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In light of recent media and enforcement scrutiny regarding stock option granting practices, companies should begin to review their own stock option practices. Thus far about a dozen public companies have restated their financial statements, and the SEC is currently investigating more than 80 companies to determine whether options were illegally backdated or otherwise manipulated. According to a recent Wall Street Journal article, a CEO, CFO, and an HR director at one company are currently facing civil and criminal charges in one of these backdating investigations, with maximum potential penalties of 20 years in prison and a likely settlement of $7 million. One recent study has suggested that the scope of this issue could extend to thousands of public companies.

Backdating
Backdating of stock options is the practice of manipulating either the exercise date or the grant date of the option after the fact, to maximize the benefit to the holder. Backdating the exercise date could be done to minimize the option holder’s tax liability. More commonly, the grant date could be backdated in order to align the grant date with the stock’s low point. The latter appears to be the focus of current investigations. Either way, backdating enables the holder of the option to potentially increase their profit and can expose all those associated to the company to additional risks.

Another item of concern would be grant dates that fall directly before or after press releases or other public filings detailing good or bad news. This practice is often referred to as “spring-loading” options. In this instance, the company grants options and then releases a favorable earning release. This essentially will give the option holder an automatic gain. On the other hand, if a press release is released detailing unfavorable earnings, the company could potentially wait a few days and then grant options at a low point for the stock.

Backdating of stock options could also lead to understated compensation expense and overstated earnings per share on the income statement for the related period, which could potentially require restatement. Backdated stock options could also be viewed as “nonqualified deferred compensation” which could lead to additional personal tax liabilities if the options are not amended by December 31, 2006.

The SEC, PCAOB, Department of Justice as well as lawmakers on Capitol Hill have already begun investigating companies’ stock option granting practices, and Department of Justice officials have made it clear that executives can face possible prison time for backdating stock options. In addition to potential enforcement actions, companies may face class action lawsuits, revisions to prior tax returns, and restatements of annual and quarterly SEC filings. Furthermore, some experts have suggested that D&O insurance may not cover many instances of stock options dating and timing issues.

What Can Be Done
Companies should review their own stock option granting and reporting practices and the related controls to determine if potential backdating issues exist. Some steps a company can take to see if there are potential backdating issues could include: 1) review the effectiveness of the Compensation Committee, 2) review the control procedures relating to stock option grants, 3) list out all stock option grants for officers and directors of the company as reported in public filings, 4) ensure the dates of the grants per the public filing agree with those approved by the board of directors, 5) review the company’s stock performance for a period of time before and after the grants and look for peaks and valleys, 6) if the stock option grants coincide with valleys in the chart, a potential for backdating might exist, 7) review stock option grants before and after favorable and unfavorable press releases and public filings.

In addition to the above, some companies have decided in order to avoid any potential option backdating issues, the company will grant options on a recurring pre-determined calendar (i.e.: August 1 of every year). Companies should be aware that in one provision of the Sarbanes-Oxley Act of 2002, the SEC has shortened the time individuals have to report insider transactions on Form 4 from 45 days after the close of the fiscal year in which the options were granted, to two days after the options are granted.

New Rules Related to Compensation Disclosure
The Securities and Exchange Commission voted on July 26, 2006 to adopt changes to the rules requiring disclosure of executive and director compensation, related person transactions, director independence and other corporate governance matters, and security ownership of officers and directors. These changes will affect disclosure in proxy statements, annual reports and registration statements, as well as the current reporting (Form 8-K) of compensation arrangements. Some of the key changes are as follows:

• Adds requirement for a Compensation Discussion and Analysis that address the objectives and implementation of executive compensation programs. In addition, the Compensation Disclosure and Analysis will also require the Company to discuss option grants to executives including reasons a company selects certain grant dates for awards, or the methods for determining terms of the awards.
• Requirement for a Compensation Committee Report that includes a statement from the Compensation Committee of the Board of Directors that they reviewed and discussed the Compensation Discussion and Analysis with management.
• Adds additional disclosure to the current Summary Compensation Table including information on equity based award fair values, change in the actuarial present value of accumulated pension benefits, other non-equity compensation and perks over $10,000.
• Disclosure on outstanding equity interests – will include amounts realized from equity-based plans in the most recent year.
• Retirement Plan and post-employment disclosure – will require disclosure of each named executive’s accumulated benefit under each benefit plan; disclosure of activity for nonqualified deferred compensation plans; description of any arrangements that provide for payments or benefits at, or following, the termination of a named executive, change in responsibilities or change in control, and quantification of those payments.
• Option Grants - Required disclosure will include Grant date fair value, FAS 123R grant date, closing market price on the date of grant, date the compensation committee or full Board took action to grant the award.

To date there have been no formal SEC or PCAOB alerts issued on this topic. The PCAOB had been set to issue an alert but was asked by the SEC to hold off until the commission completes its own work on a proposed rule to overhaul disclosure of executive pay. The agency expects to have the executive pay rule before the commission for a vote sometime in August 2006, so the guidance from both agencies could be issued very promptly.

For more information, contact Brian Downey or your Amper representative.

We will continue to follow this issue and keep you apprised of developments as they occur.

July 2006