(skip this header)


Sunday Mar 16, 2014 3:56 PM PT





sfgate.com Businesses

« Back to Article

PHANTOM RICHES / Beneath the glitter of booming Silicon Valley, executives have been accused of lying about their products and doctoring their books, leaving devastated investors in their wake

Reynolds Holding, San Francisco Chronicle
Published 4:00 am, Monday, November 15, 1999


  • Jim Varano, sitting in his mother's home in Quincy, Mass., lost thousandsof dollars when he invested in Valence Technology's idea for lithium polymerbatteries, which shorted out and exploded more often than they worked, according to former employees Chronicle Photo by Brant Ward


Larger | Smaller
Email This
Page 1 of 1


Silicon Valley is the epicenter for 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.
In 1989, Lev Dawson scoured Stanford University's Jackson Library, searching for a shot at Silicon Valley gold.

He found it in an unproven idea for making laptop and cell phone batteries smaller, lighter and longer-lasting.

With venture capital backing, Dawson created Valence Technology Inc., and during the next four years the batterymaker issued more than $167 million in stock and signed potentially lucrative contracts with Motorola and Hewlett-Packard.

Unfortunately, the batteries had a few problems. They sparked and exploded and burned. One burst into flames so intense that it melted through the factory's tile floor and into the concrete foundation. A senior company engineer said carrying a battery was like having "a bomb in your pocket."

But word of the batteries' failures would not get out for several years. By then, Dawson was farming sweet potatoes in northeast Louisiana, having unloaded more than 2.4 million shares of his Valence stock for almost $41 million.

Public stockholders, though, were almost wiped out. Relying on company assurances that all was well, they bid up the stock to more than $25 a share before the truth emerged in 1994, and the price plunged to $3.25.

Jim Varano, a 53-year-old pharmacist living near Boston, believed Valence's prospects were so promising that he borrowed money for a $320,000 stake in the company. After his investment evaporated, he had trouble sleeping, working and paying his sons' tuition.

Today, he minces no words: "They're crooks and swindlers."

In recent years, Varano and tens of thousands of investors like him have filed lawsuits accusing Dawson and other Silicon Valley executives of securities fraud, insider trading and legal and ethical misconduct.

The executives -- including Dawson -- deny any wrongdoing.

But officials at scores of high-tech companies, from bedrock hardware manufacturers to high-flying dot.coms, have been accused of lying about revenues and products to satisfy market expectations, then dumping their stock for millions of dollars in illegal profits.

At the same time, lawyers at the valley's most influential firms have been accused of playing fast and loose with conflict-of-interest rules, in some cases allegedly betraying the clients they were committed to represent.

And some of the industry's most prominent venture capitalists, the financiers of the high-tech boom, are alleged to have stolen ideas and companies from the entrepreneurs they financed.

But the U.S. Justice Department and the Securities and Exchange Commission have largely failed to enforce laws enacted to protect the markets' integrity. During the past decade, the agencies have filed only a few criminal and civil cases in Silicon Valley, despite warnings that corporate misconduct is thriving.

"We've seen a dramatic increase in the number of complaints and investigations -- far more than three years ago. That's got to reflect a big increase in wrongdoing," said David Bayless, until June the head of the SEC office in San Francisco. "And it's the same goddamn thing every time: faked revenues, 35-day months, side agreements, hiding things in warehouses -- you name it."

This is a series about the dark side of the Silicon Valley miracle. It is about some of the most egregious cases of securities fraud, trade-secret theft and abuse of small entrepreneurs -- cases largely concealed from public scrutiny by nondisclosure agreements, sealed court documents and fears of retribution.

Set amid the tidy light-industrial parks and sprawling corporate campuses that line the south end of San Francisco Bay, it is a story about greed and hubris, about high-powered executives and boardroom dealmakers who operate with flagrant contempt for the rules of law and ethics.

The story begins with two men -- a plaintiffs' attorney and a high-tech pioneer -- whose battles with each other reflect the fundamental conflict between unrestrained corporate freedom and the need to protect the rights of investors.


