The reality about Steve Jobs and stock options

We’re not going to spend more space right now in MDJ or MWJ refuting items that were obviously false months ago, but it is disappointing to see Dave Winer appear to endorse a story about Apple’s backdated stock-option controversy, quoting a passage that says “Apple will end up being a model case of how NOT to handle such affairs, and Intellectual Dishonesty will have cost the company more than dishonesty itself.”

The actual story, from Mark Anderson of the “Strategic News Service,” claims that Steve Jobs did benefit from backdated stock options because he later traded in all of his options for shares of restricted stock, and they wouldn’t have been worth as much if they hadn’t been backdated.

This isn’t “intellectual dishonesty” from SNS as much as it is “intellectual laziness.” First, as noted in MWJ 2003.04.14, not long after Jobs traded in his options for shares, all of Jobs’ options were underwater at the time. Even the ones that hadn’t vested were still underwater. Jobs exchanged 27,500,000 options that were almost all vested but seriously underwater for less than 20% as many shares – 5,000,000 – that he would not be able to sell or vote or do anything with for three more years.

To argue now, three and a half years later, that Jobs benefited because these options were underwater by US$30 per share instead of US$32 per share doesn’t pass the laugh test. In fact, as of the day Jobs made the switch (2003.03.19), it would have been a net loss for him if Apple’s stock didn’t pass US$44.85 per share by the time the shares vested in March 2006. As of the day of the options-for-future-shares exchange, Apple’s stock closed at US$14.95 per share. If Apple’s stock didn’t at least triple in a three-year period, Jobs would lose money on the exchange. This is the transaction that SNS now says “benefitted” Jobs because his never-exercised, heavily-underwater options could have been two or three bucks more underwater per share.

Second, all this presumes that Jobs is interested in selling Apple stock or exercising Apple’s options. There is not one piece of evidence to support that idea – not a single one. For this, we quote from MWJ 2006.08.05:

Early reports seemed to zoom in on Jobs’ 2000 stock option grant, the one that was for 20,000,000 shares by the time he exchanged it for restricted shares in 2003, thanks to the February 2000 2-for-1 stock split. The famous grant captured media and analyst attention after Apple’s announcement, even though no one could explain why it might be irregular. In fact, it doesn’t look bad at all: Apple granted the options to Jobs on 2000.01.12, and announced it just one week later, on 2000.01.19. Unless the company was scanning a much larger period but chose to backdate the options by only one week, there’s not much “there” there.

Observers looking for some hint of backdating seem to have forgotten about Jobs’ second grant – 7,500,000 options with a striking price of US$18.30 per share (or US$9.15 per share in today’s split-adjusted pricing), awarded on 2001.10.19 because all of the previous 10,000,000 (pre-split) options were underwater. The potential problem? Apple didn’t reveal the grant until an SEC filing in March 2002.

Using prices in today’s shares (after 2-for-1 splits in both 2000 and 2005), an examination of Apple’s stock prices finds that during the window between 2001.10.19 and 2002.03.22, Apple’s stock closed between US$8.78 and US$12.73 per share. For example, on 2002.03.04, Apple’s stock closed at US$12.15 per share, a full US$3 per share higher than Jobs’ option striking price of US$9.15 per share. If Apple’s board actually awarded the options in early March 2002, but backdated them to 2001.10.19, it would have made Jobs’ grant worth US$45 million more than had they been awarded on 2001.10.19.

Before you shout “j’accuse!” at this revelation, you should realize there are plenty of problems with this theory. First, if Apple’s board tried to backdate options to give Jobs more money, then why didn’t the directors pick one of the four other dates in that same window when the closing price was lower than US$9.15 per share: 2001.10.23 (US$9.07), 2001.10.29 (US$8.81), 2001.10.30 (US$8.80), or 2001.10.31 (US$8.78)? Two trading days before the grant date, Apple’s stock closed at US$8.49 per share (2001.10.17); two weeks before that, the stock closed at US$7.49 per split-adjusted share (2001.10.03). If the directors were willing to backdate six months to give Jobs an additional US$45 million, why not an additional three weeks when that would have added another US$24.9 million to the same grant?

