Apple Computers is the latest in a long series of headlines relating to the SEC's crackdown on backdated option grants - an issue potentially affecting a number of public companies, primarily in the tech sector. Apple recently launched its own internal investigation which uncovered several violations which may significantly impact the valuation of their stock. In an 8k filing with the SEC dated August 4th, Apple stated:

“Apple’s financial statements for the fiscal years ended 2003, 2004 and 2005, the interim periods contained therein, the fiscal quarters ended December 31, 2005 and April 1, 2006, and all earnings and press releases and similar communications issued by Apple relating to periods commencing on September 29, 2002 should no longer be relied upon.”

The company also notified investors that it would likely delay its 10Q filing with the SEC until further notice. Many other tech companies are also feeling the heat as the SEC cracks down. Among the potentially affected companies are Broadcom, Rambus, Sycamore Networks, and McAfee. Currently, Brocade is the only company facing criminal charges by the SEC. If found guilty, company officers involved in the crime can face up to 20 years in prison and $5 million in fines.

What Are Backdated Option Grants?

Option backdating occurs when a company grants a call option (a right but not obligation to buy at a certain price) with an exercise price below the price of the stock on the day of the grant. This means that the owner is entitled to an immediate gain on paper if he/she decided to immediately exercise their option. Now, as surprising as it sounds, this is not illegal. In fact, it is perfectly legal for a company to backdate options; however, the option grants must be classified as being backdated.

The SEC recently got involved when it discovered that several companies were classifying these backdated option grants as a type in which the exercise price is the same as the stock price on the day of the offer. This enabled companies to hide millions of dollars of expenses from the public, which in turn artificially boosted net income by reducing operating expenses. As a result many companies may be forced to restate many years worth of earnings due to the manipulation of net income. This will force investors to revalue (to the downside) the companies based on the new lower net income levels. Needless to say, these investigations will have a material effect on the offending companies.