William Shannon Lerach -- the attorney despised most by corporate America -- was born a victim of the stock market.

In September 1929, after receiving a substantial inheritance, Lerach's father, Richard, went to work as a stockbroker. He invested everything he owned in the market. The next month, the market crashed, and the elder Lerach was ruined.

In 1933 and 1934, President Roosevelt signed landmark securities legislation to prevent the kind of speculation, manipulation and outright fraud that triggered the crash and caused millions of Americans to lose their savings and jobs.

The legislation came too late for Richard Lerach, who was relegated to selling metal parts for the rest of his days. But for his youngest son, William, it would provide the means for a career of wealth and notoriety, one that would ultimately earn him the sobriquet "prince of darkness" -- and a law firm draw last year of more than $16 million.

Bill Lerach was born in 1946 in the Ohio River Valley. As he grew up, he worked in a series of dead-end jobs at a plant nursery, a funeral home and a pool hall. He was a mediocre student until law school at the University of Pittsburgh, where he graduated second in his class and attracted a job offer from Pittsburgh's elite firm, Reed Smith Shaw & McClay.

He excelled there, making partner in less time than any other lawyer in the firm's history. He was brash and profane and wickedly funny, a flush-faced guy with a big head of puffy red hair.

But he was never entirely comfortable representing companies in lawsuits and deals. He could never overcome the deep mistrust of corporate America he had developed while watching his father work for almost nothing.

"They treated him like they treat pencils," he said, "shaving him down until there was nothing left but a nub."

The last straw was a lawsuit filed against his corporate client by a shareholder.

"This guy's case was so good, and he was so right," said Lerach, "and we just chopped him up into little pieces. We just blew him away. And I thought, if that guy had had more money and a better lawyer, he would have won."

Lerach realized he wanted to represent shareholders -- not to mention earn bigger paydays. So in 1976, he took a job with prominent plaintiffs' attorney Melvyn Weiss, opening a one-lawyer branch office in San Diego for Weiss' New York firm, specializing in suing companies for securities fraud.

The office prospered and quickly expanded, taking cases around the country. But it did not come into its own until 1984, when, for the first of several times, it filed a lawsuit against a Silicon Valley company called Seagate Technology, run by a man named Alan Shugart.


Al Shugart was in a hurry from the start, impatient to leave behind a downscale adolescence spent surfing and fixing motors near Chino, in San Bernardino County.

In 1951, the day after earning an engineering degree from a private college called University of Redlands, he landed work as a repair technician for International Business Machines.

Promotions came quickly. At the company's research center in San Jose, he led a team of top-flight engineers credited with developing the first rigid disk drives, a revolutionary means of storing data.

It was an extraordinary time in Silicon Valley, the eve of the computer revolution. And in 1969, when IBM wanted Shugart to join its New York headquarters, he quit instead, ending 18 years with the company.

He worked for Memorex for several years, then started his own floppy disk drive business -- Shugart Associates. But his role in the enterprise ended badly in 1976 when the directors of his company fired him for reasons he cannot -- or will not -- explain. For the next three years, Shugart fished for salmon and tended bar in Santa Cruz. Then, in 1979, he hooked up with Finis Conner, a former colleague from Shugart Associates. Demand for personal computers was rising fast, and Shugart and Conner were determined to catch the wave. Their idea: a hard disk drive with five times the capacity of a standard floppy disk -- at half the price.

The two men recruited three more engineers through newspaper ads and then created the company that would become Seagate Technology.

Seagate's new disk drives began to roll off production lines in 1980. It was an increasingly competitive market. Apple Computer, IBM and other major customers were starting to make their own hard drives. Japanese manufacturers were jumping in with even cheaper products.

Still, by the summer of 1984, Seagate claimed profits of $42 million, up 221 percent over the previous year. Shugart and other Seagate executives crowed about the company's bright prospects for growth, sending the stock price -- and Shugart's reputation as a Silicon Valley entrepreneur -- soaring.

