An honest options problem

MacJournals News (antler tip to Daring Fireball) is the latest to rush to Steve Jobs’ defense in the stock options backdating imbroglio. Responding to a post by Mark Anderson, MJN writes:

To argue now, three and a half years later, that Jobs benefited because these options were underwater by US$30 per share instead of US$32 per share doesn’t pass the laugh test.

The Macalope is normally a fan of MJN’s work and is frankly shocked that it’s missed the point here.

The present value of the options is derived by a calculation based on an expectation of their future value, not based on the current trading price. Options that are “underwater” still have a value if there is a reasonable expectation that the price of the stock will rise.

As Graef Crystal has pointed out, Jobs was given the present value for the options in March 2003 using an industry-standard means of calculation. This value is calculated based on the strike price of the options, a price that was benefitial to Jobs. He received shares valued at $75 million. If he had received a less favorable strike price – such as that on the date he received the options – he would have received less in 2003.

Crystal calculated the current value of Jobs’ windfall to be $85 million.

In comments, Anderson responds to MJN’s post:

1. Although the options were indeed underwater, the point Greif [sic] Crystal (and other Wall Street analysts) made was that they were exchanged for other instruments, and so had some inherent value that was captured. Therefore, the underwater bit is irrelevant.

2. What Steve’s sale intent is or was is completely irrelevant to the question of legality. If I broke the speed limit, why I broke it won’t help me much.

Prior to that, Anderson speculates that Jobs:

  1. Did in fact receive tainted options.
  2. Did in fact exercise some of them, in some way, and receive personal benefit.
  3. Did in fact know about the backdating practice.
  4. You know, in this list, there is probably no need for a “d,” although being involved in approval of the transaction would be a definite zinger.

The Macalope is not inclined to agree with Anderson’s probably tongue-in-cheek contention that Apple would have been better off just outright lying about its backdated option grants, but, sadly, he is inclined to suspect that Anderson is correct about Jobs.

Still, it’s important to point out that we don’t know that at this point and we may never know.

A Wall Street source of the Macalope’s believes that how this will get resolved will probably get down to the SEC’s determination of its materiality. In the case of United Health Care, another instance where a CEO was considered personally inseperable from the performance of the company, William McGuire was forced to retire after reaping hundreds of millions of dollars in backdated options. Jobs apparently benefitted in the tens of millions, which may be insufficiently egregious in the eyes of the SEC.

The source also said the SEC – depending on the outcome of its investigation – could choose to fine Apple and/or force Jobs to return some of his shares. If the SEC determines that Jobs knew about the implications of backdating his options and still personally influenced their issue to him and sought to cover it up (the worst-case scenario), the board and the shareholders would be in an interesting position: sully the image of the company by retaining an unethical CEO or force Jobs to resign and watch the value of their stock tumble.


Apple will, regardless, be required to calculate the differential between the options at the backdated prices and what they should have been issued at and take it as an expense in a future quarter, reducing its profit.

If the Macalope’s source is correct, Jobs will squeak through this on materiality. Other than those who invested in the company during the term of Jobs’ option grants but have since liquidated their holdings, this seems to be the best option for shareholders, customers and, of course, Apple’s executive corps.

Addendum: Commenter “anon” at Anderson’s blog says:

Fact: stock options can be granted at *any* strike price.

Fact: backdating is legal.

Fact: options backdating has no more bearing on shareholders than does giving him a $40m jet or paying him a $1 salary.

Fact: no one has gone to jail over this.

Yes. Yes. No. Yes.

If you give an executive a $40 million jet, you expense the lease or the depreciation on that jet and it hits the books over the period of its service. Not so with a backdated option grant. The true cost of the grant is hidden from shareholders, causing them to believe the company is in a better position than it really is and causing them to overvalue the stock in their portfolio.

ADDENDUM: See the Macalope’s response to MJN’s response to this post here.

