Disney clears (wink-wink) Steve Jobs of options backdating misconduct at Pixar
On Friday, in a terse, one-paragraph statement that was even more opaque than the very similar one Apple (AAPL) issued in December, the audit committee at Walt Disney Co. (DIS) cleared Steve Jobs of any "intentional or deliberate acts of misconduct" in connection with the options backdating that concededly occurred at Pixar (PIXR). Disney, which acquired Pixar in 2006, shed no light on how the backdating came to pass, but cleared anyone "currently associated with Disney" of wrongdoing.

The backdating at Pixar was in some respects even more extreme than at Apple: top officers were repeatedly granted options on dates when Pixar stock was at its lowest point for the year. On the other hand, unlike the situation at Apple, none of the Pixar options went to Jobs himself. At Apple, the special committee also acknowledged that Jobs may have actually been involved in "recommending" dates for options grants -- a circumstance that, on its face, suggests involvement in either backdating or springloading. (The latter term refers to the suspect practice of executives granting options to themselves or others just before new market events are about to give the stock price a big boost, as the executives know due to inside information.)

The story line at both Apple and Pixar appears to be that Jobs, the notorious micromanager who headed both companies at the time of the backdating, did not understand the legal or accounting ramifications of backdating. Interestingly enough, virtually Jobs's only compensation at either company during this period was coming from the Apple options whose workings he so poorly understood. (During the relevant years, his salary at Apple was famously just $1 per year, while at Pixar it was about $55 per year.)

The thing that puzzles me most is this: If you don't understand the accounting ramifications of backdating, why do it? Why not just issue the options dated as of the actual date you're issuing them, and simply choose whatever strike price you think is appropriate -- even though it may not correspond to the current stock price?

Take, for example, the situation at Apple, for instance, where Jobs received a grant of 7.5 million options options that wasn't finalized until December 19, 2001, when the stock price was $21.01. The special committee found that these options were backdated to October 19, 2001, when the price had been $18.30. (Phony documents were created to reflect a board meeting on October 19 which never really occurred.) Well, if you don't understand the accounting implications of backdating, why not just issue the options as of December 19, but announce a strike price of $18.30?

The answer, of course, is that someone at the company certainly did understand that if you did that, you'd be granting "in-the-money" options, which have onerous accounting and income tax repercussions for the company. The whole point of backdating is to avoid those consequences. To do that, you pretend that the options aren't in-the-money, even though they really are. So why go through that deception if you don't understand the accounting implications of granting in-the-money options?

And if Jobs himself didn't understand the accounting implications that were driving the deception that he himself (at Apple, at least) was benefiting from and, to the extent he was "recommending" grant dates, participating in, why didn't the underlings who did understand ever try to explain to Jobs the perilous legal situation he was getting himself into? Were they too petrified to tell him something they assumed he didn't want to hear, or already knew, or both? What a guy to work for.

Can readers explain to me why a company's executives would engage in backdating when they didn't understand its accounting implications?
Posted by Roger Parloff 6:47 AM 14 Comments comment | Add a Comment

The simple explanation that I can come up with as a finance student at the moment is that although a person such as Steve Jobs is certainly very capable of knowing that it would be nicer to give someone options at a lower price since it would guarantee more money to whoever it was being given to, this is different than understanding the underlying accounting principles of this transaction. It is like showing an incoming undergraduate student $1000 versus $15000. The student will certainly take the $15000 since he knows it will help him pay for his education more than the $1000. But... This does not mean that the student thought about whether his uncle who gave him this money was writing it off on his taxes properly, or that the student thought about whether he would have to pay taxes on the gift he received because the federal government only gives you a tax break up to a certain amount for a gift (I believe 12k this year?? I'm not an accounting major..) So in saying this, I think it is obvious why someone of Job's position chose to date the option farther back without knowing the accounting implications. A monkey would have chosen to give more money to someone versus less money if he was told it wouldnt cost him anything (at least for now...) . My only question to his accounting department is, who decided it was a good idea not to explain the ramnifications of this action. This isnt just an Apple accounting department issue, this has now occurred in hundreds of BIG companies...where are the public accounting firms that do their books? Are they so shy of coming out of the woodwork to explain that this cannot be done without legal ramnifications? I certainly don't expect a creative person to know the legal aspects of accounting practices, of which there are 158 recommendations by FASB that even most accounting students do not entirely know until they get their CPA. So no Mr. Jobs, I do no blame you, you picked the option that was most beneficial, anyone not knowing the actual accounting issues would have done that, and even if they did know the accounting basis, they would most likely assume that such an action would not even be presented to them since they had paid so kingly for a public accounting firm to do their books. Who would have thought...
Posted By Alex, Champaign Illinois : 9:17 AM  

