Archive for the ‘Backdated Options’ Category

ECFFSOA?

Monday, October 1st, 2007 by Joe Kristan

Congresscritters have a bad habit of giving their tax bills grotesque names that produce a lame acronym. Who can forget the “National Employee Savings and Trust Equity Guarantee Act” – “NESTEG”?
So what’s with the “Ending Corporate Favors for Stock Options Act”? ECFFSOA? That sounds like something a Senator would say with his mouth full at a lobbyists hor’s d’ourvres counter. If you don’t even get a pronouncable acronym, why go with a tortured name?
This awkwardly-named bill would place more restrictions on deductions for executive compensation – in this case, just for stock options. The current $1 million deduction limit for cash compensation is arguably a major factor in the 1990s stock option frenzy and the resulting option backdating scandal. Daniel Shaviro analyses the proposal:

Even if you like the $1 million limit, and few people do, this is just silly. All one needs to do to avoid it is have a virtual stock option instead of a literal one. E.g., you have performance-based compensation that pays you off based on the stock price, but it isn’t called a stock option despite having identical economics.

Read the whole thing.

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IRS SAYS BACKDATED OPTIONS ARE A ‘TIER 1’ EXAM ISSUE

Thursday, July 12th, 2007 by Joe Kristan

The TaxProf reports:

The IRS yesterday made public a directive sent to agents in the field targeting transactions involving backdated stock options for the highest level of specialized enforcement within the Large and Mid-Size Business Division.

This can’t be good news for the dozens of companies that appear to have backdated stock options to lower the exercise price and maximize income to executives.
DEDUCTION ISSUE
The directive focuses on three issues, but the issue likely to cause the most headaches is the likelihood of the loss of millions of dollars of executive comp deductions.
The tax law exempts stock options from the $1 million limit on executive compensation deductions. That allows the corporation can deduct the amount that the stock has appreciated from the time the stock option was awarded to the executive to the time the option is exercised and coverted into shares. For example, if an option is issued at $1 per share and the executive exercises it when the stock is trading at $10, he has $9 income and the corporation has a $9 deduction.
The exemption from the $1 million deduction lid only applies for option income resulting “solely” from appreciation from the grant date. If the options are backdated, it’s hard to say that the option income is “solely” attributable to subsequent appreciation.
It seems unlikely that the government will consider all stock option backdating to be a securities law crime, and they may not succeed if they try.
The real breach of trust, it seems to me, is the willingness of executives to risk the loss of their companies’ compensation deductions to squeeze a bit more out of their stock option programs. The $1 million compensation limit is bad tax policy, but that doesn’t excuse executives who cause it to apply by backdating their own options
Now that the IRS is making backdating a priority, maybe they can engage Remy Welling as a consultant. Ms. Welling was fired for blowing the whistle when the IRS ignored option backdating on a corporate exam.
Link: Complete Tax Update coverage of backdating.

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IRS APPLIES DEFERRED COMP RULES FOR 2006 BACKDATED OPTIONS

Friday, February 9th, 2007 by Joe Kristan

The IRS yesterday set down a plan dealing with small fry in the options backdating scandal. The program “allows” companies to pay the 20% penalty tax for backdated options exercised in 2006 by employees who are not “insiders” for SEC disclosure purposes. The employees have to include the company payment in income.
The 20% penalty tax under the recently-enacted Section 409A applies to non-compliant deferred compensation plans. In this announcement the IRS lays down a marker: it says that 409A applies to backdated options.
There doesn’t appear to be much of a concession here on the part of the IRS. It seems that the company always has the option to pay the employee’s Section 409A penalty, as long as the payment is included in employee income. Tax Analysts reports ($link) that tax advisors for holders of backdated options aren’t happy:

The IRS program departs significantly from the practitioners’ recommendations and was quickly criticized. The group had suggested that employers be allowed to make a payment equal to 20 percent of the option discount at the time it was granted to remedy any backdated options, whether or not exercised. Instead, the IRS would force employers to make the 20 percent payment, plus interest, and then count the payments on behalf of their employees as compensation.
One practitioner, who asked to remain anonymous to protect IRS relationships, said the initiative offers no carrots for either companies or taxpayers. Companies are not currently liable for the tax and would be acting only to save thousands of potential taxpayers from having to fix the problem individually — thus saving the IRS from the trouble of pursuing thousands of cases.
“I will not recommend that any of my clients take this offer,” the practitioner said.


Unfortunately for this practitioner’s clients, the IRS already has them over a barrel. The only thing that can keep the IRS from catching up with them not assigning enough agents assigned to the option backdating project. If I were an employee, I’d rather have my employer pay my 20% penalty, even if it increases my taxes, if I would otherwise have to pay the whole penalty myself. If I were the employer, though, I’d have another view entirely.
Link: Complete Tax Update backdated option coverage.

