Federal prosecutors say white-collar crime is a priority, but they have
filed only a few charges against Silicon Valley executives. Silicon
Valley is the epicenter of the fastest creation of wealth in history.
But the high-tech miracle has a dark side: untold stories of ruined
investors, betrayed entrepreneurs and regulators who are overmatched and
overwhelmed. Robert Crowe was afraid he wouldn't be ready.
For months, the assistant U.S. attorney had been preparing a securities
fraud case against executives at California Micro Devices, a Milpitas
chip manufacturer. But as the 1998 trial neared, Crowe was inundated
with 600,000 pages of documents and didn't even have a clerk to work the
copy machine.
Meanwhile, the FBI and the Securities and Exchange Commission continued
to bring him promising cases against other Silicon Valley companies. But
Crowe was the only federal prosecutor in San Francisco working full time
on investment fraud, and there was nothing he could do with them. "The
inventory of cases kept building," said Crowe. "I couldn't keep up."
Cal Micro was the first major Silicon Valley fraud case tried by the
U.S. attorney's office in San Francisco. It was also the last -- even
though shareholders have sued more than 60 high-tech companies in
Northern California's federal courts since 1995.
Silicon Valley executives contend that most of the complaints are
frivolous, but Crowe and others say the rising number of class-action
suits shows that fraud is rampant in the high-tech industry. "If they
put together a special federal task force and sent it into the valley,
they could bring a ton of fraud cases," said one senior prosecutor at
the U.S. Department of Justice.
But the U.S. attorney's office has done little to deter securities fraud
in Silicon Valley, filing criminal charges against only a handful of
high-tech executives the entire decade.
Since shaking the recession of the early 1990s, Silicon Valley has
become the epicenter of the fastest creation of wealth the world has
ever seen. And the opportunities and motives for financial deceit have
never been greater. Silicon Valley executives face intense pressure to
meet Wall Street's expectations. Missing quarterly projections can mean
financial disaster for a company -- and for the executives whose
compensation packages depend on the company's stock price.
For many corporate officers, the temptation to "cook the books" -- and
then unload shares before the company's stock price collapses -- is
overwhelming. And unless federal prosecutors crack down, experts warn,
securities fraud will continue to flourish. "More executives should be
going to jail," said Stanford University law Professor Joseph Grundfest,
a former SEC commissioner and national expert in securities fraud. "That
will grab their attention . . . and hand a valuable lesson to the entire
economy."
This is the story of how federal prosecutors have allowed securities
fraud to spread through Silicon Valley like a virus. It is an account of
the one major case that the U.S. attorney's office in San Francisco
prosecuted, desperately hoping the trial would serve as a warning to the
high-tech industry. And it is about an even bigger case, one of the most
flagrant in Silicon Valley history, that federal prosecutors let sit on
the shelf.
Yamaguchi's Vow, 1993
When Michael Yamaguchi was appointed U.S. attorney for the Northern
District of California in 1993, he took over an office that had been
adrift for years under a string of temporary chiefs. As one of his first
priorities, Yamaguchi pledged an aggressive campaign against
white-collar crime. But the soft-spoken tax specialist quickly learned
it wasn't going to be easy.
"We did not have nearly enough resources," said Richard Seeborg, a
former prosecutor in the agency's San Jose office. "When you compare our
office to U.S. attorney's offices around the country, we were grossly
understaffed." In the 1990s, the Northern California district office
had, on average, only one-quarter of the federal prosecutors per capita
that were assigned to lower Manhattan and one-third the number of
prosecutors posted to Southern California.
Yamaguchi's first test came in June 1994, when former Chronicle
columnist Herb Greenberg reported allegations from former employees at
California Micro Devices that the company had been booking fake or
premature revenue for years. Shortly after the disclosures, as the FBI
and SEC investigated, the company's senior financial officer, Steven
Henke, resigned. A few weeks later, the board of directors fired Chief
Executive Officer Chan Desaigoudar, and Cal Micro's stock plummeted an
estimated $139 million.
