At least that seems to be the conclusion reached by the Department of Justice and the Securities and Exchange Commission regarding their first case against executives charged with fraud related to backdating.
In order to qualify for this exception, the option in question must have an exercise price that equals or exceeds the per share value on the grant date (other requirements also apply). The second tax consideration identified in the Directive focuses on whether an option qualifies as an Incentive Stock Option ("ISO") pursuant to § 422.Further, the form IDR requires the company to identify information relating to individuals who may have benefited from backdating.Specifically, the form IDR requires the company to provide the names and positions of each individual who exercised stock option grants during the years under examination, including: (i) the date the necessary corporate action was completed for the grant of each stock option; (ii) the effective date (or backdate) of the stock option grant; (iii) the fair market value of the underlying stock on each of the aforementioned dates; (iv) the exercise price for each stock option grant; (v) the exercise date for each stock option grant; (vi) the fair market value of the underlying stock on the exercise dates; and (vii) the income tax deduction claimed for compensation reported on exercised options, including § 162(m) computations.As expected, the charges focused on backdating stock options by doctoring employment documents, neglecting to record the stock-option expense on the company’s books, and misleading investors.The cascading litany of alleged charges is not likely to stop with the Brocade case.Because the on-going possibility of securities litigation, it is important to carefully manage all responses to the IRS audit so as to avoid any waiver of the attorney-client privilege or the attorney work product privilege. Fuller, Partner, Tax Group [email protected], 650.335.7205 Scott P.Spector, Partner, Corporate Group [email protected], 650.335.7251 Barton W. Bassett, Partner, Tax Group [email protected], 650.335.7908 ©2007 Fenwick & West LLP. This alert is intended by Fenwick & West LLP to summarize recent developments in the law.The form IDR set forth in the Directive is designed to allow the IRS to leverage off of backdating investigations and information previously provided by taxpayers to the SEC in connection with backdating issues.For instance, the form IDR instructs the company to provide copies of final or preliminary SEC reports or filings, internal audit reports, independent investigation reports, and any other reports relating to the company's practices concerning the grant or exercise of stock options, including the backdating of stock options.Indeed, with more than 80 companies being reviewed by the SEC for potential illegal backdating practices, and one academic study claiming that more than 2,000 companies have engaged in the practice, civil and criminal charges will probably mushroom in the next few months. The purpose of backdating is straightforward: it gives options holders an immediate paper gain, and a real gain once the option is exercised.A quick examination of the cases against Brocade clearly identifies why backdating is synonymous with fraud, even though no U. The practice involves using hindsight to assign a stock-option contract an earlier date than its actual grant date.