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TOO BAD YOU CAN’T BACKDATE YOUR SENTENCE

Tuesday, October 24th, 2006 by Joe Kristan

The stock option backdating scandal has netted its first guilty plea. From the Wall Street Journal online ($link):

The former chief financial officer of Comverse Technology Inc., David Kreinberg, pleaded guilty to securities-fraud charges in federal court today, after agreeing to cooperate in the investigation of a scheme to make millions of dollars by manipulating stock options.
Mr. Kreinberg is the first person to plead guilty in the stock-options backdating scandal that has roiled executive suites across the country. More than 100 companies are under federal investigation, and a number of executives have lost their jobs.


While the indictment mentions tax issues, the charges in the plea deal are securities violations.
The indictment is here.

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BACKDATING AND BOARD MEMBER GOSSIP

Monday, October 23rd, 2006 by Joe Kristan

A new study seems to imply that the practice of backdating options spread like a flea-borne disease from company to company on the backs of corporate directors. Many of the companies also use the same law firm. Footnoted.org picks up the story:

Of the 120 [companies tied to option backdating] so far, the study found that over 40% have at least one director who sat on a board at two companies involved in options backdating. Six directors sat on the boards of three of the implicated companies. The bottom line is that options backdating seems to have spread via word-of-mouth from one director to the other.
The study also found that at the center of that circle ? the monkey in the middle ? seems to have been Silicon Valley power lawyer Larry Sonsini and other principals and partners at the law firm of Wilson Sonsini Goodrich & Rosati (WSGR). Though the report notes that there?s no evidence to suggest that WSGR invented options backdating or that WSGR attorneys did anything illegal, it does point to a number of odd coincidences.


Interesting. I figured some sort of country-club gossip grapevine helped spread the backdating craze, but it never would have occured to me to try to connect the dots this way.

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SEC AND BACKDATING

Wednesday, September 27th, 2006 by Joe Kristan

BenefitsBlog reports that the SEC has issued guidance on stock option backdating issues. It appears to have been well-received.

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WHITHER THE $1 MILLION COMP CAP?

Friday, September 8th, 2006 by Joe Kristan

Lawer-blogger Stuart Levine weighs in on this weeks hearings on possible changes to Section 162(m), the $1 million cap on executive pay deductions for public companies:

The hearings were directed toward the supposed cause and effect relationship between the $1 Million cap on executive compensation imposed by IRC Section 162(m) and the stock option backdating scandal. The argument in favor of the repeal of Section 162(m) goes like this: Section 162(m) imposes a penalty tax on executive compensation in excess of $1 Million a year, except compensation that is “performance-based.” This has caused a growth in such performance-based compensation mechanisms as stock options which, in turn, have lead to such abuses as backdating of the options.
While I have some doubt as to the wisdom of Section 162(m), the option backdating scandal hardly provides a basis for repeal of the section any more than Bonnie and Clyde provided a justification for outlawing banks. (Although, I suppose that argument would have been a good excuse for a catchy slogan: “Unless banks are outlawed, only outlaws will have banks.”)


I can only wish Mr. Levine were right in thinking that there is any intention of repealing 162(m), which is a clumsy and ineffectual attempt by Congress to tell the nation’s public company compensation committees how to do their jobs. Alas… I see nothing that indicates Congress would do anything so sensible. Far more likely that they will add some new parts to a law that already doesn’t work well.
Mr. Levine’s analogy on repealing 162(m) in the wake of the option backdating scandals is interesting – like outlawing banks in response to Bonnie and Clyde. A better analogy is to repealing prohibition in response to Al Capone. That actually worked out all right.
Link: IT’S NOT WORKING? HIT IT AGAIN, HARDER.

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IT’S NOT WORKING? HIT IT AGAIN, HARDER.

Thursday, September 7th, 2006 by Joe Kristan

The Senate Finance Committee got together yesterday to look at stock option backdating. The result is likely to be more vindication of the saying “when all you have is a hammer, everything looks like a nail.” The Finance Committee’s hammer is the tax law.
Dozens, perhaps hundreds, of public corporations apparently backdated their stock option grant dates to make exercising options cheaper for their executives. This will usually cost the company deductions they would otherwise get for executive pay. Failure to disclose the options could mean criminal problems. What do you do when the taxpayers ignore the tax laws you’ve already passed? If you’re Senator Grassley, you ponder passing more tax laws:

Companies have found it easy to get around the law. It has more holes than Swiss cheese. And it seems to have encouraged the options industry. These sophisticated folks are working with Swiss watch-like devices to game this Swiss cheese-like rule.
I want to know what went wrong and consider whether it makes sense to make changes. Modifying the deduction for performance-based pay or at least tightening up the eligibility are possibilities I think members of the Finance Committee will want to consider based on comments made at this hearing. Today’s hearing is helpful in sorting through the pros and cons of changing the deduction and possible alternatives. It’s challenging for Congress to stay one step ahead of some companies that try to exploit tax loopholes faster than we can close them.


