IBM's Subpoenas to Analysts and Investors: Why? Why? Why?

Wednesday, November 12 2003 @ 01:08 PM EST

Contributed by: PJ

Forbes' Daniel Lyons has an article about IBM sending subpoenas to investors and analysts:

"The legal battle between SCO Group and IBM is widening, as IBM has sent subpoenas to investors and analysts who have supported SCO.

"On Oct. 30, IBM issued subpoenas to Baystar Capital, Deutsche Bank, Renaissance Ventures and Yankee Group, companies that have either invested in SCO or published reports suggesting that SCO's claims against IBM could be legitimate.

"'I view this as an attempt to bully and intimidate analysts--to try to cow them into silence,' says Christopher Sontag, executive vice president at SCO, in Lindon, Utah."

That's one theory. But is it the only one? The most likely, even?

As Lyons goes on to report:

"One legal expert says the subpoenas may be IBM's way to get at information that SCO will not provide. 'If you're having trouble compelling discovery, you go to outside sources,' says Brian Ferguson, an attorney at McDermott, Will & Emery, a Washington, D.C., law firm.

"Ferguson, who is on the advisory board of a Linux enthusiast magazine and has published an article declaring SCO's case a long shot, points out that in its counter-claim IBM alleges SCO has unjustly enriched itself through the lawsuit.

"Investors and analysts have participated, perhaps unwittingly, in that enrichment, Ferguson says. SCO shares, which traded at less than $1 before the suit was filed, now change hands at nearly $16 per share. Some insiders have sold shares.

"'IBM needs to get answers from analysts about why they wrote positive reports and from Baystar about why they invested,' Ferguson says."

There may other factors too. Some of those on the list saw the allegedly infringing code, and no doubt IBM would like to hear about that. And there is one other conceivable factor. But it involves bringing you up-to-date on the Caldera IPO litigation.

On October 31, 2003, the SEC announced a settlement of enforcement actions involving conflicts of interest between brokerage firm analysts and investment banks:

"The Securities and Exchange Commission announced today that the Honorable William H. Pauley III, United States District Judge for the Southern District of New York, approved the $1.4 billion global settlement of enforcement actions against ten of the nation's top investment firms and two associated individuals. The enforcement actions alleged undue influence of investment banking interests on securities research at brokerage firms. The enforcement actions and the proposed settlements were announced on April 28, 2003. . . . The Court also entered separate Final Judgments as to each of the 12 defendants.

Under the terms of the Final Judgments and Orders that Judge Pauley approved today, the ten firms and two individuals will pay a total of $894 million in penalties and disgorgement, consisting of $397 million in disgorgement and $497 million in penalties, which includes one firm's previous payment of $100 million in connection with its prior settlement with the states.

"The Final Judgments also require the firms to make payments totaling $432.5 million to fund independent research for investors. Seven of the firms will make payments of $80 million to fund and promote investor education. In addition to the monetary payments, the firms are required to undertake dramatic reforms to their future practices, including separating their research and investment banking departments."

"Independent research for investors" sounds good, huh? Here is the Final Judgment regarding Bear, Stearns, as just one example, whereby they are permanently enjoined from, among other things:

"(1) engaging in acts or practices that create or maintain inappropriate influence by investment banking over research analysts and therefore impose conflicts of interest on research analysts, and by failing to manage these conflicts in an adequate or appropriate manner;
"(2) publishing research reports that do not provide a sound basis for evaluating facts, are not properly balanced, and/or contain exaggerated or unwarranted claims and/or opinions for which there is no reasonable basis;
"(3) promising, implicitly or explicitly, favorable research coverage to investment banking clients or potential clients;
"and (4) failing to disclose or cause to be disclosed in offering documents or elsewhere the use of proceeds from offerings to make payments to other persons or entities for research coverage."

If you have a strong stomach, you might want to read the complaint against Bear, Stearns here. While it may not amaze you to learn that analysts haven't always told the truth, the whole truth, and nothing but the truth about companies, you may be wondering what this all has to do with SCO.

