The company exonerated Steve Jobs, but its SEC filing didn't answer everything about options backdating
Investors hoping Apple Computer would end the year on a high note were not disappointed on Dec. 29, the last trading day of 2006.
That's when Apple (AAPL) filed statements with the U.S. Securities and Exchange Commission that took pains to exonerate Chief Executive Steve Jobs from wrongdoing in the company's handling of stock options from 1997 to 2002. A special committee appointed by Apple's board "found no misconduct by current management," the company said in a lengthy explanatory note attached to its yearend financial filing. That reiterated remarks made by Apple in October, and it was exactly what many investors and analysts wanted to hear. Apple's shares gained nearly 5%, to $84.84.
As upbeat as the tone was toward management, the documents nevertheless underscores concerns over the way Apple handled options, which were used by many companies in recent years to compensate employees, and have become the target of widespread investigation. The practice of backdating, or changing a grant date to artificially boost the value of the option, can skew results by understating compensation costs and overstating profit.
Apple said its own probe turned up "a number of grants for which grant dates were intentionally selected in order to obtain favorable exercise prices," and that Jobs was "aware or recommended the selection of some of the favorable grant dates." Jobs "did not receive or financially benefit from these grants or appreciate the accounting implications."
But if Steve Jobs didn't fully understand the accounting implications of backdating stock options, then who did? As it did in October, Apple pointed the finger at two former officers it hasn't identified. Former general counsel Nancy Heinen left Apple in May and former chief financial officer and director Fred Anderson resigned his board seat in October. Heinen's attorney didn't return calls seeking comment.
Anderson's lawyer, Jerome Roth, released a statement on Dec. 29 saying Anderson was "disappointed to learn that during part of his tenure as chief financial officer at Apple, the company apparently was not strictly complying with its processes for granting stock options." Roth said that Anderson "did not play any day-to-day role in the granting, reporting, and accounting of stock options and he was not involved in any knowing manipulation of the process."
One of the most controversial grants came in late 2001, when Jobs received 7.5 million options. Initially approved at a board meeting on Aug. 29, the terms of the grant weren't finalized until Dec. 18 of that year. In the Dec. 29 filings Apple said the grant showed an improperly recorded approval date of Oct. 19, 2001—a date when in fact no board meeting took place. Apple also said it unearthed no evidence that current managers were aware of the irregularity surrounding the approval of the options.
Searching the Options
Roth stressed that Anderson was not a member of the board of directors at the time. "As such, Fred had no knowledge of any impropriety relating to this option grant to Mr. Jobs," Roth said. The grant was part of a larger block of 27.5 million options, which Jobs canceled in 2003 because they were under water. Instead he took a grant of restricted stock.
To be sure, the members of Apple's special committee are not the kind who would sign off on an independent review that is anything but rock-solid. Jerome York implemented massive restructuring as IBM's (IBM) chief financial officer in the early 1990s and earlier this year was front man for Kirk Kerkorian's bid to take over General Motors (GM). Former Vice President Al Gore, sometimes mentioned as a possible Presidential candidate, would also be unlikely to succumb to pressures that might cause political trouble down the road. "I'm sure Apple did a super-thorough investigation," says Rich Marmaro, a defense attorney at Skadden, Arps, Slate, Meagher & Flom who is involved in a number of cases concerning backdating. "Given that Al Gore is on the special committee, I'm sure it was even more super-thorough."
Also, backdating expert Erik Lie, the University of Iowa professor whose research helped spark the recent scrutiny of options, says he's unconvinced the suspicious 2001 grant to Jobs is nefarious. Even though the facts of the grant fit the classic scenario for backdating, Lie points out that Apple could have picked a more lucrative day to set the price than Oct. 19.
Lie says his research suggests backdated grants tend to be granted at the low end of V-shaped curves—that is, after periods in which the underlying shares have declined in price, and before big run-ups. But on Oct. 19, Apple's shares had been on the rise for two weeks. While Apple shares did rise 20% from Oct. 19 through the end of that year, the pattern isn't all that striking compared to other grants, says Lie.
Maybe not, but at that time there were nevertheless several stock-moving events around which the company could have timed the granting of options. The date of the fictitious board meeting was two days after Apple reported earnings for its fiscal 2001 fourth quarter. Those earnings beat expectations, but Apple gave a downbeat forecast for the quarter ahead, citing uncertainty in the global economy and the sales environment, prompted in part by the aftermath of the September 11 terrorist attacks.
Apple's stock closed at $16.99 on Oct. 17, before earnings were announced. That happened to be the same day Apple invited journalists to an Oct. 23 event at which Jobs would unveil the iPod.
In all, Apple said it would take an $84 million after-tax charge for recognizing expenses related to options grants. Apple said an outside committee of lawyers had examined evidence surrounding more than 42,000 options grants made on 259 distinct dates between October, 1996 and January, 2003, and also examined options grants made from 1994 to 1997. The team "spent over 26,500 person-hours searching more than 1 million physical and electronic documents and interviewing more than 40 current and former directors, officers, employees, and advisors," the company said.
Whatever questions the filing left unanswered, it left many analysts assured for now of one key matter: the fate of Steve Jobs. "The No. 1 question was whether or not Jobs would keep his job," says Jonathan Hoopes of Thinkequity Partners in New York. "Any overhang on the stock around the question is now almost entirely gone."
The Main Point
In a research note issued after the filing was made public, David Bailey of Goldman Sachs concurred. "While all of the potential implications of Apple's options backdating cannot be neatly resolved with a single filing, Apple's long-awaited 10K puts to rest the relatively minor impact of its backdating issues," he wrote. "This should allow the stock to be driven more by fundamentals in the near term where we see several positive catalysts which should take the stock higher."
Shannon Cross of Cross-Soleil Research in New York put it more succinctly. "It appears from the filings today, that Steve Jobs is safe both from an employment standpoint as well as with respect to the SEC."
Getting the options morass behind it will refocus attention on Apple's coming year, which is expected to kick off on Jan. 9, 2007, when Steve Jobs is scheduled to deliver the keynote address at the Macworld Expo in San Francisco. At that event, Jobs is widely expected to unveil a wireless phone derived in part from the iPod music player, which the company has popularized over the last five years. Jobs will also likely disclose some details about a product in development known at Apple as "iTV."