As Yamaguchi's prosecutors conducted interviews and pored over Cal
Micro's records, they found that the company had booked millions of
dollars in revenue for products that had not been shipped. They also
discovered double bookkeeping, false financial filings and illegal
write-offs. At the same time, the prosecutors discovered, Desaigoudar
and Henke had dumped more than $1.1 million of their own stock before
its price collapsed. It was the perfect case for Yamaguchi to
demonstrate that his office was serious about white-collar crime.
The Mastermind, 1989
Phil White was always ambitious -- even before he was accused of
masterminding one of the largest securities fraud scandals in Silicon
Valley. The sandy-haired White grew up in small-town Illinois, the son
of an accountant and a public school teacher. He majored in business at
Illinois Wesleyan University and later graduated from the University of
Illinois' business school. He first worked for a travel company, leading
tours through Latin America, Europe and Canada and running the company's
Hawaii office. But when he realized he had no chance to head the
family-owned business, he quit. "I didn't go to school," he once told a
financial trade magazine, "to be second or third fiddle." Next, he moved
to IBM's St. Louis office, where he consistently won sales awards. But
he knew he would never challenge for the top job at IBM, either, and
after 15 years, nearing middle age, he decided to change course. In
1982, White moved to a sales and marketing job in Silicon Valley and two
years later joined the board of Wyse Technology. In 1986, when the
company needed an aggressive new president and chief operating officer,
White seized the chance.
Wyse had been a prosperous manufacturer of video display terminals for
many years, but its market niche was doomed by a new generation of
desktop computers that could operate without mainframes. Shortly after
White took over, Wyse moved into the personal computer market, and
White's management team promised 20 percent revenue increases every
three months. It was an ambitious goal, and almost immediately it led to
disaster.
In the haste to meet the target, Wyse made a lot of shoddy computers.
They overheated, erased information and ejected circuit boards during
shipping. The pressure to meet revenue goals grew so intense that in
December 1987 the company shipped computers in garbage bags after the
anti-static containers ran out. According to court documents, the
company claimed sales on computers that were actually sent "around the
corner" to shippers' warehouses, then returned to Wyse after the end of
the financial quarter. Some computers were not shipped at all, merely
entered into records as ordered and "processed." On Feb. 16, 1988, the
company reported quarterly revenue of $128 million -- an astonishing 75
percent increase over the quarter one year earlier. At an industry
conference in September, White proclaimed that 1988 "looks to be a
banner year for all of us."
But on Jan. 5, 1989, the company abruptly announced that revenues for
the previous quarter were down by half from a year earlier. The stock
price plunged to $5 a share, far below its high of $25.50. Almost 600
employees -- 15 percent of the company's workforce -- would soon be
fired. Before the year was over, a Taiwanese company would buy Wyse for
$10 a share. Investors, mutual funds and pension funds lost tens of
millions of dollars. Bill Lerach and other plaintiffs' attorneys sued
White and other company officials for securities fraud and insider
trading.
The suit was settled in 1992 for $15.5 million in cash -- with no
admission of wrongdoing. It was not the last time White would be accused
of "cooking the books."
The Prosecutor, 1990
Robert Crowe charged out of Cornell University law school in 1983, eager
to become a criminal defense lawyer. But he quickly found positions as a
public defender more difficult to find than prosecutor jobs, so he wound
up as an assistant district attorney in Brooklyn, N.Y., and loved it.
After several years of prosecuting street crimes, the Chicago native
began looking for something more challenging. He found it in 1989 when
he went to work in the U.S. attorney's branch office in San Jose.
In 1990 he got his first securities fraud case. It involved a company in
Campbell called StarSignal Inc. At the time, the U.S attorney's office
didn't pay much attention to investment-fraud cases. According to
several former prosecutors, the lawyer responsible for them just sat on
the complaints in the San Francisco office. It got so bad, they said,
that frustrated SEC officials stopped sending cases over. "The head of
SEC enforcement was thrilled when I began working on StarSignal," Crowe
said.
StarSignal was the brainchild of an excitable and brilliant engineer
named Robert Widergren. With several million dollars raised from private
investors, the company developed the world's first commercial color fax
machine. But the early machines were expensive, costing as much as
$26,000, and sales never took off.
