Executive Fraud Blog

As each month passes there are more companies coming to the surface admitting that they must restate their financial statements to correct for option backdating. Glass Lewis & Co. has reported that 152 companies have been discovered in violation of the rules and have collectively lost $5.1 billion in market capitalization by the exposure of the problem. This number is seen by many as just the tip of the iceberg and there will be many other company restatements as the SEC continues their investigations.

Critics of the numbers presented have claimed that the economic value of the option backdating is not as significant as one would imagine. They claim that there are six factors going into an option price when using the Black-Scholes model and the strike price is only a small part of the valuation. Ultimately, they acknowledge that the practices are bad for the market because it destroys investor confidence but they claim that many other factors dictate the value executives receive from their options.

In the future, regulators will likely improve definitions of the requirements for filing options and will continue to enforce disclosure in order to encourage further declines in the backdating practice. Investors can take advantage of information that certain companies have a higher risk of option manipulating by shorting the stock prior to SEC or internal investigations. After companies have admitted problems there will likely be a drop in stock price especially when there is uncertainty of the restated earnings.

Issues that will come under further scrutiny as well when companies are under investigation include spring-loading and bullet dodging which involve timing options before good news or after bad news in order to reap the benefits of lower stock prices. Once regulators crack down on backdating it is likely a new form of manipulation will prevail. Despite this difficult truth, companies that demonstrate consistency in transparent financial reporting and swift justice against violations such as asset misappropriation will be rewarded with the confidence of investors.