Second, you must consider that Jobs has not exercised a single option or sold a single share of his Apple stock since returning to the company, except in March 2006. We explained that at the time on the MacJournals-Talk mailing list, currently on hiatus. Jobs sold almost half of his shares of Apple stock, starting on 2006.03.19 (yes, a Sunday), at US$64.66 per share.

As of that week, Jobs completely owned 10,000,004 shares of Apple stock. Jobs received 1,500,000 shares of Apple stock in late 1996 for selling NeXT to Apple Computer, and according to former CEO Gil Amelio’s book On the Firing Line, Jobs promised not to sell the shares for six months to avoid undermining public confidence in Apple. Amelio says that Jobs professed to understand how important it was to hold that stock longer than six months.

Instead, just as he had sold all but one share of Apple stock after being evicted from the company in 1986, Jobs turned around in 1997 and sold all but one of his new shares as soon as the six-month period had elapsed. The sale, at near record-low prices for Apple stock, hurt investor confidence in Apple and helped usher Amelio out the door nine years ago (MWJ 1998.04.06). That one share turned into four shares with 2-for-1 stock splits in 2000 and 2005.

That was all of the stock Jobs owned until March 2006, when his restricted grant of 10,000,000 shares (not options, and doubled from 5,000,000 thanks to the 2005 split) vested in full. Once they vested, though, they became his personal property. As far as the IRS is concerned, a gain of 10,000,000 shares at US$64.66 per share is income of US$646,600,000. That makes for a hefty tax bill that has to be paid in cash, not in shares of stock.

The SEC recognizes that this happens. Company insiders (executives and directors) are required to notify the SEC and the public when they sell shares of stock so that there’s no secret insider trading. Every year, around the time of Apple’s annual meeting, another round of executive stock options vests, and there’s a slew of SEC Form 4 filings as Apple’s executives turn those restricted options into actual Mercedes-buying cash.

Jobs had never done this, and his own filing showed that his sale wasn’t the usual kind. Form 4 has a “transaction code” in section 3 of Table I, and it’s almost always either “P” (purchase) or “S” (sell). For Jobs’ transaction, the code was “F”: “Payment of exercise price or tax liability by delivering or withholding securities incident to the receipt, exercise or vesting of a security issued in accordance with Rule 16b-3.” That rule lists exemptions to filing notice of insider trading; Apple’s grant of shares to Jobs qualifies because Apple’s board of directors approved it. It means that Jobs didn’t have to file Form 4 when he gained ownership of the shares.

In short, Jobs sold 46% of his new Apple shares to pay the taxes on the 54% that he kept. Even if Jobs had US$295 million in cash lying around, he probably didn’t want to spend it on taxes just to preserve shares that he hasn’t shown any interest in exploiting for nine years. Other than this tax obligation, Jobs has neither sold shares nor exercised options on Apple stock [since taking over as interim CEO in July 1997], not on a single share, even though they were worth hundreds of millions of dollars.

Jobs’ history with Apple shares strongly suggests that he views [options and shares] not as liquid assets, but as recognition of success and as power chits. Jobs doesn’t seek compensation from the companies where he works, and recently made news by refusing compensation for his service on the board of directors of The Walt Disney Company. (Disney’s board had to modify the director compensation policy to accommodate Jobs – the existing plan had no provision for a director declining to be paid. The SEC filing about the change tipped off the media.)

Jobs holds on to the stock of companies where he works, and sells it only in dramatic gestures when he’s not in charge and things aren’t going his way. It wouldn’t surprise us for Jobs to sell all but one share of his Disney stock if he perceives management as fouling up his Pixar legacy. Given all this, it just doesn’t make much sense to believe that Apple’s board would go to such lengths to backdate options for a man who obviously didn’t care to exercise them anyway. As long as Jobs is in charge of Apple Computer, he has no interest in selling stock or options.

Given these facts, what does Mark Anderson of SNS say about it?

Here is my conclusion: I think (and I have no direct evidence for this, other than the behaviors and quotes from those involved) that Steve Jobs was aware of the practice, did personally benefit, and had some role in the granting and dating of those options.

So, Anderson says if certain things had happened that didn’t, and if Jobs had done something that he didn’t do, then the statements that Apple made about what really happened would be false and Steve Jobs is in legal trouble.

We were talking about “intellectual dishonesty?”