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Last Updated: Thursday, 12 October 2006, 23:01 GMT 00:01 UK
Quick guide: US stock option scandal
Erik Lie
Mr Lie's studies have led to a huge US corporate investigation
Stock options are a very popular device for companies to financially entice - and retain - employees, particularly in the technology sector.

They are used to reward executives by giving them the right to buy company shares in the future at a fixed price (known as an option), usually the price the shares stood at on the day when the option was issued.

Quick guides are concise explanations of topics or issues in the news.

If they have worked hard and the business has done well, there is a good chance that the share price will have risen during that period, giving the executive an extra profit if they then sell them.

Some executives have made ten of millions of dollars from cashing in their stock options.

The main issue that has got lawyers, shareholders and regulators in a frenzy is the practice of backdating.

What is backdating?

Companies that backdate their options choose a date for the option that is often earlier than when it was actually awarded.

This allows them to pick a date in history when the company share price was at a low point.

The lower the share price when the option is granted, the greater the potential profit later on.

While backdating is not illegal, it must be properly and clearly accounted for because it can give misleading profit figures or result in underpaid taxes.

How the scandal emerged

In May 2005, business professor Erik Lie had his article "On the timing of CEO stock option awards" published in the Management Science journal.

Securities and Exchange Commission logo
The SEC has filed civil charges against some executives

It analysed the timing of nearly 6,000 stock option grants awarded by US firms to executives between 1992 and 2002.

It recorded the startling regularity with which a company's share price fell just before an executive's stock options were granted, and then rose soon afterwards.

His conclusion was that these executives were not all either really lucky or very clever at reading the stock market, and that "at least some of the awards are timed retroactively".

Basically, Mr Lie was accusing companies of backdating stock options to boost their value.

His paper was followed by a brief article in the Wall Street Journal in March 2006 which actually named some companies that had suspicious option grant dates.

The extent of the problem

Within a few months more than 120 companies had either begun their own investigations or were being investigated by US authorities including the Securities and Exchange Commission (SEC).

The affair has snowballed into the one of the widest US investigations of corporate wrongdoing.

Executives at Brocade Communications Systems and Comverse Technology have been charged with stock options fraud, and a host of managers have resigned, including bosses at online publisher CNet Networks and antivirus software firm McAfee.

Computer giant Apple Computer recently said it expected it to restate some of its financial statements in order to properly account for the expenses resulting from the backdated options it had awarded executives.

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