Silicon Valley business leaders have long served on each other’s boards, giving bright minds a way to share their collective wisdom and fostering a climate of corporate clubbiness that prizes personal networks as much as computer networks.
But what happens when bad ideas seep into chummy boardrooms?
An answer may be emerging as federal prosecutors and regulators dig deeper into a stock options scandal that has already forced dozens of companies across the country to wipe out more than $5 billion in combined profits.
At least 28 of the Northern California companies nursing stock options headaches share a common director with one other company wrestling a similar problem, according to a recent analysis that blames the close relationships for spreading the accounting shenanigans like a nasty virus.
“The theory behind social networks would seem to suggest very strongly indeed that these interconnected boards have something do with stock option (manipulation),” said Paul Hodgson, who co-authored the study for the Corporate Library, a shareholder watchdog group.
Most of the trouble revolves around the “backdating” of employee stock options without properly accounting for the maneuver — a deception that can boost profits and lower taxes.
Backdating refers to options that are issued retroactively to coincide with low points in a company’s share price to increase the recipient’s potential windfall.
The practice isn’t necessarily illegal as long as the backdated stock options are properly recorded on the company books. If the accounting for the rewards is bungled, it can exaggerate corporate profits and improperly lower taxes.
Even more earnings could evaporate in the months ahead because not all the companies with potential stock option trouble have calculated the financial damage.
More than 160 companies nationwide have disclosed their stock option practices are under internal review or being investigated by the government. At least 51 of those companies, including the 28 in Northern California, shared common directors, according to the Corporate Library.
No concrete evidence
So far, there’s no concrete evidence to tie Silicon Valley’s stock option chicanery to the circle of directors who sat on common boards. But the Securities and Exchange Commission is examining the role directors played in the scandal.
“It wouldn’t be a surprise if knowledge like this got passed along among executives and had a cascading effect through the community,” said James Post, a Boston University professor specializing in corporate governance and business ethics. “Just as networks pass along good ideas, they can play a critical role in passing along bad ideas too.”
Regulators already have signaled they are considering a civil suit against three directors at Mercury Interactive Corp., one of the first Silicon Valley companies to acknowledge stock options manipulation. The three directors — Chairman Giora Yaron, Igal Kohavi and Yair Shamir — have maintained they did nothing wrong and remained on Mercury’s board until the company’s recent $4.5 billion sale to Hewlett-Packard Co.
None of these three belonged to the boards of other companies embroiled in the scandal. But another former Mercury board member, Ken Klein, now runs Wind River Systems Inc., a Silicon Valley company that is conducting its own investigation into its stock options bookkeeping.
Two more valley companies, Mountain View-based VeriSign Inc. and Juniper Networks Inc., each had four directors who sat on the boards of other companies trying to clean up a stock option mess.
The list of overlapping directors include the CEOs of the companies, VeriSign’s Stratton Sclavos and Juniper’s Scott Kriens.
Sclavos joined Juniper’s board in May 2000 and Kriens reciprocated by joining VeriSign’s board eight months later.
And VeriSign has other directors with ties to more than one company in the scandal, including Roger Moore of Western Digital Corp., and Gregory Reyes, the former CEO of San Jose-based Brocade Communications System Inc. Reyes became the first prominent Silicon Valley leader to face criminal charges in the options imbroglio.
Reyes, who has pleaded not guilty, resigned from VeriSign’s board two weeks after his July indictment on securities fraud and other charges. He voluntarily resigned from VeriSign’s board so he could devote more time to his defense in the Brocade case, said Richard Marmaro, Reyes’ attorney. “He was not forced off,” Marmaro said. “It was simply time for him to move on.”
Sclavos’ business ties with Reyes extend beyond their tenure on VeriSign’s board. The two are part of a partnership that bought a piece of the National Hockey League’s San Jose Sharks in 2002, shortly after Reyes joined VeriSign’s board.
VeriSign, which is also a target of SEC and U.S. Department of Justice investigations, didn’t respond to requests to interview Sclavos.
Besides belonging to the VeriSign and Juniper boards, Sclavos also is a director at Intuit Inc., which last month disclosed the SEC had closed its investigation into the Mountain View-based company’s stock option practices without taking punitive action.
Juniper’s other boardroom links to the scandal are provided by Frank Marshall, a longtime director at Santa Clara-based PMC Sierra Inc., and Kenneth Levy, a co-founder of KLA Tencor Corp. Levy, 64, retired as KLA’s chairman last month with a less valuable stock option package after the San Jose-based company revealed its mishandling of options would cost up to $400 million to fix.
Citing the inquiries into its stock option accounting, Juniper turned down a request to interview Kriens, who became the company’s CEO a decade ago.
The fallout from stock option backdating has caused Juniper and VeriSign to miss government-mandated deadlines for filing their quarterly financial statements — lapses that threaten to oust them from the Nasdaq Stock Market.
Several shareholders also have filed lawsuits against Brocade, Juniper and VeriSign, alleging that the backdating of stock options duped investors.
'Cavalier attitude toward corporate governance'
The confluence of friendly CEOs in Silicon Valley boardrooms is a longtime peeve of corporate governance experts, who believe the amiable atmosphere makes directors less likely to detect and crack down on abuses such as backdating stock options.
“Silicon Valley has always had a very cavalier attitude toward corporate governance,” said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.
Apple Computer Inc., a Silicon Valley icon, has raised questions about its board’s independence by picking directors with potential conflicts.
The Cupertino-based company is in the process of recalculating its past profits and also faces possible removal from the Nasdaq for mishandling stock option awards that included a large grant given to its influential CEO, Steve Jobs. The options that Jobs received were never exercised.
Still, the manipulation elicited a public apology from Jobs and provoked the resignation of former Chief Financial Officer Fred Anderson from the company’s board. Cupertino-based Apple said it had “serious concerns” about how two former executives accounted for the company’s the stock options. Those former executives haven’t been identified.
Oracle Corp. CEO Larry Ellison, who regularly describes Jobs as his best friend, served on Apple Computer Inc.’s board from 1997 until 2002 — a period that coincided with some of the company stock options now under review.
And in 1999, Apple added retailing executive Millard “Mickey” Drexler to its board in 1999 and Jobs joined Drexler’s board at Gap Inc. four months later.
Jobs left the Gap board in 2002 shortly after Drexler’s ouster as CEO in 2002, but Drexler remains on Apple’s board. Drexler now runs clothing retailer J. Crew Group Inc.
Redwood Shores-based Oracle has said it has no backdating problems, but San Francisco-based Gap is among the companies revising its stock option accounting.
Elson said conflicts of interest are even more likely to arise among directors when CEOs agree to serve on each other’s boards.
The overlap “creates independence issues and it challenges a director’s ability to remain objective,” Elson said. “You can be the smartest person in the world and not be objective. Shareholders need people who are objective on the board.”