Steve Jobs (pg. 3)
Among the first things Jobs did in 1997 was to reprice underwater stock options for all Apple employees, twice in six months. Apple also made a big grant in a way that looked like "springloading," issuing options one day before the announcement of a big deal with Microsoft sent Apple shares soaring 33%.
Repricing and springloading are controversial (they give insiders an edge that shareholders don't enjoy), but they are not illegal. Neither is it illegal to grant "in-the-money" options with a below-market price as long as the action is disclosed and accounted for. What is illegal, though, is backdating - the picking of a date in the past, when a stock's value was lower, to assign the exercise price of options - without those adjustments. Backdating invariably involves lying to investors, creating false documentation, and avoiding the earnings hit required for giving employees in-the-money grants.
In 2006, after the Wall Street Journal ran its Pulitzer Prize-winning series about backdated stock options, Apple (which hadn't been named in the coverage) scrambled to assess whether it had a problem. The company appointed a special board committee to investigate, which concluded that it did. The company discovered "irregularities" with 6,428 grants between 1997 and 2001 - roughly one in six that Apple issued during that period. (New disclosure requirements after that time caused backdating to dry up.) The company also found no instances of backdating before Jobs took over as CEO. Apple was forced to restate its earnings, taking a pretax charge for unreported compensation expenses of $105 million.
Disney, which bought Pixar in 2006, also investigated and found a backdating problem there during Jobs' time as CEO. As the Wall Street Journal first reported, key Pixar executives received options grants priced at the stock's yearly low in 1997,1998, 2000, and 2003. A Merrill Lynch analyst put the odds of that happening by chance at one in 112 million. (Disney declined to comment on backdating.) But the events at the two companies don't quite fit the classic backdating template, which has cost dozens of executives their jobs. For one thing, Jobs didn't personally benefit from backdated options - at least not directly. For another, in a climate where many were rushing to judgment, Jobs enjoyed the benefit of the doubt from protective boards.
Was Jobs himself involved in backdating stock options? At Apple, the answer is yes: In an SEC filing, Apple acknowledged that Jobs "was aware [of] or recommended the selection of some favorable grant dates." But Apple's investigation concluded that Jobs' involvement didn't amount to misconduct because he "was unaware of the accounting implications." As for Pixar, Disney issued a four-sentence summary of its own internal inquiry, concluding that "while options were backdated at Pixar" before its sale to Disney, "no one currently associated with the Company engaged in any intentional or deliberate acts of misconduct."
The SEC and the Justice Department are still investigating backdating at both Apple and Pixar. The SEC last April announced that it would take no action against Apple, citing the company's "swift, extensive, and extraordinary cooperation," including its "prompt self-reporting, an independent internal investigation, the sharing of the results of that investigation with the government, and the implementation of new controls designed to prevent the recurrence of fraudulent conduct."
At the same time, the SEC filed charges against two former members of Jobs' inner circle - general counsel Heinen and CFO Anderson. Heinen, accused of orchestrating two backdated grants and falsifying documentation for them, has pleaded innocent to fraud claims and is preparing for trial. Anderson has settled a lesser claim of negligence involving one grant, paying $3.64 million in disgorgement and fines, while remaining free to serve as an officer or director of public companies (he chairs the audit committee at eBay).
Anderson, in an extraordinary public statement he issued after settling his case with the SEC, disputed Apple's exoneration of Jobs. Through his lawyer, he said he alerted Jobs to the accounting implications even as the CEO was in the process of picking a retroactive date for the grant to his top lieutenants. He also said Jobs assured him that the award had been properly approved by Apple's board.
The story of that grant opens in late 2000, a panicky time for Apple. Silicon Valley was reeling from the dot-com crash. Apple had missed its quarterly numbers, and after a big run-up in the company's stock (multiplying the company's market cap from $2 billion to $16 billion), Apple's market value had melted back down to $5 billion. Jobs feared that his inner circle was ripe for poaching.
In October 2000, Jobs started talking to the directors about giving the executive team a big grant to place them in golden handcuffs. At the time - for 15 months, in fact - Apple's board had no compensation committee providing oversight over the CEO's grant practices, an extremely unusual situation. (Almost 99% of public companies at the time had compensation committees, according to a study by the research firm ISS, a unit of RiskMetrics.)
