Polishing The Apple: Steve Jobs and The Options Affair 9 comments
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As we have all heard, Mr. Jobs has admitted to being aware of improper backdating of Options in his role as CEO of the Company. While he claims not to have directly profited from these backdates (a claim not yet proven), his Board of Directors and other senior managers did profit. It is not unreasonable to infer that, other than being just a “good guy” to his friends and a “bad guy” to his shareholders, Mr. Jobs must surely have had a financial motive for allowing these backdatings to occur.
Let’s entertain ourselves with some additional information.
In defense of Mr. Jobs, an internal committee study was initiated by Apple and found him innocent of any violation. Furthermore, the Apple Board (some of whom are beneficiaries of the backdating) was quick to support Mr. Jobs and absolve him of any wrongdoing.
Facts seem to prove otherwise.
Mr. Jobs was granted a substantial number of Options in 2000 and 2001. According to findings, some of these Options were backdated. The number of Options was not insignificant: 17,500,000 in total. Apple was quick to point out that Mr. Jobs canceled these Options and made no profit. What they failed to tell us was that the Options were so far out of the money that they were valueless at the time of cancellation.
In lieu of his valueless Options, Mr. Jobs received 5,000,000 shares of restricted shares in 2003. The Company repurchased these shares in 2006 for $296,000,000. It’s not hard to imagine why Mr. Jobs proudly displays his $1-per-year salary in the financial statement. Of course, the $296,000,000 stock repurchase of Mr. Jobs’ shares by the Company is not reported as salary, but is disclosed in a footnote.
Another interesting tidbit is generated by the internal committee’s remarks. The committee states that the backdating was “limited, isolated, episodic…” The facts don’t seem to support this view. Company analysis determined that the originally assigned grant dates for 6,428 grants on 42 dates are not the proper measurement dates. This is hardly “limited,” “isolated,” or “episodic.” The cost to shareholders: $105,000,000. In addition to this deliberate and regular backdating, evidence shows that Option grants were also front-run (granted just prior to the release of good Company news). Furthermore, the backdating and front-running correspond to Mr. Jobs’ rehiring at Apple, Inc.
The table below, taken from Apple, Inc.’s most recent 10-K filing, illustrates the timing and expense of the backdated grants (dollars in millions):
It is interesting to note that an internal review focused on the fiscal period 1997 through 2003. Per the Table in the same financial statement it appears that additional backdating occurred up to and through 2006.
The Annual Report (10-K) filed December 29, 2006 states:
The internal review and independent investigation discovered no stock option grants after January, 2003 that required accounting adjustments.
If I read the Table correctly, it appears that backdating occurred not only after
Sarbanes-Oxley became regulation, but during a period of time when Mr. Jobs signed a certification that the financial statements were “true and correct.” If my interpretation is accurate, Mr. Jobs may have signed the document with knowledge that it was incorrect, as evidenced by the dramatic restatements to the financial statements for the years 2002 through 2005.
Even if we assume there was no wrongdoing, I am puzzled that Mr. Jobs, or his CFO, or KPMG (their auditor, who would have been or should have been aware of Options backdating) did not at a minimum disclose this information to their shareholders. I am forced to arrive at the conclusion that this information was intentionally withheld because if disclosed, it would have raised numerous unpleasant questions. So much for transparency.
The Company states in its 2006 Annual Report that there are “inherent limitations over internal controls”:
The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
The report goes on to state:
In coming to the conclusion that the Company’s disclosure controls and procedures and the Company’s internal control over financial reporting were effective as of September 30, 2006, management considered, among other things, the impact of the restatement to the financial statements and the effectiveness of the internal controls in this area as of the fiscal years ended 2006 and 2005. Management has concluded, therefore, that control deficiencies resulting in the restatement of previously issued financial statements did not constitute a material weakness in disclosure controls and procedures, or internal controls and procedures over financial reporting, as of September 30, 2006.
In addition to the significant improvements implemented between 2003 and 2005 discussed above, the Company will adopt other measures identified by the Special Committee and management to enhance the oversight of the stock option granting and administration function and the review and preparation of financial statements, including:
• The Company will engage experienced General Counsel, increase the resources of the Corporate Legal Department, and review the adequacy of its procedures and practices
• The CFO will arrange for senior management to undertake professional training to enhance awareness and understanding of standards and principles for accounting and financial reporting, particularly those relevant to stock options
• The Company will review all current policies, practices, and controls related to the granting of stock options and provide education and training to those who implement those policies and processes, as needed
• The Company will establish improved procedures for regular communication among the General Counsel, the CFO, and stock administrators to improve monitoring of all company practices with regard to stock option grants, including formal written confirmation that all grant dates correspond precisely with the dates authorized
• The Company will also establish improved procedures for the review of the preparation and presentation of financial statements by senior management
I am confident that Mr. Jobs’ defense will rest on at least two issues: (1) “I didn’t’ benefit directly,” and (2) “I wasn’t aware of the problems associated with backdating.” He might prevail, in my view, not because either argument holds water, but rather because overall, Mr. Jobs has done a good job for Apple and its shareholders in spite of his wizardry. If he is found innocent of wrongdoing, one major risk remains: should he be unable to find another “pony,” and the stock fall, every shareholder will be looking for justice.
