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ACCT 74 De Anza College Backdating of Executive Stock Options Discussion

ACCT 74 De Anza College Backdating of Executive Stock Options Discussion

Question Description

A number of the lower level executives at Enron believed that because they were directed by upper management to participate in financial fraud, that they had no culpability in the Enron downfall. They reasoned that business was competitive, the bosses were smart (smartest guys in the room), and everyone seemed to be making money.

That outlook has been described as a sub-culture that can pervade startup companies where the executive officers are young, inexperienced and aggressive and don’t believe that rules and regulations apply entirely them. This is one of the reasons that backdating options has become such an issue. For example, a company wants a critical employee to stay with them and not leave for a competitor. The stock, when the employee is contemplating leaving is worth $10 per share. However, just 12 months ago the stock was worth $1 per share. The company considers giving the employee and option to purchase 250,000 shares of the stock at $1 per share, saying it was promised to him a year ago. As we know, with stock options, there is generally no payroll tax to deal with upon the grant so the company is able to creatively compensate a talented employee and keep her on board and avoid paying payroll taxes. Moreover, the CEO says, this employee will stay with the company, help make the company more profitable and thus pay more taxes in the long run. Additionally, because the employee is working on an important technology that will be patented, will allow the company to hire more employees in the near future.

Is this kind of backdating of options legal? Why or why not? How would you deal with this if you were the audit senior manager or partner in charge? How would you deal with this if you are the CFO? Identify who benefits and who could get harmed if this scenario plays out as planned by the CEO.

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