Later that summer, though, the Seagate success story began to unravel.

In August, without warning, Seagate executives announced that they expected dramatically lower profits and slower growth. The company would have to set aside millions of dollars to cover obsolete inventory and accounts that might never be collected. The huge Watsonville plant -- touted as a symbol of the company's astounding growth -- had, in fact, never been used, and it was for sale.

The earnings report that Seagate issued in late 1984 showed precipitous declines in revenues and profits. Almost instantly, Seagate stock plummeted to $4.38 a share -- a 75 percent drop from its high of $17.13 in June 1983.

Public shareholders took a beating. But shortly before the company issued its dire report, Shugart and other executives had unloaded much of their own stock for gross proceeds of more than $84 million. Shugart's take alone was more than $15 million.

Bill Lerach smelled a rat.


Lerach had been filing class-action lawsuits on behalf of shareholders for years, extracting multimillion-dollar settlements from notable companies such as Gap Inc. and Memorex and -- with the lawyers' standard one-third contingency fee -- amassing a personal fortune.

But Shugart and Seagate were prized game, potential trophies from the heart of Silicon Valley. And less than a month after the company released its financial report, Lerach and several other lawyers filed class-action suits that accused Shugart and his colleagues of securities fraud and insider trading.

In Seagate's Scotts Valley headquarters, Shugart was furious. He vehemently denied the allegations and vowed to fight the suits no matter how long it took, no matter how much it cost.

He hated anyone who tried to obstruct his entrepreneurial freedom. He hated lawyers most of all.

"Al Shugart hated lawyers so much he kept a lawyer doll on his desk so he could periodically snap its head off," said one plaintiffs' attorney. "But he really detested Bill Lerach."


In 1986, as the Seagate case dragged through its second year of pretrial motions, Lerach turned his attention to a lawsuit that had the potential to make him the nation's best-known class-action attorney.

It involved Nucorp Energy Inc., a San Diego oil company that issued $150 million in securities in 1981 before declaring bankruptcy a year later. Lerach and the SEC contended that the company used phony revenues to lure investors into a disastrous deal.

Lerach tried the case to a jury verdict, his first in more than 18 years of practicing law. He was so sure of victory that he told the lawyer on the other side, "This is going to be an ignominious end to your mediocre career." When jurors requested a calculator, he asked the judge to make sure it could handle nine figures.

On April 25, 1988, he invited his colleagues and the media to court for the verdict.

Then he lost.

Lerach was stunned. His face blanched, then burned a furious red before he stormed from the courtroom. His colleagues say the fury lasted weeks.

But rather than weaken Lerach, the humiliating defeat seemed to galvanize him for battle against the titans of corporate America. It intensified his belief, as he wrote in a memo about jurors one week later, that "60-year-old Republicans" were inherently unsympathetic toward victims of securities fraud, and a person's "position in society, his sense of class, is probably the single most important factor in determining his attitude toward (investors' claims)."

And Shugart -- 58 years old and rich -- would soon experience the force of Lerach's wrath.


By the end of 1987, Seagate had recovered from its financial problems to become one of the most prosperous companies in the high-tech industry. And Shugart, undaunted by the lawsuit Lerach had filed against him, emerged as one of the most visible and outspoken executives in Silicon Valley.

With a new 3.5-inch disk drive, Seagate earned revenues surpassing $1 billion a year. The company's sprawling new production facilities in Thailand and Singapore made it the largest private employer in both of those countries.

And in March 1988, Shugart announced a new order from Seagate's biggest customer -- IBM -- a major announcement that nervous investors had long been waiting for.

Wall Street applauded, and the company's stock price soared, but there was a problem: The deal didn't require IBM to order anything from Seagate.

IBM executives were horrified by Shugart's announcement.

They called him and another Seagate executive to Washington, D.C., in May. Over dinner, the men from IBM accused Shugart of blatantly violating a written agreement that barred him from announcing the deal.

