The Globe and Mail's Jack Kapica explains the new 8K exhibits in an article entitled "RBC Rethinks SCO Deal". Of course, he is writing for a Canadian audience, so his focus is on RBC, but it's a very clear explanation of the deal:
"The Royal Bank of Canada is changing the terms of its investment in SCO Group, which claims copyright ownership over parts of the Linux operating system.
"RBC, which along with investors at U.S-based BayStar Capital Partners pumped $50-million (U.S.) into the company in October, wants to distance itself from any sale of SCO that would result in a 20-per-cent contingency payment to the company's lawyers.
"The agreement between the software maker and its lawyers for the high contingency fees has raised many eyebrows in the banking and high-tech industries.
"The filing stated that SCO cannot be sold 'without first obtaining the consent of the private placement investors holding at least two thirds of the shares of SCO's outstanding Series A Convertible Preferred Stock.'
"The filing explained that 'SCO's agreement with the law firms provides that the law firms will receive a contingency fee of 20 per cent of the proceeds from specified events related to the protection of SCO's intellectual property rights. These events include settlements, judgments, licensing fees, subject to certain exceptions, or a sale of our company during the pendancy of litigation or through settlement, subject to agreed upon credits for amounts received as discounted hourly fees and unused retainer fees and may include issuances of SCO equity securities.'
"According to a filing Monday by the SCO Group, RBC and BayStar now have veto power over any SCO action that would trigger the 20-per-cent payment to SCO's attorneys at Boies, Schiller & Flexner LLP."
That probably explains part of the puzzle, the delay. The agreement wasn't signed until after the date of the original teleconference. But what about Boies not showing up and exactly what is the arrangement he struck with SCO? We now know. He only has to show up for special occasions:
"David Boies will make himself available to handle critical hearings and depositions and, if applicable, at trial."
Missing from the narrative are any earlier letters between them, but we do have the February 26 letter of engagement, in which Boies enumerates his terms. It is quite normal for an attorney to draw up a letter of engagement.
He drives a hard bargain, something BayStar seems to have finally noticed, but before we look at the terms, notice the date. As you may recall, back when questions began to arise about SCO insiders selling stock, Robert Bench characterized his stock sale plan as having been put in place "months" before the legal action against IBM was contemplated, and as you know the lawsuit was filed March 7. Notice in this quotation exactly when the stock sale plan was allegedly drawn up:
"Bench submitted a sale plan in January, months before any legal action against IBM was contemplated, McBride said. His agreement called for the sales to begin on March 8. He planned to sell 5,000 shares a month for the next 12 months, according to the plan."
This letter of engagement is dated February 26, and it says Boies was hired to further pursue either a settlement or legal action against IBM. It makes reference to earlier discussions, and to earlier letters and events leading up to the final agreement ("We have previously sent our standard hourly rates for selected partners"), so any way you slice it, even if his sale plan was dated January 1, January to February 26 isn't a full two months, let alone January 1 to whatever date they began contemplating and discussing, and was it on January 1st that the plan was set up? When were the first discussions, if the final agreement is dated February 26? Therefore, I think we may fairly conclude that the sale plan was probably not set up "months before any legal action against IBM was contemplated." Weeks maybe. Days, OK. But months? As I have explained before, there is something called Rule 10b-5 that governs insiders trading under a sales plan:
"Rule 10b-5 -- Employment of Manipulative and Deceptive Devices"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
"a. To employ any device, scheme, or artifice to defraud,
"b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
"c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."
Is It a Contingency Arrangement? I'd call it more a standard hourly fee arrangement with bonusus on top if certain events occur. To call it a contingency arrangement without qualification is simply misleading. People have formed the impression that Boies' willingness to represent SCO on a contingency basis indicated he thought a lot of their chances. Laura DiDio was one who expressed that thought:
"Significantly, DiDio noted, famed attorney David Boies is handling SCO's case on a contingency basis. Boies has handled some of the most high-profile technology lawsuits to date, including the government's successful antitrust case against Microsoft.
"That such an attorney would agree to handle SCO's case with no guarantee of a fee unless SCO wins suggests the Utah-based company has a good chance of success, DiDio said."
And she had reason to think they meant it was such a contingency arrangement. That isn't the complete picture by any stretch, as we now discover. Let's review Robert Bench's words at the most recent teleconference on November 18, which was attended also by Darl McBride and David Boies, and see if it doesn't sound to you like they are indicating a true contingency arrangement:
"Bench: Our agreement there with the law firms is contingent in nature. We entered into that agreement in February of this year. It includes the payment of 20% fee on proceeds from events related to the protection of SCO's intellectual property rights.
