The Apple iWash: Steve Jobs’s premature exoneration
Apple’s SEC filing last Friday disclosing the outcome of its internal probe into options backdating is masterfully, tantalizingly opaque. Though entitled “explanatory note,” the 20-paragraph document contains precious little explanation. It recounts that certain events did, indeed, occur at Apple, but sheds almost no light on how or why.
Investors greeted the announcement with glee–Apple’s stock rose 4.9%–but I can’t imagine why.
It must be because the Special Committee of outside directors who looked into the matter said they “found no misconduct by current management.” At the same time, the committee said that its inquiry “raised serious concerns regarding the actions of two former officers in connection with the accounting, recording and reporting of stock option grants.” The designated fall guys here, though unnamed, are widely reported to be former general counsel Nancy R. Heinen and former chief financial officer Fred D. Anderson, but each of their lawyers issued statements vociferously denying any wrongdoing. This seems to set the stage for some lively he-said, she-said colloquy before federal regulators or prosecutors, and would not be prodding me to buy Apple stock at the moment.
The most intriguing factual revelation of the filing, of course, was that one of the two enormous options grants that CEO Steve Jobs received was priced as of October 19, 2001, a good two months before the grant was actually finalized on December 18, 2001. The price of these 7.5 million option shares had increased 15% during the time lapse, from $18.30 to $21.01. Worse still, records had been falsified, the committee concluded, to make it appear as if a special board meeting had been held on October 19 to approve the options grant when, in fact, none had occurred. The SEC has noted in the past (sensibly enough) that an important factor it uses to distinguish accidental-and-innocuous backdating from serious, enforcement-action-worthy backdating is any evidence of falsification of documents. (By the way, the circumstances surrounding Jobs’s other options grant–for 10 million shares–were also fishy, as the New York Times describes toward the end of this good article.)
But here’s the mysterious crux of the filing: “Although the investigation found that CEO Steve Jobs was aware or recommended the selection of some favorable grant dates, he did not receive or financially benefit from these grants or appreciate the accounting implications.”
Let’s unpack that sentence. What would it mean to “recommend the selection of some favorable grant dates”? I can think of three possibilities.
Scenario one is, he said something like: “Let’s grant options as soon as we can since, in my opinion, our stock is generally undervalued at the moment.” Nothing wrong with that at all. But if that’s all he did, I can’t believe they’d even be disclosing it, let alone doing so in such ominous terms.
Scenario two is: “Let’s grant options now, since we’re going to announce the release of our newest iPod next week, and our stock will soar.” That would be spring-loading and, depending on what the directors were told and other variables, it could be a form of securities fraud.
Scenario three is: “Let’s grant options today, but set the grant date as of two months ago, because our stock was much lower back then.” That would be Backdating with a capital B, and under most circumstances it would be illegal.
So problematic scenarios sound more likely than innocuous ones. More worrisome still, the only reason we have to guess this way is that Apple chose not to tell us precisely what the special committee thinks Jobs did. I guess it concluded that the nitty-gritty just wouldn’t interest us.
We’re then told that no one needs to worry about whatever it was that Jobs “recommended” regarding “favorable grant dates” because “he did not receive or financially benefit from these grants or appreciate the accounting implications.” That clause contains three arguments, so now let’s look at those.
The first is: We don’t have to worry about whether Jobs was trying to backdate or springload options because “he did not receive” some or all of the options in question. Well, his not having personally received the backdated options is no defense to anything. If he was knowingly giving someone else backdated options, he could still be deceiving shareholders and the IRS, and he could also be unfairly gaining an advantage over law-abiding competitors in the labor pool by being able to offer Apple employees illegally priced (i.e., improperly accounted for) options.
The second argument is: We don’t have to worry about whether Jobs was trying to backdate or springload options because “he did not . . . financially benefit from these grants.” Again, this is no defense. If a hypothetical CEO gave himself backdated options in a effort fraudulently to deceive shareholders and enrich himself, that attempt would be a completed crime regardless of whether the dot-com bubble subsequently burst before he could capitalize on the attempted fraud. (The bursting of the bubble did, in fact, wipe out the value of all Jobs’s options. Apple replaced them with 5 million shares of restricted stock, worth almost $75 million, in 2003.) And if a hypothetical CEO gave someone else backdated options, then it’s hard to believe that he really wasn’t benefiting financially–albeit indirectly. His company would have been benefiting–it was able to offer higher compensation to employees than its law-abiding competitors could–and anything that benefited the company would have indirectly enhanced the CEO’s compensation and the value of his stock.
The third claim is that we don’t have to worry about whether Jobs was trying to backdate or springload options because he didn’t “appreciate the accounting implications.” Well, that’s getting closer to a defense, but I still don’t think he’s there yet. None of us fully appreciated the accounting implications of awarding in-the-money options at that time; the rules were excruciatingly complex and everyone twisted themselves into pretzels to avoid ever having to grapple with them. The relevant question is whether Jobs understood that backdating was morally or legally wrong–and the filing doesn’t tell us the answer to that one.
Furthermore, even if Jobs says he didn’t understand that backdating was illegal or wrong, and even if we believe him, I’m still not sure that gets him out of the woods. Yes, ignorance of the law is a defense to some white-collar crimes (mainly tax offenses), but it’s not a defense to most others. (Look at Pattie Dunn, the former chairman of Hewlett-Packard (HPQ), now facing four state-law felonies for having conducted an investigation that two top in-house attorneys repeatedly kept assuring her was A-okay.)
To me, Friday’s filing does not look like the curtain closing on this particular play, but more like the curtain closing on Act I, Scene I. What do others think–am I missing something?