Why Steve Jobs Should Resign

Operational Risk: The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. The definition includes legal risk, which is the risk of loss resulting from failure to comply with laws as well as prudent ethical standards and contractual obligations. It also includes the exposure to litigation from all aspects of an institution’s activities. The definition does not include strategic or reputational risks.

We have been big fans of Apple Computer (AAPL) and its CEO, Steve Jobs, for quite some time -- even before Dennis Santiago and Chris Whalen founded Institutional Risk Analytics in August 2003.

Last February, for example, Barron's lionized us for our bullish stance and caused a bit of a ruckus in bubble land by repeating our long-held view that a tie-up between AAPL and Walt Disney (DIS) would be all so sweet, in large part because of the value creating catalyst of Steve Jobs.

Needless to say, when reports of stock options backdating at AAPL first hit the news last year, we felt like chucking our cookies. Some comfort remained, however, because those dutiful public affairs minions at AAPL kept telling the media and the company's investors (we don't have a position in AAPL or DIS, for the record) that the Jobster "was not aware" of the stock options backdating and other bad acts.

Between the first half of 2006 and December 29, 2006, however, when the company filed its delayed 10-K with the SEC, a Special Committee of the AAPL board of directors gradually revealed that Mr. Jobs was not only aware of the back dating of the stocks options, but that he actually was involved in recommending some of the exercise dates. Yuk!

On Page 3 of the AAPL 10-K NT it states: "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. The Special Committee also found that the investigation had raised serious concerns regarding the actions of two former officers in connection with the accounting, recording and reporting of stock option grants."

Based on the report by the Special Committee, a number of commentators concluded that the errors and omissions committed by Mr. Jobs and other AAPL directors, errors and omissions that are now the subject of at least nine shareholder lawsuits and an investigation by federal prosecutors, are not a big deal.

Our friend Tom Donlan, for instance, editorializing in this week's issue of Barron's, likens AAPL shareholders demanding the removal of Jobs and his fellow directors to misguided Jacobins whose extreme reaction to a minor infraction will ultimately damage their own interests.

We respectfully disagree with that conclusion and believe that Mr. Jobs and his fellow AAPL directors should step down as soon as possible. Here are just some of our reasons:

First, by failing to disclose the options grants accurately and in a timely fashion, Jobs and the AAPL directors involved apparently violated federal securities laws. Moreover, the actions and/or omissions by Jobs and other directors and officers of the corporation which are alleged in various civil lawsuits seemly violated the company's stock options plans, plans which were approved by shareholder vote, including the provision that the exercise price of the grants would be "no less than 100% of the fair market value" of the price of the stock on the day of the grant.

Second, several of the civil lawsuits allege that starting in 1997, Jobs and the AAPL board engaged in a series of options grants for various officers of the corporation at below market price. This included a grant to Jobs himself in January 2000, apparently contradicting the company's statement that Jobs himself did not benefit. Many of these grants, the lawsuits allege, were "spring loaded" to coincide with a public announcement by AAPL that had the effect of greatly increasing the value of the options. And all of these options grants were designed to benefit insiders with personal and professional ties to Jobs and members of the board of directors of AAPL.

Third and perhaps most seriously, the failure by Jobs and other officers and directors of AAPL to perform their fiduciary duty to the corporation, and to properly conduct and disclose the grant of options to company insiders, has exposed AAPL to considerable legal and financial risks, and has created financial expenses and liabilities for the corporation which did not previously exist. That's why at the top of this comment we include the definition of Operational Risk taken from the Office of the Comptroller of the Currency, a definition that is derived from the COSO framework for enterprise risk management. No officer of a US corporation, public or private, can credibly claim to be ignorant of the fiduciary requirements set forth in the COSO framework.

Fourth, because Jobs and several current and former officers and directors of AAPL are now defendants in almost a dozen civil lawsuits and are reported to be targets in a federal criminal investigation, the ability of these individuals to serve as independent fiduciaries of the corporation is compromised. Steve Jobs, former Vice President Al Gore, former CFO Fred Anderson and a number of other current and former officers and directors, many with long-standing personal ties to AAPL and Jobs, are facing prolonged litigation and possible criminal sanctions. Indeed, the direct involvement of Al Gore in this legal morass may effectively end the former Vice President's hopes to again seek the US presidency in 2008.