CONGRESS AND THE OPTION PROBLEM
In one of its periodic spasms of self-righteousness, Congress passed a law in the 1990s (Code Section 162(m)) limiting deductible compensation of public company executives to $1 million annually. It then carved out loopholes for “incentive based compensation,” including stock options (Backdated options fall outside the exclusion because the compensation is not “solely” from appreciation after the grant date). This deduction limit discouraged straight cash pay and made options a better after-tax compensation vehicle. The absurd accounting rules that allowed companies to not expense option compensation on their financial statements – rules largely resulting from Congressional interference – also favored options over cash compansation.
There are philosophical disagreements about how much executive compensation should be in cash, how much should be in options, and whether straight stock bonuses are more appropriate than options (with stock bonuses, the executives are at risk for stock declines, too; with options, its all upside and no downside). In any case, it’s impossible to see why Congress should make these calls in place of the compensation committees of public company boards.
WHY DID THEY BACKDATE?
Companies backdated options because of the natural tendency of public company executives to carve for themselves. Economists call this the “agency problem.” By backdating the options to a lower price, the executives could pay less for the options and make more. This violates the justification for options – motivating the executives to increase share price – because share price is built in. From the viewpoint of the executive, though, the response is, “So?”.
There are several reasons they thought they could get away with it. The securities rules used to allow a lag between the granting of options and the reporting of the options. This gave the companies time to cherry-pick the grant dates. I suspect that country club banter helped the idea get around among executives. Corporate culture probably tended to favor backdating (“Who do you think you are, complaining about backdating options? The IRS? Or the SEC?”). And they never thought they’d get caught; it didn’t occur to them that statistical modeling could identify habitual backdating as clearly as a dirty face identifies a little boy who’s been sneaking chocolate chip cookies:

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(Source: Wall Street Journal)

Once the securities rules were tightened to require disclosure of options within 2 days, backdating opportunities pretty much disappeared (though there may be residual problems with late filings). Problem solved – no tax legislation required.
THEN WHY NEW TAX LEGISLATION?
It’s what legislators do. The smart thing would be for Congress to admit that it has no role in deciding the compensation of public company executives by repealing Section 162(m). Highly unlikely; rather than leaving the grown-ups on corporate boards to do their jobs, Congress is likely to “close loopholes” in Section 162(m). This will mean more billable time for CPAs and attorneys while doing nothing for corporate governance or, for that matter, to make American companies competitive. But they have a hammer, so…
Links:
Senate Finance Committee Hearing member and witness statements
Real-player feed of hearings
Complete Tax Update coverage of option backdating
Wall Street Journal option backdating scorecard

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OPTION BACKDATING GRANDSTANDING HEARINGS TODAY

Wednesday, September 6th, 2006 by Joe Kristan

The Senate Finance Committee has its hearing on stock option backdating today. This will give Congress a chance to draft baroque and incomprehensible legislation to crack down on activities that are already illegal, while displaying mock outrage at accounting violations (“How dare you cook the books? That’s our job!”)
Yet some good comes out of the process: an excellent TaxProf Blog post full of links to scholarly and not-so-scholarly discussion of tax and legal issues around the backdating scandal. You can read my jaded take on the hearings here.
UPDATE: The Wall Street Journal ($link) says today that Congress may consider eliminating the stock option exception to the $1 million limitation on executive pay – even though the exception aready doesn’t apply to backdated options.

In an interview, Sen. Grassley, whose committee opens hearings on options and executive compensation today , said doing away with the deduction for performance-based pay entirely is a “possibility,” as is “at least tightening it up.” Though he said he couldn’t give a precise head count of support in Congress, he said “a lot of members are interested” in possibly scaling back executive-pay deductions.


Far better to just eliminate the $1 million cap. I guess it’s too dangerous to allow consenting adults to engage in compensation without micromanagement from the 535 economic geniuses in Congress.

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GRASSLEY TO HOLD EXECUTIVE COMP HEARINGS

Tuesday, August 29th, 2006 by Joe Kristan

Senate Finance Committee Chairman Grassley will hold a hearing September 6 to look at stock option backdating and executive compensation tax issues. The press release says:

Chairman Grassley is exploring the extent of abuse of executive compensation tax restrictions with an eye toward possible legislation.

It’s hard to say any tax law changes are needed here. The backdating of stock options already violates tax rules and has led to some securities law indictments.
The last time Congress tackled executive compensation issues, the result was the awful “Section 409A” rules on deferred compensation. Passed in the Enron political preening frenzy, these rules apply to every business with non-qualified deferred compensation, even if just a simple retirement bonus plan. They are so complicated and poorly written that after nearly two years the IRS still hasn’t been able to come up with workable regulations. The situation is so bad that the AICPA threw up its hands earlier this month and called for either drastic revisions or outright repeal.
It’s probably too much to hope that Senator Grassley will decide that they should undo the damage done already, rather than add yet more complexity to the already baroque tax code.
Link: BenefitsBlog Section 409A link collection.

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