Backdating employee stock options accounting and legal implications
I am pleased to testify with Acting IRS Commissioner Kevin Brown today and to share with you the Securities and Exchange Commission's perspective and insights on this form of compensation, which has become a significant component of executive pay among today's public companies. Securities & Exchange Commission Chairman Levin, Senator Coleman, and members of the Subcommittee: Introduction Thank you for inviting me to testify before you on behalf of the Securities and Exchange Commission on issues concerning stock option compensation.Whether executives will be criminally liable depends on whether they were consciously trying to cover up the practice of backdating. Like securities fraud, the criminal tax fraud statutes require an intent element. Securities Fraud The primary source of criminal liability for backdating are the federal securities acts, which regulate the sale of securities by publicly traded companies. Wire And/Or Mail Fraud Finally, improper backdating practices could also subject an executive to criminal liability for violations of the federal mail and wire fraud statutes, which prohibit the use of mail or wire communication in furtherance of a 'scheme or artifice to defraud' or to 'obtain money or property by means of false or fraudulent pretenses, representations, or promises.' 18 U. Two GAAP approaches, Accounting for Stock Issued to Employees , Accounting Principles Bd. Section 409A would apply only to options granted since its enactment in 2004. Under either statute, the penalties are the same and a conviction can result in substantial fines plus up to 20 years imprisonment. This article is excerpted from a Jones Day Commentary, which is available on request from the authors. 1972) and Accounting for Stock-Based Compensation , Statement of Fin. Rene Beltranena Bea is a trial Associate in Jones Day's New York office.
Internal Revenue Code Section 422 Section 422 permits public companies to grant employees 'incentive stock options' (ISOs), allowing them to purchase the company's stock at a discount rate and free from taxes, unless and until the employee later sells any purchased shares.
In addition, discounted options that do not have a fixed exercise date are subject to an additional twenty percent penalty tax.
Therefore, any executive who failed to account for backdated options under 409A and/or failed to pay the penalty tax for options lacking a fixed exercise date could be criminally liable for willfully failing to pay taxes, see, e.g., I. C.7202, or providing fraudulent and false statements in a tax return, see, e.g.
In addition, any inadequate internal controls that led to the inaccurate reporting would constitute a separate violation. Intent Requirement For Securities Fraud Under the securities acts, a defendant must act 'willfully' or 'willfully and knowingly.' See 15 U. This intent requirement is important in options backdating cases to determine whether executives may face criminal, rather than merely civil, penalties.
If an executive who participated in backdating certified the company's financial reports, and those reports did not disclose and account for backdating, then he would be liable for making a fraudulent certification. Though federal courts have inconsistently construed these terms, Where the statute requires the person acted 'willfully and knowingly,' however, some courts require the government to show not only that the defendant knew that backdating was wrongful (willfully), but also that it was unlawful (knowingly). Internal Revenue Code Section 162(m) Section 162(m) caps the annual deduction for compensation paid to top executives at one million dollars. The company would be liable for any taxes it failed to withhold, as well as interest and other penalties, and executives' concomitant personal liability would depend on whether they committed these acts 'willfully' and in violation of the Code's criminal provisions.