Telos in Turmoil Over Shares
Preferred Stockholders Want Their Money
By Terence O'Hara
Washington Post Staff Writer
Monday, September 25, 2006; D01
The trouble began on the golf course, when unidentified insiders at Telos Corp. began questioning whether director David Borland's use of a company club membership compromised his independence as a member of the firm's audit committee.
The fuse quickly burned, and by August more than half of the company's board had resigned. The imbroglio was the latest in a fight that has gone on for years, with the owners of Telos's preferred stock in revolt trying to collect more than $80 million they say is long overdue.
It didn't matter much when Telos, a small defense contractor that specializes in network and communications security applications, was a languishing technology company. But in recent years, its business with the Defense Department has been booming. Though Telos is unprofitable it is considered a potential takeover target, and its owners are fighting over the possible spoils.
"I'm just insisting on rights I have that are in writing," said Marshall Greenblatt of Potomac, a former Telos director who has owned preferred stock since it was issued 17 years ago, and wants the money he was guaranteed at that time. "A deal is a deal." Preferred stock typically includes a guaranteed dividend and other advantages.
One of Greenblatt's fellow preferred shareholders, New York hedge fund Costa Brava LP, has sued Telos and asked a judge to put the company in receivership. Costa Brava contends that the company's majority shareholder, British millionaire John R. C. Porter, is siphoning cash from the company in the form of fees and high-interest on loans he has made to Telos.
Anger over Porter, and frustration that the company may have favored him over preferred shareholders, prompted some of the directors to resign in August, according to company Securities and Exchange Commission filings.
None of those who resigned could be reached for comment. Requests to interview Porter were made to the company, but a Telos official said he could not be reached.
Longtime Telos chief executive John B. Wood said the company's problems have been stoked by hedge-fund shareholders who are being too hasty in demanding benefits from their preferred stock -- and hurting the company's chances to become more valuable in a possible future sale.
"We have activist hedge funds who use the cloak of corporate governance to litigate their returns," Wood said of the company's dissident investors. "We as a company have a responsibility and a duty to protect the interest of all of our stakeholders, and not give a priority of one group over another group."
Wood would not comment on any aspect of the resignations. However, he noted that "we reconstituted the board quickly thereafter," and that the incident has not damaged the company's stock price.
At the heart of the dispute is Telos's stock structure, the remnant of a 1989 leveraged buyout. All of Telos's common stock is held by insiders, including Porter, who bought control of the company in 1994. Yet Telos's preferred stock, issued in the 1989 leveraged buyout, is publicly traded on the over-the-counter exchange. It has done well in the past three years, rising from 50 cents a share in 2003 to around $19 a share.
The owners of that preferred stock are owed more than $80 million in dividends and redemptions. If Telos were sold, preferred shareholders, not Porter, would get most, if not all, of the leftover cash from a sale after its lenders are paid off.
The spat on the board began this summer, when fellow directors learned that Borland used a company-owned golf membership. Borland paid the $38,000 in dues and other expenses with his own money. But the fact that the company owned the membership was seen by some board members as a conflict with his duties on the audit committee -- and emblematic of broader problems.
Borland resigned as chairman of the audit committee. But three directors, Geoffrey B. Baker, Malcolm M.B. Sterrett, and Norman P. Byers, thought Borland should have resigned from other board committees as well and possibly left the board altogether. When he didn't, they quit.
They resigned at the same time as three other board members. Langhorne A. Motley said he was quitting for health reasons and because of the workload of being a director. Bruce J. Stewart and Thomas L. Owsley did not say why they resigned.
Most worrisome for Telos, Motley and Byers were the two members of Telos's proxy board, an independent subset of the board of directors required by the Defense Department to make sure that Telos's foreign ownership doesn't compromise national security. Porter is a British citizen.
Byers was the proxy board's chairman, and was on the board since 1994.
"Uppermost in my mind has been my fiduciary duties . . . and to provide the oversight necessary to insure the company's compliance with all federal security laws," Byers wrote in his resignation letter, using language similar to that Sterrett and Baker used. "Unfortunately, on several recent occasions, other important participants in the corporate enterprise have done everything possible to obstruct or prevent the board of directors from taking those actions I believe are absolutely necessary and appropriate to insure good corporate governance and compliance. It has been made abundantly clear to me I will not be allowed to function effectively or independently as a fiduciary for the Department of Defense, the Company, all its stockholders and employees."
Wood, who has worked at Telos for 14 years and became chief executive in 1994, said all he wants to do is build the company, and that he hopes the differences between the two classes of stockholders can be resolved. He also held out hope that the company could reach an out-of-court settlement with the preferred shareholders, but that seems unlikely.
"What it boils down to: One group wants their money now, one group is more patient," he said of the preferred and common shareholders, respectively. "Having said that, would we prefer to reach a settlement that's fair for everybody? Absolutely."
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