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Attorneys have more bad news for corporate executives caught in the stock-options backdating quagmire: Millions of dollars in unpaid taxes on the option gains will be due by the end of this year. Some lawyers had hoped that the Internal Revenue Service (IRS) might give companies a longer period to investigate the issue and clean up any problems, getting executives off the hook for higher taxes on their gains. Instead, the IRS in a recent bulletin followed through on threats to cut no slack for executives who profited from backdated options. “Anyone unfortunate enough to be an officer under this process may get hammered,” said Joseph Ronan, a Morgan, Lewis & Bockius attorney in Philadelphia who works on employee benefits and executive compensation issues. The IRS ruling could affect the top 20 officers at the 152 companies that have so far disclosed that they may have a problem with backdated options. A stock option gives its holder the opportunity to buy stock at a certain price, usually the price on the date that the option is granted. In backdating, a company will peg the option to a date before it is granted, allowing the holder to benefit from the stock’s rise between the two dates. It is not illegal if it is disclosed to shareholders and accounted for properly, but some companies didn’t follow those guidelines. The oversight is forcing those companies to restate earnings to take account of additional noncash compensation given to executives. The U.S. Securities and Exchange Commission has said it is investigating the issue. ‘In the soup’ Some 152 companies have announced internal reviews, SEC inquiries or U.S. Department of Justice subpoenas related to stock-options grants, according to shareholder advocate group Glass Lewis & Co. Some of the companies include Children’s Place Retail Stores Inc., information security company Safenet Inc. and health insurer UnitedHealth Group Inc. Executives at Web site owner Monster Worldwide Inc. and telecommunications software company Comverse Technology Inc. have resigned over the issue. Now, the IRS is saying that executives who received the options and whose companies are restating earnings should pay the additional tax. “The SEC’s authority, expertise and ability to access information on a real-time basis allow us to identify potential options backdating exam subjects more precisely and more quickly than we would be able to do on our own,” said IRS Commissioner Mark Everson in testimony before a congressional committee in September. While the October IRS statement is a proposal, attorneys expect it to become final soon. “If you’ve restated your earnings or expect to restate, then you’re in the soup,” said Ronan, who heads the Philadelphia Bar Association’s tax section. Being in the “soup” will mean a 20% tax in addition to the usual 35% rate for income from exercised options, resulting in a 55% rate. In some states, such as California, there will be another 20% tax, Ronan said. On top of that, there may also be interest to pay. “The tax rate gets pretty high,” said Stuart Lewis, an attorney in the Washington office of Pittsburgh-based Buchanan Ingersoll & Rooney. “It’s just going to pile on to the other problems that these people have.” Some companies are still figuring out whether they have a problem with back-dating and, if so, how to deal with it, attorneys for corporate clients said. In most cases, it’s not an issue of fraud as much as being careless, said Pam Baker, a Sonnenschein Nath & Rosenthal attorney in Chicago. “What companies do about it depends in part on what triggered the problem, how big it is and how many people are affected by it,” said Baker, who leads her firm’s employment benefits and executive compensation practice. If there is a problem, then restating earnings is just part of the solution. There is still the complicated task of fixing the options, and it is a bit unclear how that task is to be accomplished, the attorneys said. The companies can ask executives to revise options agreements or, if options have already been exercised, the executive could return the shares, but chances are that the stock has already been sold, Ronan said.

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