Options and the Steve Jobs Reality Distortion Field

19 Oct ’06

Apple’s latest financials are spectacular; no particular surprise there – sales of iPods are healthy and sales of the new Intel Macs have been on fire. Despite increasing accounts of problems with many MacBooks and MacBook Pros (including a possible class action), the financials suggest that switching is picking up – as anecdotal evidence has clearly suggested for months now.

But perhaps the more interesting financial issue on Apple’s plate now is its involvement in option backdating, the scandal that has ruined more than a few tech careers in the last few months (including the careers of a growing number of General Counsels). I’ve not been following the issue very closely, but closely enough to note that Steve Jobs is now involved:

Steve Jobs, Apple’s chief executive, on Wednesday admitted to knowing about backdated employee stock option practices at the iPod and Macintosh computer maker, as a former chief financial officer resigned from its board over the affair.

Mr Jobs’ admission, and a public apology he issued over the matter, make him the most prominent Silicon Valley executive yet to be tarnished by the spreading options backdating scandal.

“If this were to escalate to the point where Steve Jobs were forced to resign, it would be a disaster for Apple,” said Van Baker, analyst at Gartner. He added, though, that that seemed unlikely, since Apple said on Wednesday that its chief had not benefited personally from the practice.

Apple said that a three-month internal enquiry had shown that Apple had backdated options on 15 occasions between 1997 and 2002. The practice, which involved issuing options to employees at exercise prices more favourable than the stock price at the time, was not in itself illegal, but could have been if companies failed to disclose or account properly for the practice. Apple is one of more than 100 US companies that have been caught up in the affair.

In a filing with the SEC, Apple said that Mr Jobs was aware of the backdating “in a few instances”, but that he “did not receive or otherwise benefit from these grants and was unaware of the accounting implications”.

My friend Mathew covers the ground on the topic, though for the sake of precision I’ll note that well-timed or backdated options don’t “instantly soar” in value (except perhaps in a strict option pricing sense) or “ensure a big payout”, unless they’re already vested and in the latter case are exercised – I’m pretty sure there have been cases where backdated options have expired without value because of later price drops in the underlying stock price.

But that’s really beside the point; backdating increases the odds of a payout. One might find that incompatible with sensible corporate governance, but that of course is for the issuer’s owners (the shareholders) and managers to decide – which is one reason why I’m less interested in this issue than some others are. Backdating is as I understand it not illegal in the U.S., as long as the shareholders are made aware of it through required disclosure and proper accounting treatment – this makes sense – it’s a business issue for the company and its shareholders. But the disclosure and accounting requirements are where many companies have gone stray. In the worst cases, executives have benefited from the practice, apparently after directing employees to backdate the executives’ options, and the practice has not been disclosed, in circumstances that suggest attempts to conceal the practice from shareholders and regulators. Of course, it’s these nuances that make the facts of each particular case so important.

In Steve Jobs’ case, the facts are perhaps not completely clear yet. But assuming he didn’t personally benefit, and knew the company was doing it but thought everything was above board, should there be fallout for him? I can’t see why – reality distortion field or not.

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