Jobs is a micromanager of technology, not necessarily of stock options. I find it very much believable that he deferred to his accountants. "Handle the stock options while I go scrutinize the exact menu layouts of the next Mac OS." And, yes, based on the litany of stories over the years about how Steve treats employees, it's also believable that his accounting flunkies were too scared to tell him what they'd done. As for WHY they did it, I will leave to someone else to decipher.
Posted By K. Tappe, Wilmington, DE : 9:41 AM  

I think you are looking too hard malicious intent. Indeed there were improper practices with backdating but I believe each company needs to be looked at for their "intent" in backdating. In the example of Apple and Pixar it appears that the backdating was used towards the benefit of the companies and not to extort cash from shareholders. To be sure they should be investigated and any liability needs to be compensated for (even fines for any tax implications) - However, the best interest of the shareholders must be the primary concern and in the case of options backdating the best solution is for management to stop the practice.

I say 'good job SEC' and thanks for doing your job and putting a stop to this practice.
Posted By R. Johnston, Onancock VA : 9:50 AM  

The lawyers (inside counsel + outside counsel such
as Larry Sonsini) of the day were in the business
of *encouraging* this intepretation of an obscure,
ambiguous SEC regulation, not *discouraging* it.

All this attempted criminalization is ex-post facto.
The CEOs just did what the lawyers thought were OK.

Accounting departments are only now coming to
understand the options zoo after Saranes-Oxley,
Black-Scholes, etc. Silicon valley CEOs who
practiced options favoritism for many years just
signed off on what their attorneys recommended.

Ask the law offices of Larry Sonsini about this, not the hundreds of CEOs following his recommendation.
Posted By Retiarius, San Francisco, California : 10:33 AM  

I think it is inaccurate to say Jobs is a notorious micro manager. This may be true in some aspect, for instance deciding what Apple products will ship. Jobs, however, has tended to allow others to handle other parts of Apple's business ands solicits the opinion of those he trusts. Finance is one of those areas. Jobs always let Fred Anderson handle all aspects of dealing with Wall street. It was Fred giving the quarterly report information, not Jobs.

Moreover, there is an interesting Interview with Ed Woolard, one of Apple's former board of directors. He states that Jobs public reputation is not an accurate reflection of the man. He confirms that Jobs let others take care of Apple's business, and often asked for input.

http://macdailynews.com/index.php/weblog/comments/8397/

Finally, Apple hired accountants and lawyers to understand the law. Jobs is not expected to know the law himself and is entitled to rely on the advice of such lawyers and accountants.
Posted By Terrin, Ann Arbor MI : 10:40 AM  

Why are you picking on Apple? Didn't hundreds of other well known tech companies make the same accounting errors? Oh that's right, if you write about that you won't get nearly the same number of page hits as if you single out Steve Jobs...
Posted By Mark, St Paul, MN : 11:25 AM  

They frequently granted themselves stock options at the lowest price for the year. We are supposed to believe that wealthy people pay no attention to the details of their financial arrangements. Well, that is ridiculous. Jobs and the lawyers are guilty of self-dealing -- but clearly unethical. Did others do it? Are you picking on Apple? What difference? Shame, shame.
Posted By John, Phoenix AZ : 11:47 AM  

If anyone is hurt by options backdating, it is the stockholders. But in the case of Steve Jobs, look at the entire picture - he is at the top of the heap in making money for his stockholders.

Jobs is good at his work. Let's leave him alone to do it.
Posted By Art, Clearwater FL : 11:56 AM  

