Tax consequences of backdating options
A client or, in the case of an in house lawyer colleague (who for the purposes of this article will also be considered a client), asks you to prepare a document and then your heart sinks as he says “oh and it has to be dated” and gives a date which has already passed.
The argument is obviously not valid if the transaction is one which is required by law to be in writing such as a transfer of land.
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.
Internal Revenue Code Section 409A Section 409A requires companies that grant discounted stock options to treat them as a form of 'non-qualified deferred compensation' for taxation purposes.
Any person who willfully violates ' any provision' of the Securities Act or the Exchange Act and ' any rule or regulation thereunder' commits a criminal offense, and could be subject to substantial fines as well as imprisonment. Two of these new regulations may give rise to liability, but only for backdating that occurred after August 29, 2002, the effective date of the amendments. Section 302 requires the principal executive and financial officers of publicly-traded corporations to certify each annual or quarterly report filed with the SEC. The officers also certify that they are responsible for establishing and maintaining internal corporate controls to ensure the proper disclosure of all material information.
In addition, regardless of the GAAP accounting method the company used, the company must have recorded some sort of compensation expense for the discounted options. Additional Liabilities Under Sarbanes-Oxley When Congress and the SEC approved the Sarbanes-Oxley Act to amend the Exchange Act, they created additional financial regulations for publicly-owned corporations. Section 403 significantly shortened the time companies are permitted to wait before disclosing transactions involving management or principal stockholders, including option grants. This shortened time frame essentially removes the significant benefits of backdating because the limited volatility most stocks experience over the course of two days narrows the potential discount margin between the market price on the grant date and the strike price. This certification represents that the officers reviewed the company's financial data, and that it presents the financial condition of the company in all material respects. Certain 'performance-based' compensation payments are not counted toward the cap, including stock options that are granted with an exercise price equal to or greater than the FMV of the companies' shares on the date of the grant.