Apple Computer, Steve Jobs
Paul Sakuma  /  AP file
Apple CEO Steve Jobs is seen as key to the company's success, but regulators may take harsh view of his role in the pricing of stock options.
updated 1/5/2007 4:59:25 PM ET 2007-01-05T21:59:25

In Silicon Valley, Steve Jobs is admired for many things: His storybook resuscitation of Apple Computer Inc., his billion-dollar-plus fortune, his rock star status as the driving force behind iconic products such as the iPod. Near the top of the list is Jobs's famed ability to spin what admiring techies refer to as a "reality distortion field" to win consumers over to the Apple view of the world.

But will it work with government regulators? As Jobs prepares to wow the masses once again with his keynote at the annual Macworld trade show on Jan. 9, skepticism abounds among options experts, as well as techies, that the Apple chief executive is totally in the clear over his role in resetting start dates for company stock options. A report issued on Dec. 29 by a two-member special committee, composed of no less than former Vice-President Al Gore and tough-minded finance veteran Jerome B. York, "found no misconduct" by Jobs or other managers. Yet it acknowledged that he knew about some of the 6,428 option grants handed out between late 1996 and early 2003--roughly 15% of the total in that time--that were improperly dated to give employees an artificially low price. On some occasions, Jobs even recommended the dates.

The Securities & Exchange Commission is scrutinizing Apple's internal audit as part of a formal investigation into the company's backdating. Moreover, several legal and pay experts wonder at what seems to be a different standard in how Apple is dealing with its most valuable employee when other CEOs are being pushed out for similar or less obvious involvement in backdating. Says managing director Alan Johnson of Johnson Associates, a compensation consulting firm in New York: "He knew what he was doing. It wasn't `the dog ate it.' He backdated the options on purpose and the committee said it will give him a free pass." Even some Valley companies are troubled by the conclusions reached in the Apple report. "It looks like Apple's board is trying to whitewash the situation because they like him so much," says Willem P. Roelandts, CEO of chipmaker Xilinx Inc.

But is the world ready to see one of its greatest innovators sacrificed at the altar of the good-governance gods--especially when it's not clear how he was enriched or his shareholders damaged? The backdating scandal has been rumbling along for months now, claiming numerous high-profile victims such as United Health Group CEO Dr. William W. McGuire, who retired in December. The involvement of Jobs, though, raises the stakes to a whole new level.

No big company has more of its success wrapped up in one person. Jobs is a master marketer whose 30 years of experience have sharpened his skill at creating stylish, breakthrough products. He combines not just hardware and software smarts but a sense for how all that technology must fit together with the music, movies, and other content consumers want. Jobs proved that in his stewardship of Pixar Animation Studios Inc. before it was sold to Walt Disney & Co. a year ago, and in forging agreements with music companies and Hollywood studios to create the iTunes marketplace. The reward for shareholders: Apple's stock price has climbed 1,025% since Jan. 1, 2001, just before the iPod era began, to a total market value of $72 billion.

That's why few expect Apple's board to push Jobs out even if the government does move against him. Some suggest that it would hang tough with him even if criminal charges were filed by the Justice Dept., which is a remote possibility for many reasons. So far, the government has found sufficient grounds to indict only five executives on backdating out of all those at the 200-plus companies involved in the scandal. It's not easy to prove that an executive intended to deceive shareholders rather than just engaged in sloppy paperwork, say lawyers. And there would be hell to pay for going after Jobs given the damage that could be done to Apple's investors, customers, and business partners. Says Harvard Business School management professor David B. Yoffie: "Obviously, these are inappropriate activities that anyone should be ashamed of. But it wouldn't be in shareholders' best interests to have Steve Jobs leave for something that happened four years ago that didn't have a material impact on their holdings."

Two resignations
Just look at the numbers. The total financial hit to shareholders announced by Apple -- some $84 million in noncash expenses -- is negligible given Apple's size. On the other hand, Apple's stock price plunged 5% at the start of trading on Dec. 27 after a legal publication, The Recorder, said Jobs had hired a lawyer to represent him in the investigation. Over the next few hours, buyers rushed in on the belief the market had overreacted and bid the stock right back up. Two mornings later, the stock jumped another 5% when Apple's special committee of directors vouched for Jobs and declared the options problem corrected. Just in those 48 hours of trading, keeping Jobs on as CEO was shown to be worth at least 9% of the value of Apple. And his true value is probably much higher. Analyst Gene Munster of Piper Jaffray Cos. estimates if Jobs were ousted, Apple's stock would take an immediate hit of up to 20%, roughly $14 billion, and continue south as investors considered the longer-term implications.

