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Wall Street Journal, December 30, 2006 article


The Wall Street Journal  

December 30, 2006


Jobs Helped Pick
'Favorable' Dates
For Option Grants

Apple Report Clears the CEO
Of Wrongdoing, Blames
Ex-Executives in Backdating
December 30, 2006; Page A1


Apple Computer Inc. acknowledged that it backdated stock options and that Steve Jobs recommended "favorable" dates for some options awards. But the company said he was absolved of misconduct by a special internal investigation.

[Steve Jobs]
Steve Jobs
Apple's filings this morning reveal details of the company's options probe. Some excerpts:
On options dating:
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. Read more1.
On Jobs's October 2001 grant:
The approval for the grant was improperly recorded as occurring at a special Board meeting on October 19, 2001. Such a special Board meeting did not occur. There was no evidence, however, that any current member of management was aware of this irregularity. Read more2.

Directors and others close to the Apple probe defended Mr. Jobs, the company's iconic chief executive, even as it detailed his part in a widespread pattern of options irregularities between 1997 and 2002. But Mr. Jobs and Apple, still under federal scrutiny as part of a broad investigation of options backdating, are not yet out of the woods.

Some options and corporate-governance experts said yesterday that they couldn't reconcile Apple's statements defending Mr. Jobs with the facts the company disclosed, and called on the company to seek recovery from him for a giant grant he received that the company yesterday acknowledged was backdated.

Apple has previously said that two of its former executives were responsible for improper options-granting practices, without identifying the pair. Yesterday, people familiar with the matter said the internal investigation had raised questions about Nancy Heinen, Apple's former general counsel and board secretary, and Fred Anderson, a former chief financial officer and board member. Attorneys for both former Apple executives deny their clients did anything wrong.

An option gives its holder the right to buy a stock at a fixed, or exercise price, usually for up to 10 years after the date of the grant. By backdating the exercise price -- or pretending it was granted on a date before the award was made -- the employee gets an instant boost to the possible profits from the award. The practice can violate securities laws and accounting rules. The U.S. attorney's office in San Francisco and the Securities and Exchange Commission are examining Apple's options practices.

The disclosure yesterday by Apple in filings with the SEC said that 6,428 grants of options at Apple on 42 dates between 1997 and 2002 were improperly dated, resulting in charges to earnings for those years. Apple restated its financial results between 1998 and 2006 to recognize a new after-tax, noncash expense of $84 million in connection with the improperly dated options. (See details of Apple's filings.7)

Since these charges -- essentially, previously unreported compensation to employees -- generally are only mandated in case of backdating, the restatement represents an acknowledgement that grants were backdated on a large scale.

Since Apple first disclosed in June that it had discovered irregularities with past option grants, the key question has been whether the investigation would jeopardize the position of Mr. Jobs, the co-founder of Apple who is widely credited with reviving the company in the late 1990s and turning it once again into an arbiter of popular technologies with products such as the iPod portable music device. Investors interpreted Apple's latest disclosures and the board's support for Mr. Jobs as a sign that his status at the company is secure, sending its shares up 5% to $84.84.

Mr. Jobs could come under further scrutiny because of a series of fortunately timed option grants when he was chairman at Pixar Animation Studios that are also being probed by federal investigators. As chairman during the time when favorably priced options were granted, Mr. Jobs was also effectively in charge of administering options plans, since the full board performed the functions of a compensation committee year after year.

Pixar granted options to executives at the lowest closing prices of 1997, 1998, 2000 and 2003 -- a highly improbable pattern. Mr. Jobs wasn't among the executives who received options. Walt Disney Co., which subsequently bought Pixar, said in November that its board, on which Mr. Jobs sits, was conducting an independent review of Pixar's option grants after inquiries from the SEC and Department of Justice.

Former Vice President Al Gore and Jerome York, two of the three Apple directors who oversaw the internal probe, said in a statement that the board "is confident that the company has corrected the problems" that led to the options irregularities and that "it has complete confidence in Steve Jobs and the senior management team."

But David Yermack, a finance professor at New York University who has studied options issues, said he was perplexed about directors' expressions of confidence in Mr. Jobs. "They have pretty much admitted that he was directly involved in a fraud," Mr. Yermack said, pointing to Apple's statement that Mr. Jobs "recommended" the selection of favorable grant dates. "If he had directly participated in altering depreciation schedules, or booking revenue that wasn't yet earned, would they have full confidence in him?"


In response, Apple spokesman Steve Dowling said: "Following an exhaustive independent investigation, the special committee found no misconduct by Steve Jobs or any other current management. The board has expressed complete confidence in Steve and senior management."

The Cupertino, Calif., company is one of the highest-profile companies to be caught up in the probes over backdated stock options. To date, at least 130 U.S. corporations are under investigation for possible options backdating. Some have admitted to the practice, and more than 60 executives and directors of public companies have lost their jobs.

It remains unclear in which cases Mr. Jobs "recommended the selection of some favorable grant dates," as Apple's filing states. The company's internal probe, conducted by the law firm Quinn Emanuel Urquhart Oliver & Hedges, didn't find evidence that Mr. Jobs recommended backdating any of the options grants he received himself, according to people familiar with the matter. "To the extent it occurred, it was pretty limited," one person said. "These were episodic, limited, isolated."

