AT APPLE, TIMING LED TO OVERNIGHT WINDFALLS
In August 1997, Apple Computer Inc. handed four top executives options to buy a total of nearly 1 million shares. The next day, the value of those options jumped a staggering 48%, or $7.7 million.
This was no coincidence, according to a shareholder lawsuit filed against executives and directors of the Cupertino, Calif.-based company in federal court in Northern California. Rather, the options were granted to coincide with good news that would give the four executives an overnight windfall.
The stock soared when co-founder Steve Jobs announced that Apple’s sworn enemy, Microsoft Corp., threw the struggling company a life raft in the form of a $150-million cash infusion. In exchange, Apple gave Microsoft a stake in the company and agreed to use the software giant’s Web browser on its Mac personal computers.
The investment rocked the high-tech world at the time but became only a footnote in the astonishing comeback of a company as celebrated today for its marketing and design prowess as Nike, Prada or Mercedes-Benz.
But the grants are an example of the fast-and-loose practices that went unchecked in a corporate culture fashioned by Jobs to revive Apple, which by 1997 was hemorrhaging money, according to the lawsuit, a combination of 11 shareholder complaints.
“The company was struggling, was cash-poor and reliant upon stock options to bring and keep executives there, so the conditions [for manipulation] were ripe,” said Mark Molumphy, a partner at Cotchett, Pitre, Simon & McCarthy, the lead law firm in the case.
Apple declined to comment on the lawsuit.
Filed days before Christmas, it alleges that Apple engaged in widespread manipulation of option grants to allow employees to buy shares at low prices. Apple “spring-loaded” options in advance of good news and “backdated” other grants to days when the stock traded at low prices to create an automatic paper profit, claims the suit, which has only recently come to light.
“What they’ve done -- and it’s not isolated -- is utilized confidential internal corporate data in a way to divert to themselves substantial profits,” said Darren Robbins, a San Diego lawyer involved in the shareholder lawsuit. “That constitutes both a breach of fiduciary duty and a violation of federal securities law.”
On Friday, Apple absolved Jobs of wrongdoing after a three-month internal investigation of its option practices. The company, however, acknowledged 6,428 instances of improperly dating option grants over a six-year period, when it had “insufficient safeguards” to prevent stock manipulation, according to a filing with the Securities and Exchange Commission. The first incident occurred on Dec. 29, 1997, just a few months after Jobs had returned to the company and taken the title of “interim” chief executive.
In some cases, Apple’s filing said, Jobs had recommended the options be backdated to create an instant windfall for executives. It said he had neither benefited financially nor appreciated the accounting implications of backdating, which forced the company to take an $83-million charge against earnings in 2006 for underreporting expenses related to employee compensation.
The company’s admissions have raised new questions among securities lawyers and corporate governance experts about Jobs’ role in the controversy. “There has been a tacit admission that Steve Jobs served as a ringleader in this backdating process,” said Christopher Bebel, a former SEC counsel and prosecutor who is not involved in the lawsuit.
He predicted that Apple’s insistence that current management had done nothing wrong could “come back to haunt the company” in a scenario similar to Martha Stewart telling investors she had participated in no wrongdoing and later being indicted on securities fraud. "[Jobs] may find himself in a Martha Stewart quandary with obstruction of justice charges.”
In its filing Friday, Apple said it had “serious concerns” about the involvement in the granting, recording and accounting of option grants by two former corporate officers it did not name but who are believed to be former General Counsel Nancy R. Heinen and former Chief Financial Officer Fred D. Anderson.
The company said its review found no instances of backdating from 2003 through 2005, when new procedures and controls on granting options were put in place to comply with the Sarbanes-Oxley Act.
Apple is among nearly 200 companies whose option-dating practices are under internal investigation or being probed by federal regulators. At least 65 executives and directors have resigned or been fired after being implicated in the scandal, including Bruce Karatz, head of Los Angeles home builder KB Home, and UnitedHealth Group Inc. CEO William McGuire.
An option is the right to buy stock at a set price within a certain time period. The price is generally determined by the stock’s close on the day the option is granted by a company’s board. In their current probes, regulators are focusing on backdating, whereby grant dates are changed by weeks or months to coincide with the stock’s lowest price in a set period. Doing so could give executives instant paper gains and cause a company to understate compensation costs and overstate earnings.
Backdating isn’t necessarily illegal, but failing to disclose the practice in a timely manner is.
Apple’s is the highest-profile case so far. A host of high-tech companies have been ensnared in part, observers say, because stock options are the currency of choice in Silicon Valley for keeping top talent from jumping to another venture.
“This is how Silicon Valley works,” said Alan Deutschman, the author of a critical book about the Apple chief, “The Second Coming of Steve Jobs.” “Even though Apple is an anomaly -- because of Steve’s passion for design and his ability to connect to the zeitgeist and the popular culture -- in a lot of ways it epitomizes how Silicon Valley is run. Steve, from his earliest experience in the corporate world, has been very conscious and political about stock and stock options and rewarding loyalists.”
Options’ indispensable role in Silicon Valley has made it hard for some experts to accept Apple’s contention that Jobs was naive about the practices surrounding them. It’s also hard to swallow considering that Jobs has been an officer of a public company since 1980 and has a net worth of more than $5 billion.
Curiously, options themselves have not built Jobs’ wealth. When the charismatic leader rejoined the company in 1997, he held only a single share of Apple stock. He has received a salary of only $1 a year since 1998. But he holds 5.4 million shares of Apple worth about $460 million today. Only 120,000 are options, worth about $10 million.