Even for Jobs's staunchest defenders, though, the Apple board's latest disclosures raise troubling questions. For example, what role did Jobs have in approving a 10 million-share grant to him that was finalized on Jan. 18, 2000, but priced as of Jan. 12, when Apple shares were trading 19% lower? Apple also admitted that 7.5 million options granted to Jobs in 2001 were priced at a board meeting that never took place. But the company didn't say how that meeting came to exist in Apple's books, or how it is possible that Jobs, also chairman of Apple's board, wouldn't have known about that move.

If the point of launching a special committee investigation is to convince regulators that you've closely examined any irregularities and dealt with any problems, "I just don't think the Apple report is going to do that," says James L. Sanders, a former SEC attorney now with the law firm of McDermott, Will & Emery. Apple officials would not comment for this story beyond their public filings.

Some lawyers say government investigators may be troubled that Jobs's role in the backdating has appeared to grow with each of the four filings since Apple first reported last June, and could cause them to question the reliability of Apple's findings. "One of the factors the SEC looks to is [whether there is] full and complete public disclosure, not the dance of the seven veils," says one highly regarded securities lawyer. Then there's Jobs's tenure as a director at Pixar, where Disney is now looking at a number of grants.

Also, Apple's committee report suggests that two former executives were somehow culpable for the backdating. While Apple doesn't name names, many observers take that to mean former Chief Financial Officer Fred Anderson, who resigned from Apple's board on Sept. 30, and former general counsel Nancy Heinen, who abruptly left the company in May. Her attorney, Cris Arguedas, says Heinen does not know if she's one of the duo implicated by Apple, but defends her character. A source close to Anderson confirms that he dropped his board seat after learning that he might be a target of the board's investigation. But his lawyer says Anderson had no day-to-day role in options administration.

Apple's treatment of Jobs stands in stark contrast to what has happened at other companies caught up in the backdating scandal. In most cases where executives were found to have a role in backdating, they left.

Take security software maker McAfee Inc. On Oct. 11, a special committee to the board announced the retirement of CEO George Samenuk. On the same day, the committee said McAfee would incur $100 million-plus in expenses that should have been paid on backdated options, as required by accounting rules at the time. The company's press release hinted that Samenuk's only transgression was providing insufficient oversight. He was quoted in the statement as saying: "I regret that some of the stock option problems identified by the special committee occurred on my watch."

In its report, Apple suggests that one reason Jobs tolerated backdating is that he didn't understand basic options accounting, particularly the pre-Sarbanes-Oxley need to expense any option carrying a price other than that established on the date it was made final. It may beg credulity that such a powerful executive is such an accounting novice, but many techies say they paid little attention to those details during the boom years. Options were a way to lure talent, and they left the details to auditors and lawyers. Says one Valley CEO: "Today's perspective is being applied to something that was an industry practice. We were all fighting to find and keep great people."

But now that backdating is front and center, it's clear that Jobs-led companies were knee-deep in it. On numerous occasions since 1997, top lieutenants at Apple and Pixar received options priced on days when the stock was at monthly, or in Pixar's case, near-yearly lows. That includes the 10 million-share grant to Jobs in early 2000, which came just after a 22% nine-day plunge in Apple's stock price and preceded a subsequent 30% increase in the eight days that followed. "I'm not saying it was backdated and I'm not saying they did anything illegal, but [the circumstances are] consistent with manipulation," says University of Iowa finance professor Erik Lie, whose research helped ignite the options scandal.

Jobs never directly cashed in on those options, or those from another big grant in 2001, because Apple's share price fell below the strike price. But in 2003, Apple's board swapped the "underwater" options for 5 million restricted shares of stock with a value of $75 million. For some, that raises the question whether Apple pegged the stock grant to the backdated value of the options, and whether Jobs, as the special committee maintains, "did not receive or financially benefit from these grants."

If Jobs ever does step down, there's no obvious replacement, compounding the risk for Apple shareholders. More than likely, Chief Operating Officer Timothy D. Cook would take the helm; that's what happened when Jobs took six weeks off in 2004 to undergo successful cancer surgery. But while Cook is a respected operations wonk, he lacks Jobs's charisma, leadership, and gut for tech trends, say analysts.

Some legal experts say Apple missed an opportunity when the board committee issued its report. Rather than absolve Jobs of all blame, it should have admitted he'd made a mistake that was common during the excesses of the boom and agree to have Apple employees, including Jobs, reimburse investors for any losses.

Now all Apple's shareholders can do is hope that regulators prove as forgiving as the board. Says former SEC Commissioner Joseph A. Grundfest, a professor at Stanford Law School: "Steve Jobs is a national treasure, and Apple has to do everything it can to keep him actively engaged. If Martha Stewart can stay at her company, there should be no issue -- even in the worst case -- in designing a structure that keeps Steve Jobs at Apple."

Copyright © 2012 Bloomberg L.P.All rights reserved.


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