July 11, 2006

Backdating Stock Options – Emerging Threat in Hedge Fund Industry

With the Securities Exchange Commission (SEC) probing the numerous irregularities in trading and frauds by hedge funds, there is increasing pressure from all quarters to bring a level of transparency to the way hedge funds operate. 

One commonly perpetrated fraud is the tendency of corporate executives to backdate stock options to increase their payoffs. How does this work?

Executives are usually given stock options in their organization as an incentive to try and increase the market price of the stock. The logic is simple, if the stock price rises, the executive is richer by that amount for each share he/she owns.

Stock options allow executives to buy the shares at a set price. When the options vest after a few years, the executives can exercise their options and make a profit from the difference between the current market rate and the set price. They try to play up this advantage by backdating options to an earlier time when the value of the stock was relatively low.

As of now, more than 60 companies are being investigated by the SEC and federal prosecutors for irregularities in dating options.

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