Do you remember reading about the Caldera IPO litigation in their SEC filings? For example, if you look at their 10Q for April of 2003, you find them describing the litigation like this:

"Beginning in July 2001, the Company, certain of its officers and directors, and the underwriters of the Company’s initial public offering were named as defendants in a series of class action lawsuits filed in the United States District Court for the Southern District of New York (the 'Actions') by parties alleging violations of the securities laws.  The complaints were subsequently amended and consolidated into a single complaint.  The consolidated complaint alleges certain improprieties regarding the circumstances surrounding the underwriters’ conduct during the Company’s initial public offering and the failure to disclose such conduct in the registration statement in violation of the Securities Act of 1933, as amended.  The consolidated complaint also alleges that, whether or not the Company’s officers or directors were aware of the underwriters’ conduct, the Company and those officers and directors have statutory liability under the securities laws for issuing a registration statement in connection with the Company’s initial public offering that failed to disclose that conduct. . . .

"The consolidated complaint also alleges claims solely against the underwriters under the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended.  Over 300 other issuers, and their underwriters and officers and directors, have been sued in similar cases pending in the same court.  In September 2002, the plaintiffs agreed to dismiss the individual defendants, but may elect to bring the individual defendants back into the case at a later date.  Management believes that the claims against the Company and any of its officers and directors are without legal merit and intend to defend them vigorously.  The Company is not aware of any improper conduct by the Company, its officers and directors, or its underwriters, and the Company denies any liability relating thereto.  In addition, the Company’s underwriting agreement with its underwriter provides for the indemnification of the Company and its officers and directors for liabilities arising out of misstatements in its registration statement attributable to material non-disclosures by the underwriters.  The Company also maintains liability insurance coverage that is expected to substantially cover the costs of defending the claims, once the retention amount has been expended.  During the six months ended April 30, 2003, the Company had paid and/or accrued the full retention amount of $200,000.

"The Company has notified its underwriters and insurance companies of the existence of the claims.  The initial round of motions to dismiss under the securities laws were recently denied on the basis that the Plaintiffs had alleged, but not proven, proper causes of action.  The actions are now in the discovery phase of litigation.  Management believes, after consultation with legal counsel, that the ultimate outcome of this matter will not have a material adverse effect on the Company’s results of operations or financial position."

Clearly, the company didn't seem worried. For one thing, they had shifted liability on to the underwriters by contract, so no matter what happened, they were somewhat protected. No one can take the rap for you if you commit a crime, of course, but if there were any fines, it looked like they were saying that the underwriters would have to pay them. Then, in the July 10Q, I noticed that they reported new developments in the case:

"We are an issuer defendant in a series of class action lawsuits filed in the United States District Court for the Southern District of New York, involving over 300 issuers that have been consolidated under In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS).  The plaintiffs, the issuers and the insurance companies have negotiated a Memorandum of Understanding ('MOU') with the intent of settling the dispute between the plaintiffs and the issuers.  We have executed this MOU and have been advised that almost all (if not all) of the issuers have elected to proceed under the MOU.  The MOU is still subject to court approval and the preparation of appropriate settlement documents.  If the settlement is approved by the court and settlement agreements can be entered into by the parties, and if no cross-claims, counter claims or third party claims are later asserted, this action will be dismissed with respect to the Company and its individuals."

So, apparently a deal is in the works that, subject to court approval, would settle the allegations against the company's executives on terms the SCO SEC filing doesn't specify. Since all parties seem to have signed the MOU, it is likely the court will approve it. What exactly was this case all about? I decided to find out.

Armed with the name of the consolidated case, I went looking for it. Before the consolidation of the cases into one, which SCO reported in its SEC 10Qs, as mentioned, there was a class action brought by Bernstein, Liebhard & Lifshitz just against Caldera, and you can read a press release about it here. Then in 2001, the New York Law Journal reported on a class action against hundreds of companies, excerpted by Stanford University Law School's Securities and Exchange Clearinghouse:

"In re: Initial Public Offering Securities Litigation Judge Scheindlin

"New York Law Journal. November 16, 2001

"Excerpt: Over the last eleven months, plaintiffs have brought over 860 securities class actions against more than 200 companies and approximately 40 investment banks ('underwriters') alleging, in the broadest terms, that these defendants violated federal law by manipulating the prices of stocks that the companies had issued to the public. Because the hundreds of complaints share some common issues, Chief Judge Michael B. Mukasey ordered them consolidated for pretrial purposes and assigned the cases to this Court on August 9, 2001. See Order, In re Initial Public Offering Sec. Litig., 21 MC 92 (Aug. 9, 2001)."

Here it mentions 200 companies, but eventually there were more than 300. You can read a list of the companies here. If you click on each name on the list, you find out what that particular company was charged with. The common thread seems to be an allegation of selling pre-IPO stock with an agreement that the buyer had to buy after the IPO at pre-determined prices to lift the stock up to artificial levels. Everyone and his cousin's underwriter seems to have been doing that back in the wacky salad days Before the Fall, according to the allegations in the case. One example is the allegation against Here is the description of the Caldera allegations.

