Some high-tech businesses exploit market buzz, cost investors millions

In the spring of 1998, Ronald Kassover got the call that any investor with nerve would die for: an exclusive invitation to buy stock in a high-tech company's initial public offering.

Kassover jumped at the chance, ordering 500 shares of Sunnyvale's Aspec Technology, a maker of sophisticated software for designing silicon chips. After the stock rose modestly on its first day of trading, the Long Island accountant bought an additional 7,500 shares and dreamed of making a killing.

But six months later, Aspec's stock – and Kassover's dreams -- were dead.

In a startling admission, Aspec executives disclosed that the company had exaggerated its revenues for 2 1/2 years. Its markets were drying up, its prospects heading south.

The news sent Aspec's stock tumbling. Once almost $16 a share, the price plunged to under a dollar,  and Kassover kissed more than $30,000 goodbye.

``It was all,'' he says, ``a bunch of lies.''

From Apple Computer in 1980 to Palm Inc. last month, the dazzling success of the high-tech ndustry's choicest offerings has blinded even sophisticated investors to a difficult truth: Most IPO stocks are overpriced, losing propositions.

The reasons can be as simple as market risk and timing. But in dozens of class-action lawsuits,  Silicon Valley executives and some of the most powerful lawyers and venture capitalists in the high-tech industry have been accused of lying to investors about a company's prospects while taking the company public.

``The entrepreneurial world has figured out that investors will buy just about anything,'' says Professor Lynn Stout, a securities law expert at Georgetown University Law Center. ``It's the most attractive opportunity con artists have seen in years.''

Since 1990, the number of IPOs has tripled, and their annual value has risen 15-fold to nearly $70 billion. The frenzy for new offerings has intensified pressure on corporate watchdogs -- outside legal counsel, independent auditors and boards of directors -- to ignore or even condone financial misconduct and to let an IPO proceed, in some cases because their own financial interests are at stake.

``In a superheated market,'' says Columbia Law School Professor John Coffee, ``the pressure to go public makes the usual gatekeepers more prepared to say, `Damn the torpedoes, full speed ahead.' ''

Yet the U.S. Securities and Exchange Commission has filed only about 15 cases involving IPOs in recent years -- despite stern warnings from on high.  Last month, SEC Chairman Arthur Levitt sharply criticized the overheated IPO market and cautioned that young companies sometimes run ``this race to an IPO . . . at the expense of laying the foundation for a viable long-term'' business.

This is the inside story of how one of those companies, Aspec Technology, a promising high-tech startup, became the Bay Area's worst performing IPO of 1998.

It is a cautionary, increasingly common tale in which a company's officers and directors -- with millions of dollars of their own investments on the line -- play fast and loose with the laws against securities fraud.

  At the center of the Aspec case are two insiders,  one a powerful Silicon Valley attorney, the other a prominent venture capitalist, who helped rush the company to an IPO, despite warnings that it was not ready.

And in the end, unsuspecting investors never had a chance.

A STAR ATTORNEY

Even before it opened for business in December 1991, Aspec looked like a sure-fire thing.

Its founders were top managers from one of the valley's most successful companies, silicon chipmaker LSI Logic. Its proposed software was complex yet ingenious: standardized designs for electronic pieces that could be arranged into customized chips. And its initial finances were assured by a lucrative contract with a major Korean chipmaker.

By 1993, Aspec was reporting revenues of $8 million, and company executives    --intrigued by the year's record number of IPOs -- were talking about going public. They turned to Silicon Valley's most powerful law firm, Wilson,  Sonsini, Goodrich & Rosati, and one of its star partners, Jeffrey Saper.

Born in Brooklyn in 1946, Saper shuffled through two New York law firms and the SEC before joining Wilson, Sonsini in 1979 to build a securities practice. He was there just a year when he closed the deal that would make his -- and the firm's -- reputation: the enormously successful IPO of Apple omputer.

Suddenly, Saper was an attorney of choice for the booming high-tech industry. Over the next decade,  scores of its hottest companies would ask for his help in going public. Quantum. Micron. Linear Technology.

