Last week, on a sunny Tuesday morning in San Francisco, California, fans of Apple Macs queued up outside the convention centre to witness chief executive Steve Jobs' keynote address at the 2007 Macworld Expo. Jobs was due to speak at 9 in the morning; the line was already growing around midnight.

Apple chief executive Steve Jobs has been accused of benefiting from backdated stock options. Credit: P. SAKUMA/AP

The annual Expo is a celebration of all things Apple. But attendees were not just queuing to see the new iPhone. They came for the pageantry and to witness Jobs' famous enthusiasm first hand.

Jobs has been in the spotlight for the wrong reasons this year, however — for his possible involvement in the manipulation of the timing of stock options at Apple.

Stock options are awards of equity that senior employees can sell long after the date they were granted. But Apple, along with other US companies, now stands accused of fixing the dates of its stock-options grants retrospectively, so that their award date marks a low point in the share price. That means that when the option is exercised, the awardee can buy at this low price and sell at a tidy profit.

Apple, now the defendant in a lawsuit brought against it by shareholders, has already confessed to backdating stock options, and Jobs knew about the practice — he even recommended a few good dates to use. But whether or not Jobs benefited personally remains an open question.

Backdating is illegal only if the company does not account for it in its earnings reports. But it is now evident that many companies, including Apple, have not followed this procedure. In the past year alone, more than 120 similar investigations have been launched, and lawsuits have been brought against 22 companies for securities fraud.

For some companies, the consequences are minor. Affymetrix, a gene-chip company in Santa Clara, California, launched an internal investigation in response to a shareholder lawsuit. It eventually concluded that despite a few isolated “documentation lapses”, there was no pattern of stock-option backdating. The lawsuit is still pending, but Quintin Lai, an analyst at the Milwaukee-based financial-advice firm Robert W. Baird, doubts that the episode will have a major impact on the company.

But the consequences can sometimes be severe. “In the worst-case situation,” says Joseph Grundfest, a securities law professor at Stanford University in California, “you lose your senior management team, the company spends tens of millions of dollars on an investigation, and the stock gets trashed.” Executives at Comverse, a telecommunications firm based in New York, for example, have been charged with criminal fraud. One of the executives agreed to pay US$3 million to settle the case with the Securities and Exchange Commission (SEC) — the body that regulates public companies in the United States.

The allegations started to gather steam after Erik Lie, an economist at the University of Iowa in Iowa City, sent a paper he wrote on the topic (Management Sci. 51, 802–812; 2005) to the SEC. The paper described a peculiar trend — a graph of average stock prices before and after a stock-option grant was shaped like a 'v', with the trough on the day of the award (see graph). “The results suggest that at least some of the awards are timed retroactively,” Lie wrote.

Credit: SOURCE: E. LIE

The SEC's investigations became public in spring 2006. So far, more than half the investigations are in sectors such as computer software and biotechnology, in which profits are often low and senior executives look to stock options for their reward. “In the high-tech sector, the currency of the realm was stock options,” says James Cox, a law professor at Duke Law School in Durham, North Carolina. “It was a very seductive environment for backdating to prevail.”

Most investigations revolve around awards granted before 2002, when the SEC tightened disclosure requirements in response to the Enron scandal, and required that options be reported within two days of their starting date. That gave firms a much smaller window from which to select a stock price, and Lie's data show that the prevalence of backdating of stock options retreated sharply after that time.

But Lie says that the practice was still alive in 2005, with 13% of stock-option grants still filed late, and the SEC does not have the staff to pursue late compliers.

And as painful as it may prove to be for Jobs and others who have been accused, the Apple scandal is unlikely to rock corporate America as the Enron one did five years ago. Grundfest says that enhanced disclosure requirements have already drawn the sting from the issue. “The word is out,” as Grundfest puts it: “Thou shalt not backdate.” Companies have now found other ways to reward key employees, such as restricted stock. Only time will tell whether these methods are also being manipulated to gain an advantage over ordinary shareholders.