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The SEC and Department of Justice have recently filed enforcement actions relating to stock option backdating. Numerous companies have announced internal investigations. Reports of correlations between option grant dates and low points in a company’s stock price, which sometimes appear simply too good to be true, have led regulators to conclude that option grants were backdated or otherwise manipulated to capture the lowest possible strike prices. But backdating options, in and of itself, is not illegal. Rather, it is the impact that backdating has on other issues that raises legal difficulties. What are these issues � and what should companies do now? ACCOUNTING ISSUES Until recently, most public companies accounted for stock options under Accounting Principles Board Opinion 25 (Accounting for Stock Issued to Employees), as supplemented primarily by Financial Accounting Standards Board Interpretation 44 (Accounting for Certain Transactions Involving Stock Compensation). A company was not required to record any compensation expense for granting options if the strike price was equal to or greater than fair market value at the date of the grant. To qualify for this accounting treatment, the date of the grant must be defined and the number of shares fixed. The day on which both conditions are first met is the “measurement date.” But if below market-value options are granted, the difference between the option price and the fair market value is treated as a “compensation” expense. This must be amortized to expense over the vesting period. And if there is no defined grant date or the number of shares is not fixed, the company may be forced to adopt “variable accounting” under which the compensation expense is recognized at the time of the grant and in each succeeding quarter until the grant is exercised, cancelled or forfeited. Thus, the primary accounting questions that companies, their lawyers and their auditors must now address include:

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