There were hundreds of companies allegedly involved, by means of their underwriters, although not all to the same degree by any means, including well-known companies like TicketMaster, Doubleclick, Martha Stewart Living, Handspring, iVillage,, and, and among the underwriters listed were Deutsche Bank, Merrill Lynch, and Bear Stearns. More information on Bear Stearns' numerous litigations can be found here. And yes, one of the companies on the list was Caldera. A complete list of the allegations as PDF is here, but you need very good eyesight, because it's not legible or easy to read.

The MOU is designed, I gather, to separate the companies from the underwriters' activities, and if you put yourself in the shoes of the companies' executives, you can see how this might be appropriate, because a company IPOing might well rely on its underwriters to handle their side of things appropriately, so separating the underwriters from the companies they did the work for makes some sense. For example, Red Hat, another company that IPO'd during that same period, has signed the MOU and is expected to be completely dismissed from the case shortly, with no penalties.

So far, a nonstory, unless you are looking into underwriters and their ways. It wasn't until I read the actual Complaint against Caldera that I got my socks knocked off. As I read the details, I started to get that "deja vu all over again" feeling. I haven't read the allegations against all 300+ companies, but I've read quite a few, and I so far have not found any that match this Complaint's allegations regarding manipulation by means of analysts' reports. There may be some others that I just haven't come across yet. Feel free to research that yourself. But whatever may be the case with others, I think you will see another angle that IBM might have in mind. Here is the Complaint against Caldera, and I hope you are sitting down:

"As part and parcel of the scheme alleged herein, certain of the underwriters named as Defendants herein also improperly utilized their analysts, who, unbeknownst to investors, were compromised by conflicts of interest, to artificially inflate or maintain the price of Caldera stock by issuing favorable recommendations in analyst reports.

"The Individual Defendants (defined below) not only benefitted from the manipulative and deceptive schemes described herein as a result of their personal holdings of the Issuer's stock, these defendants also knew of or recklessly disregarded the conduct complained of herein through their participation in the 'Road Show' process by which underwriters generate interest in public offerings. . . .


"Defendant Ransom H. Love ('Love') served, at the time of the Offering, the Issuer's President, Chief Executive Officer and as a member of the Board of Directors. Love signed the Registration Statement.

"Defendant Ralph J. Yarro III ('Yarro') served, at the time of the Offering, the Issuer's Chairman of the Board of Directors. Yarro signed the Registration Statement.

"Defendant Alan Hansen ('Hansen') served, at the time of the Offering, as the Issuer's Chief Financial Officer and Secretary. Hansen signed the Registration Statement.

"Defendant Raymond J. Noorda ("Noorda") served, at the time of the Offering, as a member of the Issuer's Board of Directors. Noorda signed the Registration Statement.

"Defendant Thomas J. Raimondi, Jr. ("Raimondi") served, at the time of the Offering, as a member of the Issuer's Board of Directors. Raimondi signed the Registration Statement. . . .


"As demonstrated in the 'Use of Analysts' section of the Master Allegations in furtherance of their manipulative scheme, Underwriter Defendants Robertson Stephens (FleetBoston) and Bear Stearns improperly used their analysts, who suffered from conflicts of interest, to issue glowing research reports and positive recommendations on or about the expiration of the 'quiet period' so as to manipulate the Issuer's aftermarket stock price.

"On April 17, 2000, just after the expiration of the 'quiet period' with respect to the Caldera IPO, Robertson Stephens (FleetBoston) issued a 'buy' recommendation. On the following day, Bear Stearns initiated coverage with an 'attractive' recommendation and stated a 12-month price target of $20.00 per share. As of the preceding day, Caldera common stock closed trading at $11.00 per share. On the day after the analysts issued their respective recommendations, the price of the stock rose as high as $54 per share (on a split-adjusted basis).

"The price target set forth in the Bear Stearns' report was materially false and misleading as it was based upon a manipulated price. . . .


"Defendants’ conduct alleged herein had the effect of inflating the price of the Issuer’s common stock above the price that would have otherwise prevailed in a fair and open market throughout the Class Period.. . .