Saper, it seemed, was a perfect fit for Aspec – but there were some troublesome deals in his past.

DUE DILIGENCE

It was June 1992 when the call came from Montgomery Securities, a San Francisco investment bank and longtime Wilson, Sonsini client.

Montgomery wanted Saper to represent it and another firm as underwriters in an IPO for Media Vision Inc., a Fremont multimedia company founded and run by entrepreneur Paul Jain.

Jain and Wilson, Sonsini had crossed paths before.  According to court records, one of three Silicon Valley companies that had fired Jain for falsifying revenues was LSI Logic, a Wilson, Sonsini client whose board of directors included Sonsini himself.

If Saper was unfamiliar with Jain's checkered past,  he might have learned about it while overseeing due diligence, the process of making sure that Media Vision was financially and legally sound enough to offer shares publicly.

But according to court records, Saper never bothered to contact Jain's former employers. If he had, at least one of them says, he would have told Saper that Jain was a ``crook,'' which might have prompted closer scrutiny of Media Vision's business practices.

Saper has refused to comment for this story.

On Nov. 11, 1992, Montgomery took Media Vision public. The IPO raised $246 million. On Jan.  20, 1994, the company's stock peaked at more than $46 a share.

Six months later, Media Vision filed for bankruptcy.  It had allegedly faked more than $100 million of revenues by hiding returned inventory, booking sales that never occurred and by not recording millions of dollars in expenses.

The alleged scam would cost investors hundreds of millions of dollars, prompt dozens of lawsuits against the company and the underwriters, and result in the criminal indictments of Jain and several other executives.

No action was taken against Saper.

In legal documents filed in May 1996, though, one of Jain's former bosses criticized Saper and the underwriters for not having asked him about Jain.

``They turned due diligence into a mockery,'' the executive said, and that ``gives everyone in the Silicon Valley a bad name.''

VENTURE CAPITAL

By May 1996 the Media Vision IPO was just a memory, and Saper was busy preparing Aspec to go public while serving as its legal counsel and secretary.

Helping him pull off the proposed deal was Walter Kortschak, a Palo Alto venture capitalist.

Kortschak was a general partner at Summit Partners, one of two firms that had just invested $10 million each in Aspec. He joined Saper as an Aspec director and a member of the board's audit committee, the three-man group responsible for overseeing the company's accounting practices.

Saper and Kortschak were friends who had worked together before, but they were, in some ways, stark opposites. Saper was dark and very New York. Kortschak was blue-eyed and blond,  an urbane jock who had spent his youth racing the slopes of European ski resorts.

In his first deal as a Summit partner, Kortschak invested $10 million in a fledgling antivirus-software company called McAfee Associates. The company went public in 1992. Three years later, Summit cashed out, having profited 100-fold.

The deal, says Kortschak, ``put our name on the map'' in Silicon Valley. It was just one of dozens that would make Summit's -- and Kortschak's -- record in IPOs the envy of the venture-capital industry.

But not all of Kortschak's deals would go so smoothly, including several that involved Saper.

FRAUD ALLEGATIONS

In 1993, Summit invested in Simulation Sciences Inc., a software maker for the oil and chemical industries. Kortschak was on the company's audit committee, which was responsible for the integrity of the company's financial reporting, and Saper served as corporate secretary and legal counsel.

In late 1996, Simulation Sciences went public,  turning into ``a very successful investment'' for Summit, says Kortschak. But in early 1998, public shareholders lost millions of dollars after the company revealed substantial losses and its stock plummeted.

Kortschak blames the drop on poor market conditions, but shareholders allege in lawsuits that he and other directors and officers helped the company fake its revenues with back-dated documents and bogus sales.

The allegations of revenue fraud would be similar in the next deal that Kortschak and Saper did together: the IPO of San Jose's Diamond Multimedia.

In December 1994, Summit invested more than $27 million in Diamond, and Kortschak joined its board of directors and audit committee. Saper was already a director and stockholder of Diamond as well as its secretary and corporate counsel.

In April 1995, Diamond went public, raising more than $127 million. A mere seven months later, the company raised an additional $94 million in a secondary offering of stock.

