Backdating stock scandal
Reyes was fined million and sentenced to 21 months in federal prison after being found guilty in 2007 of picking favorable dates in the past for the awarding of stock options without revealing that information to shareholders. Circuit Court of Appeals tossed Reyes conviction Tuesday, finding that prosecutors lied to the jury in final arguments, telling them that no one in the Brocade's finance department knew about the backdating.He was the first of more than a dozen executives who faced criminal prosecution in the wide-ranging scandal. In fact, some of those employees explicitly told the FBI they knew about the shenanigans.The Wall Street Journal (see discussion of article below) pointed out a CEO option grant dated October 1998.The number of shares subject to option was 250,000 and the exercise price was (the trough in the stock price graph below.) Given a year-end price of , the intrinsic value of the options at the end of the year was (-) x 250,000 = ,750,000.Backdating allows executives to choose a past date when the market price was particularly low, thereby inflating the value of the options.An example illustrates the potential benefit of backdating to the recipient.Furthermore, the pre-and post-grant price pattern has intensified over time (see graph below).By the end of the 1990s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase.
He attributed most of this pattern to grant timing, whereby executives would be granted options before predicted price increases.According to court testimony, Brocade’s failure to expense more than 0 million from backdated options resulted in Brocade reporting profits in 20, when it should have reported large losses.Brocade was just one of many tech companies which came under SEC investigation for distorting their earnings starting in the late 1990s by not disclosing this kind of executive compensation.In comparison, had the options been granted at the year-end price when the decision to grant to options actually might have been made, the year-end intrinsic value would have been zero.
Backdating does not violate shareholder-approved option plans.
The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates.