The art of backdating appears to have been a popular scheme for executives to capitalize on the potential for a stock to earn big dividends by backdating a stock option to co-incide with a historical low point in the corporation's stock price. Such a practice makes the stock instantly profitable when compared to the current price.
A handful of executives have either been convicted, or accused of such practices in recent years. The latest incident was just last week, when a former Vice President of Human Resources at Broadcom Corporation was accused of participating in a scheme that involved the backdating of stock options to the low closing price of the company's stock.The result, according to the action filed by the Securities and Exchange Commission (SEC), was the issuance of 'in-the-money' grants for the defendant, as well as a number of others in a scheme that reportedly ran from 1998 through 2003.
The term 'in the money' is financial lingo that represents a stock option exercised at a price below the current trading price. Conversely, an 'at-the-money' transaction is when the option is exercised at the current value of the stock.
Needless to say, such schemes have 'in-the-money' as a common goal, as it represents instant profit for the executives, and his or her associates.
In late January it was reported that Carole D. Argo, the former CFO of SafeNet Inc. was sentenced to six months in prison and ordered to pay a $1 million fine in connection with her role in the backdating of millions of dollars' worth of employee stock option grants.
The scheme, a preferred activity indulged by others at various major corporations, is remarkably simple and deliciously devious.
A stock option, commonly offered as a bonus or incentive for key employees, is the opportunity to buy company stock at a set price, or strike price, at a future date. The amount of stock the grantee actually gets depends upon the value of the stock on the date the option is exercised. Assuming the value of the stock is equal to the set price reflected in the option on strike day, then the trade is 'at the money' with no immediate profit.
However, if the stock is valued lower on the day in which the option is exercised, given that the strike price on the option is higher suggests that the purchaser will get more stock for his money.
It can be assumed that most holders of stock options will wait for a favorable difference between the strike price and stock value, before exercising the option.
However, with backdating a conspirator simply checks back to see when the stock price was at a low ebb, at which point the option is backdated to correspond to the low stock price, triggering an immediate profit for the owner of the option. No need to wait for well-performing stock to fall below the strike price on your option in order to make a profit. Rather, just find a low point in the past performance of the stock, backdate the option and Bob's your uncle.
The downside to all of this is the possibility that beyond the fraudulent activity and undeserved profit realized by the conspirators, the practice could have an impact on the company's financial reporting. As it was, it has been reported that prosecutors claimed that between 2000 and 2006 Argo and the others served to deceive SafeNet's Board of Directors, shareholders, auditors, securities analysts, the SEC, as well as members of the investing public.
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Including anyone who holds stock in a 401(k).
Under ERISA guidelines, a company has a fiduciary duty to manage, and conduct 401(k) plans in a responsible manner, with the investor's best interest at heart. That's a top-down strategy. Not only does a corporation need to conduct itself in a manner that represents the best interests of its clients, employees and shareholders, it needs to avoid any unethical activity that could bring ruin to the company, and in turn, its shareholders, including retirement investors.