Disclaimer: the Macalope holds an insignificant number of Apple shares. This post was edited slightly to put the attribution to Graef Crystal in the right spot and then edited again as MacJournals News is actually written by an editorial staff rather than just Matt Deatherage.

Trackbacks Comments
  • BarakTheCat:

    Whoa . . . where am I?

  • How is it possible to “overvalue” a stock when the price of said stock has gone up around $22 per in the time frame in question? Try as I might, I just can’t see how people who held the stock during the backdating (me included) can cry a river over any “loss”.

    Personally, my laughing all the way to the bank after reaping $10+ per share drowned out the sound of my crying over this issue. I don’t know how the people who have already filed lawsuits will prove “harm” if they made out half as well as I did.

  • How is it possible to “overvalue” a stock when the price of said stock has gone up around $22 per in the time frame in question?

    Great, Apple’s stock has done really well. But they still haven’t accounted for this. They’re going to have to take a hit in a future period (possibly and hopefully the current period just to get this over with) and take a charge that will reduce their profit. This charge should have been taken at the time the options were granted or appropriately documented. Apple understated its liability to Steve Jobs and the others that received backdated options, making the company appear to be in better condition than it was.

    The stock has already taken some of the hit from the news that Apple will have to restate its books. It’s doing well now in spite of that because iPod sales are still strong, Mac sales are up and people believe the company has a future. But it would be doing better if it has properly accounted for these options.

    The point here is information. Steve Jobs had information that other shareholders should have had but did not. The Macalope’s not talking about trade secrets like the details of the iPhone – he’s talking about what is rightly public information for a publicly traded company.

  • That’s all fine and good, Macalope, but the point is *harm*. I won’t join the lawsuits because I made out like a friggin’ bandit on AAPL. I dispute the basic premise that AAPL shares would have somehow been affected because of information Steve Jobs may or may not have had at the time.

    And even if the case could be made, so what? Who has a crystal ball that can tell us where AAPL *should be* right now if the information had become public back then? The point was, is, and always will be that Steve Jobs has added (roughly) $60 billion in value to AAPL. Is that worth $85 million and a $40 million jet? Not only yeah, but hell yeah! And judging by AAPL’s price, I think the market backs me up on this one…

  • Well, the Macalope’s personal assessment is the same as yours. He won’t be joining any lawsuits. But he can tell you that the big money players – the pension fund and the mutual fund managers – don’t look at it the same way we do. They want that information when it’s supposed to be reported and if they have to squeeze it out of Steve Jobs personally, that’s what they’ll try to do.

    But this isn’t a crystal ball. This issue has cost Apple shareholders *now*. Apple’s stock would be higher than it is right now and they now have to deal the uncertainty of not knowing what kind of hit the company has to take.

    The Macalope doubts the shareholder lawsuits would seek to remove Jobs. What they want is for him to return the money.

    Nobody has a problem with compensating Steve (well, some people do, but that’s a different problem, really). But backdating is a really poor vehicle to use. If you want to hand him money, give him a bonus (or a salary!) and mark it up for the tax hit he’d take. Otherwise tie his compensation to the stock performance like everyone thought it was.

  • Ron:

    “Apple’s stock would be higher than it is right now…”

    You can’t prove that statement.

  • Spare the Macalope.

    At the end of June Apple announced that it had discovered stock option irregularities and its stock went into a two week slide.

    In August it announced it was delaying its SEC filing because it would have to restate earnings. Shares dropped 1.85%.

    Fine. You can’t completely untie the reasons for every stock sale.

    But please.

  • Ron:

    I didn’t say the stock decline wasn’t related. But the stock did bounce back close to the 52 week high. You’re implying that if it weren’t for these irregularities, it would be even higher and there is no way you can know that. Maybe some of the bounce back was due to investrs who sold buying back in. Maybe not.
    The important point here is that you’re drawing a conclusion you can’t prove.

  • Given two companies that are exactly the same in all regards except one has admitted it has a problem with option backdating and one says it has no backdating problem, the one that has admitted the problem is going to have a lower share price.

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