ComputerWorld: The Real Story is SCO's Vultus Acquisition

Monday, July 28 2003 @ 04:33 PM EDT

Contributed by: PJ

We've been regularly posting insider trading news by SCO players. In fact here is another one. But ComputerWorld is today saying that the real story is SCO making money in what it calls a "shell game." They say SCO's legal and business tactics seem questionable, so what's the deal?

"SCO is a software company that has slashed its R&D budget, alienated its customers and demolished the value of its brand. That's not the way you build a business.

" So, what do you do when you have no real business but your stock price keeps going up? We all learned that lesson during the dot-com bubble: You use that stock as currency.

"That brings us back to Vultus, which was majority-owned by The Canopy Group, former Novell boss Ray Noorda's personal investment fund. And Canopy -- surprise! -- also controls SCO, as well as some 30 other small companies. Last week, SCO didn't disclose much information about the deal. But in fact, the details were already on the record in SCO's recent filings with the SEC. It turns out SCO didn't simply use stock to buy another company. SCO printed up about $3 million in new stock. Then, in the complicated deal in which SCO acquired Vultus, the stock was cashed out, with most of the proceeds going to Canopy.

"Some went to Canopy as a Vultus shareholder; the rest went to Canopy as compensation for taking on Vultus' debt, some of which was presumably owed to Canopy.

"Got all that? If it sounds like a shell game, well, that's the way Canopy likes to move its companies around. But in effect, Canopy used SCO's stock price, boosted by SCO's Linux threats, to rake in a couple of million dollars in cash behind the scenes."

Story about Vultus buy here and here. Vultus' press release here. Want to see a picture of the the SCO/Vultus sign outside the building where they both are officed? Here.

Note that Michael Meservy, mentioned in an SEC filing as one of the SCO shareholders planning to sell SCO shares is the President and CEO of Vultus. Ty Mattingly is also mentioned as a SCO shareholder about to sell and is also a Vultus executive. And Ralph J. Yarro, President and CEO of the Canopy Group is also on the board of Vultus. Pics and bios of all three here. Vultus, being privately owned, isn't in SEC records.

There is something in corporate law called "alter ego", which is when a corporation isn't really anything but a front for another entity, doing its bidding, not necessarily in the corporation's best interest. You might want to review this as well. It has a link to the most recent 10Q SEC filing and some information on piercing the corporate veil, which is what alter ego makes possible, if proven. Obviously, I am personally making no assertions. Just providing info.

"Alter Ego" theory: Alter ego liability is "the judicial doctrine applied to corporations where a court may hold the individual shareholders liable where the business entity is merely the 'Alter Ego' of its shareholders." Here's a clip from a case, Meyer v. Holley, 258 F.3d 1127, from an amicus brief offered by the government. It descibes the theory better than any other I could quickly find:

"The alter ego doctrine states that, when the corporation is the mere instrumentality or business conduit of another corporation or person, the corporate form may be disregarded." 1 Fletcher Cyclopedia, supra, § 41.10, at 568; see Chicago, Milwaukee & St. Paul Ry. v. Minneapolis Civic & Commerce Ass'n, 247 U.S. 490, 500-501 (1918) (rule that one corporation's ownership of stock in another does not generally "create the relation of principal and agent or representative between the two" is inapplicable "where stock ownership has been resorted to . . . for the purpose . . . of controlling a subsidiary company so that it may be used as a mere agency or instrumentality of the owning company or companies"). As the Tenth Circuit has explained, the federal common law doctrine of piercing the corporate veil under an alter ego theory can best be described by the following two-part test: (i) was there such unity of interest and lack of respect given to the separate identity of the corporation by its shareholders that the personalities and assets of the corporation and the individual are indistinct, and (ii) would adherence to the corporate fiction sanction a fraud, promote injustice, or lead to an evasion of legal obligations. NLRB v. Greater Kansas City Roofing, 2 F.3d 1047, 1052 (10th Cir. 1993); accord 1 Fletcher Cyclopedia, supra, § 41.30, at 619.

Here's a list of cases where one side or the other brought the issue up.

New SCO Financials Page

I have put up a permanent page with links to SEC filings and articles on SCO financials. The link is to the left. Similar information has been on the Legal Links page for a while, but it just got promoted to its own page. I am not personally a stock guru, but maybe you are, so this is provided as a starting-off point.

SCO's Quarterly 10Q for the quarter ending in April 2003 said they would pay their directors with stock :

"Stock-Based Compensation

"During the three and six months ended April 30, 2003, the Company granted 774,000 and 1,113,000 stock options with average exercise prices of $2.07 and $1.90, respectively, per share.  None of these stock options were granted at prices that were below the quoted market price on the date of grant.  During the three and six months ended April 30, 2003, 117,000 and 247,000 options to purchase shares of common stock were exercised with average exercise prices of $0.86 and $0.91, respectively, per share.  As of April 30, 2003, there were 4,299,000 stock options outstanding with a weighted average exercise price of $2.10 per share.

"Amortization of deferred compensation was $239,000 and $396,000, respectively, during the three and six months ended April 30, 2003 and $216,000 and $431,000, respectively, during the three and six months ended April 30, 2002.

"During the quarter ended April 30, 2003, the Company[base ']s board of directors approved a resolution to receive remaining amounts owed to them for services provided during the 2002 fiscal year in the form of restricted stock awards.  The Company issued 27,500 shares of restricted common stock with a fair value of $36,000.  The fair value of the restricted stock was recorded as stock-based compensation for the three and six months ended April 30, 2003.

"During the six months ended April 30, 2003, the Company issued 218,000 shares of restricted stock to certain key employees and 150,000 shares of restricted common stock to members of the Company[base ']s board of directors.  The restricted common stock issued to the board of directors was in lieu of cash compensation for their services to the Company during the 2003 fiscal year and the restrictions lapse at October 31, 2003.  The restrictions on the restricted stock awards granted to key employees lapse over a period of 24 months.  The fair value of the restricted stock awards granted of $549,000 was recorded as a component of deferred compensation and is amortized to stock-based compensation as the restrictions lapse or as the services are performed.

"During the six months ended April 30, 2003, the Company issued a ten-year option to acquire 100,000 shares of the Company[base ']s common stock at $1.52 per share to a consultant for services.  The option vests as follows, (i) options to purchase 50,000 shares vest on a monthly basis over a 12-month period, and (ii) the remaining options to purchase 50,000 shares vest upon the achievement of certain milestones.  The fair value of the options will be determined and recorded as expense in the periods the services are performed and the milestones are achieved.  During the quarter ended April 30, 2003, the Company recorded $131,000 of expense related to this option.  For the six months ended April 30, 2003, the Company recorded $186,000 of expense related to this option.  Assumptions used in the Black-Scholes option-pricing model to determine the fair value of the options vested during the quarter ended April 30, 2003 were the following: estimated fair value of common stock of $2.66 per share; risk-free interest rate of three percent; expected dividend yield of 0 percent; volatility of 232 percent; and expected exercise life of ten years."


Canopy's self-description is here:

"Canopy Group's management team shares the philosophy that synergies exist across the company's portfolio and should be optimized. Providing financial coaching, strategy assessment, business development, enhanced operational approaches, access to critical resources, and more are the hallmark characteristics of this management team."

The most recent 10K has information on earlier deals with other Canopy properties, like Lineo.

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