``It was,'' says Kortschak, ``a terrific investment for us.''

But not so terrific for many public shareholders.

The market's initial enthusiasm for Diamond stock was based in part on the anticipated release of several new products that essentially increased the speed at which computers could display graphics and video.

But throughout 1995, the company rushed the products to market without testing their touted features, say former engineers and sales managers. ome products never worked at all. The result,  according to court records and former employees,  was inflated revenues.

Diamond ``got on a real bad heroin addiction,'' says Debby Feeney, a former sales director, ``stuffing the channels, booking what it hadn't sold yet. . . . It was all about the revenue, not about anything else.''

The company's internal inventory controls were so lax that in January 1996 it reported almost $4 million of inventory inexplicably missing.

The stock plummeted on the news. And by June 1996, with the company reporting losses, the stock dropped to just over $9 from a high of $41,  attracting dozens of suits from shareholders contending that they had been victims of fraud.

But by then, Saper and Kortschak, who were not named in any of the suits, had turned their attention to Aspec.

RUSH TO MARKET

It didn't take long for the warnings to emerge.

In the summer of 1996, Aspec was booming, and Saper, Kortschak and other officers and directors spoke of taking the company public as soon as possible.

But the company's accounting systems were seriously flawed.

Aspec is a ``relatively young company with a lack of sophisticated financial systems and controls,'' said a 1996 Summit memo. ``Infrastructure in sales and marketing is lacking.''

So Summit and company management moved quickly to shake up the staff and clean up the company's books.

Aspec hired several new sales and marketing executives. In December 1996, the company replaced its financial auditor, KPMG Peat Marwick, with Deloitte & Touche. The next month,  the company hired a new chief financial officer.

And on Feb. 25, 1997, Saper, Kortschak and the other members of Aspec's board authorized company officials to file documents with the SEC and the NASDAQ National Market Systems.

Aspec was going public. Or so it thought.

AN ABRUPT RETREAT

On June 2, the U.S. Customs Service blindsided Aspec by accusing it of selling unlicensed software to China Great Wall Import/Export Co., the purchasing arm of China's space programs.

Although company officials believed that they were innocent -- Customs would soon drop the charges and clear the company of wrongdoing – the unexpected allegations complicated plans to go public.

About two weeks later, the board got more bad news: The new auditors from Deloitte & Touche had discovered serious accounting problems.

In a letter to Saper, Kortschak and the other directors, the auditors wrote that Aspec had been booking sales of software that customers never paid for because ``the company had not met all its commitments under the contract.'' In some cases,  payments remained due for 460 days before the company was forced to reverse the revenue it had lready booked.

On June 17, in a letter filed with the SEC, Aspec asked that its registration statement for the IPO ``be withdrawn immediately.''

UNDER PRESSURE

The pressure on Aspec's directors to take the company public was mounting by the hour.

Looming over them was the weakening economy in Asia, where most silicon chips were made. If the chip industry collapsed, so might Aspec's business,  and any chance for an IPO would vanish.

Engineers and other employees with stock had been let down once and were growing restless. The company's founders believed that they had waited long enough to cash out.

And Kortschak, Saper and other investors held preferred stock that would be redeemed at a premium when the company went public. Absent an IPO, they would have to wait until June 2003 before getting paid in full.

Early on a Saturday afternoon in August, slouched around a conference table at their Sunnyvale offices,  Aspec executives listened as James Lindstrom, the company's chief financial officer, outlined his reorganization plan.

It would take about a year to complete, Lindstrom said. New managers had to be hired. Accounting problems had to be fixed. Engineering work had to be made more efficient and predictable.

It was not what they wanted to hear.

``Everyone else was like, `Yeah, well, we can take care of all that later,' '' recalls one of the executives at the meeting, `` `but we've got to go public now.' ''

Lindstrom, though, would not back down, and it quickly became clear that he and the founders would never see eye to eye. A month later,  Lindstrom was gone.

A SECOND WARNING

Aspec replaced Lindstrom with Mitchell Bohn, a mammoth, swaggering Texan who had worked at LSI Logic with some of Aspec's founders and, says one former executive, could be counted on to ``bull through an IPO.''

