IF YOUR COMPANY HAS BEEN BACKDATING OPTIONS ...

Know that you’re not alone. More than 250 companies have announced internal reviews, S.E.C. inquiries, or Department of Justice subpoenas in the two years since a professor at the University of Iowa published a report in 2005 noting that backdating options might be, well, illicit or illegal. Among those with some explaining to do: Apple, Barnes & Noble, McAfee, Novell, and Forrester Research.

Most controversial was the assertion by the professor, Erik Lie, in that 2005 report that “unless executives possess an extraordinary ability to forecast the future marketwide movements that drive these predicted returns, the results suggest that at least some of the awards are timed retroactively.” Oops.

The situation becomes dicey—read: illegal—if the backdating hasn’t been revealed to investors and okayed by them or the board. Backdating can lead to overblown profits, significant unpaid taxes, and courtroom-bound executives.

But what should you do if you discover that executives at your company have been backdating options without your knowledge?

1. Immediately Start the Cleanup Process
“The next 24 to 48 hours are critical for setting the tone for what follows,” says Michael Robinson, senior vice president of Levick Strategic Communications and a former S.E.C. public affairs and policy chief. “If in the first 48 hours you run to the crisis, pledging to get to the bottom of it, then employees and regulators and investors will see you trying to do the right things. If you try to sweep it under the rug, they’ll think there’s something else going on. Think of this time like an overture to a musical.”

2. Make Sure It’s True
As soon as you find out (likely from your accounting firm or a whistleblower), initiate a probe. You have to determine the facts, separating out rumor and innuendo; hire outside lawyers and accountants, even forensic accountants if necessary. Since these professionals aren’t currently doing any other work for your firm, they will focus on this one problem and not have any taint of the scandal.

3. Spill the Beans to the Board
In a perfect situation, you could sequence your admissions, going first to tell the chairman, then the audit committee chair, next the compensation committee chair, and then the entire board. The timing might be such, however, that you must speak to everyone at once. They need to hear it from you first. As management, you are reporting to the board, which is in a position to support you or not. Remember, cautions Robinson, “board members like to do one thing—be on boards. So, they’re going to preserve their reputations at any cost. You want to make sure their interests are aligned with your interests.”

4. Freeze All the Controversial Options Granted
Enough said.

5. Start Your Own Spin Before the Spin Starts You
Bring in an outside P.R. team and an external investor relations group. Work with them to get the company’s message together before you speak with regulators, employees, investors, and the press. Once you start talking, you’re committed to what you say.

What should you cover? It’s fairly standard. Suggests Robinson: “Although you don’t know the whole of what happened as of now, tell them you’re committed to keeping them informed and the guilty will be held accountable.”

6. Tell Regulators and Law Enforcement Agencies Before They Tell You
Move quickly to inform regulators, such as the S.E.C. and the N.Y.S.E. or Nasdaq, depending on where your company is listed, as well as law enforcement agencies. They should get the same message that’s given in the press, to the board, and in internal memos. Be consistent.

Check out the Department of Justice’s “McNulty Memo”. This document lays out the level of cooperation that the Department of Justice will expect when deciding whether to charge a corporation with criminal offenses.
 
7. Quell Employee Fears
Enron’s 2001 scandal has triggered employee fears about corporate financial misbehavior. So there needs to be good press internally, too. This event may lower your company’s stock price, which will impact the value of options owned by employees.

Be as up-front as possible with employees so they are not immensely concerned or distracted by the news onslaught—and therefore less willing to be picked off by competitors.

8. Deal With Taxing Matters
It will take months, but amend and refile tax returns as needed and pay back taxes and fines, including whatever tax breaks the company received as a result of the backdated options. Suggestion: Pay the I.R.S. any taxes owed by rank-and-file employees on options illegally backdated without their knowledge. That’s not required, but it’s a nice thing to do. In fact, the I.R.S. has been encouraging this; it even set up a program for employers to help with backdated employee options exercised in 2006.

9. Keep on Fixing It
Learning the full extent of what happened will take months. But as you find out, do whatever is needed to make things right. This could include restating financials; disciplining, and possibly firing, the executives involved; requiring that the top guilty exec reimburse the company; and continuing to coordinate with law enforcement agencies.

To show people you’re serious, Robinson counsels, you could go one step further. Write a book about how not to get scammed—with the proceeds going into a fund for employees—for example.

SOURCES: Steven Davidoff, assistant professor of law, Wayne State University Law School; Eric Dezenhall, C.E.O., Dezenhall Resources; Randall Heron, associate professor, Kelley School of Business at Indiana University; Erik Lie, associate professor and research fellow, Henry B. Tippie College of Business, University of Iowa; Kevin McKeon, I.R.S. media relations specialist; and Michael Robinson, senior vice president, Levick Strategic Communications, and a former S.E.C. public affairs and policy chief.