Backdating

Ooh. This is bad. Scandals. Jail. Silicon Valley soap opera. 

When an important employee is hired by a young company, they might get a generous option plan for company stock and a more modest salary and bonuses. Why? Because young companies don't have a lot of cash now but want to attract good workers, and they're betting on the fact that employees will be tempted by the possibilities of those options.  

There are usually some limits with the options. For example, the employee might have to stay in good standing at the company for 4 years and must sell their options within 10 years or so of them being granted. So far so good, but these options must also come with a strike price, which is the price at which the employee can buy the stock. That's where things can get sticky. How is this strike price created? Usually by looking at the average closing price over the last 120 days of trading or something like that.

Some shady companies (and employees) realized that they could backdate their options, which means slapping on a price from a date a few days, a few weeks, or a few months earlier (when prices were lower). Getting that lower price by fudging a few dates means bigger potential profits for the employees who will eventually sell the stock.

Just one tiny problem: backdating is illegal.

In 2008 and 2009, though, it didn't prevent some big backdating scandals in Silicon Valley. Since then, laws about backdating have gotten stricter.

Example

XYZ stock was at $80 a share 20 weeks ago; now it's at $200. In 4, years it might be at $400. The employee getting the $80 strike price on 100,000 shares will have appreciated $320 per share times 100,000 shares or... $32 million. But if the employee had received as their strike price the average of $200 and $80, assuming an arithmetic set of closing price gains, the strike on their options would have been $140. The gain would then only be an appreciation of $260 or $26 million.