I hope that policy coverage levels of Directors & Officers insurance are deep and broad, not only for Apple, Inc. and its auditor, KPMG, but for all the fiduciaries that hold this stock on behalf of their investor clients with the knowledge that there are some serious management issues. This is one time you will not be able to say, “If only I had known….”
All of the views expressed in this research report accurately reflect the research analyst’s personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
This report is for information purposes and should not be considered a solicitation to buy or sell any security. Neither Audit Integrity nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without written permission. Copyright © 2006 Audit Integrity, Inc. and its affiliates, Directors and Officers of the company may own stock or options to purchase or sell stock in the companies mentioned on our website and in our publications and may elect to increase or decrease the size of these positions at any time. However, we are not compensated in any way for publishing information about subject companies.
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Mr. Jobs was granted a substantial number of Options in 2000 and 2001. According to findings, some of these Options were backdated. The number of Options was not insignificant: 17,500,000 in total. Apple was quick to point out that Mr. Jobs canceled these Options and made no profit. What they failed to tell us was that the Options were so far out of the money that they were valueless at the time of cancellation."
So what? Steve Jobs was paid a salary of $1 year. Of course he had to be adequately remunerated. This was agreed to be done by way of stock options originally. When those options ended up underwater after AAPL's decline, a new approach was necessitated.
There's nothing wrong with this! Would you work for $1/year? Thought not. Repeat after me: backdating was not illegal. backdating was not illegal. backdating was not illegal. Only the manner of its reporting can make it an offence. Get over it! The guy just wanted to get paid.
Either Mr. Jobs is incredibly ignorant of accounting and financial practices for a corporate executive, and was deficient in his choice of financial officers, legal counsel, and auditors -- or he is a damn liar.
If I still held AAPL (I sold awhile back) I would prefer the second.
If I was a director, I would at the minimum change auditors and several of the senior executives, and insist on detailed oversight of all compensation processes, audit planning, and financial reporting discussions.
It is not about whether he deserves the money he made or will make -- its about stewardship of other peoples money. The day Steve Jobs agreed to work for Apple at any salary, he agreed to be a steward of the shareholders interest. I would be happy to see any humility whatsoever from the Apple camp.
Your whole post is hysterical in its tone. Repeat after me: "backdating was not illegal. backdating was not illegal. backdating was not illegal." Only the manner of its reporting can make it an offence. There has obviously been some chenanigans with regard to the date the options agreement was made, but the actual grant was legal (first authorised in August, approved in December, backdated to October), so there hasn't actually been anything illegal to do with the grant per se (which was duly reported in SEC filings and was thus completely legal), just a misstatement regarding the date of the meeting at which it was agreed (which happens to have coincided with a meeting of Apple's salary review board rather than a full Board meeting).
If everyone is convinced that Steve Jobs is not complicit and bears no significant responsibility, fine... but somebody is certainly responsible for YEARS of incorrect reporting.
There is no formal "criminal investigation."
There is no "FBI investigation."
There's is just an informal investigation by the SEC with Apple's full cooperation into the matter, with the SEC and DoJ not yet having decided whether to conduct a formal probe or not. People forget that it was Apple, not the SEC or DoJ, who started this investigation. So far the SEC has not declared whether it wishes to take escalate the matter to a formal investigation or not. They may decide to, or they may declare that they're satisfied with Apple's own statement and remedy.
Its that simple.
Nobody has been charged. Nobody has been arrested. Nobody has been interrogated. There is no formal probe (yet).
There are just discussions and informal investigations going on.
Kaplan:
--------
The committee states that the backdating was “limited, isolated, episodic…” The facts don’t seem to support this view. Company analysis determined that the originally assigned grant dates for 6,428 grants on 42 dates are not the proper measurement dates. This is hardly “limited,” “isolated,” or “episodic.” The cost to shareholders: $105,000,000
THE FACTS:
---------
Restatement says of focal grants ( grants to employees throughout the year - not directors, management or the CEO) : the # of improperly dated focal grants was 5,594 on 5 dates. So 87% of the improperly dated grants occurred on 5 dates or about 12% of the total dates involved. And the 5 dates occurred in a time frame of 1997 to 2003. And 3744 of the 5,594 focal grants were on 2 of the 5 dates AND these grants were improperly dated by ONE DAY. Talk about scrupulous accounting! Was the committee so far off in characterizing the backdating as ' limited?" Also the $105 million is pre-tax and not so stated.