In 1990, a former executive tipped the SEC that the company was raising
money by sending investors false information -- including news of an
imminent sale in Spain worth $83 million. The figure, said the tipster,
was "extracted from the air." That August, the FBI moved in, arresting
Widergren after learning that he planned to transfer money to Belize in
Central America. Widergren was charged with bilking investors of more
than $3 million.
The StarSignal case gave Crowe his first inkling that securities fraud
was more widespread in Silicon Valley than anyone suspected. "Why are
you doing this to me?" Crowe remembers Widergren asking during breaks in
the 1991 StarSignal trial. "My case is just a few million dollars.
There's fraud going on all over the valley worth hundreds of millions."
Informix's Turnaround, 1993
For nearly a decade, Informix flourished as one of Silicon Valley's
leading makers of software for managing computer databases. But in 1989
the Menlo Park company bought a software firm in Kansas City, and the
acquisition started to drag revenues down. So Informix founder Roger
Sippl turned to White, unfazed by Wyse's collapse and the allegations of
securities fraud.
White quickly swung into action, firing a fifth of the company's
workforce. He expanded the company's business to Europe and Asia. He
directed Informix's engineers to change the database software so it
would work in networks of personal computers rather than just
mainframes. When PC networks became the rage, Informix cleaned up.
Within four years, the company rebounded from a $46.3 million annual
loss to post a $56 million profit. Its stock rose from 56 cents a share
to more than $ 30. The numbers dazzled Wall Street, and White looked
like a genius. But then the industry began to slow. And the next year,
company executives found new ways to keep revenues growing.
The First Warning, 1994
Something was wrong with the numbers. In May 1994, internal auditors at
Informix were examining the Australian accounts, and the figures didn't
add up. The company's Australian subsidiary had booked sales a full
quarter before the software products were even shipped.
A few months later, the company's outside auditors -- Ernst & Young --
warned company officers of similar problems in Europe. The auditors also
chided Informix for selling software in Latin America on "handshake"
agreements. "Shareholders will expect agreements with customers to be
documented," the auditors wrote in a draft memo for the 1994 year-end
audit.
Informix executives dismissed the incidents as aberrations. But at an
annual meeting in January 1995, Chief Financial Officer Howard Graham
met with sales representatives to backdate contracts so that January
deals appeared to have closed in December, according to a shareholders'
suit. The result was inflated revenues for 1994. The executives joked
among themselves that they were closing the quarter on "December 45th."
A Company On A Roll, 1996
In early 1996, White negotiated Informix's $400 million purchase of
Oakland-based Illustra Information Technologies. It seemed a stiff price
for a company with less than $10 million in annual sales and an unproven
technology that stored images and sound in electronic databases. But
White touted the acquisition and the wonders of Illustra's technology.
"This stuff is going to change the way people think," he said.
And Informix, it seemed, was on a roll. White declared that he expected
the firm "to become a billion-dollar company in 1996." But for nearly
two years, auditors had warned Informix's board of directors that White,
Graham and other executives were inflating revenues through a variety of
questionable accounting practices, including backdated sales, "burn
deals," barter transactions and side letters.
Under what Informix employees called "Howard's rule," Graham would allow
sales contracts to count toward revenue even before they were fully
signed. In barter transactions or "Phil deals" -- named for Phil White
-- Informix would agree to buy another company's products if that
company would license Informix's software. Informix would then count as
revenue the entire value of the software licenses -- without disclosing
that it still had to buy the other products before it could get paid. In
some cases, it never received payment because the software was returned.
And in complex "burn" transactions, Informix would agree to sell
software licenses to a distributor, then loan the distributor money for
the purchase price. Informix would book the transaction as revenue and
the distributor would, in theory, resell the software so that it could
repay -- or "burn" -- its loan commitment to Informix.
But in many cases, the distributor was under no obligation to resell the
software or to repay the loan. Sometimes Informix would never even
deliver the software. The sales, though, remained on the company's
books.
