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Perhaps the biggest business story of the year—the story of backdating, today’s candidate for DealBreaker of the Year—kicked off when the Wall Street Journal stated investigating the options granting practices of several companies beginning in March. Executives at these companies seemed to have been the beneficiaries of having their stock options granted on a day when the stock was trading at historic lows. Following the work of some academics, the Journal calculated that the odds were very much against this kind of luck. What really seemed to be happening was that the companies involved were granting stock options on one date, and pegging them to an earlier date when the stock price was low.
It subsequently came to light that backdating was not something confined to a handful of companies, but a practice that had become quite common in corporate America. Although backdating has the same effect of granting options at lower than the current market price—a practice which is referred to as granting an “in the money” option and is completely legal—or making direct grants of restricted stock, backdating options allowed both the companies and the recipients certain accounting and tax advantages. Those advantages, however, may have come at the price of violating securities laws and tax regulations, and pretty soon the SEC was announcing investigations of companies it suspected as backdating.
Soon scores of companies found themselves under investigation or felt the need to launch an internal investigations. When these investigations turned up evidence of backdating, quite a few executives were forced to resign. Criminal charges were filed against some corporate leaders. Most pleaded guilty. One chief executive, Kobi Alexander of Comverse, went fugitive and turned up in Namibia, where he is fighting extradition.
Two thousand and six would have been a very different year without the revelations of backdating. And that is why backdating is a candidate for DealBreaker of the Year.
Value Added: Many have questioned whether backdating should even be regarded as a scandal. The Journal’s Holman Jenkins has pointed out that the accounting rule which allowed companies to treat “at the money” options—including backdated options—as valueless but required them to expense “in the money” options was nonsensical, and practically invited creative avoidance. SEC commissioner Paul Atkins would later go on to explain that well-timed options were a good way for a company short on cash to compensate employees without giving rise to real or accounting costs.
Risk Factors: Regardless of whether backdating is seen as an over-hyped pseudo-scandal or just the latest chapter in a long series of corporate crimes and executive lootings, it has unseated many executives and cost scores of companies millions of dollars as they investigated the practice. Backdating may have been a useful fiction when it was done but in retrospect it probably doesn’t seem worth it to many executives who have lost their jobs or reputations and shareholders who have seen the value of their investments sink.
Should backdating be the DealBreaker of the Year? So far, backdating is up against challenges from Hank Paulson and Patricia Dunn. In terms of its impact on corporate America in 2006, it seems pretty clear that backdating probably comes out on top. But we’re not done yet, and backdating might well be a passing fad. We invite you to let loose with your inner-most feelings in the comments section below. And if you have other candidate you’d like to nominate, please feel free to email us at email@example.com. (If you can use the format we’ve laid out above, all the better. If it’s a hassle, we’ll take ‘em as we get ‘em.) If we use your nomination, you’ll get a free copy of Winning: The Answers: Confronting 74 of the Toughest Questions in Business Today.