Compensation packages for executives often use stock options as performance incentives for their actions that increase the company’s stock price. Recently executives have been criticized for receiving abnormal historical returns related to when their options were issued causing government agencies such as the SEC to review the practices used to issue these options.

The most egregious manipulation of stock options involves retroactively issuing unscheduled options after a period of significant growth in stock price. Other such abnormal returns they have found are related to timing grants with predicted stock price increases or timing beneficial information after the issuance of options. These timing issues do not necessarily result in fraud but the company must adhere to several criteria.

Criteria for Legal Backdating
If you followed the rules, there’d be no reason to backdate when you could issue more favorable, newer options.

1. No documents can be forged.
This is specifically an issue after a favorable stock increases because executives create documentation for the issuance of their options and forge authorization of the transaction.

2. If there is backdating of options then the information must be communicated to the company’s shareholders prior to the issuance.
As long as those affected by the dilution of the stock price are aware of the upcoming backdating and approve the transaction then there will not be unexpected damages. Ultimately shareholders are giving up some value of their stock price to compensate the executive for their success during that period.

3. Backdating is properly reflected in taxes and earnings.
The US tax system provides favorable treatment of performance based compensation but if the options were issued in the money they would not receive the deduction. Rules regarding the expensing of stock options for earnings have changed over the years but as long as the company is in compliance with these rules the options are legal.