Bohn declined to be interviewed for this story.

On March 11, 1998, Saper, Kortschak and Aspec's other board members met again. For the second time, they authorized company executives to proceed with a public offering.

And again they ran into trouble.

The day after the directors met, the company's auditors sent the board a letter remarkably similar to the one they had delivered the previous June.

Citing ``the recent deterioration'' in Aspec's ability to get paid and ``financial issues facing certain customers,'' the letter urged ``immediate . . .  corrective action.''

But this time, Saper, Kortschak and the rest of the board would not be denied.

Five days after receiving the auditors' letter, Aspec filed with the SEC the registration statement required for an initial public offering.

``Everybody on that board knew there were problems,'' says the former executive. ``But they were thinking, `If we can just go (public), we are going to get our money back.' ''

THE OFFERING

For the next several weeks, in a ritual known colloquially as a ``road show,'' Aspec and its underwriters touted the company's prospects to corporations, pension funds and other institutional investors across the nation.

They assured their potential investors that Aspec's revenues would grow 50 percent a year over the next two years. They said profit margins would exceed 25 percent over the next several quarters.  And they predicted that earnings per share would rise 60 percent through 1999.

On April 16, the company amended its registration statement to show that revenues had more than tripled over the past three years and had increased steadily in 1998. Deloitte & Touche certified the figures.

The road show was a success. The Aspec offering was oversubscribed, leaving all but a select few investors disappointed at missing the chance for a fabulous return.

Ronald Kassover was one of the select few.

He had been in the stock market for almost 40 years and, though not yet wealthy, at age 61, had amassed the size of account that encouraged brokers to offer him stocks in IPOs.

``They know I'm interested,'' he says, ``and usually the deals work out.''

So in late April, when brokers from Aspec underwriters Hambrecht & Quist and Merrill Lynch & Co. phoned his Long Island home, Kassover felt like a boy about to wager that the hometown Yankees would reach the World Series.

The IPO went down on April 27 with resounding success. Aspec offered 6 million shares of common stock for $13 each, raising $78 million.

It was the largest IPO in the Bay Area so far that year -- and a windfall for Saper, Kortschak and other insiders.

Of the $78 million raised, $18.5 million went to cash out Saper, Kortschak and the other holders of preferred stock, a return of almost 50 percent.

Kortschak and Summit still owned 2.6 million shares of common stock in the company, and Saper and Wilson, Sonsini owned more than 180,000 shares, all potentially worth tens of millions of dollars -- as long as the company's stock price remained high.

BOOSTER SHOTS

Shortly after Aspec went public, though, its stock price started drifting down, at one point sinking to $8 per share.

But rather than sell, investors like Kassover viewed the drop as an opportunity to buy more stock in the company.

``I'm an accountant, so I do my homework,'' Kassover says. ``And when I looked at its prospectus, this company was very impressive.''

Meanwhile, financial analysts at Aspec's underwriters encouraged investors with a series of ``booster shots'' -- favorable comments that can raise the stock's price.

In mid-May, for example, during a dinner program at Hyatt Rickeys in Palo Alto, Hambrecht & Quist analyst Doug Van Dorsten was asked for his hot pick among chip stocks. His answer: Aspec.

Van Dorsten reinforced the recommendation with a June 18 report rating Aspec stock a ``buy'' and with
  two later reports recommending it as a ``strong buy.''

``(Aspec) is expected to report results for the May quarter on June 24,'' wrote Van Dorsten, ``and we
  believe revenue growth may exceed our forecast.''

In the early afternoon of June 24, investor John McKee sat at his office in Redwood Shores,  eagerly awaiting a conference call with top Aspec officials to learn about the company's latest earnings.

As the operator gathered the call's participants,  McKee's mind drifted back to early June and his substantial purchase of Aspec stock for about $8 a share. The latest numbers were supposed to be great, and McKee could profit handsomely.

He waited, and waited, then started to wonder what was taking so long. Suddenly, the operator's voice broke in and announced that the call was canceled.