he knew what he was doing...plain and simple
Posted By Rob, NYC : 11:57 AM  

During the past year the word "scandal" has come to be hitched to the phrase "back-dated options" almost as frequently and unreflectively as the word "Saddam" was linked a few years ago to the phrase "Weapons of Mass Destruction." In each case insufficient attention was paid to alternative views and to the relevant facts.
In the case of options, the fact is that backdating has been legal historically and is no more scandalous, per se, than giving clothing store employees price breaks on clothes, restaurant workers free meals, or corporate employees free shares of stock - a common practice today. Obviously, if such practices bankrupt the underlying business and enrich only a greedy few, they are wrong. But if wisely administered, such benefits may well help the growth of a well-run company.
As to the fundamental justice or injustice of the options back-dating practice, arguably Apple's history makes a very good case for a wise use of such options. One of the most important (but insufficiently recognized) segments of the recent option news from Apple is that those grants were made to hundreds of employees, not just to a greedy few. Moreover, they represent only a tiny portion (less than 1 percent) of Apple's operating costs for the past half decade.
It's hard to remember now, but just five years ago Apple was on the ropes, with its stock trading at less than 10 percent of its current value. Those legal, back-dated options gave employees some faint hope of realizing gains if the stock should recover. Undoubtedly those grants helped attract employees to Apple who brought about one of the great recoveries in American business history.
As to Steve Jobs, himself, he profited not at all from the options and relinquished them long ago; they were �underwater� soon after he received them, worth less that their face value. But unfortunately, some of the press seems hell bent on condemning Steve Jobs whatever the facts. In recent months one journal, for example, has featured contradictory articles condemning Jobs (1) for compensating himself with backdated stocks and (2) for not caring about his company because he owns only a tiny portion of Apple's stock!
When a CEO takes a huge bite out of a weak company and comes out rich while the company falters, well, that is a scandal -- but when a CEO brings a staggering company back from the brink of oblivion, makes billions of dollars for its shareholders, takes little for himself, and provides some of the most attractive technology in the universe, and then that CEO is subjected to constant and unreflective badgering about the ways he compensated himself and his company's employees - in that case the scandal is in the paucity of insight and balance demonstrated by the press covering the story!
Posted By Bill Youngs, Cheney, Washington : 12:35 PM  

There are plenty of things that I would love to bust Steve Jobs' chops over...

Planned obscelecence in Apple's consumer computer models...Bare-boned, dumbed-down features in iLife apps that force you to build huge libraries of images and songs on your internal hard drive that tend to run out of space much too quickly...The lack of sequel support at Pixar for great brands such as A Bug's Life, Monster's Inc., Finding Nemo, and the Incredibles...General megolimaniac CEO coldness and ruthlessness and a lack of human warmth when it comes to his business dealings...

But not over this issue, which seems foggy at best, both in regard to the SEC and the IRS. This is a topic for a CPA's continued education hours, not corporate CEO melodrama.

I do believe that there are responsible knowledgeable individuals at both organizations who should be held accountable, because they did knowlingly try and cheat the system, whether or not they let Mr. Jobs in on that fact for his part.

I would imagine that Mr. Jobs would find that a very desirable hiring attribute for future accountants and attorneys that they would give him complete deniability based on ignorance.
Posted By Tim L. Burbank, CA : 2:05 PM  

back dating may have been good idea as away to make a package attrctive to ket executives, but not reporting it preprely means the shareholders pay for it (through dilution) but teh cost is not reflected in teh company's tax retrn, so the cost does not reduce teh taxes paid to the IRS.

If you are going to do, then it is in the shareholders' interest to get a tax break for the expense, by reporting properly.
Posted By Oliver, Oxford, Maine : 2:31 PM  

Finally someone who comes out tells it
clearly. By the way how come no one delved into which firm the former backdating option sec prosecutor Chris
Steskal, ended up at. A firm that represented AAPL no less. Clearly the powers that be feel that pursuing Jobs could shake the entire stock market and thus have decided to relax their efforts.
Posted By Jake Toronto, Ontario Canada : 11:04 PM  

Why is getting a stock option grant at the most advantageous time for the year more "extreme" than getting one at the most advantageous time for a month? Or a week? The law being broken is not giving a stock option at an advantageous date (this is NOT illegal!), but failing to report it on time. Even backdating itself is not strictly speaking illegal, but only practically made so by the very short reporting deadlines. So a very advantageous grant is not any more extreme a violation than a slightly advantageous grant -- they are both equally "unreported", and that isn't a matter of degrees.

Also, why is "springloading" as you call it suspect? It is not illegal for company employees to buy stocks in their own company based on their own knowledge of its prospects, nor is it illegal for employers to reward employees on this basis.

Try to remember: this is *compensation* -- not some kind of bribe. The employees are *supposed* to be awarded advantages from the assets of their employers, and foreknowledge of company plans is one of those assets. Where's the conflict of interest here?

This is just about paperwork being missing that is required by law -- none of that actual money received or financial benefits are illegal. This is why we see Apple moving to compensate their employees for the loss of the advantage given by backdating, with no fear of legal reprisal.

Talking about this issue like it's a case of backroom payola going around is doing a disservice to your readers and actually the entire business world.
Posted By Paul Delacroix, Toronto Ontario : 4:18 AM  

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About this blog
This blog is about legal issues that matter to business people, and it's geared for nonlawyers and lawyers alike. Roger Parloff is Fortune magazine's senior editor (legal affairs). He practiced law for five years in Manhattan before becoming a full-time journalist. To join in the discussion or suggest topics, please email rparloff@fortunemail.com.

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.