"Schopick: Yes. However, this most recent announcement, if I understand it correctly, does provide for a million dollars in cash and the issuance of 400,000 shares of SCO stock. That doesn't seem to be contingent upon anything.
"Bench: The contingency in those events as we've disclosed previously include settlements, judgments, certain licensing fees, and the sale of the company, during the pendancy of litigation or through settlement and can include events such as the equity event that just occurred.
"Schopick: Can? Or does ?
"Bench: Err, you know, the future issues with this agreement have not yet been memorialized but they include events such as these, if and when they occur, and as you can recognize, a contingency agreement such as this, that is far-reaching, has many future events that may or may not occur and we really consider this much like a partnership as we move forward to protect SCO's intellectual property, and we would expect future events not dissimilar to come into place and we will, we will reach agreement on those as they, as they come about.
"Schopick: Will there be a million dollar cash payment that will be recorded on your profit and loss, on your income statement, to reflect this agreement ?
"Bench: Yes, that will recorded on, in our Q4 as stated in our press release.
"Schopick: So it is not contingent?
"Bench: That event has already con . . . has already occurred, so it was contingent.
"Schopick: And the issuance of the 400.000 shares was also tied to prior contingencies ?
"Bench: That's right."
And look at this, McBride's attempt to explain to a confused reporter how the arrangement was a contingency:
"Darl McBride: We view this is an overall partnership here, David, as we look at the Boies firm. When we signed them up early on, our market cap was I think down around $17 million dollars, and we said we're going to go out and enforce our intellectual property, and as the company is successful along the way, there are going to be contingent events that happen. And if we have a license fee, as we succeed then the Boies firm will succeed. As we have success in the courtroom, the Boies firm will also share in that success. As we have an ability to bring money into the company in this particular case by putting consideration into David's hands we are now fully stocked to go after this next wave of enforcement issues.
"David Bank: OK, am I just not understanding the technical meaning of 'contingency'? I thought that came after some kind of settlement came in. This sounds like it's before. So maybe I'm not understanding what 'contingency' means.
"Darl McBride: Well, I think we did have, I guess what I'm focusing on here is we've had some successful events occur. We've had some licensing events occur and we've shared that with David. We've had some successful events to get some money in here, we've shared that with David. That's going to help us go out and fight this next battle, OK? So we've went out and said we're setting up for the long haul here, we've raised $50 million, we didn't raise $50 million to get CD interest sitting over in the bank. We've brought this money in . . . now in this case we're able to -- David's coming in at a partnership level, he's coming in, he's taking stock for the most part, he's coming in with his firm and we're going after this in a very strong partnership way, so we couldn't be more pleased with getting him on board with this strong partnership arrangement.
David Bank: OK.
"David Boies: David Bank, this is David Boies.
"David Bank: Hi.
"David Boies: How ya doing?
"David Bank: Good.
"David Boies: I think the key thing as Darl is saying is the contingency is not simply a contingency with a final resolution. There are a series of contingent events, some of which have already occurred, which is why you have the stock and cash being paid, and we've agreed to take a obviously very substantial portion of what we would otherwise receive in the form of stock because we have confidence in where the company is going."
A third reporter still probes to try to make the math compute with a contingency:
"David Politis: Bob, I have a question for you specifically to start off. Will you clarify again the contingency relationship with Boies, Flexner, Boies, Schiller, I'm sorry.. It's 20% based upon three different events occurring. Is that correct?
"Bench: Thanks, David. There may be a number of events but some of those events that are specific would be any settlements, judgments, license fees, the sale of the company. And as I mentioned there may be future events which have not yet been memorialized but that will come about in the future. And that’s why I said that this, uh, this has to be an agreement that is somewhat flexible for those future events that may or may not occur.
"David Politis: Understand that. And then, in connection with that, then, if my math is correct, 20% of 50 million dollars comes out to about 10 Million dollars, is that right?
"Darl: Ah, yes.
"David Politis: Yes. So does this nearly 10 million dollar contingent payment, is that tied back into the 50 million dollars that was announced here back in October, as far as a private placement?
"Bench: I think that and and all of the benefits that have been derived and some of the other contingencies. But yes, that's certainly an event."
