Backdating employee stock options

On August 7, 2007, former Brocade CEO Gregory Reyes was convicted of 10 counts of conspiracy and securities fraud.

Reyes, once listed on the Forbes 400 list, now faces 20 years in prison and a million fine.

And it is triggering a new round of outrage by shareowners, and justifiably so.

Generally, options are granted at a specific date and price, called the exercise price.

It is better for the option recipient if the exercise price is as low as possible, allowing for higher returns to such a recipient if the price of the stock goes up.

There are two parts to this controversy, and it is not yet clear which one is the focus of recent SEC subpoenas of more than 20 companies.

In solving this financial puzzle, lie touched off a firestorm with immediate and far-reaching public-policy implications. In one of the first cases involving stock option grant manipulation, the U. Attorney's Office, the sec, and the FBI filed criminal and civil securities fraud charges against former Brocade Communications executives on July 20, 2006.

Although researchers may have been puzzled by this phenomenon, jurists are not.

Companies usually backdate options in order to reap tax benefits and produce greater executive compensations.

However, that comes unfairly at the expense of shareholders who would probably receive lower earnings and bear the brunt of a potential deterioration in earning predictions.

On August 12, 2006, Reyes and Jensen were indicted on eight charges of conspiracy, securities fraud, mail fraud, and false entries in the company's books.

A new probe by the Securities and Exchange Commission into stock options practices at public companies sounds a familiar refrain: "What are board directors and senior managers doing with shareholders' money?

Until recently, financial research has been puzzled by an unusual pattern of stock returns during the period surrounding stock option grant dates for CEOs and other top executives. Chauvin and Catherine Shenoy ("Stock Price Decreases Prior To Executive Stock Option Grants," Journal of Corporate Finance, vol. 1, March 2001) first documented that stock prices tend to fall in the period before, and rise in the period following, employee stock option grant dates.