From the San Jose Mercury:
Posted on Sun, Dec. 08, 2002
Some execs scored big as company values plunged
By Chris O'Brien and Jack Davis
Mercury News
Running companies that became almost worthless didn't stop dozens of Silicon Valley insiders from pocketing billions of dollars by selling their stock during the tech boom and bust.
The Mercury News examined the stock sales record of insiders at 40 companies in Silicon Valley that have lost virtually all their value since the stock market peaked in March 2000. The executives, board members and venture capitalists at these companies walked off with $3.41 billion, while their companies' total market value plunged 99.8 percent to a mere $229.5 million at the end of September.
It represented a remarkable transfer of wealth from the pockets of thousands of anonymous investors -- from day traders to pension funds -- into the wallets of executives and directors who turned out to be winners even when their companies became some of Silicon Valley's biggest losers.
Coming at a time of public discontent with corporate ethics, the disconnect between the performance of these companies and the executives' fantastic rewards is symptomatic of the problems that have ignited calls to reform executive compensation and corporate governance.
``The people who bought the stock they sold are the victims here,'' said Charles Elson, director of the Center for Corporate Governance at the University of Delaware. ``This money was taken from investors who didn't have the same information as these insiders and lost their money.''
The Mercury News compiled a list of local companies whose stock price dropped at least 99.5 percent from March 2000, when the Nasdaq peaked, to Sept. 30, 2002. Those companies were then ranked by the amount of stock sold by insiders -- roughly 300 -- since the beginning of 1997.
This means the list leaves off some spectacular flameouts where executives weren't shy about selling stock. For instance, JDS Uniphase missed the cut, with a 97.1 percent drop, even though executives sold $1.17 billion in stock between May 1997 and November 2002, even as the optical components company was firing two-thirds of its employees. Also absent is software company Ariba, whose stock dropped 98.7 percent and where insiders sold $1.26 billion between October 1999 and November 2002.
The survey also excludes some of the valley's household names. Not included are John Chambers, who between August 1997 and February 2000 sold $296.2 million in Cisco stock; Larry Ellison, who in January 2001 sold $894.8 million in Oracle stock; and Scott McNealy, who from May 1997 to July 2002 sold $107.9 million in Sun Microsystems stock. These corporate giants generally are older and remain strong competitors even as their stock prices have tanked.
Supposed good bets
The 40 companies on the Mercury News list are primarily software, hardware and telecommunications companies -- the infrastructure providers that were supposed to be good bets rather than flighty dot-coms.
These companies are a seriously wounded bunch. While not true of every company, as a group, they have a variety of problems. Most had major restructurings that led to mass firings. Fifteen went bankrupt. Several more are running out of cash.
Almost half the companies face lawsuits from angry shareholders. Five of the Top 15 companies had to restate earnings, some from periods when insiders were selling stock. And a handful of the companies have been cited in investigations by Congress and the Securities and Exchange Commission into investment banks accused of manipulating IPOs.
Though option grants usually get the most attention, much of the stock sold by insiders at these companies were shares they gained from being founders or early-stage venture investors prior to IPOs. Once their standard 180-day lock-up periods ended, many of these insiders began selling their stock like there was no tomorrow.
For some of their companies, there isn't much of a tomorrow:
• John Little, founder and CEO of Portal Software, sold $127.5 million of stock in Portal, which is on the verge of being delisted by Nasdaq. Portal, which sells billing software, topped the Mercury News list with insiders selling $704 million in stock -- more than its total revenue since the May 1999 IPO.
• David Peterschmidt, CEO of Inktomi, sold $90.5 million of stock at the No. 2 company on the list. Inktomi, once a promising Internet search engine company, in November sold off a major division to raise cash it needs to survive.
• K.B. Chandrasekhar, founder and former CEO of the former Exodus Communications, cashed out $135.1 million in stock at the Web hosting company before it went bankrupt. Chandrasekhar is now founder and CEO of Jamcracker. Exodus was bought out of bankruptcy by Cable & Wireless, which recently announced more layoffs at the hosting division.
• Dennis Barsema, former CEO of Redback Networks, sold $138.4 million in stock before he left in July 2000 after 2 1/2 years at the helm. Barsema later became CEO at Onetta, another networking start-up. He donated $20 million in stock to his alma mater, Northern Illinois University. Meanwhile, Redback announced another round of layoffs Nov. 14 and says it may have to raise more financing to stay afloat.
• Jerry Shaw-Yau Chang, former CEO of Clarent, sold a measly $16.5 million, though insiders at his telecom company dumped $355.8 million. Mired in accounting irregularities, the company has restated financial statements for 2000 and part of 2001, and been unable to report earnings for most of 2002.
• Thomas Jermoluk, former CEO of At Home, sold $50.3 million before the cable broadband giant filed for bankruptcy. The company, known as Excite@Home, once boasted a market value of $13 billion before vaporizing following squabbles with its main shareholder and partner, AT&T. Jermoluk is now a venture partner at Kleiner Perkins Caufield & Byers.
