Old NY Times article, but the stipe on the skunk stays white over time:
January 22, 2001
Market Place: A Question of Conflict
Amid a Web of Interests
For the last four years, Harry J. Carr has
been ahead of the curve in the
communications equipment business. Should
investors follow?
In 1997, after 16 years at AT&T, Mr. Carr
became president of Yurie Systems, a
Maryland-based developer of switches for
telecommunications networks. Less than a
year later, the AT&T spinoff Lucent
Technologies bought Yurie for $1 billion, and
Mr. Carr reaped a $35 million windfall.
He was soon promoted to run Lucent's
broadband carrier networks division, where
he sold the kind of sophisticated equipment
that undergirds the Internet. As Lucent stock peaked in December 1999,
Mr. Carr quit to become chairman and chief executive of Tellium, which
makes optical switches to control the flow of data where fiber-optic
cables meet.
To lure Mr. Carr, Tellium, based in Oceanport, N.J., offered him options
to buy 13.2 million shares — 7 percent of the company — for about $1
a share.
Now, after signing three big sales contracts for its switches, Tellium has
filed to sell shares to the public for about $15 each. At that price, Mr.
Carr's stake would be worth $200 million. Tellium has not yet set a date
for the offering, but it has generated strong interest from institutional
investors.
Mr. Carr deserves much of the credit for Tellium's success so far, said
Jennifer Pigg, executive vice president for the Yankee Group, a
consulting company that has worked for Tellium. "He is a good
combination of somebody who is operationally proficient, can make sure
the company is staying within budget, and yet also is a very good
strategist as well," Ms. Pigg said.
But potential Tellium shareholders might want to consider that at Yurie
and Lucent, Mr. Carr oversaw and participated in deals that, although
legal, stretched ethical standards, in the view of some independent
analysts.
When Mr. Carr was president of Yurie in 1997, one third of Yurie's
sales went directly or indirectly to a company controlled by Yurie's vice
chairman. Skeptics questioned whether Yurie could have received the
same prices for its equipment on the open market. In any case, the sales
fattened Yurie's sales book.
At Lucent, Mr. Carr personally invested in a company that sold
equipment to his division. In an interview last Thursday, Mr. Carr said his
actions had been proper and fully disclosed to investors and his
superiors. He said related-party transactions and equity sweeteners are
common in the information technology industry, as are executives who
make personal investments in their companies' suppliers and customers.
Whatever Mr. Carr's personal integrity, Yurie's heavy reliance for sales
on Splitrock, a company controlled by Yurie's vice chairman, Kwok Li,
raised eyebrows among short-sellers — investors who place bets that a
company's price will fall.
In 1997, Yurie had about $51 million in sales. Of that total, $12.6 million
went directly to Splitrock. Another $7.3 million went to Ericsson, which
later sold $5 million of the Yurie equipment to Splitrock. In all, $17.6
million of Yurie's $51 million in sales went to Splitrock.
"The Yurie product never really took off," said Russell Young of Hintz
Holman and Hecksher, a hedge fund. Splitrock was "really propping up
the numbers of Yurie," Mr. Young said. "All their sales were going to
Splitrock."
Investors should be wary of sales between related companies, because it
is impossible to be sure that the deal is fair to both sides — even if the
companies protest otherwise, said Jack Ciesielski, publisher of The
Analyst's Accounting Observer. "If you look at a lot of these disasters
that have happened," he said, "you do find a trail where you have related
parties."
Mr. Carr said Yurie had done nothing wrong. Yurie fully disclosed the
connections between the two companies to investors, and Lucent
validated Yurie's technology in 1998 when it bought Yurie for $35 a
share, almost triple the price of Yurie's initial offering a year earlier.
When the Lucent acquisition was announced, "I was happy to have all
those people who bet against the Yurie management team lose an
incredible amount of money," Mr. Carr said. "The market proved that
they were just wrong."
The market told a different story a year later, when Mr. Carr became
involved with Fantastic, a Swiss company that develops software to
manage the flow of data over broadband networks.
In June 1999, Mr. Carr, who at the time was vice president of Lucent's
data networking division, announced that Lucent would become a
reseller of Fantastic's software. Lucent agreed to buy $10 million worth
of Fantastic software, almost 40 percent of Fantastic's total sales for
1999. Lucent also became an investor in Fantastic, buying several million
dollars in Fantastic stock.
Later that summer, Mr. Carr personally invested in Fantastic. He
declined to disclose the size of his investment. "It's a number that some
people might think is significant," he said, "but relative to my net worth it
isn't."
But Mr. Carr's investment in Fantastic — which was doing business with
the Lucent division he ran — was problematic whatever its size, said
Steven D. Levy, an analyst at Lehman Brothers.
"It does not take a whole lot of economic incentive for any individual in
my experience to have a conflict of interest," Mr. Levy said. "If you have
executives who have hundreds of thousands or millions of dollars in
potential earnings — I don't care how saintly they are, I have to believe
they're going to be influenced."
Mr. Carr disagrees. He said that he cleared his Fantastic investment, in
writing, with Lucent, and that he recused himself from the relationship
between Fantastic and Lucent after he made the investment.
"I don't really see it as a conflict of interest," he said. "I guess there could
be a purist view that it is a conflict of interest, but the reality is it's done all
the time."
Mr. Carr said he made the investment for the same reason that he put
Lucent into business with Fantastic — because he liked the company's
software. "I believed in the company," he said.
The deal turned out to be a bust commercially, as Lucent was unable to
find customers for Fantastic's software, according to two former Lucent
executives. But both Mr. Carr and Lucent profited on their investments in
Fantastic, which had its initial public offering on Germany's Neuer Markt
in September 1999.
Lucent sold its Fantastic shares in March 2000, making about $50
million. Mr. Carr said he sold his own shares in the summer of 2000,
making a "moderate" profit.
Many other Fantastic shareholders were not so lucky. After peaking last
February at 55 euros, or more than $50, a share, Fantastic closed Friday
at 3.12 euros, or less than $3.
Paul Sagawa, a senior research analyst at Sanford C. Bernstein, said he
was troubled when executives invest in their suppliers or partners. "The
insidiousness of a conflict of interest is you can't prove either way that it
made the difference," Mr. Sagawa said. "It reeks of kickback."
Mr. Carr said his views have not changed now that he runs his own
company. He will allow employees at Tellium to invest in companies they
do business with, he said, as long as they disclose those investments.
And Mr. Carr has not been afraid to offer the chance to buy Tellium
stock as a sweetener to executives at potential customers.
In September, Tellium gave executives at the telecommunications carrier
Qwest the opportunity to buy $10 million in Tellium stock for $15 a
share, according to Tellium's prospectus. Tellium also gave Qwest itself 4
million warrants to buy Tellium stock as part of a $300 million contract
that Qwest signed to buy Tellium's switches.
Mr. Carr said Tellium needed to offer warrants and stock to its
customers as a way to compete with bigger competitors that can offer
potential customers low-interest loans.
"What this really is is a form of vendor financing," he said. "A lot of time
companies are making decisions not based on who's got the best product
but who's got the best financing." |