Given the legal conflicts already mentioned, the investigation of Jobs conducted by the AAPL board deserves little if any weight, in our view. Lynn Turner, managing director of research at Glass Lewis and former chief accountant at the SEC, told the San Jose Mercury News that "Apple's board deserves an 'F' for how it has handled its backdating investigation... The question is not merely one of whether Jobs benefited or not, but also one of whether Jobs was involved in the backdating of documents, or providing investors with misleading or incomplete disclosures."

As much as we continue to admire AAPL and its management team as an innovative technology company, we cannot help but notice how little attention is given to investor information on the AAPL web site. If you take the time to visit www.apple.com, you will notice that there is no obvious link directing investors and others to the company's SEC filings and press releases. Everything on the AAPL web site seems focused on product and news announcements regarding same. Buried beneath the product hype, at the bottom of the AAPL home page, under a small, barely noticeable tab labeled "media info," you'll find another link that takes you to AAPL's news release library and SEC filings.

What is really sad about the AAPL options scandal is that it did not need to happen. Jobs and the rest of the AAPL board are wealthy, well-educated people with access to the best legal advice and possessing the time and resources to get this right. When we see members of the US business elite behaving in such an ill-considered fashion, it confirms in our mind why we do, in fact, need prescriptive laws like Sarbanes-Oxley. Even in the wake of scandals like Enron and World Com, still there seems to be something lacking in the DNA of corporate America when it comes to basic issues like public disclosure and corporate governance.

The sloppiness and lack of attention to legal requirements seemingly in evidence at AAPL is present at many other technology companies, where the entrepreneurial culture puts business and profits first on the scale of priorities, including options grants, and everything else a distant second. In some parts of Silicon Valley, there is still a barely hidden contempt for legal norms of disclosure and documentation that, in the case of AAPL and a growing number of companies, is creating serious legal problems and new financial liabilities, a cost that ultimately will come out of the pocket of shareholders.

In coming months, other high tech companies may be forced to restate their accounting disclosure and in the process will lose the services of valuable officers and directors, and all because of poor internal controls and procedures with respect to awarding stock options. We can scarcely imagine a situation more ridiculous, more destructive to shareholder value at the organizations concerned and more hurtful to investor confidence generally, thus our view that the parties responsible must be held fully accountable before the law -- no matter who they are.

Disclosure: Author has no position in AAPL.

AAPL 1-yr chart:

Comments

[Julian Ivan...:]

- A man increases shareholder value by 1200% in 5 years.
- This man takes a $1 salary.
- He gets some perfectly legal restricted stock as compensation for his work afer exchanging a bunch of stock options which seem to have been issued under grey circusmtances.
- He saves his company, thousands of jobs, benefits millions of people with great products, continues to take $1 salary.
- He benefits. Shareholders benefit. Consumers benefit. Nobody loses anything.
- He should resign?

2007 Jan 08 04:53 AM

[dana maryla:]

Whoever you are Christopher Whalen, you discredit yourself and indicate yoursel to be a complete fool. From now on anything else you have to say will be viewed through the lens of this laughable and simplemindedly destructive piece. You should direct your attention to the Enrons, Worldcoms, Delphias and others of the world. As the above comment points out this is akin to punishing someone for jaywalking, while rapists and murderers are walking the streets. It is merely an exercise for those without wits and without will to truly perform their jobs at the SEC...and apparent those equally without wits and will in the so-called "media', such as yourself.

2007 Jan 08 07:40 AM

[reinharden:]

I've heard that there's this thing called "Due Process". Perhaps you should include a definition of it before abusing your bully pulpit by calling for the "as soon as possible" resignation of those people who have been convicted in the court of Christopher Whalen.

I especially like the way that you've decided that they simultaneously backdated and springloaded their options date. Methinks that perhaps you might want to check those definitions again as well...'cause springloading is picking a date before an event...so if you pick the date after the event has occurred, you've only backdated seeing as how it's no longer before the event.

Anyway, your article is ridiculous and not really worth the time of my response, so rather walk through it, I'll just say "If we made all business decisions on the basis of shareholder lawsuits, there'd be no companies in the S&P 500. The vast majority of shareholder lawsuits (and class action lawsuits) are simply vehicles to enrich lawyers by attempting to extract settlements."

reinharden

2007 Jan 08 08:04 AM

[Julian Ivan...:]

"Second, several of the civil lawsuits allege that starting in 1997, Jobs and the AAPL board engaged in a series of options grants for various officers of the corporation at below market price. This included a grant to Jobs himself in January 2000, apparently contradicting the company's statement that Jobs himself did not benefit."

- Jobs cancelled his stock options. Was given restricted stock afterwards. He did not benefit from stock options, period.

"..the direct involvement of Al Gore in this legal morass may effectively end the former Vice President's hopes to again seek the US presidency in 2008."

- yeah well allagedly being a drunk and a cocacine user didn't stop Bush become President did it? Lol... FUD, glorious FUD.

Anyway, to conclude my second post:

a) Backdating was not illegal. Backdating was not illegal. Backdating was not illegal. Backdating was not illegal. Backdating was not illegal. Backdating was not illegal. Backdating was not illegal. Backdating was not illegal. Unethical, you might say - but not illegal. Clearly there's a difference.

b) Accounting implications were $84m. No impact on earnings. No shareholder impact. In fact, the only impact on shareholders of Apple's dastardly financial shenanigans has been a 1200% rise in 5 years. Oh - how terrible.

c) Apple voluntarily started its own probe, which was not prompted by the media or "smart sleuths."

AAPL is not UNH or BRCM.

The rest of my post I am simply cut & pasting from previous posts I've made on the subject. I don't see anything wrong with this, as Whalan's article itself is simply a regurgitation of previous articles itself.

So what if the options were cancelled and he was issued with stock? The guy gets paid $1, and received compensation in the form of stock and/or options. Irrespective of whether the original granting of the options was fully approved by the Board and/or backdated, the guy can't be expected to work for nothing. With the options cancelled, the Board granted Jobs a different form of compensation - restricted stock. While one may have followed on from the other, that does not necessarily mean that LEGALLY one is derivative of the other in the sense that the tainted nature of the first has any bearing on the second.
2) It has already been stated that Jobs approved the backdating of others' options in some cases. This was not necessarily in itself either wrong or criminal in itself. At stake is not the question of whether he approved of the backdating, but whether Jobs personally acted illegally rather than someone else, in the execution and recording of any backdating. Amidst the hysteria, it is usually forgotten that backdating was not in itself illegal, and was common place. It is the manner of the recording of any backdating in company documents, and whether shareholders were thus privy to such actions, that either makes such practice illegal or not.
Jobs' approval of stock options grants, or the backdating of them, does not in any way criminalise him if others were responsible for the lack of legal accounting of those grants in SEC and shareholders' documents.

The only spin I keep seeing is not from Apple, but all the media whores and legal pundits surrounding it vying for attention and squawking complete FUD.

Jobs may have gotten up to something naughty, or he may not, but at this point, there seems to be absolutely no evidence that he did and anything else is sheer, utter, speculation. So far, the evidence suggests he is NOT guilty of anything illegal, even if the whole concept of backdating may seem unethical in itself.

2007 Jan 08 08:15 AM

[Macbth:]

I will keep my comment short-
What dana said in comment #2-
“you discredit yourself and indicate yourself to be a complete fool.’
When I see your name I will not read your Seeking Alpha emails, I get enough of them already.
The comments were better then the article.

2007 Jan 08 08:38 AM

[Tom B:]

You just want AAPL to dip so you can dump your MSFT (a company with that also has backdating issues) and buy.

Losing the smartest CEO on the planet could hardly be good for Apple. It's hard to get tech "right". Look again at MSFT-- all the money in the world and they can't can't design a kernel or an user interface to save their lives. XBox might be there only product (of hundreds) that rises above the level of "awful".

2007 Jan 08 09:40 AM

[Frank Z:]

Come on, be serious. Steve Jobs stepping down will be the second death of Apple. Apple needs to do whatever they can to keep Jobs in place. Steve Jobs is the Teflon God of Apple. People still love him regardless. You seem to think this isn't common practice throughout the industry. Puhlease!

2007 Jan 08 09:47 AM

[violinda:]

I HOPE AND PRAY THAT STEVE JOBS STAY'S ON- DONT LISTEN TO THAT KOOK.NO OTHER CAN DO THE JOB HE HAA DONE-IN A MILLION YEARS- HE HAS GREAT KNOWLEDGE OF WHAT HE DOES.
KELLY

2007 Jan 08 11:24 AM

[Julian Ivan...:]

TAKING OPTIONS OR NOT

Fred Anderson: $51 million
----------------------
How much Anderson made in his time at Apple Computer exercising options to buy company shares and then selling them.

Nancy Heinen: $48.9 million
----------------------
How much Heinen made at Apple Computer exercising options to buy company shares and then selling them.

Steve Jobs: $0
----------------------
Since returning as chief executive in 1997, Jobs has been granted options to buy 27.5 million split-adjusted Apple shares, but has never exercised any. In March 2003, he returned the options in return for 10 million split-adjusted shares of restricted stock. When they vested in March 2006, Jobs sold 4.57 million of them for $295.7 million to pay taxes, leaving him with 5.43 million shares currently worth $461.8 million.

Source: Securities and Exchanges Commission regulatory filings, Thomson Financial, Mercury News research

(thanks to IV AAPL Board)

2007 Jan 08 11:43 AM

[Paul Meisel:]

"What is really sad about the AAPL options scandal is that it did not need to happen. Jobs and the rest of the AAPL board are wealthy, well-educated people with access to the best legal advice and possessing the time and resources to get this right. When we see members of the US business elite behaving in such an ill-considered fashion..."

This is true of every one of the options scandals, the HP issue, Enron, Arthur Andersen, and just about every scandal of the last century.

The unfortunate part of highly driven, competitive, and ambitious individuals is that drive and ambition (and maybe greed) overcome the memory that in a corporate structure they work for the shareholders. It ceased to be "their company" the minute they went public.

If Steve Jobs didn't know that backdating options was wrong, he certainly should have -- there are plenty of experts on the payroll that had the duty to inform him. Is he then guilty of employing people who are incompetent, or have no backbone to tell the boss something he may not want to hear? At some point he has to admit to some part of the failure.

2007 Jan 08 01:30 PM

[Viswakarma:]

One can get away with corruption, murder and mayhem if one can put appropriate spin on it. Microsoft, after it was found guilty of monopolistic actions should have been split up. No! Instead, its "holey" operating system was allowed to maintain a strangle hold on innovation, costing billions of dollars in damages caused by viruses and the the non-productive labor that goes into protecting the computing systems based on this "holey" operating system.

Unix, a proven and robust computer operating system, which had many people-years of intellectual input and tax-payer investment was pushed into obscurity until Steve Jobs came back to Apple and resurrected it as Mac OS X for ordinary people.

"The law is blind" maxim implies that the laws are absolute and that they are applied without any interpretation. Unfortunately, this is not the case. No law is absolute! Laws are made and applied by humans based on the demands made by those with self-interests. The populous generally behaves like a mob and is blood thirsty. It takes one or two with self-interest to make this mob go in the direction they want.

Most of these who are screaming for Steve Jobs to resign are likely to benefit when he resigns and Apple stock goes down. The only ones I can see benefitting from this are Apple's Competitors or those have a financial stake in Apple's Competitors. My take on this whole Apple & Steve Jobs "Witch Hunt" is, that it is initiated and kept fueled by those who either hate Apple for its success after Steve Jobs' return or those that are going to benefit from its downfall.

Citing morals and ethics as reasons behind the calls for Steve Jobs' resignation is nothing but a cloak to disguise financial interests of those making this ruckus.

Since you disclosed that you don't have position in Apple, can you say the same thing about your positions in its competitors?

If an internal investigation was made and the financial statements were corrected, the case should be closed and people should shut up. The public outcry should be proportional to the damage caused by the act. A write off $90 million is a drop in the ocean when compared to the massive financial and horrendous social damage that was caused and continue to be caused by our leaders.

You should perhaps perform and "Institutional Risk Analysis" on the damage that was caused and is still being caused to the "American Institution" by our "so called" leaders.

2007 Jan 08 09:40 PM

[Mike Boyer:]

The ultimate arbiter is Mr. Market and he says Jobs should stay.

Whalen is apparently very naive and definitely a sanctimonious IDIOT who should have his computer taken away from him.

2007 Jan 09 06:03 PM

[Ryan Thomson:]

Hi Christopher, very interesting article.

I am an MBA student currently analysing Apple's iPhone strategy. Are you aware of the organizational structure of Apple? Is it a product team structure?

I would greatly appreciate any assistance you could provide

2007 Sep 27 06:01 AM