In recent years, many well-known companies, including Apple and Home Depot, have been accused of backdating options. A February 2009 National Post article titled “OSC, RIM in tentative settlement” explained that the Ontario Securities Commission was charging Research In Motion Limited (RIM) with the backdating of options. The following are some excerpts from the article:
“According to a statement of allegations filed by the OSC late yesterday, the total ‘in the money’ benefit resulting from the incorrect dating practices for all employees was about $66-million, including $33-million that has not been reimbursed or repaid to RIM or otherwise forfeited. The regulator said 1,400 of 3,200 option grants made between 1998 and 2006 were made using incorrect dating practices.
“An internal investigation at RIM revealed that options had been ‘backdated’—or set at earlier lower prices that would give the recipient an immediate gain on paper—leading to improper accounting treatment in the company’s books. As a result of the internal probe and earnings restatement, Mr. Balsillie left his chairman’s post and Mr. Kavelman was assigned to a different job within the company. Some directors were also replaced.
“According to the OSC’s statement of allegations, the directors and officers involved ‘did not take reasonable steps to provide proper oversight in relation to RIM’s options granting practices or to ensure that RIM’s public disclosure reflected those practices.’
“The regulator alleged that the grant dates selected resulted in more favourable pricing for the options or ‘in the money’ grants.
“In many instances, the lowest share price in a period was chosen using hindsight in order to set the grant date and, therefore, the exercise price,’ the OSC said.
“Between July, 1998, and August, 2006, ‘RIM repeatedly made statements in many of its filings, including prospectuses, financial statements, annual reports, and management information circulars, that contained the misleading or untrue statement that options were priced at the fair market value of RIM’s common shares at the date of the grant and were granted in accordance with the terms of the plan,’ the OSC said in its final statement of allegations released yesterday.”*
In settlement of this case, four senior executives (Kavelman, Loberto, Balsillie and Lazaridis) were required to pay $77 million in fines to the OSC and restitution to RIM. In addition, the executives were required to pay $1.76 million to the SEC for penalties plus give back more than $800,000 in profits made on the sale of the backdated options.
Instructions
Access the financial statements of Research In Motion Limited for the fiscal year ended March 3, 2007, from SEDAR (www.sedar.com) or from the company’s website.
(a) Explain the nature of the errors that the company has made. Describe the process that the company undertook to determine the extent and nature of these errors. What is meant by backdating of the options?
(b) What was the impact of these errors on the net income and cumulatively on retained earnings for each of the years 1999 to 2006? In what years does this restatement appear to have the largest impact?
(c) For the years ended March 4, 2006, and February 26, 2005, explain the impact on cost of sales; research and development; and selling, marketing, and administration expenses. What percentage of net income did total restatements represent for each of these years? What is the impact on the EPS for each year?
(d) What is the impact on the balance sheet for March 4, 2006? What is the impact on the current ratio and debt-to-equity ratio before and after these restatements?
(e) What is the impact on the operating cash flows for the years ended March 4, 2006, and February 26, 2005?