During a heated exchange after dessert, the ranking IBM executive, Irv Abzug, accused Shugart of trying to please "security analysts" and "hype" Seagate's stock. At that point Shugart walked out.

For more than a month, he assured financial analysts that demand for Seagate's disk drives was so strong that the company would expand production and even raise prices -- an unheard of move in the highly competitive disk-drive industry. But in July, Seagate disclosed that its earnings were down 57 percent from the previous year. Over the next day, the value of Seagate shares plunged $250 million -- a record for high-tech stocks at the time.

Shugart, however, had unloaded 100,000 shares in April, when the stock price was up.

Lerach struck quickly. On July 29, 1988, just three months after the devastating Nucorp verdict, he filed a second class-action suit against Seagate, again accusing Shugart and other top executives of securities fraud and insider trading.

In a rage, Shugart categorically denied the allegations -- and vowed to fight them with everything he had.


A tip came late the next year.

Two attorneys working with Lerach on the Seagate case flew to San Jose and knocked on the door of a trucker named George Armour, who had been employed by the shipping firm that Seagate used in 1983 and 1984.

For four years Lerach and his associates had heard the rumors that Seagate boosted revenues by claiming to have sold disk drives that were actually stored in warehouses. And now, it seemed, the rumors could be true.

At first Amour was reticent, but then he told the attorneys how Seagate cleared disk drives out of its warehouses at the end of every business quarter.

He told them that he and other truck drivers often worked 16- to 18-hour shifts, hauling semitrailer trucks packed with disk drives to rented warehouses in Santa Clara and San Jose.

At one point, he said, the company parked at least six fully loaded trailers in the Santa's Village parking lot in Scotts Valley. The trailers were parked back-to-back, so the doors could not be opened. A security guard patrolled the lot.

"It seemed a little funny to me at the time," Armour said. "Those disk drives cost a lot. They were like gold." Later, a second trucking employee, Peter Page, described how semitrailer trucks loaded with pallets of Seagate disk drives arrived through the night at a local freight warehouse. Two trucking lines delivered the merchandise at the end of a financial quarter in 1983 or 1984, he said, and it was not removed until later the next month.

The truckers' statements would be the turning point in Lerach's first suit against Seagate. He would eventually force Shugart to the bargaining table for a settlement: Without admitting any wrongdoing, Seagate agreed to pay $5 million to 17,000 shareholders.

Lerach and the other attorneys who had sued the company collected $3.1 million in fees and $1.26 million in expenses.


"Enough is enough," blared the full-page ad from the back cover of the April 1990 Upside magazine, a glossy monthly that covers the high-tech industry. "Are securities lawyers holding your company ransom?"

The ad was Shugart's, a public declaration of war against class-action lawsuits.

For years, scores of executives at some of the most prominent companies in Silicon Valley -- including Oracle, Apple and Sun Microsystems -- had been sued for securities fraud. And whatever the merits of the allegations, legal fees and settlements cost the high-tech industry millions of dollars every year.

In the ad, Shugart asked other executives to send him their business cards if they wanted to help stop the lawsuits against their companies. His plans were uncertain, but during the next few weeks, he received a couple of dozen business cards.

Then a mysterious envelope arrived from San Diego. In it was one of Lerach's business cards. Scrawled on the front was a message:

"Dear Al: More is coming."

True to his word, on June 25, 1991 -- just 11 days after the settlement of his first suit against Seagate -- Lerach struck again, filing a third lawsuit accusing Seagate and Shugart of securities fraud.


The class-action business was making Lerach rich, providing him the means to support a sprawling mansion in Rancho Santa Fe, an enclave of multimillion-dollar homes in the Southern California hills overlooking the Pacific.

It was also earning him the enmity of corporate America, whose executives called him "pond scum" and "blood-sucking scumbag" while commiserating with other targets of shareholder suits about being "Lerached."

But no one despised Lerach more than Shugart, who in 1994 found himself a defendant in yet another shareholder suit -- this one over his involvement with Valence Technology.

