How Jobs dodged the stock option backdating bullet

In researching this post, I came across a number of recent reports on Henry Nicholas III, the once high-flying CEO and cofounder of Broadcom. The allegations of illicit sex, drugs, and rock and roll reminded me of the 60s ... or was it the 70s? Funny, I can't remember.

While the story was enthralling, I didn't understand what any of it had to do with a federal investigation into stock option backdating. Sure, Broadcom had to take a $2.2 billion charge to fix the accounting mess left by the company's former executives. But how does that relate to hiring prostitutes and drugging customers without their knowledge?

Said another way, do the feds really need to dig that deep to find enough rope to hang executives with? After all, stock option backdating is all the rage these days. You'd think they'd be up to their eyeballs in rope.

I count no fewer than 38 top executives at 19 high-tech companies that have bit the dust over this stuff. We're talking top executives at big-name companies like Apple, Altera, Broadcom, Brocade, Cirrus Logic, Comverse, KLA-Tencor, Maxim, McAfee, Rambus, Sanmina-SCI, Take Two, Trident, Verisign, and Vitesse. And we're just getting started.

That's serious fallout considering that options backdating is legit as long as the company reports it and accounts for it accurately. You see, if you backdate stock options to a date when the price of the stock was lower, then the options are "in-the-money" when granted. That means the company incurs an expense equal to the difference in the share price between the two dates.

If you cover it up and fail to report that expense, the way Apple's folks allegedly did, well, that amounts to accounting fraud. While a few of those 38 terminations may turn out to be the result of such activity, it's likely that the vast majority fell on their swords to avoid sullying the good names of their companies. Of course, they may have actually been pushed on their swords by their boards, but let?s not squabble over details.

In the case of Apple, not only did the board send two sacrificial lambs to slaughter, but the feds hung some pretty hefty charges on their necks to boot. The lambs in question are former Sr. VP, General Counsel, and Secretary Nancy Heinen, and former CFO and director Fred D. Anderson.

The SEC's complaint focuses on the backdating of two large option grants, one of 4.8 million shares for Apple's executive team and the other of 7.5 million shares for Steve Jobs.

Heinen allegedly covered up the back-dating, which caused Apple's earnings to be inflated. This apparently violates a whole bunch of SEC rules. Heinen also exercised and sold 400,000 back-dated shares. For that, the feds seek disgorgement of the ill-gotten gains (about $1.6 million), plus an order barring her from serving as an officer or director of a public company. That's a big hit for Heinen who, at 50, presumably had lots of mileage left in her career.

Anderson got nailed because, according to the complaint, he should have noticed what Heinen was doing and either stopped it or reported the expense properly. He also exercised and sold 750,000 back-dated shares. In a settlement announced concurrent with the complaint, Anderson - who neither admitted nor denied the allegations - agreed to pay back $3.6 million and never to do bad stuff again. That seemed like a contradiction to me, but whatever.

Anderson had already retired in 2004 so, except for giving up some money and his board seat, he got off relatively easy, compared to Heinen.

As for Jobs, a report from Apple's internal investigation indicated that, while he was indeed aware of the options backdating, "he did not financially benefit from these grants or appreciate the accounting implications." In addition to vindicating Jobs, that same report fingered Heinen and Anderson.

Never mind that Anderson, in a press release, claimed to have informed Jobs of the accounting implications of backdating options in 2001. Or that Jobs gave up his outstanding options, which were "underwater," in exchange for 5 million restricted shares in 2003. Or that an investigation by Disney into options backdating at Pixar also cleared Jobs of any wrongdoing, even though he helped negotiate the deal in which Pixar's star film director, John Lasseter, received backdated options.

The bottom line: Claims that Jobs was unaware of the accounting implications of backdating are hardly believable, but there was no evidence to the contrary. And, he did not directly benefit from the backdated options because they were canceled and exchanged for restricted shares. Worst case, it happened on Jobs' watch, but he was far enough removed from the action to claim plausible deniability.

Look, this stuff isn't black and white. Broadcom and others fingered the CEO, but that just shows how subjective this issue is. At the end of the day, Jobs dodged a bullet because of 1) his value to Apple's shareholders, 2) his value to the U.S. economy, and 3) just plain luck that neither Apple's board nor the SEC found a smoking gun to force them to do something they didn't want to do.