In late 2000, Jobs told at least one of his top lieutenants to expect the options to be priced on Jan. 2, 2001. But at the end of January, Jobs was still consulting with Heinen about the grant. The stock had been climbing that month, which meant that options would have a higher exercise price than if they had been granted on Jan. 2.
On Jan. 30, 2001, according to the SEC's suit, Heinen e-mailed Jobs with a list of possible retroactive dates for the grant; Anderson got the list too. The goal was to get the executive team a price almost as low as the close on Jan. 2. (Heinen thought that using the original date might draw public criticism for springloading because Apple stock had jumped just a few days later on product announcements by Jobs at Macworld.)
Jobs picked Jan. 17 for the executive team grant, a date when Apple shares still had a nice low closing price. According to the SEC suit, Heinen instructed a staff attorney, Wendy Howell, to prepare a "unanimous written consent" (UWC) for the signature of Apple board members, retroactively approving the options with "an effective date of Jan. 17, 2001, priced at [$8.41]." (All share prices and numbers of options in this story are adjusted for subsequent splits in Apple stock.)
The board members didn't fax back the signed papers for the executive-team stock-options grant until Feb. 7 - which, in the SEC's view, made that the proper grant date. By then, Apple stock was up 23% over the Jan. 17 grant price. This meant each of the six executives receiving options got a paper windfall of either $1.6 million or $3.9 million, depending on the size of their grant. According to the SEC, it also meant Apple had engaged in illegal backdating, awarding in-the-money options without disclosing it and inflating company earnings by failing to record the $18.9 million expense on its financial statements.
Apple directors, like the company, refused to make any public comment for this story. But in response to shareholder lawsuits, Apple's lawyers argued that the directors routinely signed UWCs giving perfunctory approval to option grants they'd effectively delegated to management. Similarly, the lawyers argued, Jobs had no reason to think there was a problem, because his CFO and general counsel had signed off on the grant.
As a condition of taking over in 1997, Jobs had fired most of Apple's board, installing a new one with just six members. Only two directors were holdovers: Edgar Woolard, the retired DuPont chairman, and Gareth Chang, senior vice president of Hughes Electronics. The others were Oracle (ORCL, Fortune 500) CEO Larry Ellison, a close friend of Jobs; Intuit CEO Bill Campbell, who had worked at Apple back in the 1980s and was Jobs' neighbor; Jerry York, a former CFO of IBM and Chrysler, who later became CEO of Micro Warehouse, a computer reseller that did extensive business with Apple; and Jobs himself.
Apple's board has drawn criticism from governance experts for years. In his 2002 book, "Take On the Street," former SEC chairman Arthur Levitt complained that Apple's governing body simply failed to meet "good governance litmus tests." Levitt wrote, "It's plain to me that Apple's board is not designed to act independently of the CEO." A self-described "Apple junkie," Levitt had actually been invited by Jobs to become an Apple director in February 2001 - only to be "disinvited" after returning from a visit to Silicon Valley. "Arthur, I don't think you'd be happy on our board and I think it best if we not invite you," Levitt recounts Jobs telling him in a phone call. Levitt says Jobs explained that he had come to this conclusion after reading a Levitt speech on corporate governance. "Frankly, I think some of the issues you raised, while appropriate for some companies, really don't apply to Apple's culture," Jobs told him. Levitt says he was "floored."
No question, Apple's culture at this level was out of the ordinary. Jobs accepted a salary of $1 a year. In January 2000, after the stock had soared and the company's survival seemed assured, Apple announced that it was buying Jobs a jet - not a corporate jet for him to use, mind you, but his own Gulfstream V. Total cost to the company, including Jobs' taxes on the gift: $88 million. While the plane has long been cast as a board's creative gesture of gratitude, Woolard says Jobs is the one who thought of it. "He brought up the idea: 'What I really need is a plane where I can take my family to Hawaii on vacation, go to the East Coast.' I said, 'All right.'" Larry Ellison declared, "With what he's done, we ought to give him five airplanes!" Jobs also got a mega-grant of 40 million options - almost 6% of the company, priced at $21.80 a share. Half would vest immediately, the rest within 18 months. That was unusual, but the board reasoned that it should make up for the 30 months when Jobs had worked for a buck a year.