Kaplan:
-------
In defense of Mr. Jobs, an internal committee study was initiated by Apple and found him innocent of any violation. Furthermore, the Apple Board (some of whom are beneficiaries of the backdating) was quick to support Mr. Jobs and absolve him of any wrongdoing.
Facts seem to prove otherwise.
Mr. Jobs was granted a substantial number of Options in 2000 and 2001. According to findings, some of these Options were backdated. The number of Options was not insignificant: 17,500,000 in total. Apple was quick to point out that Mr. Jobs canceled these Options and made no profit. What they failed to tell us was that the Options were so far out of the money that they were valueless at the time of cancellation.
In lieu of his valueless Options, Mr. Jobs received 5,000,000 shares of restricted shares in 2003. The Company repurchased these shares in 2006 for $296,000,000. It’s not hard to imagine why Mr. Jobs proudly displays his $1-per-year salary in the financial statement. Of course, the $296,000,000 stock repurchase of Mr. Jobs’ shares by the Company is not reported as salary, but is disclosed in a footnote.
THE FACTS:
----------
Kaplan completely glosses over the crucial issue here. In 2003 Jobs owned a large number of out-of-the-money options. At this point, the compensation committee had several choices. They could leave the situation as it was and hope that the price would eventually recover; they could grant still more stock options, at a different price; or they could grant restricted shares. They chose, with full legality to grant him the restricted shares. That was their decision; that was SJ's due reward for his efforts to that point.
Does Kaplan mean to say that the board did not have the right to do so? What if they had granted him many more shares, far beyond any imputed value of his original options grant? Would the fact that the grant *far exceeded* the options value mean that it could never be seen as a substitute for those options and thus was better for the stockholders than the actual, lesser grant of restricted shares? In short, Kaplan's insistence that the restricted shares are necessarily tied to the options grant, in my opinion, denies the legal authority of the compensation committee and board to make such decisions based on SJ's performance as of 2003.
Kaplan:
------
Even if we assume there was no wrongdoing, I am puzzled that Mr. Jobs, or his CFO, or KPMG (their auditor, who would have been or should have been aware of Options backdating) did not at a minimum disclose this information to their shareholders. I am forced to arrive at the conclusion that this information was intentionally withheld because if disclosed, it would have raised numerous unpleasant questions. So much for transparency.
THE REBUTTAL::
-------------
Kaplan takes a complicated issue involving professional auditors and reduces it to having been "intentional withheld . . . [because] it would have raised numerous unpleasant questions", a conclusion he "is forced to arrive at".
Kaplan:
------
Mr. Jobs was granted a substantial number of Options in 2000 and 2001. According to findings, some of these Options were backdated. The number of Options was not insignificant: 17,500,000 in total.
THE FACTS:
---------
The restatement clearly says the 10 million share grant in 2000 was recorded on the CORRECT measurement date and NO expense adjustment was necessary. The 7.5 million share grant in 2001 was dated Oct 19 and not ratified until Dec 18, so Apple corrected the expense accounting in the restatement.
Anyone who has read the restatement knows there are not 17.5 million in question. How hard is it to state the correct information? Kaplan is either uninformed or deliberately distorting the facts.
Kaplan:
------
Per the Table in the same financial statement it appears that additional backdating occurred up to and through 2006.
The Annual Report (10-K) filed December 29, 2006 states: The internal review and independent investigation discovered no stock option grants after January, 2003 that required accounting adjustments. If I read the Table correctly, it appears that backdating occurred not only after Sarbanes-Oxley became regulation,
THE REBUTTAL:
--------------
The expenses in the table for 2004, 2005, 2006 are the impact on those years from the backdating expense taken in the prior years. There was no backdating after 2003. This is why I posted the table yesterday. Kaplan says it APPEARS backdating occurred after 2003. The forensic accountants say it did not. Take your pick.
Kaplan:
-------
The committee states that the backdating was “limited, isolated, episodic…” The facts don’t seem to support this view. Company analysis determined that the originally assigned grant dates for 6,428 grants on 42 dates are not the proper measurement dates. This is hardly “limited,” “isolated,” or “episodic.” The cost to shareholders: $105,000,000
THE FACTS:
----------
Restatement says of focal grants ( grants to employees throughout the year - not directors, management or the CEO) : the # of improperly dated focal grants was 5,594 on 5 dates. So 87% of the improperly dated grants occurred on 5 dates or about 12% of the total dates involved. And the 5 dates occurred in a time frame of 1997 to 2003. And 3744 of the 5,594 focal grants were on 2 of the 5 dates AND these grants were improperly dated by ONE DAY. Talk about scrupulous accounting! Was the committee so far off in characterizing the backdating as ' limited?" Also the $105 million is pre-tax and not so stated.