Among the most potentially serious discoveries of the investigation, Apple said company records improperly showed that approval of a grant of 7.5 million options to Mr. Jobs on Oct. 19, 2001, occurred at a special meeting of its board of directors. The company's investigation found that the meeting didn't actually occur.

In its filing, Apple said the grant was "originally approved" at a board meeting on Aug. 29 at an exercise price of $17.83, before stock splits. But it said the terms of the grant weren't finalized until Dec. 18, a day when Apple's share closed at $21.01. The grant was then dated back to Oct. 19 with an exercise price of $18.30.

Apple in its statement said it was taking a $20 million charge, before taxes, related to this grant. But it echoed earlier defenses of Mr. Jobs, saying that "he did not receive or financially benefit from these grants or appreciate the accounting implications."

But Patrick McGurn, executive vice president of Institutional Shareholder Services, which advises on corporate governance, says that "clearly, there was a benefit from the options that Jobs received...There was some fruit from those options, and it's clear because there's a $20 million charge," says Mr. McGurn. In 2003, Mr. Jobs returned the 2001 options grant and another granted to him in 2000 for five million shares of restricted Apple stock then worth over $70 million. Mr. Jobs's restricted shares "generally vest in full" three years after the grant date, according to Apple filings.

"I can't understand why they're [the board] not recouping those shares," Mr. McGurn said, adding that the cloud hanging over Apple isn't cleared by the filing because "there's a risk though that some other body [of regulators or others] will reach a different conclusion about this matter based on exactly the same set of facts."

According to a person familiar with the internal investigation, Apple believes it has evidence that Ms. Heinen, as corporate secretary, was aware of improper documentation that said a board meeting occurred on Oct. 19. Cristina Arguedas, Ms. Heinen's attorney, couldn't be reached for comment following the Apple filing, but earlier this week said: "Nancy's reputation is rock-solid and long-standing as a person of high integrity and honesty. Rumors and innuendo to the contrary are without foundation."

As it had previously, Apple said yesterday that its "investigation had raised serious concerns regarding the actions of two former officers in connection with the accounting, recording and reporting of stock option grants." An Apple spokesman yesterday declined to confirm whether Mr. Anderson and Ms. Heinen are the two unnamed former officers.

Apple may argue to federal investigators that as CFO, Mr. Anderson should have been responsible for proper accounting of the backdated options, according to a person familiar with the company's thinking. Mr. Anderson was CFO at Apple between 1996 and 2004.

Jerome Roth, an attorney for Mr. Anderson, who is now a partner at Silicon Valley private-equity firm Elevation Partners, said his client was "disappointed to learn that during part of his tenure" as CFO "the company apparently was not strictly complying with its processes for granting stock options. As CFO, Fred did not play any day-to-day role in the granting, reporting and accounting of stock options and he was not involved in any knowing manipulation of the process."

Federal prosecutors have already brought two criminal cases in the stock-options backdating scandal. In one case, the former CEO of Brocade Communications Systems Inc. was charged with fraud and accused of altering the dates of option grants to hundreds of employees and concealing millions of dollars in compensation expenses from shareholders. The executive, Gregory Reyes, who didn't receive any of the backdated grants himself, has denied any wrongdoing.

Apple believes the case against Mr. Reyes can't be compared to Mr. Jobs's involvement in the backdated options at Apple, according to a person familiar with the matter. "This is not the Reyes model by a long stretch of the imagination," the person said. "The government says Reyes systematically and routinely backdated options and knew the implications."

In 2003, Mr. Jobs canceled the 2001 option, along with a massive 2000 grant, and in exchange received five million shares of restricted stock (the figure is before adjustment for splits). An Apple spokesman wouldn't say how the company arrived at the five-million share figure.

Warren Miller, an analyst at Beckmill Research of Lexington, Va., which values options and other equity instruments, calculates that the 2001 option was worth about $76 million when it was exchanged in 2003, about $2 million higher than it would have been had it not been backdated. All told, Mr. Miller figures the two options together were worth about $200 million when they were swapped for restricted stock that Apple valued at $74.8 million.

Mr. Miller says executives typically prefer to receive restricted shares, and hence value them more, because there is less risk involved than there is with an option.

Frederick W. Lambert, a law professor and an expert in securities law at the University of California's Hastings law school in San Francisco, says Mr. Jobs will likely escape any criminal or civil charges stemming from this matter. "In proving a criminal case, it would have to be beyond a reasonable doubt, and intent would play an element in this." A lack of knowledge about accounting implications "would constitute some kind of defense here," Mr. Lambert says.

Aitan Goelman, a lawyer at Zuckerman Spaeder LLP in Washington, says prosecutors and regulators, flooded with backdating cases, have to triage and pick the most promising ones to pursue. For criminal fraud cases, he says, prosecutors need to establish that a defendant intentionally defrauded or deceived someone; the SEC, bringing civil charges, has a lower threshold. He says the apparently phony board records at Apple might well draw federal officials' scrutiny to the company or former executives.

-- Pui-Wing Tam contributed to this article.

Write to Nick Wingfield at nick.wingfield@wsj.com8, Steve Stecklow at steve.stecklow@wsj.com9 and Charles Forelle at charles.forelle@wsj.com10

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