revision (APB 25) in accounting rules resulted in the ability of any company to avoid having to report executive incomes as an expense to their shareholders if the income resulted from an issuance of “at the money” stock options.

In addition to being illegal, backdating isn't always a sure thing.

The general reason companies backdate options is to create a lower exercise price, which in turn increases the probability that exercising the options will make more money for the optionee.

Those options give John the right but not the on the date of the grant.

The board formally grants the stock options to John every year at its January board meeting.

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