A report on the Apple investigation

Today's WSJ has some interesting details about the Jobs option grant in its report on the ongoing federal investigation.

Jobs got 7.5 million options on December 18, 2001 when the stock was at $21.01, backdated to Oct. 19, 2001, when the share price was $18.30. That was the date of a compensation committee meeting, but the compensation committee didn't have the power to issue any options to Jobs. Apple's internal investigation ordered a $20 million earnings charge for the false dating.

Jobs signed a disclosure statement on Aug. 8, 2002 with the false price and date. Apple found no evidence Jobs knew of the false records.  It said he didn't understand the accounting implications of backdated grants, and didn't financially benefit from them because he didn't exercise them – just exchanged them for restricted stock. [As I've asked previously, did this exchange constitute a sort of reload of the option?]

An interesting aspect of the story is that it says Apple's board "originally approved" the grant on Aug. 29 of that year when the stock was trading at $17.83, but that Jobs kept negotiating the grant until it the authorization on 12/18. Of course, unless the options were backdated, the negotiations would have been complicated by not knowing the strike price until the negotiations were completed. So backdating simplified the negotiations. This, as John Carney, Holman Jenkins and I have been saying is a business reason for backdating.

Says Jenkins:

A company and its executive both have an interest in simplifying the negotiation as well as an interest in understanding clearly what the package is likely to be worth. Why would backdating be appealing in this light? Because it lets one parameter be locked in so negotiation can focus efficiently on the other, the size of the grant. It eliminates a perverse incentive to game the stock price during the negotiation. It leaves a valued executive no reason to grump about the issue date or feel there was any invidious message in its selection, yet the company retains full control over the size of the package.

Meanwhile, since Jobs supposedly didn't know what was going on with all the records and stuff, one of the people who may take the fall is Apple lawyer Wendy Howell, who reportedly did the false documentation. Howell joined Apple in 1997 straight from law school and in 2001 found herself in charge of stock-options administration. Lucky Wendy.

And lucky for Jobs there was somebody like Wendy around.  Jobs was too busy building the company to pay attention to details like where the price was coming from (although he had been reportedly negotiating the details of the options for months)

My question: is this really the stuff of a criminal investigation? Which bad result are the screeching journalists and executive compensation moralists going to make us live with: trashing the career of one of the country's most successful business executives? Letting him walk and ruining the life of a young lawyer who found herself in the middle?  Or letting Apple off the hook because it's successful and the journalists all have iPods, but sending backdaters at lesser companies to jail?

So far Howell and her former immediate superior GC Heinen aren't talking.  Will the feds allow Apple to pay for their defense?  Or will Apple have to let them twist in the wind in order to save Jobs?

Update:  Kirkendall compares the backdating travesty to the Duke lacrosse affair.

Update 2: Jobs reacts to journalists on backdating (CNBC clip at about 5:37, linked by Carney):  "A lot of these folks have no idea what they're talking about." Sure he's self-interested.  But this is the understatement of the decade.

Comments

[save_the_rustbelt]

In an era when a clerk can be fired for checking her Yahoo e-mail on a company computer at break time, why the hell shouldn't corporate executives play by the rules?

When I was trained as an auditor any backdating of paperwork was unethical at least and an indicator of possible criminal activity at worst. So what has changed? The size of the $$$$?

[Matt Bodie]

The need for a certain strike price has *nothing* to do with backdating. Apple was free to give Jobs a certain strike price at any point. They could have given him a strike price of $17.83 in December -- while stating that the options were given in December. Of course, by backdating, they avoided having to expense it and pay taxes on it. I'm surprised that this flimsy excuse has any traction whatsoever.

[Larry E. Ribstein]

Holman Jenkins (and I) have responded to this point. At the time, one kind of expense (in the money) was expensed while the other kind of expense (at the money) was not. It's not a question of an "excuse" (I don't know what that would be in this context). It's an explanation. It's why so many ordinary business people were engaging in this practice. And because we have had too much moralizing and not enough explanation, you're now in the position of having to explain your way out of the box I describe in my post.

[Matt Bodie]

In terms of the "box," I assume you're talking about whether criminal prosecution is warranted, and if so, of whom. It's a tricky question. Here's what I'm primarily interested in: (1) recognition that backdating broke several laws; (2) disgorgement of the profits made by backdating; (3) correction of the books; (4) payment of the necessary taxes. In terms of reforms, the necessary reforms have already been made, so we won't see it happen again. Maybe this phenomenon will make companies think a little more about awarding stock options, and instead look to restricted stock or other forms of compensation that are not so vulnerable to price-gaming and are not limited to upside effects.

I'm curious -- do you think backdating is wrong, and some punishment is required, but criminal prosecution is overdoing it? Or do you think it's not really wrong at all, and we should just forget about the whole thing? I can't really tell from your posts. I agree some differentiation is required in terms of criminal prosecution. But backdating broke the law, and it was clearly wrong. To imply that media coverage of the issue is a "scandal" or a "mob mentality" is strange, since much of the reporting (e.g., at the WSJ) is just detailing what happened. I haven't really seen people clamoring for jail time like I did in the Enron case. But that doesn't mean we should just forget about investigating it. Isn't some sort of remedy necessary here?

Should Jobs go to jail? I don't know. I know for some people, Jobs could kill a drifter and keep the body in his office, and they still would want him as CEO. He's clearly a talented guy. And I have qualms about using criminal sanctions in this area. But where do you draw the line? If Jobs backdated, or knew of the backdating, didn't he commit a crime? Where would you draw the line? Do you think no one should do time for backdating? Even the Comverse folks?

[Larry E. Ribstein]

No conduct that I have seen in the backdating so called scandal merits criminal punishment. The reporting is a scandal because (1) so much of it has mischaracterized the facts; (2) the story has been blown way out of proportion; and (3) the journalists have failed to report in a balanced way the business and institutional context. I have made these statements countless times and ways.

[Matt Bodie]

Just a quick question -- who has mischaracterized the facts, and when? Are we talking rhetorical spin or actual misrepresentations?

[Larry E. Ribstein]

My posts on backdating are all in my executive compensation archive. Enjoy!