Executives at every company contacted either did not return phone calls or declined to comment, in many cases citing pending litigation. The one exception was Frederick D. Lawrence, former CEO of Adaptive Broadband, who agreed -- after speaking with his lawyer -- to discuss executive compensation though not the specifics of his company.
He pointed out that executive pay plans are publicly available and that most investors never bother to read them. And when insiders sell stock, they must also publicly disclose the sales in filings to the SEC.
``People really work hard in these industries,'' Lawrence said. ``They spend hours away from friends and family. Although that's not an excuse for any poor behavior.''
No surprise
However, Nell Minow, editor of the Corporate Library, a research center that focuses on corporate governance, said the heavy insider stock sales are no surprise. Minow is a leading critic of allowing insiders to sell their stock because it creates the temptation to push the envelope on things like accounting.
``They sell the stock and then they restate the earnings,'' Minow said. ``That brings it one step closer to being a Ponzi scheme.''
The increasing use of stock and options to compensate executives over the past decade grew out of a broader shareholder value movement. The idea was to align the interests of executives with the stockholders who, in theory, are more important than employees or managers.
But the practice has come under fire from critics who say stock grants have forced executives to become too focused on short-term results and doing whatever it takes to boost the stock price. That in turn can lead to everything from laying off employees after a bad quarter to feeling pressure to bend or break accounting rules to make the numbers.
``Their decisions are distorted,'' said Neelam Jain, assistant professor at Jones Graduate School of Management at Rice University. ``What the managers are trying to do is maximize their own profits and not the firm's profits.''
Graef Crystal, a leading compensation expert in Las Vegas, believes the problem has been overblown. He points out that while many executives sold their stock, many of them could have sold far more, which they elected to keep and which eventually became worthless.
Did they know?
``The fact that they left huge amounts of money on the table does not suggest they knew something was coming,'' Crystal said.
But the criticism of these insider stock sales continues to grow. That backlash increased in November, when the Conference Board released an annual survey of 2,841 companies in 14 industries that showed executive pay and perks continued to rise in 2001 even as the stock market and economy slumped.
At the same time executive compensation has exploded, bankruptcies have soared and publicly traded companies are facing record numbers of shareholder lawsuits. According to the Securities Class Action Clearinghouse at Stanford Law School, the number of shareholder suits rose from 213 in 2000 to 488 in 2001 -- despite a law passed in 1996 by Congress to discourage such litigation.
While many companies dismiss such litigation as a nuisance, observers say many corporate insiders still underestimate the anger of investors who lost big sums during the boom and bust and are still feeling burned.
``This is not a victimless crime,'' said Charlie Cray, director of Citizen Works' Campaign for Corporate Reform. ``The argument is that they're taking risks. But they're taking risks with other people's money.
``This is really a question of fairness.''
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Contact Chris O'Brien at cobrien@sjmercury.com or (415) 477-2504. Contact Jack Davis at jdavis@sjmercury.com or (408) 271-3788.
bayarea.com
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Posted on Sun, Dec. 08, 2002
How Portal insiders reaped huge windfall
EXECUTIVES, BOARD MEMBERS MADE MILLIONS WHILE INVESTORS LOST THEIR SHIRTS
By Chris O'Brien and Jack Davis
Mercury News
The executives and board members of Portal Software have had more success selling their stock than they have running the company.
Since Portal of Cupertino went public in May 1999, 21 insiders have cashed in $704 million in stock. During that time, the company has sold only $616.2 million of its billing software and services.
That's not a bad payday considering Portal has never been profitable, its revenue has evaporated, half its employees have been laid off and its stock is about to be delisted by Nasdaq. Facing several shareholder lawsuits, Portal also recently was named in a congressional investigation into manipulation of IPOs by investment banks.
When Portal went public at the height of the stock-market bubble, it looked like the kind of entrepreneurial success that has fueled the Silicon Valley mystique. Instead, it turned out to epitomize a dark side of the late-1990s tech boom in which investors, tantalized by the Internet's promise, ended up losing their shirts while insiders made a windfall.
Portal is an example of how critics say insiders can reap enormous rewards even when their companies perform dismally.
The use of stock as compensation ``leads to a focus on short-term gain rather than creating long-term value and the security of employees,'' said Charlie Cray, director of the Citizen Works' Campaign for Corporate Reform.
Internet pioneer
Portal was founded in 1985 by John Little, a Princeton graduate who had seen an early demonstration of the Internet. He came to California and spent the next decade trying to build a company around this new technology.
Little sold commercial access to the Internet and later developed a billing software product for his company called Infranet. By the mid-1990s, Portal began to focus on selling Infranet to telecom companies.
By then, companies were going public at a blinding pace. Portal raised less than $18 million in venture capital in two rounds before Goldman Sachs took it public.
On May 6, 1999, Portal completed its initial public offering of stock, raising $56 million. The stock shot up, rising from $14 to $37.38 on its first day of public trading.
