"You broke my heart, Fredo." And… scene!

The New York Times reports (free registration) that Apple left some unanswered questions about its backdating of certain stock option grants. Of particular interest to the Macalope was this quote:

“I would say that Jobs and the Apple board threw Fred under the bus to keep it from hitting them,” said Lynn E. Turner, a former chief accountant at the Securities and Exchange Commission and a managing director at Glass, Lewis & Company, which advises institutional investors on corporate governance.

The Macalope suspects Fred Anderson may have jumped rather than been pushed, but either way he seems to be taking one for the team.

And by “team” the Macalope means “Steve Jobs.”

The Macalope knows his way around accounting and finance, but has never had the pleasure of stock options, so he did a little research for his personal edification (using Wikipedia for some background).

Stock options are a popular expression of a company’s love for a particular employee, often used in the technology world. The company is effectively saying “As an important cog in our engine, we recognize that you need incentives to help make the value of the company grow, so we’re going to grant you a share of that growth.”

The employee is granted a certain number of stock options (called “options” because they are exercised at the employee’s discretion) at the price of the company’s shares at the day of the grant. The employee doesn’t “get” the shares, he or she gets the amount the shares appreciate in the future (or, if they don’t appreciate, gets nothing). As the company’s stock price rises, the employee can – depending on vesting schedules and the expiration date – exercise the options at any time. A broker buys the shares from the company at the grant price and sells them on the market for the current price. The employee pockets the difference, less the brokerage fees.

So, let’s say an Apple employee – let’s call him “Jon Rubinstein” – was given options of 100 shares at a price of $35 on January 15, 2005. The price hits $50 on September 8, 2005 and Jon Rubinstein exercises his options, netting the difference between the two prices times the number of shares: $5000 – $3500 = $1500.

Just add a whole heck of a lot more zeros and deduct a brokerage fee.

Now, in backdating, the company says “We want to give you 100 shares but, you know, it’s January 15th 2005 and the price is $35. Three months ago it was $20 and you’re so fricking awesome you deserve it at $20 a share. So, just between you and me and the board, we’re going to mark the date on the shares as October 6th so you can start from $20. Don’t tell anyone. Shhh. A special deal for you just because you’re so fricking awesome.”

You can see how that’s financially beneficial to the employee. But, realistically, this example is overly naive. In most companies upper managers – through either the use of powerful Jedi mind tricks or just old fashioned childish screaming tantrums (or both!) – are able to influence their compensation.

Apple apparently had these incidences of backdating for years, so why is it only coming up now?

According to BusinessWeek, the current spate of concern over options was kicked off after a review by the Wall Street Journal revealed that executions of stock options at the companies reviewed were making executives more money than they should have based on random share prices. Meaning the dates and consequently the share prices were not being picked randomly.


Sarbanes/Oxley effectively eliminated this backdating issue by mandating that both option grants and exercises must be reported by the end of the second business day following the day on which the transaction was executed. So companies could no longer “pretend” grants had been given three months prior.

As BusinessWeek notes, backdating isn’t necessarily illegal depending on the bylaws of the company and how its reported. But Apple clearly did not disclose these backdated grants and actually still has not, pending the conclusion of the SEC’s investigation.

While certainly not any admission of guilt, that’s at least an admission that the company would rather not have to provide a full accounting of these grants.

No one really needs to know who offed Fredo Anderson.

Clearly, this issue does not appear to be over for Apple, despite Anderson’s resignation from the board. What is probably paramount in the mind of an Apple fan is “What does this mean for Steve Jobs?”

In the case of Mercury Interactive Corp., the case that prompted the Wall Street Journal’s review, there were 49 cases of backdating and three executives including the CEO resigned. As a result of the Wall Street Journal’s analysis, several other companies faced criminal investigations and shareholder lawsuits.

Apple has only admitted that backdated options were granted on 15 dates and has not specified to how many individuals. At the Times notes, Apple said Jobs only knew about a few, but did not say how many shares were involved.

It’s unlikely in Apple’s case that the board would ask Jobs to resign. Jobs, to a certain degree, is Apple. At this point, there’s absolutely no reason to believe that he would be asked to step down. To the contrary, Apple is taking pains to clear Jobs of any malfeasance and there’s no evidence he’s done anything wrong.

Anderson may be being made a sacrificial lamb, but that doesn’t mean there was deliberate, coordinated, systemic abuse of stock options. Anderson’s resignation may simply be for healthy PR purposes. Indeed, regardless of criminal intent, something was screwed up so someone has to go. Anderson had already retired from being CFO and was a likely candidate. He may have actually had little to do with the granting of options. If Anderson has to step down from his board position at eBay, too, then you can start to think he’s possibly tainted goods.

It is somewhat disturbing that the company is not more forthcoming with information on these grants, but more information may become available when Apple’s quarterly results are announced on the 18th.

UPDATE: MacNN has more on Jobs’ current position in this.

Glenn Fleishman has a similar report to the Macalope’s on TidBITS.

Disclaimer: the Macalope holds an insignificant number of Apple shares.

  • Thanks for the easy explanation of stock options. That really clears things up for those of us who don’t have any experience in the business world.

  • Padraig:

    Thanks for the article and great site! Tiny nit-picky, almost irrelevant correction though:
    $35 * 100 = $3500
    $50 * 100 = $5000

    …So, let’s say an Apple employee – let’s call him “Jon Rubinstein” – was given options of 100 shares at a price of $35 on January 15, 2005. The price hits $50 on September 8, 2005 and Jon Rubinstein exercises his options, netting the difference between the two prices times the number of shares: $500 – $350 = $150…

  • Oops! The Macalope changed the scenario and neglected to update all the numbers.

  • I should try Jedi mind tricks to increase my compensation. The kicking and screaming has not seemed to work up to this point. [said while doing that hand wave thing] “You will give me a bonus for no apparent reason, and double my salary… and throw in some iOptions while you’re at it… yeah.”

  • Dhrakar:

    Are you really John Gruber in disguise? Or, more likely, are you his alter ego that comes out when he sleeps? (I’m thinking of the Creature from the Id in Forbidden Planet 🙂
    Anyway, great column John^H^H^H^H Macalope. I’ll have to try the Jedi trick m’self one of these days…

  • Gruber would have somehow made a Stanley Kubrick reference instead of a Coppola reference.

  • Kordan Harvey:

    and Sony really ended up being a marketshare leader with the Walkman until the whole technology became obsolete. Future is bring for the iPod if it follows the same pattern.

  • Kordan Harvey:

    dammit, commented in the wrong article, I don’t even really know how that happened. Oh well, disregard the previous post.

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