In other transactions, White would negotiate side letters that granted
customers undisclosed concessions such as price breaks or longer payment
terms. The letters changed the deal so that the original sales contracts
-- and the revenues recorded under them -- were no longer accurate.
As Ernst & Young was privately warning Informix directors about these
practices, though, it was publicly issuing letters giving the company a
clean bill of health. On April 15, 1996, Informix reported $204 million
in revenue for the first three months of the year -- a 38 percent jump
from the year before. Wall Street was impressed. The next day, Informix
stock rose $5 to $24.25 a share. Over the next three weeks it would top
$26. And White and Graham would begin to unload tens of thousands of
their shares in the company.
Dumping Stock, 1996
Auditors could barely conceal their frustration about the accounting
irregularities at Informix. "It just gets better all the time," wrote
one Ernst & Young auditor after discovering several improper deals.
In 1996, Informix booked tens of millions of dollars from transactions
that were backdated, incomplete, subject to secret conditions -- or
simply nonexistent, court documents show.
"Phil deals," or barter transactions, accounted for much of the
improperly recorded revenue. That year, Informix sold about $170 million
worth of software to companies from which it bought about $130 million
worth of computer equipment. Although Informix denied the transactions
were related, an audit would later determine that at least some were,
and that they had artificially boosted revenues by $55 million. Burn
deals and side letters contributed tens of millions of dollars more. By
mid-1996, Informix's European subsidiary had booked more than $105
million from burn deals for which the company remained unpaid. The
tactics served their immediate purpose: They increased revenues and kept
the share price high.
By December, before leaving to become chief financial officer at Siebel
Systems, a San Mateo software company, Graham had sold more than $2.8
million worth of his Informix stock. During the next two months, White
and other executives dumped more than $20 million in shares. Then,
suddenly, everything began to come apart.
Informix In Free Fall, 1997
Despite its inflated revenues and soaring stock price, Informix was
starved for cash. And as the company tried to collect on the burn deals
it had written, customers objected, and, in some cases, refused to
conduct further business with the company. British software firm Logical
Systems International, for example, had agreed to "buy" Informix
software with the understanding that Informix would resell it and not
make Logical Systems pay. "Informix asked us to do them a favor," wrote
managing director Stewart Ashton in a March 27, 1997, letter to the
company, a favor that would "artificially inflate the quarter numbers
(of Informix) for last June and September."
But when Informix squeezed Ashton for payment, he howled at having been
"coerced into this . . . arrangement." Finally, Informix could no longer
hide its crumbling finances. On May 14, in its quarterly filing with the
Securities and Exchange Commission, Informix announced that it had lost
$140.1 million in the first quarter of 1997, and that "almost half of
the licenses sold to resellers" since 1995 "have not been resold."
White blamed an "overemphasis" on selling the new Illustra-based
technology rather than traditional software, but financial analysts knew
better. "An unmitigated disaster," one analyst called the company's
announcement.
Yamaguchi's Retreat, 1997
Robert Crowe watched from his desk in San Francisco as much of the U.S.
attorney's office sank slowly into disarray. He had transferred from the
San Jose office after Widergren's conviction in the StarSignal case. He
had taken charge of screening most investment-fraud prosecutions and
coordinating investigations with the SEC. But Yamaguchi's vow to crack
down on white-collar crime in Silicon Valley quickly turned hollow.
In December 1996, Sen. Diane Feinstein recommended Yamaguchi to fill a
vacancy on the U.S. District Court in San Jose. The judgeship should
have been a crowning achievement for the 46-year-old prosecutor, whose
father, grandparents and thousands of other Japanese Americans were kept
in World War II internment camps after a series of rulings by federal
judges.
But five months later, Yamaguchi withdrew his name after his public
comment about an important drug prosecution led to a mistrial in the
case. "After that, and all the bad press around the case, Mike just
disengaged and hid out in his office," said one former assistant U.S.
attorney. Even Yamaguchi acknowledged later that he had "crawled into a
shell."
