Ethics of options repricing and backdating

The company should be attentive to the obvious shareholder concern that management and employees (who may bear some obvious responsibility for the very problem being addressed) are in some way being made whole, unlike the shareholders who are left to hold their underwater stock.

A company’s stock option plan should also be reviewed to make sure that it does not preclude a repricing of stock options.

Traditionally repricing simply involved canceling the existing stock options and granting new stock options with a price equal to the current fair market value of the underlying stock; but over the years alternative approaches to traditional repricing have been developed to avoid the unfavorable accounting treatment now associated with a simple repricing.

We advise our clients that repricing is not a straightforward process and that they should carefully consider the following three aspects associated with a repricing – corporate governance, tax and accounting aspects.

In order to preserve the favorable ISO tax treatment that is permitted under that section of the Code, the new stock options must be granted at the current fair market value of the underlying stock.

Assessing the current fair market value of a privately held company will require the board to set a new value on the common stock of the company.

This causes the option to be treated under so-called “variable” accounting rules.

These rules require the constant remeasurement of the difference between the exercise price of the stock option and the fair market value of the underlying stock during the life of the option, resulting in constant uncertain impacts on a company’s income statement.

In general the board of directors of a company has the authority to reprice stock options, although some thought should be given to whether this is an appropriate exercise of the board’s business judgment.Other issues that should be considered include the terms of the new option grants, including the number of replacement shares and whether to continue the current vesting schedule or introduce a new vesting schedule for the repriced options.Tax Considerations Tax concerns weigh heavily in repricing decisions if the stock options being repriced are incentive stock options (or “ISOs”) under Section §422 of the Internal Revenue Code.However, each of these approaches is not without its own separate concerns and should be reviewed in light of the facts and circumstances of the particular situation.For example, when considering a six and one day exchange, there is risk to the employee that the fair market value will rise as of the reissuance date; or when considering a restricted stock award a company should consider whether the employees will have the cash available to pay for the stock at the time of award.

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