While options backdating is not always illegal,[2] it has been called "cheating the corporation in order to give the CEO more money than was authorized.
"[3] According to a study by Erik Lie, a finance professor at the University of Iowa, more than 2,000 companies used options backdating in some form to reward their senior executives between 1996 and 2002.
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.
The problem with this practice, according to the SEC, was that stock option backdating, while difficult to prove, could be considered a criminal act.
It was forced to restate earnings by recognizing a stock-based expense increase of $723 million between 1999 and 2004, after allegedly manipulating its stock options grants for the benefit of its senior executives.
[15] 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.
Numerous financial analysts replicated and expanded upon the prior academic research, developing lists of companies whose stock price performance immediately after options grants to senior management (the purported dates of which can be ascertained by inspecting a company's Form 4 filings, generally available online at the SEC's website) was suspicious.
However, if the company granted options with an exercise price below fair market value, there would be a compensation expense that had to be recognized under applicable accounting rules.
[16] Anderson immediately settled the charges for a payment of a civil penalty of $150,000 and disgorgement of "ill-gotten gains" of approximately $3.49 million.
[16] Heinen was charged with, among other things, violating the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, lying to Apple's auditors, and violating prohibitions on circumventing internal controls, based on the options awarded to Steve Jobs (dated October 19, 2001 but allegedly granted in December 2001) and also option grants awarded to top company executives, including Heinen (dated January 17, 2001, but allegedly granted in February 2001.
)[16] The SEC is seeking injunctive relief, disgorgement, and money penalties against Heinen, in addition to an order barring her from serving as an officer or director of a public company.
The 1993 Clinton tax increase amended the Code to include Section 162(m) which presumptively makes compensation in excess of one million dollars unreasonable for public companies.