After the IPO, Little still held 18.9 million shares, or 25.2 percent, of the company. He eventually unloaded $127.5 million in stock through May 4, 2001.
Among the other big winners were Portal's board members:
• Arthur Patterson, co-founder of Accel Partners, sold $79.4 million in stock owned by his family partnership and an additional $3.1 million he owned.
• Ed Zander, at the time president of Sun Microsystems, sold $4.9 million.
• David Peterschmidt, CEO of Inktomi, sold $7.3 million in Portal stock -- crumbs compared to the $90.5 million in Inktomi stock he cashed out.
By late 1999, Little was worth more than $1.3 billion on paper and was named by Forbes magazine as one of the 400 richest Americans. He appeared on a bicycle on the Oct. 11 cover of the magazine under the headline, ``The Billionaire Next Door.''
Little experienced firsthand the resentment this newfound wealth caused. In October 1999, he was at the Hotel De Anza in San Jose attending an Inktomi party when he ran into conservative pundit Dinesh D'Souza.
In the introduction to his book ``The Virtue of Prosperity,'' D'Souza wrote that as they chatted at the party, Little told him that he had recently been on a plane reading the Forbes issue with himself on the cover when the passenger next to him began to complain that ``Internet brats'' were making so much money.
``I've had my time in the wilderness,'' Little later told D'Souza in relating the anecdote. ``Show me someone who had been at it as long as I have. Show me somebody who's worked as hard as I have. Show me someone who's taken the risks that I've taken. Then if they haven't seen any rewards, then if they want to complain, I'm willing to listen.''
Little, 45, declined through a representative to be interviewed for this article.
How insiders benefit
In retrospect, some regulators and politicians say there may have been more than hard work and innovation behind the surge in IPO prices that became a staple of the boom.
Critics calling for reforms on Wall Street have pointed to a number of practices ingrained in the financial system that may have ultimately benefited insiders selling their stock. Those strategies tended to inflate IPO prices, giving insiders more opportunity to sell their shares and pocket huge gains.
The U.S. House Committee on Financial Services released a report Oct. 2 that said Goldman Sachs and Credit Suisse First Boston took companies public too early in order to generate banking fees, may have illegally underpriced IPOs so shares would soar on the first day of trading and then issued positive research reports to get investors to buy even as stock prices fell. Goldman and CSFB have denied the accusations.
Among the 14 Goldman clients the committee examined was Portal Software.
Portal's stock rose 167 percent -- $23.38 a share -- on its first day of trading.
Such huge first-day spikes generated great publicity for fledgling companies.
But Charles Elson, director of the Center for Corporate Governance at the University of Delaware, said that if Goldman and other banks had priced their IPOs higher, the companies going public could have captured more of that windfall.
Portal apparently needed more cash than its initial public offering raised. A few days after the May 6 IPO, Portal announced it had sold 3 million shares to Cisco Systems and 380,000 shares to Andersen Consulting at $13 apiece to raise an additional $43.9 million.
It was a sweet deal for Cisco and Andersen, considering Portal's stock was trading at $31.62 the day before it was announced. The news drove Portal's stock up another $9.38.
As the stock rose that summer, insiders at Portal couldn't cash in because they had agreed to a standard 180-day ``lockup'' period.
But four months later, Goldman agreed to let them out of that lockup period early. Portal sold 5 million more shares to the public -- including 2.8 million shares held by insiders. While the company raised an additional $79.5 million in this second offering, insiders sold $101.2 million worth of stock.
Portal's stock peaked at $83.94 on Feb. 24, 2000. The stock then began a steady slide to $6.75 on Nov. 22, 2000, when Portal reported disappointing quarterly results. A Goldman analyst downgraded Portal for the first time that day from his recommended list to ``market outperform'' -- still the equivalent of a buy rating.
But while Goldman continued to tell investors to buy, insiders at Portal were selling. By the time of the downgrade, Portal had been public only 18 months and insiders had already sold more than $695 million in stock.
Since then, Portal's revenues have plummeted, from a high of $81 million in the final quarter of 2000 to $30.2 million in the most recent quarter. The company has restructured three times and fired 870 employees on its way to reducing its workforce to 600 by the end of this year.
And five lawsuits have been filed against the company alleging securities fraud for the way its IPO was conducted.
Portal is in danger of being delisted from Nasdaq because its stock price has been at around $1 a share for so long. Once worth more than $1 billion, the more than 35.1 million shares of Portal currently owned by CEO Little are now worth $38.6 million. The company recently offered to reprice options for everyone except Little.
On Nov. 19, during Portal's conference call to report third-quarter results, an analyst asked Howard Bain, Portal's chief financial officer, how many staffers had benefited from the repricing of options. Bain drew a big laugh when he said:
``Oh, I would say probably most employees -- with the exception of John, who is wiping a tear from his eye here!''
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Contact Chris O'Brien at cobrien@sjmercury.com or (415) 477-2504. Contact Jack Davis at jdavis@sjmercury.com or (408) 271-3788.
siliconvalley.com
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