Executive Fraud Blog

Authoritative literature on the accounting for stock options until 2005 had been Accounting Principles Board Opinion No. 25 “Accounting Stock Issued to Employees”. Under APB 25, as long as the options were issued at the money (exercise price equal to than current price) there was no recognized expense until the options were exercised. Manipulation of these rules during the technology boom of the late 1990s allowed them to recruit executives without having to show any effect on the financial statements. Although once the reported earnings led to significant returns for the executives they would exercise the options causing immediate current period expenses that would destroy the company’s earnings.

In response to this behavior, the Financial Accounting Standards Board issued FAS 123, “Share-Based Payment” that encouraged the use of the fair value method but still allowed company’s to use APB 25 as long as they disclosed pro forma financial statements. In 2005, FAS 123R eliminated the use of the intrinsic value method and made fair valuing of options the standard.

Another rule change has come from the SEC in August 2002 for the disclosure of the grants that they must be filed within 2 days of the grant date instead of the original 45 days before the year end. Sarbanes-Oxley legislation has also created higher reporting standards for public traded companies.