The SEC's Apple probe: What you need to know

Earlier this week, the investigation into the practice of backdating stock options at Apple resulted in the U.S. Securities and Exchange Commission filing charges against one former Apple executive while reaching a settlement with another. Here’s a summary of what’s happened in the investigation so far and what could potentially happen in the wake of this week’s events.

What is stock-option backdating, and why is Apple under scrutiny for it?

We offer a more thorough explanation of backdating here, but as a quick refresher, backdating is a perfectly legal practice in which a company backdates the strike price of an option to a more favorable date, so that the employee’s option becomes more valuable. Again, this is all above board; it only becomes an issue when companies fail to notify shareholders and regulators that it’s taking place so that everyone has the complete picture of the company’s financial dealings.

That’s why Apple—like hundreds of other companies—finds its practices under scrutiny. The company has acknowledged irregularities in some of the stock option grants it issued between 1997 and 2001. More troubling from the perspective of regulators is that some of the options in question were allegedly approved by Apple’s board of directors at meetings that never took place.

What, specifically, has happened so far?

After announcing in June 2006 that its internal probe had found irregularities in stock option grants—including one issued to CEO Steve Jobs—Apple conducted an internal investigation, restated its quarterly earnings from 1997 to 2005, and cleared current executives of any misconduct. In October 2006, as Apple announced the results of a three-month probe into stock option practices, Fred Anderson, Apple’s CFO from 1996 to 2004, resigned from his seat on the company’s board of directors. His departure followed that of Apple counsel Nancy Heinen, who left the company last May.

The exits of Heinen and Anderson, coupled with Apple clearing current employees of any wrong-doing, seemed to suggest that the two ex-Apple executives would be the focus of the government’s investigation. And that speculation proved correct this week, when the SEC announced its plans to pursue a complaint against Heinen while settling with Anderson.

What are the charges against Heinen?

The SEC alleges that Heinen helped backdate options given to top Apple executives, causing the company to under-report its expenses by $40 million. Specifically, the SEC claims that Heinen backdated a February 2001 grant of 4.8 million options to January 17, allegedly telling her staff to prepare false documents showing that the board of directors had acted on that day. A December 2001 grant of 7.5 million options to Jobs was attributed to a non-existent board meeting on October 19. The SEC is seeking a penalty payment and refund of profits from Heinen, as well as an order barring her from serving as an officer or director of any other public company.

Heinen’s attorney has refuted the SEC’s allegations saying, “Nancy Heinen’s integrity is unimpeachable.”

What are the terms of Fred Anderson’s settlement with the SEC?

Anderson will repay $3.5 million in what the SEC termed “ill-gotten gains and prejudgment interest,” plus a $150,000 fine. “[Heinen and Anderson] failed in their duty as gatekeepers and caused Apple to conceal millions of dollars in stock option expenses,” said Marc Fagel, associate regional director of the SEC’s San Francisco office.

So that settles the matter?

Possibly. In announcing the action against Heinen and the settlement with Anderson, the SEC said it would not bring any enforcement action against Apple, citing the company’s “swift, extensive, and extraordinary cooperation in the Commission’s investigation.” When Apple was reached for comment by Macworld this week, it specifically cited the SEC’s statement on its cooperation and reiterated that no current employee has been charged with any wrong-doing.

“Wall Street views this as an all-clear for [Steve Jobs],” said Piper Jaffray analyst Gene Munster.

However, in a research note to clients, Lehman Brothers senior vice president Harry Blount noted that the SEC’s press release made no mention of Jobs, specifically, or whether the investigation was completed. “We unsuccessfully attempted to get an answer to both questions,” Blount wrote.

That’s a potentially significant point, in light of a statement released by Anderson, blaming the backdating incident on Jobs.

What did Fred Anderson say about Jobs?

According to a statement released through Anderson’s attorney Tuesday, the one-time chief financial officer was told by Jobs in late January 2001 that he had an agreement with the board of directors to grant stock options on Jan. 2. Anderson said he “cautioned” Jobs that the grant for executives would have to be priced based on the date of the board agreement “or there could be an accounting charge,” and also told Jobs the board would have to confirm it had given prior approval for the grant dates “in a legally satisfactory method.“ According to Anderson, Jobs assured him that the board had given approval and Anderson “relied on these statements by Mr. Jobs and from them concluded the grant was being properly handled.”

Anderson’s comments contradict Apple’s assertion that Jobs, while aware of the backdating, did not realize the accounting implications.

For its part, Apple took the unusual step of issuing a statement from six members of the board of directors dismissing Anderson’s claim and backing Jobs. “We have complete confidence in the conclusions of Apple’s independent investigation, and in Steve’s integrity and his ability to lead Apple,” the statement read.

Why did Anderson make his statement? “The public statement might have been part of the negotiated settlement,” said Andrew Heath, a compliance expert with BusinessEdge solutions. Previous deals between the SEC and targets of backdating probes have prompted similar public statements, he added.

And that statement could be part of a strategy for a subsequent wave of legal action against either Apple or Jobs. “I… think that Mr. Anderson himself, in connection with his SEC settlement, likely agreed to provide testimony that [may] mean additional actions against Apple executives, perhaps even Jobs,” said Robert Brighton, head of the securities law practice group with the law firm Ruden McClosky.

Others have been more dismissive of Anderson’s statement. “This is a self-serving press release for Anderson,” Piper Jaffray’s Munster said. “Everything he said [Tuesday] is what he said to the SEC over the last nine months.”

Still, Lehman’s Blount wrote in his research note, the impact of Anderson’s comments bears watching. “We would note that Apple and Pixar have both already absolved Jobs of wrongdoing relating to the stock option investigation,” Blount wrote. “However, Mr. Anderson’s statement suggests that Mr. Jobs misrepresented the Board’s approval of the option grant. We believe Mr. Anderson’s statement modestly increases the possibility of an adverse outcome for shareholders.”

Are there likely to be more shareholder lawsuits?

A shareholder suit filed in December 2006 charged that Apple’s improper options timing gave Apple executives a windfall at the expense of shareholders. However, it’s not clear whether or not more shareholder suits are pending in the wake of the SEC’s moves.

BusinessEdge Solutions’ Heath says that shareholder lawsuits tend to be linked to investors losing a large amount of money. Although Apple’s restated earnings pared profits by $84 million from 1997 to 2005, Heath points out that an average of $3 million per quarter may not be considered big enough money to recoup via a lawsuit.

“Class actions are kind of a nuisance, and nobody wants to face one,” Heath said. “It’s a lot of money for a law firm to put up [before the case is resolved].”

Brighton notes that another shareholder suit might have a hard time gaining traction in court. “The courts… have been influenced by a backlash against suits by plaintiffs’ attorneys targeting well-known companies and executives, at least in cases where stockholders have not suffered a decline in the value of their shares,” he said. Since Apple’s shares didn’t lose significant value from 1997 to 2002, it would be an uphill battle.

“If there aren’t any [subsequent] lawsuits, that’s a telling statement from the investment community that they don’t feel [the backdating] is a significant issue,” Heath said.

Ben Ames, Robert Mullins, and Nancy Weil of IDG News Service contributed to this report.

Editor’s Note: This article was reposted at 10:05 a.m. on April 30 to correct a typographical error on Fred Anderson’s position with Apple.

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