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Investors react negatively to Apple disclosure

As the stock option cloud over Apple Computer Inc. darkened, investors Friday tried to determine whether the firm can overcome the potential accounting and legal risks it faces.
/ Source: The Associated Press

As the stock option cloud over Apple Computer Inc. darkened, investors tried to determine Friday whether the company’s popular products are powerful enough to overcome the potential accounting and legal risks facing the maker of the iPod and the Macintosh.

The possibility that the improper handling of employee stock options might erase some of Apple’s past profits or, even worse, plunge its renowned CEO, Steve Jobs, into a legal morass spooked some investors. Apple shares shed $3.40, or 4.9 percent, to $66.19 in afternoon trading on the Nasdaq Stock Market.

“You can’t spin this as good news,” Standard & Poor’s analyst Richard Stice said Friday.

Besides jumbling its past earnings and raising worries about Jobs’ possible role in the scandal, Apple’s stock option troubles could lead to other complications.

While it reviews possible revisions to its past profits, Apple expects to miss a deadline for filing its most recent quarterly report with the Securities and Exchange Commission. If the delay is long enough, regulators could try to delist Apple’s stock from Nasdaq, although the chances of that happening are considered slim.

The deepening problems also expose Apple to legal hassles that extend beyond Jobs, who is widely regarded as the key to the company’s success.

Depending on the nature of the possible stock option abuses, class-action lawyers and prosecutors could target Apple’s board for alleged misconduct. The directors include several well-known leaders who would attract intense media attention if they are dragged into the stock option mess.

Apple’s current compensation committee consists of: former Vice President Al Gore, who has been on the board since 2003; Intuit Inc. Chairman William Campbell, who has been on the board since 1997; and J. Crew Group Inc. CEO Millard “Mickey” Drexler, who has been on the board since 1999. Oracle Corp. CEO Larry Ellison, who calls Jobs his best friend, sat on Apple’s board for five years before stepping down in September 2002.

As unsettling as all those scenarios are, Friday’s backlash against Apple wasn’t as a severe as Wall Street’s treatment of several other companies that have recently raised doubts about the accuracy of their past financial statements because insiders mishandled stock option awards.

More than 80 other companies nationwide are entangled in the stock option imbroglio. But Apple’s ubiquitous brand makes it stand out from the rest of the pack. “Many will be watching this case because ... Apple may be the closest to a household name,” predicted former federal prosecutor Michael Koenig, who is now in private practice in Washington, D.C.

Investors might be more forgiving with Apple because the iPod’s success has propelled the Cupertino, Calif.-based company on a hugely profitable streak that most analysts expect to continue for at least the next few years.

“The focus should be placed on what we view as Apple’s bright future — not the past,” ThinkEquity Partners analyst Jonathan Hoopes wrote in a research note Friday.

Most other analysts expressed similar sentiments, even as they vented some frustration.

“This issue slightly tarnishes Apple’s squeaky clean image, but, more importantly, this does not impact Apple’s underlying fundamentals,” Piper Jaffray analyst Gene Munster wrote in a Friday note.

Optimism like that has helped Apple weather the stock option storm remarkably well so far.

Despite Friday’s downturn, Apple’s stock price remained 12 percent above its value before the company’s late June disclosure of “irregularities” in the handling of options given to employees between 1997 and 2001.

Apple raised more intrigue late Thursday by announcing its stock option troubles had widened to the point that its reported earnings dating back to September 2002 can’t be trusted.

That period coincides with the most prosperous era in Apple’s colorful 30-year history. The company has reported profits totaling $3.1 billion during the past four years.

American Technology Research analyst Shaw Wu believes only a small portion of those profits might disappear. Wu estimates Apple’s stock option expenses for the past seven quarters have ranged from 3 cents to 6 cents per share — while the company’s earnings have been much higher, ranging from 34 cents to 65 cents per share.

While Apple hasn’t explained exactly how it mishandled stock options, most of the problems at other companies so far have involved “backdating.”

Under this practice, insiders try to make the rewards more lucrative by retroactively pinning the option’s exercise price to a low point in the stock’s value. Usually, an option’s exercise price coincides with the market value at the time of a grant, to give the recipient an incentive to drive the price higher.

If companies backdate options without accounting for the move, it can cause profits to be overstated and taxes to be underpaid. It also exposes companies to possible fraud charges.

Much of the angst about Apple centers on whether the stock option headaches will distract Jobs or land him in legal trouble.

Apple already has acknowledged that some of its nettlesome stock options were given to Jobs, but also emphasized that they were canceled in 2003 before he realized any gains — a factor that might help insulate him from any possible fallout.

But one Silicon Valley CEO — Gregory Reyes, the former boss of Brocade Communications Systems Inc. — already faces fraud charges for his alleged role in stock option backdating, even though his attorney insists he didn’t personally benefit.

Analysts are betting Jobs will escape serious trouble.

“While we are not exonerating management for its error in judgment, we believe a ‘worst-case’ scenario where Steve Jobs is terminated is ... unlikely to unfold,” Hoopes wrote.

Jobs will have a golden opportunity to shift the attention back to Apple’s products next week at a developers’ conference in San Francisco.