oPtion$ Book Club: A (Fictional) Version of the Backdating Scandal

I wanted to respond to the question posed by Dan Lyons: could Jobs still be indicted for the backdating at Apple?  And perhaps, the question lurking behind this one: why hasn't he been indicted already?

Many of the "oPtion$" reviews have noted its  somewhat fanciful plot.  What surprised me about the book, however, was how close the plot points actually followed reality. 

• In the book, Apple GC Sonya Bourne resigns almost immediately after the backdating scandal breaks.  In reality, Apple GC Nancy Heinen resigned in May 2006 without a reported reason.  She has since been civilly charged by the SEC for backdating.
• In the  book, Apple blames former CFO and board member Zack Johnson for the backdating.  After Apple blames him for the scandal, Johnson then agrees to a plea and to testify against Jobs.  In reality, former Apple CFO and board member Fred Anderson settled SEC backdating charges for a payment of a civil penalty and a $3.49 million disgorgement.  He also issued a statement claiming that Jobs knew about and in some cases directed the backdating.
• In the book, the final straw for the Apple board is when they find out that Jobs falsely claimed that certain options were approved at a board meeting that never happened.  In reality, Anderson claims that Jobs provided assurances that the board had approved certain grants and that Anderson "relied" on these assurances.

One of the reasons why I was eager to read "oPtion$" was to see its take on the role Jobs played in the backdating.  What was fake Steve's motive?

Motive plays a critical role in the backdating scandal.  Why did firms backdate their options grants?  Was it simply to manage the process so that the company could (knowingly) reward its employees more handsomely, given accounting constraints?  Or was backdating an attempt by some in the company (generally the officers) to increase their compensation without the approval of the board or shareholders?

The fake Steve of "oPtion$" doesn't really show his cards to the readers on this point.  Fake Steve is so rich that he seems unconcerned and disconnected from his yearly compensation.  But at other points, he seems well aware of what happened.  For example, he justifies backdating at Pixar as a way to "sweeten things a little bit more" for John Lasseter, who was being courted by Disney at the time (p. 112-13).  (Thus, in fake Steve's view, Disney is to blame for the backdating.)  At another point, former CFO Johnson claims that Jobs knew all about the backdating and, in fact, directed Jonhson to do it (pp. 87-89).  During the conversation, Jobs claims ignorance.   Although it seems like we're not supposed to believe Jobs here, he never comes out and confesses to the reader.  He just doesn't seem to care.

The closest the book comes to laying out the case against backdating is this soliloquy from Apple's chairman Tom Bowditch (p. 89):

I know what you did.  You double-dipped.  Wasn't enough for you to get ten million shares.  You had to backdate them, too, and try to squeeze a little extra out of it. . . . Maybe you figure nobody in Washington actually reads those forms you send in every quarter.  Maybe you figured nobody would care, or that they'd give you a pass because you're the Great Steve Jobs.  Well, you're wrong.

But it's hard to know if this is an accurate indictment, because (1) Jobs never owns up to this, and (2) Bowditch turns out to have a huge short position in Apple stock and thus wants Jobs to resign.

As I've said before, it's clear to me that backdating was a method of increasing the value of the options and thus increasing the value of the pay.  I don't think many CFOs said, "We can give 10 million backdated options or 10.2 million correctly date options -- which is better?"  Instead, I'd guess that the number of options was settled on, and then the backdating was applied as a "bonus."

But who knew about the bonus?  That seems critical.  If the board was on board with the backdating, it seems less like stealing.  Since the board is charged with negotiating and approving executive pay, the board's knowledge would seem to lend the corporation's approval.  Dennis Kozlowski sits in jail because he failed to get board approval for expenses and loan forgiveness.  The same could be said of backdating.

Even with Board approval, however, there are problems.  "Backdating" is, by definition, lying about the date of the option.  So a scheme of backdating is designed to mislead somebody -- the board, shareholders, and/or the SEC -- about the date of the grant.  A scheme to avoid the accounting rule in this manner is akin to other forms of accounting gamesmanship.  The scheme in Brocade was apparently along these lines.  Moreover, as Vic Fleischer has discussed, companies that were backdating options were also violating the tax law.

My sense is that when it comes to Steve Jobs, criminal charges would only come if he knew about the backdating and purposefully circumvented the board and/or accounting rules in conducting the scheme.  There is certainly evidence from Fred Anderson to this effect.  But the independent Apple report seems to place all the blame on Anderson and Heinen.  Perhaps the SEC is being overly credulous, as Lyons indicates, in believing that Jobs was not intimately involved in the scheme.  But perhaps the government may have decided to avoid a risky trial based on Jobs's intent.  In the Brocade case, there appears to have been sufficient evidence that Reyes knowingly and repeatedly backdated to avoid the accounting hit.  Although the judge in the Brocade case indicated some concern with the mens rea issue, there was evidence from a former human resources employee that Mr. Reyes told her that the practice was “not illegal if you don’t get caught.”  There may not be such clear evidence of knowing illegality with respect to Jobs.

I don't know all of the facts, certainly, so I don't want to endorse or justify this decision.  Without all of the facts, we can only speculate about motives -- which is part of what makes "oPtion$" so fun.  In the book, an iPhone-crazed mob chases U.S. attorney Doyle to his death.  I'm not sure whether this is poetic justice or an exaggerated metaphor for reality.