Options backdating schemes allow additional wealth to be transferred to an options recipient from the company. In doing so, they increase the company's compensation expenses. The next question to ask is: are the increased compensation expenses created by options backdating clearly disclosed to the company's investors, or does the company misrepresent its compensation expenses to investors as being artificially low? When expenses are misrepresented, then we are in the territory of security fraud.
Howard Schilit writes about the options backdating scandal from this perspective in his book "Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Reports".
> Most shenanigans discussed in this book share a common theme: company executives use accounting gimmicks to show impressive results in hopes of driving up the stock price so that their shares and options become very valuable. The options backdating scandal that erupted in 2006 is on a whole different level of dishonesty. Executives were able to skip the whole part about using accounting gimmicks, showing impressive results, and driving up the stock price. Instead, they cut right to the chase and secretly gave themselves stock options that had already increased in value. In so doing, executives found a simple way to loot the company’s coffers without letting anyone know. They thought it was the perfect heist -- and it was, until they were caught.
> If you were to put options backdating on one side of a scale that weighs dishonesty, and any other shenanigan on the other side, we believe that backdating would always be heavier. Why? Because all other shenanigans are designed to enrich management in a complicated, indirect manner, while backdating does so without any serious effort at all. Look at all the “hard work” Enron executives had to do to create all those crazy joint ventures to make results appear better! Look at the acquisition activity at Tyco and the gyrations that Symbol Technologies went through in order to get positive results! And no matter how much cheating went on at these companies, there was never a guarantee that the stock price would respond accordingly.
> With options backdating, however, management barely had to lift a finger in order to cheat. And, of course, the process guaranteed a positive result. For this reason, we crown backdating as the King of all Shenanigans. The options backdating scheme was really quite simple. Before finalizing an option grant, executives pulled up the stock chart and looked back in time to find a date on which the stock price was at a much lower level. They then said hocus pocus and “backdated” the paperwork to make it seem as if the stock option had really been granted on that earlier date. And voilà, the stock options had instant value. Of course, options backdating had accounting implications as well.
> By not reporting the compensation expense resulting from these “in-the-money” grants, companies were overstating their earnings to shareholders. Few companies abused options backdating as much as semiconductor giant Broadcom Corp. The saga began when Broadcom’s board initiated a review of option-granting practices on May 18, 2006, two days after a seminal CFRA (Center for Financial Research and Analysis) survey on options backdating listed Broadcom as one of the companies “presenting the highest risk of having back-dated options”. After two months of investigating, Broadcom finally admitted what it had done and estimated that this abuse of the system had allowed the company to avoid a whopping $750 million in compensation expense. But that was not the end of the story. The following January, Broadcom shocked investors by announcing an unbelievable $2.2 billion expense, which tripled the original estimate and trumped the $1.5 billion estimated restatement record held by former backdating champion UnitedHealth Group.
> Some executives still argue to this day that the media blew the backdating scandal out of proportion and that the misdated grants were simply caused by “careless record keeping.” Au contraire. (We weren’t permitted to use stronger language in this PG-rated book.) The sheer pervasiveness of this scandal across hundreds of companies actually makes it seem that many executives considered backdating to be a perk of running a public company.