Tuesday, November 07, 2006

It Took Apollo Group How Long to Figure This Out?

I’m holding in my hands a report on the potential for backdated options grants at Apollo Group, Inc.—the company whose stock collapsed following the November 3 announcement of suspicious option grants:

Apollo Group today announced that its ongoing internal investigation into the issuance of certain stock option grants has discovered various deficiencies.

After discussing earnings restatements and other details, the company said:

Apollo Group also announced that Chief Financial Officer and Treasurer Kenda B. Gonzales resigned on November 1st, citing personal reasons. In addition, Chief Accounting Officer Dan Bachus is currently on administrative leave.

Now, the report I’m holding in my hands (actually, I’m looking at it on my computer screen, but “holding in my hands” is more dramatic) is titled:

Did Apollo Backdate Options?

Its front page summary begins as follows:

While it is impossible to tell definitively from a company’s proxy and other SEC filings whether or not it is guilty of backdating, Apollo Group’s option grant history looks highly questionable, in our opinion, and we believe that scrutiny by the SEC or other gov’t bodies is a real risk to consider.

The report then goes into chapter and verse—actually three devastating tables—about how Apollo Group’s option grant prices occurred almost miraculously at the lowest price of the year in 2000, 2001, 20002 and 2004.

(Something went screwy in 2003—the option grants were 10% above the low.)

Furthermore, no other company in the educational services group included in the tables came close to Apollo. Only one company had even one year when options were granted at the lowest price possible.

The date of this report?

June 8, 2006. Almost half a year ago.

The author?

Gary Bisbee of Lehman Brothers.

His methodology?

Publicly available information from Apollo Group filings.

So it took the educational geniuses at Apollo Group how long to figure this out and hold somebody accountable?

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Its_strange said...

It looks to me TTWO is hiding behind the backdating issue, that they are using it as a excuse not to report earnings. ... Once again the public gets bagged

Sam E. Antar said...

Journalists are taught in journalism classes to have a “nose for news.”

Accounting students are theoretically likewise taught about something called the “smell test.”

If something does not “smell right” you should take steps to investigate it since more often than not coincidences do not happen.

In the case of Apollo Group you have (from publicly) available sources stock option being granted “coincidently” during a four year period at either the lowest price or slightly above it as you wrote:

“The report then goes into chapter and verse—actually three devastating tables—about how Apollo Group’s option grant prices occurred almost miraculously at the lowest price of the year in 2000, 2001, 20002 and 2004.

(Something went screwy in 2003—the option grants were 10% above the low.)”

Small note - As a former criminal and ex-felon I can attest that even successful frauds (we were successful for 18 years) do not go exactly as planned and therefore you have that 10% “hiccup.”

The main issue is where were the external auditors, the company internal auditors (if they had any), the Audit Committee of the Board of Directors (hopefully its members were all independent), corporate counsel, and the Board of Directors who were in positions to see these obvious red flags.

We can only hope there was no “conscious avoidance” involved as the stock option granting went through its various processes of approval and reporting on the company’s financial reports.

I personally find it hard to believe that there could be such a wholesale breakdown in the various “checks and balances” in place and that the only persons culpable may possibly be Chief Financial Officer and Chief Accounting Officer as implied by their respective resignations and leave of absences.

The others may point to “poor internal controls” or being duped. Should they use such excuses in any case we have the greater issue for external auditors and internal auditors (which I have commented on previous posts) of their lack of adequate education, training, skills, and experience in the area of fraud and internal controls.

Note: See "Where’s Sammy Antar When You Need Him?”


The issue to be examined for the Audit Committee and Board of Directors is whether its members have the education, training, skills, and experience to properly conduct their functions too or whether like many Board members they bring to the table very nice resumes that have little to do with the companies they are involved in or the functions they must serve in as Board members. The issue of “window dressing” Boards is especially important as it concerns Audit Committee members.

My guess is that right now the real answers are known and that the players are “lawyering up.”

My advice to your readers is when such issues such as this involves so many potential players the truth will eventually come out later rather than sooner. If criminality is involved you may see a “race to the US Attorney” since the first person in gets the best deal in most cases.

