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Others' options may have paid off for Jobs

If backdating inflated Pixar's profit, Disney might have overpaid in its $7.4-billion purchase of the studio, benefiting its biggest shareholder.

February 10, 2007|Joseph Menn | Times Staff Writer

Could Steve Jobs have benefited from backdating of stock options without actually receiving the securities in question?

Legal and business experts say he might have done just that in the $7.4-billion sale last year of Pixar Animation Studios Inc. to the Walt Disney Co. Jobs, who was Pixar's chairman and chief executive, owned half of its shares and therefore reaped a big reward from the sale of the animation studio.

But Disney shareholders might have overpaid for the animation studio behind such hits as "Cars" and "Toy Story." That could have happened if Pixar's earnings were inflated by an understatement of compensation costs related to option grants years before the Disney deal, according to these experts.

The case is forcing Disney to decide whether Jobs enriched himself at the expense of its shareholders.

Jobs, the CEO of Apple Inc., is Disney's biggest shareholder as a result of the Pixar sale, as well as a Disney director and key advisor on technology to Chief Executive Bob Iger.

In addition to Jobs' role in granting options at Pixar, federal authorities are probing option practices at Apple, which has acknowledged making two grants to him that were improperly dated.

Disney disclosed in November that it had received inquiries from federal regulators about possible option backdating at Pixar. The Burbank-based entertainment giant has launched its own probe of the issue.

A Disney spokesman didn't respond to questions Friday about the investigation. Apple declined to comment.

More than 180 companies are under investigation by the Securities and Exchange Commission for questionable option backdating practices. More than a dozen CEOs have lost their jobs, including Bruce Karatz, former head of Los Angeles-based builder KB Home. A couple of executives have been hit with criminal charges related to the scandal.

Options are rights to buy stock at a set price within a certain time period. The price of stock to be bought using an option is generally the stock's market price on the day the option is granted by the company's board.

In their probes, regulators want to know whether option grant dates were changed after the fact to make them coincide with a stock's lowest price in a particular period. Doing so could give executives instant paper gains on their options. It could also inflate a company's earnings by understating employee compensation costs.

Backdating isn't necessarily illegal, but failing to disclose the practice in a timely manner is.

Pixar is an unusual case because the company no longer exists. That would make government or private lawsuits more complicated. No such claims appear to have been filed.

Any cases would be weakened by a jump in Disney shares since the Pixar deal, in part because of Disney's aggressive Internet strategy. That would make it difficult for Pixar shareholders who held on to their Disney stock to prove they had been damaged by an overstatement of earnings.

Another complication is the widely held belief that Disney overpaid for Pixar to shore up its own weak animation unit and that the price was not actually based on Pixar's reported earnings.

Pixar expressly asserted in its sale documents to Disney that the option dates were accurate.

As of late last month, Disney's investigators hadn't questioned several of the Pixar directors who voted to approve the option grants, according to people familiar with the inquiry and who asked not to be named because of the confidential nature of the probe.

If they did talk to the former Pixar directors, they might not have learned much. The board didn't discuss the dates of the options and took minutes to approve the grants, according to two people knowledgeable of the board discussions.

Instead, the directors relied on dates that appear to have been picked by Pixar's management.

Top executives such as Jobs might have relied on financial and legal executives to choose those dates.

The bottom line at Pixar, said attorney Claudia Allen, who advises corporate boards on options matters, is that "the income was overstated," through such option grants to the likes of Ed Catmull, the former Pixar chief technology officer and now president of feature animation at Disney, and John Lasseter, Pixar vice president for creative development, who is chief creative officer at Disney's film animation and theme-park design units.

Lasseter's good timing with options dates to 1997. On Feb. 21 of that year, he was granted 125,000 at that day's price of $7.06, adjusted for a later split. That was close to the yearly low. Just three days later, Pixar announced a new distribution deal with Disney that drove shares up sharply.

A bigger payday came in 2000.

Lasseter got options on 2-million split-adjusted shares, and Catmull got 1 million options, both with a strike price of $13.25. The options were officially priced Dec. 6, 2000, the stock's lowest point for a year.

In its next proxy statement, Pixar said Lasseter's options were given "in connection with" an employment contract signed March 21, 2001.

Between Dec. 6 and March 21, Pixar's stock rose 17%, making Lasseter's options worth about $4.6 million by the time his employment contract took effect.

As a result, Pixar's fiscal 2000 profit of $78.4 million should have been reduced by roughly that amount, or 5%, ignoring taxes, to account for Lasseter's increased compensation, according to New York University business professor David Yermack, an option expert who first wrote about suspicious timing of option grants in 1997.

Merrill Lynch analyst Richard Farmer, who combed through Pixar's SEC filings and stock history, said the likelihood that so many grants were made at or near so many monthly and yearly lows was one in many millions.


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