Shugart had been asked to sit on Valence's board of directors by Carl Reed, Seagate's former vice president of operations. A tough and efficient manager, Reed was in many ways responsible for Seagate's rise to a billion-dollar corporation with almost 40,000 employees around the world.

In May 1991, Reed left Seagate to become president and chief operating officer of Valence in San Jose. Several months later, he persuaded Shugart to join the company's board.

In theory, Valence's technology was compelling: a wafer-thin lithium polymer battery that would last four times longer than standard batteries, would cost one-tenth as much to make -- and would contain no liquids that might cause the lithium to explode.

From the beginning, though, Valence had problems.

According to former Valence engineers, virtually all of the thousands of machine-made batteries eventually shorted out, emitting sparks or intense heat when pinched by assembly equipment.

The equipment itself was often broken, they say, hampering attempts to show off the factory to potential customers or investors. When visitors arrived, employees would pretend the machines were working by sending hand-made batteries down the assembly line.

And the cost of manufacturing was prohibitive: between $50 and $60 for a battery the company planned to sell for about $15.

"It was like strapping a $100 bill on one of these things and then sending it out," a former manager said.

But Chief Executive Officer Lev Dawson, Reed and other top executives publicly claimed that Valence was on the verge of success.

In May 1992, the company said basic research on the state-of-the-art battery was complete. In December, Valence announced a $100 million order from Motorola to supply batteries for cell phones and pagers, and it set early 1994 as the delivery target date.

Then, in February 1993, an article in Forbes magazine questioned the company's prospects. But Dawson controlled the potential damage, telling "Valence Followers" in an open letter, "We remain in solid financial position."

A few days later, Dawson stepped down as CEO. Reed replaced him, and the optimistic announcements continued.

In late 1993, Valence touted plans to open a huge new plant in Ireland. And in January 1994, the company announced a $3.5 million contract to supply Hewlett-Packard with batteries for laptop computers.

"We look forward to producing our first commercial batteries in 1994," Reed said in a press release.


Across the country, in Braintree, Mass., Jim Varano read about the developments with excitement. He already owned a few hundred shares of Valence, and the latest news persuaded him to buy even more.

"In effect, they were saying that the batteries were perfected," he said. "They had delivery dates. They were going to build a production plant. It meant they had a product ready."

He talked it over with his broker, and in early 1994 purchased approximately 25,000 shares on credit. Meanwhile, unknown to Varano, Dawson and other Valence insiders were unloading millions of shares of their own.

On May 4, 1994, on his way to work at the Veterans Affairs hospital in nearby Brockton, Varano stopped at a Dunkin' Donuts for a cup of coffee. He sat down and turned to the business section of the Boston Globe, eager to see whether Valence stock had continued to climb.

To his horror, he saw that the stock had plunged almost 50 percent. Valence had announced it could not meet Motorola's requirements for batteries -- and probably never would.

Overnight, Varano lost hundreds of thousands of dollars.

"I was devastated," he said.

Even worse news followed.

In June, the company announced that it could not deliver batteries to Hewlett-Packard. And in August, it announced that it would abandon development of a solid lithium battery.

Almost immediately after the stock crashed, Lerach and other plaintiffs' attorneys filed class-action lawsuits accusing Valence and Dawson, Reed, Shugart and other company executives and directors of securities fraud.

Varano became the lead plaintiff in Lerach's suit. He has yet to recover a dime.


On Dec. 15, 1995, Lerach went to dinner at the White House.

At the time, President Clinton was grappling with the Private Securities Litigation Reform Act of 1995, far-reaching legislation designed to limit securities-fraud class actions against corporate executives.

It proposed the most dramatic change in the nation's securities laws since 1934, and Clinton had four days to sign or veto the bill.

Lobbying for the Reform Act had started in earnest two years earlier, when accounting firms and Wall Street investment banks complained to Congress that they were being dragged into securities suits filed against their corporate clients simply because they had "deep pockets."

