A Scandalous Year For Tech

The best of 2006Internetnews.com wades through the top stories and issues that rocked the industry in 2006 in this week-long series.

At first, it looked like more of the same dysfunction spilling out of Hewlett-Packard’s board of directors after one member resigned in a tiff over another’s actions. Could this just be more fallout after the board’s bruising battle to oust former CEO Carly Fiorina?

Then came the revelations over the use of pretexting — such as snooping on journalists’ phone records — before the drip drip of the HP board’s media leak probe scandal would slosh throughout the tech industry and beyond. HP wasn’t the only company in trouble with regulators in 2006, although its mess was among the loudest in a year that kept the Department of Justice (DoJ) and several attorneys general, as well as the Securities and Exchange Commission, busy minding the behavior of high tech.


Will 2006 be remembered as the year Uncle Sam’s watchdogs began to wrest
tighter control of the high-tech industry?

HP Pretexting Scandal


It sounded like something out of a cloak-and-dagger film.


Take a few stories that included details leaked from boardroom discussions,
add some peeved executives in the upper echelons of one of the most powerful
high-tech companies in the world, and what do you get?


A pretexting scandal that saw executives lose their jobs, five indictments
handed out by the California prosecutor, and a CEO on the hot seat for what
he knew and when.

That sums up the HP pretexting scandal in which HP executives hired
investigators to track the activities of journalists to determine where the
source of the leaks.

Investigators engaged in pretexting, or impersonating journalists and HP
board members, to obtain their phone records (pretexting may include
financial records, but not in this case). The thinking was that if they could connect the dots of communication between board members and journalists, they could staunch the leaks.


But it backfired. Big time.


The news emerged after HP board member Thomas J. Perkins resigned and
attracted the attention of government regulators and California’s attorney
general to methods used during a 2005 investigation into leaks from board of
directors meetings.


In September, HP filed an explanation with the Securities and Exchange Commission (SEC) of its
investigation into corporate leaks and the resignation of a member of the
company’s board of directors.


Within weeks, HP’s Board Chairman Patricia Dunn and other execs resigned
and HP executives were called
to the carpet and grilled.


In October, Dunn and four others involved in the pretexting scandal were indicted
and arraigned within a week. The parties settled for $14.5 million, which will finance a new law enforcement fund to fight violations of privacy and intellectual property rights.


Verizon and other phone carriers have begun suing
alleged pretexters, which could lead to a serious continuation of the issue
in 2007.


Reed Freeman, a consumer protection attorney and partner with Kelley Drye & Warren LLP in Washington,
D.C., said that while the HP case received a lot of media attention and
scrutiny, the Federal Trade Commission has brought about five cases against
alleged phone pretexters.


Interestingly, Freeman said the FTC currently has to seek “equitable
relief,” which can include an injunction and/or repayment of funds obtained
through pretexting, because there is currently no federal statute under
which phone record pretexters may be prosecuted.


This means the FTC can’t just slap phone pretexters with a fine upon finding
them guilty.


That could change in 2007; Freeman said the FTC has recommended that
Congress enact a statute that empowers the FTC to seek fines directly from
offenders. This would fill what Freeman said the FTC “perceives to be a gap
in their enforcement authority.”


“There are a lot of high priorities in Congress but I think there is a
reasonable likelihood that legislation could pass in the 110th Congress to
address this,” Freeman said.

Next Page: Stock-option backdating exposed

The best of 2006

Page 2/3

Internetnews.com wades through the top stories and issues that rocked the industry in 2006 in this week-long series.


Backdating Bonanza


The year 2006 saw regulators crackdown on corporate malfeasance with a
long, painful whip, as more than 100 companies were investigated for
backdating stock options.


Stock options are bonuses offered to employees that allow to purchase shares in the future at the market price on the day the option was granted.


The idea is that if the employee performs well, the company will do well. By
extension, the stock will do well. Backdated grants are dated to
lower-priced days to give recipients an instant profit.


High-tech heavyweights Apple, Brocade Communications Systems, Comverse
Technologies, CNET Networks, Monster.com and Mercury Interactive were among
those investigated in U.S. regulators’ backdating dragnet.


The case at Brocade let the world know just how serious this issue could be.


In July, Gregory Reyes, the former CEO of Brocade Communications Systems,
along with the former vice president of human resources at the computer-gear
manufacturer, were charged with federal securities fraud for backdating
stock options.


Reyes and Stephanie Jensen could receive 20 years in prison,
along with $5 million in fines for granting backdated stock options to
employees between 2000 and 2004, according to the SEC and the U.S.
Attorney’s Office for the Northern District of California.


In August, former Comverse CEO Kobi Alexander, former CFO David Kreinberg
and former General Counsel William F. Sorin were charged
with criminal fraud. Alexander, who failed to show up in court and was
declared a fugitive by the FBI, was found in Namibia, and was set to be
extradited to the U.S.


That makes five former executives charged with criminal activities, with more
charges expected as the cases progress. Moreover, more than 60 executives
have lost their jobs in issues related to the backdating phenomenon.


So if many of these options were backdated years ago, why are we finding out
about them now?


Jill Fisch, professor of business law at Fordham Law School in New York,
said financial accounting regulations such as Sarbanes-Oxley have spurred an
emphasis on compliance and pressure to respond promptly and investigate
possible misconduct.


Fisch also cited continued concern over incomplete disclosure, excessive
compensation levels and stealth compensation as reasons for the
investigations.


“There was a domino effect. Once a few examples of options backdating were
revealed, companies were under pressure to examine their own practices, and
widespread nature of the problem came to light,” Fisch said.

Next page: Search under scrutiny

The best of 2006

Page 3/3

Internetnews.com wades through the top stories and issues that rocked the industry in 2006 in this week-long series.


Search Vendors, Cisco Rapped By DoJ


While executives at major companies weathered public brow beatings and
indictments for backdating and pretexting, major high-tech companies also
faced legal scrutiny from the DoJ, and lawmakers took exception to some of
the business moves of major vendors.


In February, the DoJ called
Google, Yahoo, Microsoft and Cisco to task for kowtowing to Chinese censors.


Just what did the high-tech giants do to tick off the feds?


Yahoo turned over the name of at least one cyber dissident to Beijing who
subsequently was jailed. Microsoft pulled a blog critical of Beijing at the
request of the Chinese government. Google agreed to Chinese censorship requirements in return for operating a local Chinese search engine. And Cisco simply sells the majority of routers and switches in China.


“Instead of using their power and creativity to bring openness and free
speech to China, they have caved in to Beijing’s outrageous but predictable
demands simply for the sake of profits,” Rep. Tom Lantos (D-Calif.) said at
the time.


“My message to these companies today is simple: Your abhorrent activities in
China are a disgrace. I simply do not understand how your corporate
leadership sleeps at night.”


In a separate but almost parallel squabble, the DoJ subpoenaed search
data records from Google, Microsoft, Yahoo and AOL in order to conduct a
study on the pervasiveness of pornography on the Web and the inability of
filtering software to block children’s access to such material.


Yahoo, Microsoft’s MSN and America Online caved in to the DOJ’s demand;
Google alone challenged its users’ rights to privacy and the battle raged on.


The DoJ disagreed, arguing that users’ rights would not be violated.


In March, the judge hearing the DoJ’s request for access to Google search
data denied
the government’s request for search queries of Google users but ordered the
company to provide a random sample of 50,000 Web addresses from its index.


What can we learn from all of this legal wrangling and the cat-and-mouse games
between the government and high-tech vendors?


That now, perhaps more than ever in the history of the industry, the feds
are closely scrutinizing vendors as they rise to higher levels of financial
power.

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