Is Apple's $20.5 Million Backdating Settlement Illegal?
Remember backdating? It was the pseudo-scandal launched by the Wall Street Journal's investigative unit, after its reporters began following up on an academic report that demonstrated many executive stock options awards were too well-timed to be plausible.
The basic idea was that many companies seemed to award stock options on days when their stocks were at low-points, which increased the value of the options when the stock increased and made the stock cheaper to buy for the executives. The academics concluded that something funny was going on.
The companies were awarding the options later but then marking the awards to earlier dates, when the stock's price was low.
The reason for doing this was simple: stock options priced at or above where the stock is trading (aka, "out of the money" options) get favorable tax treatment compared to stock awards priced below the market price (aka, "in the money" options). It was a tax advantaged way for companies to pay executives.
I've always considered this a pseudo-scandal. Shareholders were correctly told the number of options granted and the price of the options. No one's pay was "inflated" by backdating, unless you assume that the alternative would have been awarding executives exactly the same number of options at less-advantageous prices. Which, of course, you shouldn't assume since any sensible employee can see that if his each stock option is worth less, he should get more of them.
The total compensation to executives granted back-dated options was either unchanged or, perhaps, lower than it would have been, since people tend to irrationally over-value a bird in hand (in the money options) to a dozen in the bush (out of the money options).
But it all became worse than a pseudo-scandal, in fact. It dominated the business press in 2006 and 2007, right when the financial world was crumbling. It distracted not only the media and the public, but the regulators and courts as well. We'd all have been better off if backdating was seen for what it really was: a rational response to an irrational accounting rule.
Anyway, Apple was alleged to have backdated a number of options. (The practice seems to have been particularly popular in the tech sector.) In 2007, New York City's municipal employee pension fund sued Apple over the backdated options. A federal judge dismissed the case but class-action lawyers working for the pension fund kept the litigation going. Eventually, Apple settled the case, to the tune of $20.5 million.
It would take $20.5 million away from current Apple shareholders and distribute the money as follows:
- $14 million would go to people who bought Apple stock between August 24, 2001 and June 29, 2006 at a price of more than $65.71 a share. [As a practical matter, the highest the shares got in this period were around $75 a share in early 2006. Shares were between $12 and $15 for much of 2001 through 2004. (It closed today at $289 a share.)]
- $4 million would go to "administrative and attorneys fees associated with the settlement."
- $2.5 million would go to "corporate governance programs at 12 universities across the country." Each of the 12 programs would receive a donation of $208,333.33. The programs are the Robert Zicklin Center for Corporate Integrity at Baruch College of the City University of New York, the Center on Corporate Governance at Columbia Law School, the Harvard Law School Forum on Corporate Governance and Financial Regulation, the Institute for Corporate Governance at Indiana University's Kelly School of Business, the Corporate Governance Center at Kennesaw State University College of Business, the Corporate Governance Program at Northwestern University's Kellogg School of Management, the Corporate Governance Institute at San Diego State University, the Rock Center for Corporate Governance at Stanford Law School and the Graduate School of Business, the Weinberg Center for Corporate Governance at the University of Delaware, the Institute for Excellence in Corporate Governance at the University of Texas's Dallas School of Management, the Law & Business Program at Vanderbilt University Law School, and the Milstein Center for Corporate Governance and Performance at Yale School of Management.
Ted Frank, the president of the Center for Class Action Fairness and a leading tort-reform advocate, is making the case that the settlement is worse than nutty and unfair. He thinks it is actually illegal. Indeed, it seems the center is planning to contest the settlement in court, provided it can find people who invested in Apple between 2001 and 2006 who are willing to be named as plaintiffs. This shouldn't be too hard. Surely there are plenty of Apple investors who don't want to see Apple pay $20.5 million to settle this kind of nuisance lawsuit.
The magnitude of the settlement compared to the original claims demonstrates that it is an extortionate nuisance settlement, being made because it would cost more to defend the suit than to pay the attorneys to go away.
But it should be noted: the settlement is not just outrageous, it is illegal. Under the Ninth Circuit's Six Mexican Growers precedent, a court should not be issuing cy pres* that is not likely to benefit the class members. And as the Center for Class Action Fairness noted in recentNinth Circuit briefing, the American Law Institute has said that cy presis inappropriate where class members are readily identifiable. Given that the class attorneys are negotiating money for third parties instead of their own putative clients (for their own benefit, no less), there is also a breach of fiduciary duty that raises questions whether the class attorneys meet the Rule 23(a)(4) standard. The settlement is further problematic in that the vast majority of class members are entitled to zero compensation; it is far from clear that the sole lead plaintiff is a member of this subclass.
The Center for Class Action Fairness would love to object to such a blatantly illegal settlement. But it can't do so in a vacuum: it can only do so on behalf of a class member who is being ripped off by these attorneys. Class members are those who bought Apple stock between August 24, 2001 and June 29, 2006—but only people who bought the stock between November 2005 and May 2006 are entitled to recover any money under the settlement, and their recovery is being diluted by the excessive demand for attorneys' fees and diversion to cy pres. We'd be happy to represent you pro bono if you agree that the settlement is objectionable and wish to object: please contact me. If you're not in the class, but know people or institutions who might be, spread the word.
*For those of you scratching your head at the phrase "cy pres" here's a quick explantion. It's a legal term of art in class action settlements. It allows that money in excess of what is being paid to investors or lawyers be given to charities, in this case those "corporate governance" programs at universities.
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