Their plea for relief went nowhere at first. Then, in November 1994, the Republican Party swept into Washington brandishing the "Contract With America," which included a provision against securities class actions.

In just two months, the new Republican-led House of Representatives passed strict rules designed to put plaintiffs' attorneys out of business. The most draconian sections, which would have eliminated almost all shareholder suits, were weakened in negotiations with the Senate.

Top Silicon Valley executives, in their first serious display of political power, lobbied the president to sign the Reform Act. They argued that most securities fraud suits were frivolous. As proof, they pointed out that half of the 150 largest companies in Silicon Valley had been the focus of those lawsuits, implying that securities fraud could not possibly be that widespread.

But the Democratic Party's traditional supporters -- consumer groups, civil libertarians and plaintiffs' attorneys such as Lerach -- pushed the president for a veto.

Lerach was one of Clinton's earliest and strongest political backers. During the 1992 presidential campaign, he rode on Clinton's bus through the nation's heartland. He was host for a fund-raiser for Clinton at his mansion in Rancho Santa Fe.

Lerach disputes published reports that suggest he persuaded Clinton at the December White House dinner to veto the Reform Act.

"I was at a dinner with President Clinton and 500 other people," he said. "I shook his hand and never spoke to him about the bill. There were 20 lobbyists on the other side who were at that dinner."

But four days later, 20 minutes before the midnight deadline, Clinton vetoed the Reform Act.

"The president supports the goals of this legislation," said spokesman David Johnson in announcing the veto, "but he is unwilling to sign legislation that would have the effect of closing the courthouse door on investors who have legitimate claims."

The veto would not last. For the first time in Clinton's presidency, the House and Senate voted to override, and the Reform Act became law.


Corporate executives around the nation celebrated, and nowhere was the news greeted with more joy than in Silicon Valley. Shugart was ecstatic.

Four times he had been sued by Lerach. The first case had cost him millions. The second had been thrown out of court. The third would be settled for millions more. He had been dropped from the Valence suit because he had not participated in running the company.

Finally, it was payback time.

He fired off a fax to Lerach's San Diego office. It said: "Dear Bill, More is coming. Sincerely, Al."


With headquarters in Scotts Valley, Seagate is the world's largest manufacturer of computer disk drives.

Seagate was founded in 1979 by Alan Shugart and Finis Conner. Shugart, who is credited with leading the team of IBM engineers that invented the floppy disk, served as the company's CEO until July 1998.


Milberg Weiss is the largest law firm in the nation to focus on class-action lawsuits.

The firm specializes in securities fraud suits and has filed hundreds of shareholder suits against Silicon Valley companies, resulting in more than $2 billion in settlements.

William Lerach joined the firm in 1976. He has successfully sued some of the most notorious figures in two of the nation's biggest financial scandals, winning a $250 million settlement from Charles Keating and American Continental Corp. and $1.5 billion from Michael Milken and Drexel Burham Lambert.


For the past 10 months, Chronicle staff writers Reynolds Holding and William Carlsen investigated allegations of widespread legal and ethical misconduct in Silicon Valley.

This five-part series is based upon thousands of pages of financial reports, internal company memorandums, government records and court documents, as well as scores of interviews with corporate executives, government officials, state and federal prosecutors, judges, lawyers, academicians and entrepreneurs.

Some of those court documents were unsealed only as a result of a court order obtained by The Chronicle in San Mateo Superior Court.


Phantom Riches


products and doctoring their books


Hollow Words

Federal prosecutors say white-collar crime is a priority, but they have filed only a few charges against high-tech executives



Silicon Valley entrepreneurs say they have been betrayed by venture capitalists and lawyers, the very people they asked for help


Stolen Secrets

Technological breakthroughs are so valuable in Silicon Valley that some company executives are willing to do almost anything to get them


Beyond the Law

As the SEC attempts to crack down on improper accounting, a recent federal court ruling threatens future investor lawsuits