Let's analyse the question.

Section 16 b of the Securities and Exchange Act of 1934

requires that any profits made by executives through

purchases and sales of company equity securities

within 6 months be returnable to the company.

Prior to 1991, the "grant" of an Employee Stock Option

was not considered a "purchase" for Section 16 b

"short swing" purposes. Nor was the "grant" considered

as part of matched trades for 16 b purposes.

Prior to 1991, the "exercise" was considered the "purchase".

In 1991, the SEC decided correctly that the "grant" of

ESOs rather than the "exercise" should be the "purchase",

subject to SEC Section 16 b.

Prior to exemptions to Section 16 b by SEC rule makers, it

was a bit arkward to manage a portfolio of ESOs.

But it could be done reasonable well, especially if

the executive was interested in holding his options

for an extended period as the plan was designed .

But like everyone else, executives want to buy low and

sell high. This meant trying to be granted options with low

strike prices and sell stock at a high price. But 16 b was

interferring with their desires to back-date and spring-load

and then manipulate the price higher so they could "sell high".

In 1991, exemptions were made for grants of ESOs,

conditioned upon approval by Boards, Compensation

Committees or Shareholders and certain

restrictions imposed on the grantee. These 1991

"exemptions" granted some relief to executives but not

enough for them to be happy. Even with the 1991

exemptions, the executives still had trouble back-dating

and spring-loading with 16 b in the way.

In 1996, the SEC modified the qualifications to broaden

exemptions in order to accomodate the desires of

executives and their advisors. This opened the doors

for back-dating, spring-loading, earning manipulations to

accommdate executive grants, and artificially disguised

re-loading of the exercised ESOs.

In 1996, the SEC even considered asking Congress to

rescind Section 16 b altogether and requested comments

on that point.

Essentially, the SEC asked for comments from the foxes

guarding the hen house to determine how the foxes

could best guard the hens. Of course the foxes did not

want it to appear that they got every concession.

Otherwise the hens would discover the game.

After 1996, if 16 b-3(d) exemptions are interpreted in

the manner as some "experts" promote, every

grant of ESOs that was issued since 1996 is exempt

from SEC 16 b whether it was approved by shareholders,

the board of directors or compensation committees

or not.

According to attorneys for the foxes, if an options grant

has a vesting period of 6 months or longer it is

automatically exempt from 16 b, even if there was no

approval from anyone.

In some rare instances options are granted with no

vesting period. What could be the reasoning behind

such a lack of a vesting period if not to exercise shortly

after a back dating or a spring load or an intention to

exercise very soon after the grant.

For example:

Assume on April 1, 2006 an executive is granted 3 million

options (with a 12 month vesting period) to purchase "the

underlying stock", which he does not and can not exercise

untill after April 1, 2007. The grant day was one day before

very positive news is announced at the close on April 2, 2006.

Assume also that he held 2 million options on February 28,

2006 from grants made years earlier. Assume on April 7, 2006,

he exercises the 2 million options that he was granted years

earlier and sells the 2 million shares of common stock on

April 9, 2006 which he received from the exercise of earlier

granted options. Assume the sale price of the 2 million

shares on April 9 is 50% higher than the strike price of

the 3 million grant on April 1, 2006.

Some "experts" claim that even if there is no approval of

the grant by the shareholders, the board of directors or

the compensation committee, the grant of April 1, 2006 is

exempt from Section 16 b and no recovery is allowed.

According to some experts the grant of April 1 is exempt

because he did not exercise the options and sell the

specific received stock within 6 months of the grant.

This interpretation essentially vitiates SEC section 16 b,

and allows and encourages insider trading.

The whole purpose of back-dating and spring-loading

is to create an artificially low grant price and to sell

stock shortly afterwards at higher prices. SEC section

16 b made that practice far less attractive.

So the SEC accomodated the executives and

promulgated Rule 16 b-3 of 1996.

Whether the SEC was aware of the consequences of the

1996 Rule 16 b-3 or they were duped, the result is the same.

Without the 1996 Rule 16 b-3, the back dating and spring

loading by executives would be very small, and certainly

not what we see today.

Did the Rule 16 b-3 cause or contribute to the proliferation

of the back-dating grants and exercises, spring-loading,

bullet dodging, manipulating earning to accomodate grants

and stock sales, and disguised re-loading?

My view is that it did. And that is why most of the back

dating and other options scams are dated between 1996

and 2002.

I doubt, however, whether the SEC will agree. They

blame it on lack of proper "gate keeping".

John Olagues

olagues@hotmail.com

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John Olagues

The author, JOHN OLAGUES, is a former member of the Chicago Board Options Exchange and the Pacific Stock Exchange for over ten years. He offers a unique view of employee stock options from a trader’s standpoint rather than from the standpoint of an accountant, compensation planner or academic. To contact JOHN OLAGUES email olagues@hotmail.com and  see www.optionsforemployees.com.