An option granted at less than fair market value will not qualify as an incentive stock option and therefore generally will be subject to income tax and withholding requirements upon exercise of the option.
An option granted at less than fair market value will also not qualify as “performance based compensation” and thus must count toward the $1 million executive compensation deduction cap under Section 162(m) of the Internal Revenue Code.
In its most basic form, backdating can range from the blatant falsification of a document to take advantage of a lower stock price to allowing executives to select a grant date during a specified period, for example during the 30 days after the grant is approved by the board or committee.
Although these practices involve different types of conduct, both create problems because the date when the exercise price is set is not the same as the date on which the option is awarded.
Options granted at less than fair market value or without proper board or committee approvals may violate the terms of the applicable option plan, with the result that options could be invalid.