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At Apple, Timing Led To Overnight Windfalls

Stock option grants in 1997 came on the eve of a big share-price jump.

`Conditions Were Ripe'

Corporate culture is criticized in a lawsuit.

January 03, 2007|Dawn C. Chmielewski | Times Staff Writer

In August 1997, Apple Computer Inc. handed four top executives options to buy a total of nearly 1 million shares. The next day, the value of those options jumped a staggering 48%, or $7.7 million.

This was no coincidence, according to a shareholder lawsuit filed against executives and directors of the Cupertino, Calif.-based company in federal court in Northern California. Rather, the options were granted to coincide with good news that would give the four executives an overnight windfall.

The stock soared when co-founder Steve Jobs announced that Apple's sworn enemy, Microsoft Corp., threw the struggling company a life raft in the form of a $150-million cash infusion. In exchange, Apple gave Microsoft a stake in the company and agreed to use the software giant's Web browser on its Mac personal computers.

The investment rocked the high-tech world at the time but became only a footnote in the astonishing comeback of a company as celebrated today for its marketing and design prowess as Nike, Prada or Mercedes-Benz.

But the grants are an example of the fast-and-loose practices that went unchecked in a corporate culture fashioned by Jobs to revive Apple, which by 1997 was hemorrhaging money, according to the lawsuit, a combination of 11 shareholder complaints.

"The company was struggling, was cash-poor and reliant upon stock options to bring and keep executives there, so the conditions [for manipulation] were ripe," said Mark Molumphy, a partner at Cotchett, Pitre, Simon & McCarthy, the lead law firm in the case.

Apple declined to comment on the lawsuit.

Filed days before Christmas, it alleges that Apple engaged in widespread manipulation of option grants to allow employees to buy shares at low prices. Apple "spring-loaded" options in advance of good news and "backdated" other grants to days when the stock traded at low prices to create an automatic paper profit, claims the suit, which has only recently come to light.

"What they've done -- and it's not isolated -- is utilized confidential internal corporate data in a way to divert to themselves substantial profits," said Darren Robbins, a San Diego lawyer involved in the shareholder lawsuit. "That constitutes both a breach of fiduciary duty and a violation of federal securities law."

On Friday, Apple absolved Jobs of wrongdoing after a three-month internal investigation of its option practices. The company, however, acknowledged 6,428 instances of improperly dating option grants over a six-year period, when it had "insufficient safeguards" to prevent stock manipulation, according to a filing with the Securities and Exchange Commission. The first incident occurred on Dec. 29, 1997, just a few months after Jobs had returned to the company and taken the title of "interim" chief executive.

'Instant windfall'

In some cases, Apple's filing said, Jobs had recommended the options be backdated to create an instant windfall for executives. It said he had neither benefited financially nor appreciated the accounting implications of backdating, which forced the company to take an $83-million charge against earnings in 2006 for underreporting expenses related to employee compensation.

The company's admissions have raised new questions among securities lawyers and corporate governance experts about Jobs' role in the controversy. "There has been a tacit admission that Steve Jobs served as a ringleader in this backdating process," said Christopher Bebel, a former SEC counsel and prosecutor who is not involved in the lawsuit.

He predicted that Apple's insistence that current management had done nothing wrong could "come back to haunt the company" in a scenario similar to Martha Stewart telling investors she had participated in no wrongdoing and later being indicted on securities fraud. "[Jobs] may find himself in a Martha Stewart quandary with obstruction of justice charges."

In its filing Friday, Apple said it had "serious concerns" about the involvement in the granting, recording and accounting of option grants by two former corporate officers it did not name but who are believed to be former General Counsel Nancy R. Heinen and former Chief Financial Officer Fred D. Anderson.

The company said its review found no instances of backdating from 2003 through 2005, when new procedures and controls on granting options were put in place to comply with the Sarbanes-Oxley Act.

Apple is among nearly 200 companies whose option-dating practices are under internal investigation or being probed by federal regulators. At least 65 executives and directors have resigned or been fired after being implicated in the scandal, including Bruce Karatz, head of Los Angeles home builder KB Home, and UnitedHealth Group Inc. CEO William McGuire.

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