Actually, Holman, stock-option backdating is never okay

  • Share
  • Read Later

When I wrote my post earlier today about stock-option backdating, I hadn’t gotten as far as the editorial page of today’s WSJ, where Holman Jenkins weighs in ($) on the subject yet again.

His main point is that the whole backdating mess (uncovered initially by University of Iowa professor Erik Lie and then kept in the headlines mainly by reporters at Jenkins’ paper) is a molehill. I mostly agree with him: Unlike the various corporate scandals that came to light in 2001 and 2002, backdating hasn’t really hurt anybody other than those who committed it. Investors haven’t gone broke, companies haven’t gone under. The main damage to shareholders will be if the new CEOs and CFOs hired to replace the ones fired for backdating turn out to be less adept managers than their predecessors.

But Jenkins is also largely responsible for the most meretricious canard to come out of this whole backdating mess–that there’s nothing per se wrong with backdating, just some silly questions about how you account for it. In his latest column he gleefully cites some newspapers that have bought into this nonsense:

With care and precision, the San Jose Mercury News characterizes the scandal: “Stock options were designed as a form of incentive-based compensation; backdating to a lower price is legal only if it is properly disclosed and accounted for by the company.”
Says the New York Times: “Backdating options is not necessarily illegal, but the practice can raise serious accounting, disclosure and tax issues.”

(And yeah, Time repeated the myth a few weeks ago as well.)

Actually, what’s not illegal–or immoral, illicit, or even ignoble–is giving employees options that are in the money. That is, a company’s stock price today is $20 a share, and that company gives an employee an option to buy a share for $10. Not a problem. It might look bad if you do that for the CEO, but to lure or retain talent outside the executive suite, I say it’s totally legit. But you have to disclose what you’re doing.

Backdating is, by its very definition, not disclosing what you’re doing. Backdating is pretending that you granted an option on a date other than the one when you actually granted it. The stock price today is $20. Three weeks ago it was $10. So you grant an option today to buy the stock at $10 and report to your shareholders that you did it three weeks ago. That’s lying. I’m not entirely sure it’s illegal, although the guilty pleas of those Comverse guys would indicate that it is. But it’s certainly immoral, illicit, and ignoble.

And funny thing, the smart people at the Mercury News have figured this out (the most recent Times stories I can find still get it wrong). The paper used the erroneous formulation quoted by Jenkins only once. Now the Merc‘s standard line standard line is:

Although it’s not illegal to grant options at a discount, it must be properly disclosed to regulators, investors and tax authorities.

So there you have it: Backdating? Always wrong. Discounted options? Not necessarily a problem. The fact that lots of talented and otherwise seemingly decent executives have been caught backdating? A conundrum for regulators, prosecutors, and investors–but not one that can be resolved by pretending that backdating is okay.

Update: The Analyst’s Accounting Observer himself, Jack Ciesielski, thinks I’m going too soft on the backdaters.

Update 2: A commenter to the above post says:

Under a provision of the Internal Revenue Code added in 2004, Section 409A, backdating options may amount to tax fraud on the part of the issuing Company and the executive who holds/exercises the options.

0 comments
Sort: Newest | Oldest