For example, early tech giant Qualcomm went public in 1991 at a split-adjusted price of $2 per share. By the end of the decade, shares were trading at $176. The dot-com bubble created an estimated $10 trillion in wealth between 1994 and 1999.
When the bubble popped in March 2000, many people found themselves on the hook for massive tax bills due to underwater stock options.
For example, take Jeffrey Chou, a then-32-year-old hardware engineer at Cisco Systems who exercised 106,560 ISOs at around 5 cents per share in 2000, spending around $5,300 to do so. When he exercised, he triggered a $2.7 million AMT tax bill, because Cisco’s stock had been worth $64.69 per share at the time — giving him an assumed gain (on paper) of nearly $6.9 million.
But Cisco shares cratered in 2000, and by April 2001, were hovering around $17 per share, not enough to cover the engineer’s tax bill. He estimated he’d have to sell everything he owned, including his townhouse and 401(k), to get close to paying his tax liability.
“I've lost sleep. I can't eat. I cannot pay, and we're ruined,” Chou told reporters at the time.
Chou and others holding underwater stock options lobbied Congress for help, which came in 2008’s bailout package, which wiped out $2.3 billion in back taxes the group owed following the dot-com collapse.
Quietly, throughout the dot-com boom and bust, executives at hundreds of major companies allegedly conspired with accountants to enrich themselves using stock options backdating — a practice where they would retroactively change the grant date on their options, picking a date in the past when the company’s shares happened to be low.
For example, they might have originally been granted their shares on June 1, 2000, when the company’s stock was trading at $50 per share. Later, they’d change the grant date to a different date, say January 17, 2000, when shares were trading at $25. Now, when they’d sell their shares at current market value, say, $55 per share, they’d earn a profit of $30 per share, rather than $5.
A researcher studying stock option grant dates uncovered this pattern, and published his findings in 2005. By 2006, federal prosecutors had identified more than 130 companies they alleged had engaged in stock options backdating. That led to the firings or resignations of more than 50 executives.
The largest case involved former UnitedHealth Group CEO William W. McGuire, who paid $468 million in fines and restitution to the company.
One executive, former Comverse CEO Kobi Alexander, spent nearly two months on the run in 2006, before being arrested by Interpol in Namibia. Alexander was ultimately sentenced to 30 months in prison and ordered to surrender a $46 million bank account.
Ultimately, the same researcher found that an estimated 29 percent of publicly traded American companies had engaged in stock options backdating from 1996 to 2005.
Today, employee stock options have retaken their place in pop culture as one of the driving forces in Silicon Valley’s economy. Every day, people who get in on the ground floor at promising startups enjoy multimillion-dollar outcomes when their company eventually exits. In Silicon Valley, stock option success stories abound with the lightest of prodding.
The critical conversation around stock options has increasingly shifted to questions of whether people can afford the cost of exercising their options, particularly amid the growth of mega-rounds of investment capital designed to keep unicorn startups private for 10 years or longer.
The average tech worker spends just 2 years at a startup before joining another. The stock options they exercised early in the startup’s history might not see a liquidity event for 8 years, if at all. As a result, tech workers routinely walk away from billions of dollars in unexercised stock options every year.
Despite their long, winding history, employee stock options remain one of the biggest drivers of startup innovation. They’ve created life-changing outcomes for people who take a gamble on a startup, and work as hard as possible to even the odds — in the process, building the cornerstones of the next great multinational corporation.
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