Exercise backdating

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SEC Chairman Christopher Cox recently stated that the proposed SEC rules on disclosure of executive compensation will “almost certainly address options backdating explicitly.” I. Companies have considerable discretion in determining the timing of stock option awards.

Most employee stock options are, or purport to be, granted “at-the-money,” meaning that the exercise price of the option equals the market price of the underlying stock on the date of the grant.

Option grants to new employees have their own set of backdating issues.

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Companies and individuals could face monetary penalties, restitution and disgorgement under the securities laws and the Internal Revenue Code.Grants to new employees based on inaccurate employment commencement dates are troublesome.Options granted as of the commencement of employment based on the market price as of the date of acceptance may be problematic if the plan does not permit below-market grants or the grant is not treated as a discounted option for accounting and tax purposes.Before FAS 123R, generally only options granted below fair market value resulted in any compensation expense.After 123R, the “fair value” of discounted options will be greater than the “fair value” of comparable undiscounted options, resulting in higher compensation expenses.

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