Backdating stock scandal
Unfortunately, these conditions are rarely met, making backdating of grants illegal in most cases.(In fact, it can be argued that if these conditions hold, there is little reason to backdating options, because the firm can simply grant in-the-money options instead.)David Yermack of NYU was the first researcher to document some peculiar stock price patterns around ESO grants.In particular, he found that stock prices tend to increase shortly after the grants.
Reyes' defense was that he signed off on the backdated options without intent to deceive, and he thought the company's finance group had properly disclosed the backdating in the annual reports.
ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.
Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.
According to court testimony, Brocade’s failure to expense more than 0 million from backdated options resulted in Brocade reporting profits in 20, when it should have reported large losses.
Brocade was just one of many tech companies which came under SEC investigation for distorting their earnings starting in the late 1990s by not disclosing this kind of executive compensation.