Jobs' own options would lead to the second SEC problem for Apple, though only Heinen would face charges for it. The issue arose after the dot-com crash sent Apple's stock price back below $10, and the Apple board, eager to keep Jobs happy, voted on Aug. 29, 2001, to give him a fresh batch of 15 million options at $8.92. But Jobs - sensitive to press criticism he'd been receiving for his 2000 mega-grant, which was underwater - refused to accept the new award unless the board canceled bis previous one. Accounting complications that made it impractical to do this - as well as wrangling over the vesting schedule - dragged the matter out until December.
That created a fresh problem: How to price Jobs' award? The stock had climbed since the original board vote back in August, and using that date wouldn't have withstood scrutiny because Apple was now in a new fiscal year. After Heinen reviewed a spreadsheet showing closing prices for a three-month period with Arthur Levinson, a member of Apple's reconstituted comp committee and the CEO of Genentech (DNA), the grant was dated on Oct. 19.
The grant's strike price ($9.15) wouldn't be as good as it was back in August, but it was better than the $10.51 the stock hit on Dec. 18 - which, according to the SEC, was the proper price for the grant. Levinson informed the board about the arrangements in an e-mail, noting that he had instructed Heinen to make sure Apple was "conforming to all legal requirements/guidelines."
It wasn't. The SEC claims that Heinen ordered Howell to dummy up the necessary paperwork to make it look like the full board approved the grant at a special meeting on Oct. 19 - a meeting that never took place. Heinen denies this, blaming her subordinate for creating the phony documents.
All this gave Jobs a paper backdating windfall of about $20 million, according to the SEC. But he never cashed in the options, and in March 2003, after Apple's share price kept dropping, Jobs traded his entire stake of 55 million underwater options for the certainty often million restricted shares. In perfect hindsight, given Apple's soaring stock price since that time, he lost a fortune on the deal. Jobs' restricted shares would sell today for about $1.2 billion before taxes. His options, had he kept them, would yield about $5.8 billion (pretax).
Pixar's board did have a compensation committee, but it never met. In fact, the entire Pixar board - also handpicked by Jobs - typically met only about three times a year. Jobs personally negotiated options awards with key executives.
The biggest such grant at issue - two million options - had gone to Toy Story director John Lasseter, Pixar's star creative executive, as part of the ten-year contract he had negotiated with Jobs in 2001. Jobs never received Pixar options himself, but he owned more than half the company, and locking up Lasseter led Disney to buy Pixar in 2006, in an enormously lucrative deal for Jobs that made him Disney's largest shareholder.
Joe Graziano, the former Apple CFO who served on the Pixar board from 1995 until the Disney sale, acknowledges that Lasseter was "the single biggest asset at Pixar." He blames any backdating problems on "an administrative glitch," delaying the completion of paperwork authorizing grants that Jobs had promised. "It was normal for him to come into the board and say, 'This is what we want to do for compensation. We got these two guys. We want to give them these shares and lock them up.' And the board said, 'Go for it.' But unfortunately the documents get signed months later."
That, of course, means the grants were issued improperly. And "glitches" don't explain how grants to the company's most valuable players could be issued at the lowest annual stock price in four separate years.
Pixar, by the time of the backdating disclosures, was no longer a public company but a Disney subsidiary and had no board of its own. At Apple, however, shareholder activists have expressed dismay with the way the company has dealt with the matter. Jobs did issue a brief statement that promised remedial measures and said, "I apologize to Apple's shareholders and employees for these problems, which happened on my watch." But beyond its initial press release and a limited elaboration in a subsequent SEC filing, Apple explained nothing about how the backdating had occurred and demanded repayment from no one.
In a detailed report to Apple investors, ISS criticized the board's lack of candor, stating, "Steve Jobs has been instrumental in creating significant shareholder value; however, a cult-like devotion to any CEO can be a huge downside risk to shareholders." Glass Lewis, another shareholder advisory firm, described the special committee findings absolving Jobs as "an attempt to whitewash the backdating scandal."
At Apple's annual shareholder meeting last May in Cupertino, the two firms recommended that shareholders withhold their votes for reelecting most of the outside Apple directors. For three of the directors, more than 30% of shareholders did. By the rubber-stamp standards of such proceedings, a 30% vote against directors of a company on a tear - the iPhone was about to go on sale, the stock was headed to the moon - is noteworthy.