Veteran prosecutors were leaving the office in droves. Case filings and
conviction rates were plunging. And criminal referrals from the SEC and
FBI -- some involving serious allegations of fraud in the high-tech
industry -- were going unprosecuted. Even the Cal Micro case, the
office's best hope for sending Silicon Valley executives a message,
seemed in jeopardy.
A Day Of Reckoning, 1997
Informix was at the threshold of disaster. On July 30, 1997, directors
and top company executives gathered to hear the devastating news in the
Palo Alto offices of Wilson Sonsini Goodrich & Rosati, the most powerful
law firm in Silicon Valley. The board had already stripped White of his
title as chief executive officer and hired a replacement, former 3Com
executive Robert Finnochio, to review Informix's financial records.
After asking White to excuse himself from the meeting, the directors
listened raptly as Finnochio described the widespread accounting
irregularities that White and other company executives had allegedly
engaged in or condoned. Finnochio's grim report meant that White was
finished. When Finnochio completed his presentation, the directors
severed all ties with White and replaced him as chairman with Finnochio.
It took Ernst & Young three months to determine the full extent of the
questionable accounting schemes. On November 18, Finnochio made what he
described as "the mother of all financial announcements." Informix would
have to restate financial results for the previous three years. The
company disclosed that it had improperly claimed a staggering $278
million in revenues and $236 million in profits.
On the brink of insolvency, Informix laid off thousands of employees.
Offices were closed and operations consolidated. The company abandoned
plans to build showrooms around the world and announced that it would
sell a 27-acre parcel of land in Santa Clara, the planned site for new
headquarters.
Immediately, Lerach and other plaintiffs' attorneys filed class-action
suits on behalf of the thousands of investors who had lost millions of
dollars, and Informix braced for the onslaught.
The Eve Of Trial, 1998
It was well past midnight in the warren of cramped offices on the 11th
floor of the Phillip Burton Federal Building, and Crowe was still
working. He had been at it for days, his frustration mounting. More than
three years had passed since the investigation into Cal Micro had
opened. In the middle of trial preparations, Leo Cunningham, then
Richard Seeborg, the two prosecutors who had worked the case from the
beginning, left the U.S. attorney's office to join big law firms in
Silicon Valley.
Crowe had replaced them, and now, in early 1998, he was handling the
case alone. He looked over the 600,000 pages of documents with a mixture
of disbelief and terror. "I got started so late," he said. "There was no
secretary, no paralegal, no resources I could count on from the office
-- nothing. "At one point I had to decide between spending 80 hours with
(a key witness) or going through every document. I chose the witness,
but I was afraid the defense would find something in those papers, and I
would be blindsided during the trial."
Finally, the Department of Justice dispatched Pamela Merchant, a senior
fraud specialist in Boston, to help him try the case. Meanwhile, fraud
cases from the SEC and the FBI continued to pile up on his desk. But
there was little Crowe could do. He tried to farm them out to other
prosecutors, but he couldn't force anyone to take them. And he was
acutely aware of how Silicon Valley would view the inaction. "These big
white-collar cases . . . should have high impact," he said. "But if you
screw around for four or five years, no one takes you seriously."
An Empty Victory, 1998
The Cal Micro case finally went to trial in June. Crowe and Merchant
believed they had a strong case, a tour de force constructed around a
stack of financial records and the testimony of two former Cal Micro
executives who agreed to testify for the prosecution.
In their defense, former CEO Desaigoudar and treasurer Henke told the
jury that they had done nothing wrong, that they never saw memos or
attended meetings where the fraud was discussed. And they repeatedly
blamed the wrongdoing on their subordinates.
Their testimony proved unpersuasive. On July 14, 1998, after a five-week
trial, jurors found each man guilty of five felony charges, including
conspiracy, securities fraud, insider trading and making false SEC
filings.
It was a major victory for the demoralized U.S. attorney's office. But
for Crowe it was the end of the road.
Just before the trial, his supervisor entered his office and complained
that Crowe hadn't done anything with the mounting inventory of criminal
fraud referrals. "I exploded," Crowe said. "I had given him the cases to
reassign months earlier so I could concentrate on the trial, and he had
done nothing."
