He pays the per share exercise price and can turn around and sell those shares on the exchange for each, netting a profit of per share, or ,000.
Why It Matters 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.
The backdating scheme involved moving an effective date for the exercise of stock options from when the options were 'out of the money' to a date that made the options 'in the money' to allow certain executives to exercise their options profitably.
Companies such as Comverse, Verisign, F5 Networks, Intuit and Mc Afee - as well as Home Depot, Michael's Stores and United Health Group, to name a few - all engaged in this fraudulent activity to varying degrees and were forced to pay fines and penalties and conduct time-consuming and expensive restatements of their books.
How It Works For example, let's assume that John Doe is the CEO of Company XYZ.
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.
In our example, backdating the options is the same as giving John Doe a check for ,000 -- without recording that ,000 on the income statement as compensation.
That, in turn, understates the company's expenses and overstates its profits, which is a violation of generally accepted accounting principles and has been the grounds for a variety of fraud and miscellaneous charges from federal, state and local regulators.
Backdating is usually disallowed and even can be illegal or fraudulent based on the situation.If, however, Company XYZ decides to backdate the options, it could change the paperwork to state that it actually granted those stock options to John on, say, June 15, 2008, when the stock was only trading at per share.This would mean that John's 2012 stock option grant would have an exercise price of per share instead of per share.As a result, regulations in the Sarbanes-Oxley Act require companies to report option grants to the Securities and Exchange Commission within two business days.In addition to being illegal, backdating isn't always a sure thing.