"Plaintiffs will rely, in part, upon the presumption of reliance established by the fraud-on-the-market doctrine in that:

"(a) Defendants named under Claims brought pursuant to the Exchange Act made public misrepresentations or failed to disclose material facts during the Class Period regarding the Issuer as alleged herein;

"(b) The omissions and misrepresentations were material; . . .

"(e) The Issuer was followed by numerous securities analysts;

"(f) The market rapidly assimilated information about the Issuer which was publicly available and communicated by the foregoing means and that information was promptly reflected in the price of the Issuer’s common stock; and

"(g) The misrepresentations and omissions and the manipulative conduct alleged herein would tend to induce a reasonable investor to misjudge the value of the Issuer's common stock. . . .


" . . . .(d) Certain of the Underwriter Defendants’ analysts were motivated to and did issue favorable recommendations for companies they covered because their compensation was, at least in part, tied to the amount of investment banking fees received by their respective firms in connection with financial services provided to such companies. (See 'Analyst Compensation' section of the Master Allegations).

"(e) Certain of the Underwriter Defendants’ analysts were further motivated to and did issue favorable recommendations because they personally owned pre-IPO stock in companies they were recommending. (See 'Personal Investments of Analysts' section of the Master Allegations). . . .


"During the Class Period, the Underwriter Defendants carried out a plan, scheme and course of conduct which was intended to and, throughout the Class Period, did: (a) deceive the investing public, including Plaintiffs and other members of the Class by means of material misstatements and omissions, as alleged herein; (b) artificially inflate and maintain the market price and trading volume of the Issuer’s common stock; and (c) induce Plaintiffs and other members of the Class to purchase or otherwise acquire the Issuer’s common stock at artificially inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, the Underwriter Defendants took the actions set forth herein.

"The Underwriter Defendants employed devices, schemes, and artifices to defraud and/or engaged in acts, practices and a course of business which operated as a fraud and deceit upon the Plaintiffs and other members of the Class in an effort to inflate and artificially maintain high market prices for the Issuer’s common stock in violation of Section 10(b) of the Exchange Act and Rule 10b-5. The Underwriter Defendants are sued as primary participants in the unlawful conduct charged herein.

"The Underwriter Defendants, individually and in concert, directly and indirectly, by the use of means or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a continuous course of conduct to conceal their unlawful practices and course of business which operated as a fraud and deceit upon Plaintiffs and other members of the Class. . . .


"As alleged herein, the Issuer Defendants acted with scienter in that they: (a) knowingly or recklessly engaged in acts and practices and a course of conduct which had the effect of artificially inflating the price of the Issuer's common stock in the aftermarket; (b) knowingly or recklessly disregarded that the Registration Statement/Prospectus as set forth herein was materially false and misleading; and/or (c) knowingly or recklessly disregarded the misconduct of the Underwriter Defendants alleged herein.

"The Issuer Defendants had numerous interactions and contacts with the Underwriter Defendants prior to the IPO from which they knew or recklessly disregarded that the manipulative and deceptive scheme described herein had taken place.

"In this regard, the Underwriter Defendants provided detailed presentations to the Issuer Defendants regarding the registration process leading up to the IPO and the expected price performance in aftermarket trading based upon previous companies taken public by these underwriters. In addition, the Underwriter Defendants explained the process by which the Issuer Defendants could utilize the Issuer's publicly traded stock as currency in stock-based acquisitions, the analyst coverage they would provide for the Issuer upon the successful completion of the IPO and the effect that such positive coverage would have on the aftermarket price of the Issuer's stock. Such presentation also included a discussion of the potential for secondary or add-on offerings.

"Once the Issuer Defendants had determined to retain the Underwriter Defendants with respect to the Issuer's initial public offering, the Issuer Defendants worked closely with the Underwriter Defendants in preparing the Registration Statement/Prospectus, as well as generating interest in the IPO by speaking with various, but selected groups of investors.

"During the course of these presentations, known as "Road Shows," the Issuer Defendants learned of or recklessly disregarded the misconduct described herein. In this regard, the Chief Executive Officer, the Chief Financial Officer and/or other high-ranking Issuer employees worked side by side with representatives of the Underwriter Defendants while visiting with several potential investors in a given city on a daily basis over a two to three-week period to promote interest in the IPO. These presentations were all scheduled and attended by representatives of the Underwriter Defendants.

"As a result of the close interaction between the Issuer Defendants and the Underwriter Defendants, the Issuer Defendants learned, became aware of or recklessly disregarded the misconduct described herein. (See 'Issuer Defendants' section of the Master Allegations).