Sounds like Boies would get paid based on any number of possible contingencies and that the money and shares he had just received were for contingencies that had already occurred. However, what is the actual arrangement? Boies' engagement letter says:
"All firms will bill at a reduced hourly rate."
There you have it. Short and sweet. They're paid on an hourly basis and were to be paid monthly ("We will also make every reasonable effort to keep monthly billings within a budget . . ." ). SCO had to put up a million dollars as a retainer, to make sure the lawyers got paid, which is also normal, but not what happens in a contingency, and the three firms named each billed against it. If it sank below $250,000, SCO was to put more money into the pot. No contingency there. So, where is the contingency part? Here it is, but it's on top of the standard hourly pay:
"The Client agrees to pay a twenty percent (20%) contingency fee in cash proceeds immediately upon the occurrence of recovery in litigation or settlement, including any sale of stock or assets, and the contingency payments shall be made as set forth according to Schedule B."
Contingent events listed on Schedule B were recovery in litigation or settlement of IP claims, sale of the stock or assets of SCO during the pendency of litigation or the settlement of litigation and/or related to the dismissal of litigation and for a reasonable time thereafter, and 20% of the value of a joint venture agreement, a substantively similar transaction, or any other transaction not explicitly mentioned above that results in monetary or non-monetary benefits received by SCO in connection with, or in lieu of, settlement of claims. Any hourly fees already paid on completion of litigation were to be deducted from the contingency fees paid and then split up 80% to Boies' firm and 10% each to the other two, although the firms could refigure if they all three agreed.
Note: "This clause, however, does not apply to the current effort to enter into license agreements with Microsoft or Sun Microsystems, nor does it apply to the company’s efforts to license its intellectual property rights or trade secrets in the ordinary course of business." So whatever Boies was paid in contingency fees, it wasn't to be for the Sun and MS deals. If the client didn't hold up his end of the bargain and Boies pulled out from representing SCO, he still got the contingency fees. I gather from this document that as of February 26, less than two weeks before the lawsuit was filed against IBM, negotiations with Sun and MS were not complete and Boies was apparently involved in those negotiations.
Aside from an amusingly vague privacy notice on Schedule C ("In order to guard your nonpublic personal information, we maintain physical, electronic and procedural safeguards that comply with our professional standards."), and an arbitration clause I'd never sign, that is the end of the first document.
Next, we have the November 17, 2003 letter from Darl to David. It makes reference to an earlier October 24, 2003 letter from Boies to SCO, and this is their reply:
"In accordance with your letter of October 24, 2003, we have agreed to pay Boies, Schiller & Flexner LLP, Angelo, Barry & Bolt, P.A. and Berger Singerman (collectively, the “Law Firms”), an aggregate of $1 million and to issue, pursuant to an effective registration statement under the Securities Act of 1933, as amended, (the “1933 Act”) 400,000 shares of SCO common stock to the Law Firms on or before March 1, 2004, and such shares will be fully registered under the 1933 Act and freely resaleable by the Law Firms, as compensation related to our recent private placement transaction.
"We have also agreed to pay the Law Firms $1.6 million in connection with certain licensing arrangements we have entered into."
Note that the million and shares were to the three firms, not to Boies alone. By now, it seems the $1 million dollar retainer has been used up:
"We agree that your work on defense matters will be billed at your standard hourly rates. Additionally, you no longer need to bill against any amounts remaining in the retainer as that amount has been earned as of October 31, 2003."
So, he is still billing, but not against the original $1 million dollar retainer but against a refreshed pot, because the original million has been paid out already. Now we come to the most interesting of the letters, the December 8, 2003 letter from SCO to BayStar and Royal Bank of Canada. In it, SCO agrees to modify the February 26, 2003 engagement letter:
"The Company hereby agrees that, subject to termination as provided below in this paragraph, the Company shall not engage in any transaction or take any action that could result in a claim for a contingency payment (including, without limitation, any settlement of litigation, sale of the Company or investment in the Company, but excluding any contingency payment in connection with licenses, other than licenses entered into in connection with any settlement of litigation or sale of the Company) by any or all of the Firms under the Letter Agreement or any similar provisions in any other agreement between the Company and any of the Firms (including, without limitation, any successor to or amendment or modification of the Letter Agreement) now in effect or entered into after the date hereof without first obtaining the prior written approval of the holders (the 'Holders') of 66 2/3% of the Series A Preferred outstanding prior to the time of such proposed action, provided that such Holders consist of BayStar Capital II, L.P. (or its affiliated funds) and/or Royal Bank Of Canada."
