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« Fighting The Decline | Main | No, I'm Not Dead »

Backdating

The WSJ has an article today on backdating:

Brocade Communication Systems Inc. agreed to pay a $7 million penalty to settle ... the backdating scandal, according to people familiar with the matter.... Brocade first struck a deal to pay $7 million in March 2006, but the settlement was held up as the number of companies under investigation for backdating options expanded to more than 100....

Republicans, in general, oppose [fines for backdating] as a double hit to shareholders, who already have been penalized once for being defrauded. Democrats argue that penalties serve as deterrents.

There was not necessarily fraud on the shareholder because it's in a shareholder's interest to use backdated options to pay executives. They don't have to use as many of them because they are intrinsically worth more (H. Jenkins), but are also not taxed as highly as more regular dated ones where the date wasn't coincidentally the lowest price of the quarter.

Putting that aside, fines in general should not be paid by the damaged party, but should be paid as a deterrent--and as compensation! How about the following proposal: the company pays the fine to the shareholders of record on the day before the news that false accounts were filed. That way the ongoing shareholders aren't hurt and the shareholders that sold after the bad news came out and the stock tanked will be compensated by the new ones who bought after the news. Just like how shareholders are treated when a company goes ex dividend.

Here's another controversial idea to increase deterrence: don't prosecute companies for common practices until you've given them sufficient warning to change their ways. Otherwise the prosecutors are doing what Dr. Strangelove accused the Russians of doing:

[T]he... whole point of the doomsday machine... is lost... if you keep it a secret! Why didn't you tell the world, eh?

The Constitution guarantees no ex poste facto laws in Article I, Section 9, but we are still working on no ex poste facto judicially implemented regulation.

Who watches the watchmen? Do we need four independent judiciaries with each one's scope determined by the others like the four redundant computers on the space shuttle? No need to curb the SEC and prosecutors of public companies--the companies are helping themselves. By going private.

Posted by Sam Dinkin at May 31, 2007 12:06 PM
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Comments

arguing in favor of fraud is a losing proposition.

Posted by anonymous at May 31, 2007 12:20 PM

But it is quite arguable whether the backdating was even fraud. It's tax evasion, almost certainly, but I would argue against backdating stock options being called fraud, since no one was deceived, and deception is a key element in fraud.

Also, you neglected the major point that Rand was making, which is that ex post facto laws by judicial fiat are just as damaging as ex post facto laws by legislative fiat.

Posted by Jeff Medcalf at May 31, 2007 01:32 PM

let me know how many documents you backdate?

Backdating is a material misrepresentation, it says an
event occurred at some event when it didn't.

Is it okay if i sell you backdated pharmaceuticals?
How about backdated milk?
let's backdate your paychecks, would you like that?


it says something that simberg endorses fraud.
fraud is a material misrepresentation for a tangible gain.

Posted by anonymous at May 31, 2007 02:22 PM

it says something that simberg endorses fraud.

Yes, it says that you don't know how to read, since I didn't even write the post, Anonymous Moron.

Posted by Rand Simberg at May 31, 2007 02:31 PM

Backdating stock options is not illegal. Backdating and failing to report to shareholders or expense them properly is illegal.

Personally, I think that if the options were issued improperly then the issuee should pay, to the shareholders of record, the difference between what they were worth on the backdate and what they were worth on the date of actual issuance. That's if the options were actually exercised. If they weren't exercised then just re-date them.

I think compensation committees and accounting departments who knowingly and willingly fail to report the backdating in the proper manner should face criminal charges.

Posted by Jardinero1 at May 31, 2007 03:00 PM

Given that Simberg controls this site, and is willing to
delete any posting he disagrees with, to leave a posting up
particularly a posting by an approved editor to his site,
is to endorse that position at least tacitly

as for all those in favor of backdating?
Please tell me what things you backdate.

Insurance policies?
Contracts?

Posted by anonymous at May 31, 2007 03:08 PM

No, Anonymous Moron. I've never deleted a post simply because I "disagree" with it. I've never deleted anyone's posts except yours, and (other) spam. And I haven't been doing proper hygiene, since I've been allowing your posts to stay up, despite the fact that you remain a moronic and abusive troll.

Posted by Rand Simberg at May 31, 2007 03:23 PM

I don't understand how these executives thought that they could get away with something like that. The IRS is notorious for closing loopholes after enough fish have entered the net.

Posted by Karl Hallowell at May 31, 2007 03:54 PM

Delete him!

Posted by Mike Puckett at May 31, 2007 04:06 PM

Insurance policies are routinely backdated.

Posted by Jardinero1 at May 31, 2007 07:54 PM

If the shareholders and the executives colluded, they would pick the lowest price date of the quarter, but reduce the number of shares. That way, the executives pay lower taxes.

Since all firms did the backdating, there wasn't any relative distortion of earnings--they were all distorted roughly the same. Some of the backdating came before options had to be expensed at all!

If an enforcement regime is common practice, there's no deterrence from changing it and not telling anyone. It's like deciding one day that when the speed limit sign says 60, you don't get a ticket driving 66, but 61. Then taking the license plate of every car driving 61, then telling them about the new enforcement regime in the same letter you send them the speeding ticket! It may be illegal, but the deterrence doesn't start until after they get the letter.

Posted by Sam Dinkin at May 31, 2007 08:46 PM

Jardinero1: Surely if the executives and the compensation committees couldn't backdate, they would issue more options. This would make the price systematically higher which would mean that compensation packages would have to include more restricted stock and more cash to have the same level of risk and salience to the executive. Those forms of compensation are taxed at the income rate. Should the perpetrators be blasted for the total amount of mis-stating to the shareholders (which if the shareholders knew in advance would agree to) or just for tax fraud?

Perhaps we should start applying the same fraud standards to the federal budget numbers. Everyone wants to believe that things are better than they are. Who's harmed if the 10-year deficit figures are always $100 billion low?

It's like the ancient Chinese proverb: Don't burn down your house to annoy your mother in law.

Posted by Sam Dinkin at May 31, 2007 09:02 PM

Sam: I am not sure I follow you. I don't have a problem with backdating. I have a problem with compensation committees and accounting departments who don't report or expense them properly. Punitive measures are sometimes required to insure that the keepers of the books are kept honest.

I didn't address the personal income tax complexities of backdated options.

Posted by Jardinero1 at June 1, 2007 10:08 AM

The answer to your question, Sam, is provided by your quote:

"The Attorney General loves surprises!"

Posted by Sigivald at June 1, 2007 10:21 AM

Sam

Colour it how you wish, backdating is fraud.

It's pretending one thing is another.

If the compensation isn't adequate, pay more upfront
as cash, issue restricted shares upfront, issue more
for performance.

To backdate is to claim risk that was never taken.

Can I backdate an insurance policy and check
after an airplane crash?

Posted by anonymous at June 1, 2007 11:52 AM


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