"In addition, certain of the Issuer Defendants also had the motive and opportunity to engage in the wrongful conduct described herein for, among others, the following reasons:

"(a) The Individual Defendants beneficially owned substantial amounts of the Issuer's common stock. For example, as of the IPO, Defendant Love owned 545,750 shares, Defendant Yarro owned 62,500 shares and Defendant Noorda owned 27,857,307 shares. These holdings, which were purchased at prices below the IPO price, substantially increased in value as a result of the misconduct alleged herein.

"(b) The Issuer Defendants were motivated by the fact that the artificially inflated price of the Issuer's shares in the aftermarket would enable Individual Defendants to sell personal holdings in the Issuer's securities at artificially inflated prices in the aftermarket or otherwise. On or about March 21, 2000, Defendant Love sold 60,000 shares, generating proceeds in excess of $330,000.00

"(c) The Issuer Defendants were further motivated by the fact that the Issuer's artificially inflated stock price could be utilized as currency in negotiating and/or consummating stock-based acquisitions after the IPO. In this regard, on August 2, 2000, Caldera announced an acquisition of a division of Tarantella, Inc. This acquisition was completed on May 7, 2001 for a combination of cash and stock (16 million shares).



". . . . The Issuer and the Individual Defendants: (a) employed devices, schemes, and artifices to defraud; (b) made untrue statements of material fact and/or omitted to state material facts necessary to make the statements not misleading; and (c) engaged in acts, practices and a course of business which operated as a fraud and deceit upon Plaintiffs and other members of the Class in violation of Section 10(b) of the Exchange Act and Rule 10b-5.

"During the Class Period, the Issuer and the Individual Defendants carried out a plan, scheme and course of conduct which was intended to and, throughout the Class Period, did:

"(a) deceive the investing public, including Plaintiffs and other members of the Class, as alleged herein; (b) artificially inflate and maintain the market price of and demand for the Issuer's common stock; and (c) induce Plaintiffs and other members of the Class to acquire the Issuer's common stock at artificially inflated prices. In furtherance of this unlawful course of conduct, the Issuer and the Individual Defendants took the actions set forth herein.

"The Issuer and the Individual Defendants, directly and indirectly, by the use of means or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a continuous course of conduct to conceal material information as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon Plaintiffs and other members of the Class. . . ."

You can read it in HTML, if you prefer, by going here. The complete list of underwriters for Caldera's IPO were FleetBoston Robertson Stephens, Bear, Stearns & Co., Soundview Technology Group and First Security Van Kasper, by the way.

Now, the SEC has resolved the issues regarding the underwriters and analysts, and perhaps all of these charges regarding the executives have been resolved or will be shortly. But does it sound to you like the Caldera executives were not involved or were just innocent victims of their underwriters' excesses? Of course, being accused of something isn't at all the same as being found guilty of it. But at a minimum, I think we can assume that IBM is aware of this case. and while I have no inside information, I'm guessing that this little piece of history might inspire them to be interested in talking to the current crop of analysts, in addition to whatever other reasons they might have.

What strikes me the most is that the money from this IPO was what made it possible to buy the IP they are now claiming was put improperly in Linux. Here is Forbes on that point:

"In 2001, Caldera acquired the server software and services businesses of Santa Cruz Operations, a Unix software company founded in 1979, using money from a successful IPO. Caldera changed its name to SCO Group last summer."

"Successful IPO." I guess success, like beauty, is in the eye of the beholder. The biggest beneficiary, according to this news report on the first day of trading was Noorda:

"One of the big beneficiaries of Caldera's IPO is Ray Noorda, former Novell chairman. Noorda owns approximately 73 percent of the company's stock, according to SEC filings."

That was then, of course. So now you know what that case is about in more detail than is provided in SCO's 10Qs. All this research reminds me of something I read in Brian Skiba's Deutsche Bank report on SCO, the one where he rated SCO a buy. There is a disclaimer at the bottom of the first page that says: "Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report." That is just a generic disclosure, of course, and I don't mean to necessarily imply anything. I'm just saying that remembering this phrase, along with researching the Caldera IPO case, reminds me that I have his report, as well as the most recent -- and conflicting -- SCO report by Dion Cornett at Decatur Jones, who rated SCO very differently than Skiba's glowing recommendation. I have had both reports in hand for a while, but now it's time to focus on this part of the story. So, next, we'll take a look at both reports in detail, to see why each says he reached such very different conclusions.