The bulk of his fortune stems from Pixar Animation Studios, which transformed him from a barefoot computer geek into a full-fledged media mogul. Jobs’ 49% stake in Pixar, the computer-driven studio behind such blockbuster movies as “Cars” and “Toy Story,” was converted into 6.7% of Walt Disney Co. when he sold the company to the Burbank giant in May 2006. Those shares are worth $4.7 billion today.
Jobs received one of the biggest option grants in history during Apple’s revival, when he was given 10 million shares Jan. 12, 2000. That was one of two option grants Jobs was awarded that Apple said Friday were backdated -- and that the company canceled in 2003.
A special CEO compensation committee of the board didn’t authorize the Jan. 12 grant until a week later, on Jan. 18. The options’ exercise price of $21.80 coincided with the lowest closing price during that quarter, according to the shareholder lawsuit. The grant yielded a paper profit of $65.8 million for Jobs within 20 trading days.
Company records show that the other backdated grant Jobs received -- 7.5 million shares -- were approved at a special board meeting on Oct. 19, 2001. In its filing, however, Apple acknowledged that the meeting “did not occur.”
Apple said the two stock option grants were canceled in March 2003 in exchange for 5 million shares of restricted stock. The company would not explain why the options were canceled, but its regulatory filings said Jobs wanted them to provide “additional shares that could later be granted to employees whose contributions are critical to the long-term success of the Company.”
SEC records show that Jobs sold his restricted shares -- the only Apple stock he has sold since 1997 -- for $300 million the day they vested on March 19, 2006.
That was a day after the Wall Street Journal published the first story on the SEC’s stock options backdating probe. The story did not mention Apple, which disclosed its backdating problem in late June.
Jobs returned to Apple in February 1997 after the company spent $427 million to buy Next Software, which Jobs had founded in 1985 following his ouster from Apple. Jobs had resigned after the board stripped him of his managerial duties amid a power struggle with the company’s then-new chief executive, John Sculley.
A later Apple CEO, Gil Amelio, recalled last week how he recruited Jobs to return as the charismatic “Mr. Outside.”
“He had the stage presence and stuff that I lacked,” Amelio said. “I thought frankly I was better at literally running the company. It didn’t take very long for him to decide that wasn’t a good idea. He worked with the board, behind my back, to oust me.”
A couple of months after Amelio’s July 1997 departure, Jobs assumed the title of “interim” chief executive and set out to create a board he could control, according to the shareholder lawsuit. Jobs’ mission was to insulate himself to prevent a repeat of his painful 1985 departure, said longtime observers.
“The big lesson Steve learned from his first time around at Apple was you have to be in control, cause otherwise they can kick you out,” Deutschman said.
Jobs brought in two close friends, Larry Ellison, head of database software titan Oracle Corp., and William V. Campbell, a former Apple executive who had gone on to become chief executive of financial software maker Intuit Inc. Also joining the board were two executives with whom Jobs enjoyed professional ties: Jerome B. York, who at the time was chief executive of tech retailer Micro Warehouse Inc., and Millard Drexler, then chief executive at Gap Inc., who had appointed Jobs to the clothing firm’s board.
In addition to granting generous options to Jobs that were later canceled, they heaped them on key executives. Four executives benefited from the grants made the day before the pivotal Microsoft announcement. Chief Financial Officer Anderson, Executive Vice President of Marketing Guerrino de Luca, Controller Robert Calderoni and Senior Vice President of hardware engineering Jonathan Rubinstein received shares that vested in annual installments over three years. During that period, Apple’s shares tripled.
No small company
From April 2000 to August 2001, Apple’s board lacked a compensation committee and relied on the full board to administer stock grants as well as approve executive compensation. One swath of grants issued during that time gave four senior executives 1 million shares at the stock’s closing price on Jan. 17, 2001, the day quarterly earnings were reported. The next day, the stock surged 11% on the results, generating a paper gain of $1.9 million for each, the investor suit alleged.
Ralph Ward, publisher of the “Boardroom Insider,” an online corporate governance newsletter, said it wasn’t unusual a decade ago for boards of small companies to grant options, especially in Silicon Valley, where “it has always been, ‘We’re all pals here doing business together.’ ”
In 2000, however, Apple would not have been considered small. It had annual sales of $8 billion, mostly of iMac computers and its new iBook notebook. It was another year before the introduction of the iPod in late 2001.
“That does raise some eyebrows, particularly with Apple,” Ward said. “Companies are supposed to outgrow that when they become major, big-cap public companies. Some don’t outgrow it as well as they should.”
The shareholder lawsuit contends that Apple’s practices were no aberration. The SEC is investigating stock option practices of Pixar, where Jobs served as chief executive and chairman until the Disney acquisition.
At Pixar, four of the seven grants were recorded at the lowest price during the fiscal years in which they were granted, the suit alleges.
“This dispels any notion that Apple is now trying to portray that Jobs is somehow ignorant of the accounting effects of what they were doing because it wasn’t just happening at Apple,” said Molumphy, the shareholders’ attorney.
Apple’s portrayal also defies Job’s personality traits as a leader who gets involved in the most microscopic details.
“I don’t know if there’s a Wikipedia definition for ‘control freak’ but when they do that entry, Steve’s picture should be next to it,” Deutschman said.
“The way Apple and its allies have tried to spin this options story has been, ‘Oh, Steve is passionate about the design of the product but he doesn’t pay attention to these other things.’ One of the big things about Steve’s second time around at Apple is that he’s really mastered the financial aspects of running the company.”