Dating stock options

On July 11 the IRS released an internal Industry Director Directive memorandum dated June 15, 2007 (the "Directive"), which designates transactions involving backdated stock options as a "Tier I Issue" for IRS agents.

Tier I Issues are considered matters of "high strategic importance," The Directive has important implications for both companies and individuals.

The Directive is significant, nonetheless, in that it signals a nationally coordinated effort within the IRS to target transactions involving backdated stock options, and also establishes mandatory audit requirements and centralized reporting procedures within the IRS as relating to backdated stock options.

As noted below, the directive also signals the IRS's intention to pursue the issue against individuals who received such options.

Backdating of an option may prevent it from qualifying for the exception set forth in Treas. Backdating of a stock option might prevent such option from qualifying as an ISO as § 422(b)(4) requires that the option's exercise price be not less than the fair market value of the stock at the time such option was granted.

Withholding issues may arise for a corporation if an option that was labeled an ISO is later found to have been misclassified.

Furthermore, the Directive states the special requirements apply regardless of whether the issue arises from error or was the result of deliberate actions.

A quick examination of the cases against Brocade clearly identifies why backdating is synonymous with fraud, even though no U. The practice involves using hindsight to assign a stock-option contract an earlier date than its actual grant date.

Because the on-going possibility of securities litigation, it is important to carefully manage all responses to the IRS audit so as to avoid any waiver of the attorney-client privilege or the attorney work product privilege. Fuller, Partner, Tax Group [email protected], 650.335.7205 Scott P.

Spector, Partner, Corporate Group [email protected], 650.335.7251 Barton W. Bassett, Partner, Tax Group [email protected], 650.335.7908 ©2007 Fenwick & West LLP. This alert is intended by Fenwick & West LLP to summarize recent developments in the law.

Designated as a Tier I Issue, IRS field agents are now required to audit all transactions involving backdated stock option grants and/or backdated exercise prices.

The Directive also expands the categories of options that trigger special attention to include any options that might be discounted, mis-priced, mis-dated, or in-the-money.

The form IDR set forth in the Directive is designed to allow the IRS to leverage off of backdating investigations and information previously provided by taxpayers to the SEC in connection with backdating issues.

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