Will an Apple a day keep the lawyers away?

By DAVID MOON, Moon Capital Management
January 7, 2007

You've likely heard the adage that there are two systems of justice in our country: one for the wealthy, and one for everyone else. Perhaps being a technology and consumer electronics folk hero also earns you your own category.

Let's watch Apple's Steve Jobs and the case of the magic options to find out.

An internal investigation at Apple Computer discovered that for at least five years, the company engaged in the backdating of options.

An option gives its holder the right to buy a stock at a certain price. Companies give options to employees to create an incentive for the employees to work to increase the stock price, hence creating value when the stock price increases above its current level.

When companies backdate options, they grant options to employees at prices that are lower than the current price, guaranteeing the employee a profit even if the stock price doesn't increase at all. The award is reported, however, as if the employee had some risk in the transaction.

Not only was Apply Computer issuing these backdated options to its employees, but the investigation found that CEO Steve Jobs was aware of the practice.

Do not despair, iPod owners. Apple wants you to know that Jobs never personally received any of the backdated options and he never personally profited from the transactions, so he shouldn't be in any trouble.

But as a shareholder, Jobs did benefit to the extent that backdating the options allowed Apple to underreport its compensation expense, thus overstating its earnings.

Perhaps the Jobs fans should take a look at the pending criminal case against former Brocade Communications Systems CEO Gregory Reyes.

Brocade, based in San Jose, Calif., manufactures switching devices for data-storage networks. In the first criminal case involving options backdating, Reyes and the company's former human-resources director each face up to 20 years in prison. Prosecutors say that Reyes backdated options, thus violating accounting rules by underreporting the proper expense for the options.

Here's the irony: Reyes isn't accused of personally receiving any of the backdated options. He was aware of the practice and condoned it, but, like Jobs, argues that he never profited from it.

The Securities and Exchange Commission says it is investigating 80 or more companies for this practice. The Brocade case is an interesting one for the Justice Department to choose to try first, since the CEO didn't receive any of the backdated options.

But that might be a signal that the government doesn't intend to treat these cases lightly ' even if the CEOs argue that they didn't personally profit.

Few, if any, large companies have their identities as closely tied to their CEO as Apple. Steve Jobs is both Apple's father and savior. Some suggest that Jobs is safe from board scrutiny because he is simply too valuable to the company to dismiss.

I don't think the Department of Justice cares about that.

At this point, there's no way to tell if Jobs' involvement compares to Reyes' or if either rises to the level of criminal activity. But the 'I didn't profit from it, so I shouldn't be held responsible' arguments are almost identical.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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