Crowe was sick with frustration. He had relished prosecuting Widergren,
Desaigoudar, Henke and other white-collar criminals. He had even won an
award for his representation of financial fraud victims. In August, he
cleared out his desk in the federal building. When he submitted his
resignation, he had no idea who would take over the inventory of cases
the office still hadn't dealt with, including one potentially explosive
case referred to him months before.
The Verdict, 1998
On December 8, a vast Pacific Gas and Electric Co. power failure left
only dim, backup lighting in the San Francisco courtroom of U.S.
District Judge Vaughn Walker. Despite the jury's verdict against Chan
Desaigoudar and Steven Henke, the former Cal Micro executives refused to
acknowledge their crimes, insisting that their subordinates had betrayed
them. "If I have a regret about my conduct as a former CEO and
chairman," a defiant Desaigoudar told the judge, "it is simply this: I
might have trusted my employees. For this, I and my family will suffer
and have been suffering."
Walker tentatively ruled that he would impose prison terms of 36 months
for Desaigoudar and 32 months for Henke, far less than the government
had requested. Merchant was furious. "Your honor, the government is
deeply troubled," she said. She reminded Walker that the fraud had cost
investors tens of millions of dollars. "This is a significant, as the
court has said, grave matter." She urged Walker to reconsider and to
send a strong message "to the public and the investing community that
this type of crime would not be treated differently than any other
crime."
Walker was unswayed. He praised the accomplishments of the two
defendants. He extolled their civic and charitable contributions. He
even called their situations tragic. "This cannot by any stretch of the
imagination," he said, "be rendered equivalent to fraud which takes
advantage of helpless and uninformed or particularly gullible
individuals."
Epilogue
In August 1998, Yamaguchi resigned as U.S. attorney amid growing
criticism from judges and attorneys about his ineffectiveness. Several
months later he became an immigration law judge in San Francisco.
Yamaguchi was immediately replaced by Robert Mueller, a tough, career
prosecutor from Washington, D.C., who immediately promised to step up
prosecutions of white-collar crime, focusing on Silicon Valley.
A month later, after a four-year investigation, two former executives of
Media Vision, a Fremont chip developer, were indicted on charges of
securities fraud and insider trading. The case has yet to come to trial.
Mueller said the agency has "a number of cases in the hopper," but he
declined to comment further.
In July of this year, the shareholders' class-action suits against
Informix were settled. Without admitting any wrongdoing, the company and
Ernst & Young agreed to pay investors a total of $142 million, the
largest securities fraud settlement in Silicon Valley history.
White, who was not held personally liable for any of the settlement,
currently lives in Atherton and sits on the boards of several companies,
as well as his college alma mater. He denies any wrongdoing and has
declined to comment further. Howard Graham, who also paid nothing under
the settlement, refused to comment. o criminal charges have been filed
against White, Graham or any other Informix executives by the U.S.
attorney's office.
Desaigoudar and Henke have appealed their convictions, and they remain
free on bail. Crowe practices law in San Francisco, representing
investors.
Informix
Roger Sippl founded Informix in 1980 after Hodgkin's disease forced him
to put his medical education on hold. The company quickly grew into one
of Silicon Valley's hottest companies, and after Phil White took over in
1989 it seemed poised to surpass Oracle, Sybase and other competitors as
the top maker of data-base management software.
A troubled fling with a multimedia-database product and charges of
accounting fraud and illegal insider trading derailed the company in
1997. The company has attempted to recover ever since, and last year
posted net income of $57.7 million after a $357 million loss the year
before.
California Micro Devices
Based in Milpitas, California Micro Devices makes silicon chips, filters
and electronic circuitry for workstations and personal computers. Since
its former top officers were accused of securities fraud in 1994 and
then convicted last year, the company has attempted to recover by
expanding into new markets. For the fiscal year ended in March, Cal
Micro lost $2.8 million on sales of $33.6 million. It has 150 employees
in Milpitas and 110 in Tempe, Ariz. (The San Francisco Chronicle
Nov-16-1999)
Thursday, June 3, 2004 at 5:33AM 