Is Apple the next Enron?

[zridling]

Sure looks like the same behavior according to this business2blog post:

Apple is under increased scrutiny by the SEC for how it handled its options going back to 1997, it's quarterly filings will be held up, and the lawsuits are already rolling in.  An Apple release warns:

the financial statements and all earnings and press releases and similar communications issued by the Company relating to periods commencing on September 29, 2002 should therefore not be relied upon.

So were the last four years of iPod-fueled profits a mirage?  Probably not.  But Apple might still find itself in hot water.  One lawsuit chides CEO Steve Jobs for cancelling his options grant in 2003 after the shares fell and replacing them with an outright grant of 7.5 million shares, according to Bloomberg (although the proxy statement says he received 10 million shares that year—go figure). 

Add to that the fact that top Apple execs have been exercising millions of dollars worth of options over the past few months, not to mention making hundreds of millions of dollars more from outright sales (possibly from restricted shares like the ones granted to Jobs).

Apple is not alone in the options scandal hitting tech companies and others these days (there are about 80 companies being investigated), but it certainly would be the SEC's biggest catch.  And if the SEC likes to do one thing in these sorts of sweeps, it is to make an example out of the highest-profile company it can to scare everyone else straight.

All of this kind of puts a damper on next week's Apple developers conference, doesn't it?

[mouser]

i have a question that is not specific to apple: can someone explain to us in layman's terms what all this talk about options backdating is all about?

[zridling]

Here's a nice, though not simple, explanation from CFO.com:

Backdating — setting the grant date of an option earlier than the actual date it is granted, typically in order to take advantage of a lower stock prices — can create tax implications for the recipient, as well as the company. In some instances, it can result in underpayment of income at the ordinary income tax rate and overpayment of capital gains taxes, which carry different rates.

For example, say a company board meets on January 30, 2003, when the company's share price is $25, and decides to grant an employee a $20 stock option with a date of January 1, 2003, when the stock was $20. The board's action makes the option a non-qualified stock option because the exercise price does not equal the fair market value of the stock at the date of the grant.

Non-qualified stock options require tax payment at the ordinary income rate for the difference between the grant price and the price at which the option is exercised (the gain). Non-qualified stock options do not meet the criteria to be treated as an incentive stock option, which has a tax benefit of having the options taxed at the lower capital gains tax rate.

That's a problem if the employee who received the stock options is unaware that the board backdated the options and therefore, believes it is an incentive stock option.

Say, for example, the employee exercises the options on January 1, 2004 at the current share price of $30 and does not report the $10 gain as income. The $10 of ordinary income should have been reported and taxed at the ordinary income tax rate, notes Andrea Rattner, a tax partner at Proskauer Rose. The ordinary income tax rate at the federal level is about 30 percent (excluding situations involving the alternative minimum tax). As a result of the board's backdating and the employee's exercise of the options one year later, the employee underpaid ordinary income tax for 2004.

Say, further, that the employee sells the shares in January 2006, when the stock has reached $40. Believing the stock option to be a qualified incentive stock option, the employee would report capital gains and incorrectly pay the lower, 15 percent capital gains tax.

What would that mean if the IRS then audited the employee? If the employee does not amend his or her tax returns before an audit occurs, the employee would need to assert reasonable cause for the tax position. "They could show a W-2 form from the employer that does not show a gain from options," says Rattner. "The person may have to pay back taxes and interest, but not necessarily penalties."
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Believe it or not, this is not against the law. Crime pays... if you're a corporation!