My advice to Apollo and the players involved that if anything wrong happened (whether or not it rises to the level of criminal conduct) that prompt transparency, accountability, and taking full responsibility is your best option. Delay will only anger those hurt by your actions (whether or not criminal).

As a former criminal and ex-felon I have learned that it is better to face the graciousness and mercy of the victims of your actions than their anger.


Sam E. Antar (Former Crazy Eddie CFO and ex-felon)

Aaron Koral said...

Jeff: Is it me, or are a majority of the stocks being implicated in the options back-dating scandals are listed on NASDAQ, as opposed to the NYSE? For those NASDAQ stocks who have been implicated in the stock-backdating scandals, and whose business models are sound, could the problems they're facing already be "priced in" to their share price? Just wondering....

Sam E. Antar said...

More on “Why it took so Long for Apollo Group to Figure This Out?

We are supposed to believe that Audit Committees provide an effective function for the following as disclosed in Apollo Group’s 10-K :

“…reviewing the financial information which will be provided to shareholders and others, the systems of internal controls, which management and the Board of Directors have established, the performance and selection of independent registered public accounting firm, and our audit and financial reporting processes.”

Apollo Group’s Audit Committee is comprised of the following individuals with the following educational backgrounds:

John Blair – Bachelor of Science in Engineering
Dino J. DeConcini - Attorney
John R. Norton III - Bachelor of Science in Agriculture

The Apollo Group believes these individuals are qualified as “financial experts” to serve as Audit committee members as disclosed in its 10-K below:

“The Board of Directors has determined that Mr. Blair and Mr. Norton are “audit committee financial experts” as defined in Item 401(h) of Regulation S-K. Each of the members of this committee is an “independent director” as defined in Rule 4200 of the Marketplace Rules of the National Association of Securities Dealers, Inc.”

Note: The 10-K does not mention Mr. DeConcini (the attorney as an expert). Therefore, a “non-expert” is on the Audit Committee.

So we have two of three “experts” as defined under the law.

My Comment:
If the Apollo Group followed the law, the law must change since the qualification requirements for “experts” allows for ineffective oversight.

Does anyone believe that the above individuals have the combination of effective educational background, training, skills, knowledge, and experience to be Audit Committee members?

Does anyone really believe these individuals qualify as “financial experts” (not in the “legal sense”) but in the sense of effectively carrying out their responsibilities?

None of the individuals are CPAs or have educational backgrounds in finance.

I ask what formal audit training, internal control training, and fraud training do these individuals have?

While I am sure these Audit Committee members a very good people they have some legitimate questions to answer.

Jeff Matthews said...

Aaron: I think the poster child for option abuse was UNH, a certifiable NYSE company. So I'm not sure your NASDAQ-heavy list is complete.

However, it's a fact that Silicon Valley is where option-heavy comp became the norm, and those tend to be NASDAQ-listed companies, so it's no surprise that the NASDAQ has most of the options-related abusers.

On another note, I only wish everybody would read both excellent comments above from Sam Antar.

Aaron, you're a plugged-in guy...maybe you can circulate them elsewhere?

I hate to see great observations like that get lost.

Thanks to both of you.


Sam E. Antar said...


Thank you for the compliment in your post.

Today I met with Barry Minkow (ZZZZ Best) in New York. He explained to me the “iceberg” analysis. According to Barry, an iceberg is only 10% visible and the rest of it lies beneath the surface. It is often difficult to detect fraud and misrepresentation just by looking at financial statements. Accounting is art work and for a criminal it is relatively easy to hide issues beneath the surface since we are crafting the reports.

We would hope that at the very least the “professionals” whose responsibility it is to protect us can review the surface (the financial statements and footnotes thereof) and properly analyze them. What we have in the Apollo Group case is a pattern of suspicious stock option grants that is relatively easy to spot on the surface (at least for external independent Certified Public Accountants and so called “financial experts" on Audit Committees.

It appears that the protections in place for investors remind me of an old saying “very good presentation but no substance” once you get past the sales pitch. We supposedly have independent external auditors and Audit Committees suited to their task of protecting the integrity of financial information.

