What is Options Backdating?

In 2006, there was a huge scandal going on in the telecommunications industry. It revolved around something that’s called “options backdating.” The scandal started with a now defunct company named Broadcom Corporation, and spread to the investigation of 130 companies. What is options backdating? Why do companies do it? Is it legal? We’re going to explore that a bit today.

Options backdating is when a company sets an options package (consisting of restricted stock that is for employee benefits) at a certain date but writes the date that they were received as an earlier date. For example, say that I run a company and stocks are currently at $7. In a month, my stocks are up to $10. I then start the options package for my employees, but say that the date that they started was when my stocks were at $7, giving them $3 worth of added value right from the start.

This is actually a legal practice, but is more difficult with the addition of the Sarbanes-Oxley Act of 2002. Before this act came into play, options packages had to be reported to the US Securities and Exchange Commission (SEC) within two months. In that amount of time, stocks could easily increase or decrease in value, and senior management in companies realized that this could be advantageous to them. After the Sarbanes-Oxley Act, companies are now required to report to the SEC within 2 days of the options being distributed. This has greatly reduced the amount of fraudulent backdating.

A lot of people believe that this concept is due to corruption within the upper management of a company. But, because of the legality of backdating, this isn’t true. Backdating within a short period of time can be advantageous for both the stockholders and those in the company, because the price of stocks could increase a small bit due to the extra trading.