In other words, BayStar and RBC want to put Boies under their veto power, so he can't just arrange some contingencies on a day when he might feel like making some money. In return, Boies shows his refusal to be responsible for the new arrangement:
'Boies, Schiller & Flexner LLP ('Boies Schiller'), in its capacity as special litigation counsel to the Company, hereby accepts on behalf of the Firms the rights of the Holders set forth herein. Boies Schiller gives such acceptance with the understanding that the Holders will hold to the same standards of good faith as are applicable to the Company in the Letter Agreement. Boies Schiller has not advised the Company as to the matters set forth herein, including as to whether it is desirable or appropriate for the Company to convey to the Holders the rights set forth herein,"[sic]
He's saying, as I understand it, that he expects them to stick to the "standards of good faith" in the original February letter (or else, presumably) and he is accepting no responsibility for the deal, just agreeing to abide by it. You get the impression there is a certain underabundance of trust in this picture. The 8K itself describes the new arrangement like this:
"The letter agreement provides that SCO will not complete a transaction or take any action that could result in a claim for a contingency payment by the law firms, other than contingency payments for licenses not entered into as part of any settlement of litigation or sale of SCO, without first obtaining the consent of the private placement investors holding at least two thirds of the shares of SCO’s outstanding Series A Convertible Preferred Stock. SCO’s obligation to obtain the consent of the investors will terminate automatically if and when the aggregate number of shares of SCO’s common stock issuable upon conversion of all outstanding shares of Series A Convertible Preferred Stock held by the Investors fails to equal or exceed five percent of SCO’s outstanding shares of common stock as of December 8, 2003."
Bottom line? BayStar is holding veto power over the law firms so long as they maintain a certain percentage of stock. The original engagement letter is still in place, which means there is still standard hourly billing going on, presumably, and there are still the contingency bonuses allowed for, but amended so that they are subject to BayStar's prior approval. Contingent events have change and are now the following: " . . .settlements, judgments, licensing fees, subject to certain exceptions, or a sale of our company during the pendancy of litigation or through settlement, subject to agreed upon credits for amounts received as discounted hourly fees and unused retainer fees and may include issuances of SCO equity securities." The contingencies have changed. What I don't see on the list now is the "20% of the value of a joint venture agreement, a substantively similar transaction, or any other transaction not explicitly mentioned above that results in monetary or non-monetary benefits received by SCO in connection with, or in lieu of, settlement of claims." What I do see is sale of the company, licensing fees and "may include issuances of SCO equity securities."
So when Ms. DiDio concluded that Boies was willing to risk not being paid, she was wrong. In this case, she could probably justifiably plead she was misled. Probably a fair number of investors might feel that way, too. I know I do.
Now that you reflect back on the conduct of the reporters and analysts at the teleconference, you can see that they were on the trail back then and at least three of them realized there was something that didn't make sense. That's what makes a good journalist, I guess, the nose for the detail that doesn't smell right. And now we know they were absolutely right. The problem was they didn't keep pursuing. Maybe it was because they believed the answers they were given were true and complete and forthcoming. Or maybe there's no way to catch people in a half truth until there is a slip-up down the road. I know one thing. If a guy told me a story like this, when I found out, that'd be it.
Here's a snip from the Globe and Mail that makes my nose start to itch. Anybody know what this means?
"An RBC spokesman was reluctant to comment, saying the SEC filing was about how SCO operates its business. He said that RBC's 'investment in SCO is passive, made to hedge an economic exposure resulting from client transactions.'"
Someone posted this Maureen O'Gara piece from Linux Business Week in the comments section. It's from just after the suit against IBM was filed, apparently. O'Gara is a good reporter, in my opinion, and I didn't want you to miss seeing how close to being on target she was back then. Note that she reported back then that a source told her that Boies's arrangement was not a true contingency:
"A source, by the way, claims to know 'for a fact' that Boies is on a 'percentage retainer,' not contingency, and further claims that this suggests that he's less scrupulous about the facts of the case . . . . Of course a retainer arrangement doesn't seem feasible given that SCO has all of $5 million left in the bank and 340 people on the payroll. Boies, after all, charges $750 an hour, not that he's doing the work himself, but that's the buzz. A percentage retainer is supposed to mean Boies, a chap who's at least sensitive about his visibility, and his firm gets a piece of the action on top of their fees if they win. SCO, meanwhile, continues to decline to clarify the terms of their relationship."