Instead we have an inadequately educated and trained profession and less adequately knowledgeable Independent Audit Committees.

No law like Sarbanes-Oxley or long prison sentences handed out to white collar felons (both of which I support) can help us unless we have the requisite competence of those whose responsibility it is to protect the integrity of financial information.


Sam E. Antar (former Crazy Eddie CFO and ex-felon)

PS: The accounting profession is filled good and dedicated people and most want to increase its educational standards. However, there is insufficient leadership within the profession on this important issue.

I urge the profession to move fast in instituting education reform since you do not wish to face the consequences of having a client like I used to be.

Earl the Pearl said...

Sam said "Instead we have an inadequately educated and trained profession..."

Having just graduated from a career in external audit, I believe there are a couple factors at work here. The people doing the actual audit work have from 0 to 3 years experience. Most leave after two years and move on to less demanding and better paying jobs. The ones that stay have delusions of being a manager/partner someday, and are willing to accept tremendous workloads to prove their worth.

So you end up with newbies doing the audit, and slightly more experienced (but incredibly overloaded) people reviewing the newbies work. Oh yeah, throw in all the new SOX work during the same time frame.

And here's the kicker: what's the best way to not become a manager/partner? Letting your audit come in overbudget. How can anyone be surprised that things (like stock options) get swept under the rug? Now that the problems have surfaced, options will be examined with a fine tooth comb, and some other area will be swept under the rug.

Sam E. Antar said...


You could not have said it better about the issue of auditor’s staffing their audits with “newbie’s.” They are over using their external audits as training grounds.

In the Crazy Eddie fraud, the staffer whose job it was to audit accounts payable did not even know what a “debit memo” was until he arrived ant our premises. He had only 6 months auditing experience and never audited a retailer. As a result we reduced our accounts payable from $70 million to $50 million by utilizing phony debit memos.

Then you begin to wonder why frauds go undetected for years. You see the frustration inherent in Jeff Matthews post “It Took Apollo Group How Long to Figure This Out?”

We have a structural problem with our current system of oversight.

Remember that the criminal always has the initiative and is judgment oriented in his approach vs. the current “check the boxes” and “fill in the blanks” process oriented inexperienced kids on these audits who do most of the work.

The external auditors are “out maneuvered” at almost every turn. The Audit committees are staffed in many cases with “window dressing” members who are unqualified to effectively handle their responsibilities.

What I see here is a “perfect storm” for the future massive financial frauds that surely will occur.

Therefore, anyone reading this post be forewarned – the worse is yet to come!


Sam E. Antar (former Crazy Eddie CFO and ex-felon)

Sam E. Antar said...


More on Apollo:

The American Institute of Certified Public Accountants (AICPA) has identified “earnings management” as a risk factor for Audit Committees.

While I am assuming Apollo’s Audit Committee members have broken no applicable rules I question the effect on their required oversight and requisite objectivity and professional skepticism if they hold stock options and stock in the same company.

Specifically, I refer to Apollo Group’s 10-k for which discloses the stock holdings and rights to acquire stock for Mr. Blair, Mr. Norton, and Mr. DeConcici all members of the “independent” Audit Committee.

They will undoubtedly argue that “no laws were broken” and so on.

My point is whether or not any laws have been broken is that Audit Committee members by owning stock or having stock options in the companies for which they provide oversight have a built in disincentive to perform their task with the requisite professional skepticism and objectivity required.

I hope these persons properly carried out their responsibilities.

However, as you wrote “So it took the educational geniuses at Apollo Group how long to figure this out and hold somebody accountable?” as I research the issues deeper I begin understand why.


Sam E. Antar (former Crazy Eddie CFO and ex-felon)

StockReply said...

We would think that there was no lack of evidence at board level for the misstatements. At some point this ceased to be a financial matter and became a question of legal liability. Then it was crucial for the board not to admit they knew what was happening to cap the risk to the company.

This is analagous to the tobacco companies knowing and not knowing about carcinogens in their product. Similarly, MCD and Burger King both know that their product is unhealthy (and introduce healthier fats into their recipes, salads to the menus etc) but cannot say so.

Sam is right. They are 'lawyering', which is probably the appropriate position right now.