``I was numb,'' McKee recalls.

Unknown to investors like McKee, a bitter argument over accounting had erupted in the company's executive offices.

The immediate cause, say investors and former employees, was a research and development write-off the company took after acquiring an engineering design firm just before the IPO. Aspec's auditors argued that the amount of the write-off was excessive. Company officials insisted it was reasonable.

But the conflict ran much deeper.

For years, Aspec had been booking sales without accounting for the costs of repairing faulty software.  While customers were withholding payments until the glitches were fixed, the company was reporting revenues as if the payments had already been made.

The result was inflated revenues -- and an angry debate among the auditors and company officers and directors over what to do about them.

Finally, just before the conference call, the auditors from Deloitte & Touche refused to allow the company to release its financial statements.

When the conference call was abruptly canceled,  nervous investors started dumping their stock in the
  company. The price plummetted from $9 to $6.

 But six days later, Aspec released financial results showing more than $8 million in revenues for the
  latest quarter, a 60 percent increase over the previous year.

Bohn said that the figures had been delayed only because the quarter had been ``complex.'' He acknowledged the company's problems with tracking engineering expenses, but he assured investors that the company's accounting was sound.

THE CRASH

On August 5, without warning or explanation,  Deloitte & Touche resigned as Aspec's auditors.

Aspec replaced the firm with PricewaterhouseCoopers, but the news was growing steadily worse.

The company was losing business to its own customers -- chip manufacturers that had started creating software themselves -- and to its main competitor, which was giving away software in exchange for a cut of customers' profits. Aspec had not disclosed either development before the IPO.

On September 29, Aspec was forced to announce that its third- quarter financial statements would be delayed.

Two weeks later, the company hit rock bottom.

On October 9, less than six months after its IPO,  Aspec announced that its financial reports for 1996,  1997 and the first two quarters of 1998 would have to be restated.

The market's reaction was devastating. By the end of the day, Aspec's stock was barely worth a dollar a share.

Investors were furious.

``I've been in this market a long time and had my good days and my bad days,'' says Kassover.  ``This one was probably the worst.''

SIFTING THROUGH THE ASHES

It would take two more months, but finally, on December 17, Aspec revealed the full extent of its accounting improprieties.

Revenues had been overstated by more than 21 percent over the past 2 1/2 years. Revenues in the second quarter of 1998 alone had to be cut by 34 percent. And among the 41 Bay Area companies that went public in 1998, Aspec had the worst-performing stock.

On Feb. 1, 1999, investors filed a consolidated class-action lawsuit in Santa Clara Superior Court.  The suit accused Aspec, Saper, Kortschak and other corporate officers, directors and underwriters of defrauding the company's shareholders.

Among the lead plaintiffs in the class action was Kassover, who had called his attorney a few months before to see whether anything could be done about ``this story of lies.''

The suit contended that the defendants had lied to shareholders about the company's financial condition to force an IPO that never should have occurred, at least not at so high a price. It also contended that the directors on the audit committee,  including Saper and Kortschak, ignored the company's improper accounting practices and were compromised by their financial stake in the IPO.

Kortschak says he is ``not at liberty'' to discuss Aspec because he is no longer on the board. Saper refuses to comment for this story.

In court papers, though, their lawyers argue that Saper and Kortschak and the other defendants could not have known the company's revenues were false because the auditors had certified the financial statements.

EPILOGUE

In recent years, the Securities and Exchange Commission has harshly criticized audit committeesfor being  too passive, and at the end of January new rules went into effect requiring the committees to disclose precisely how they review a company's inancial figures.

``Strong and effective audit committees,'' the agency stressed while explaining the new rules, play a ``critical role in the financial reporting system'' by ``overseeing and monitoring'' management and auditors.

The SEC's enforcement division also sent Aspec an `informal inquiry'' more than a year ago. In its latest annual report, the company says it continues ``to provide information in response to the SEC's requests.''

But the agency's record suggests that any action may not come soon.

Although Helane Morrison, the head of the SEC's San Francisco office, stresses that ``fighting financial fraud is a top priority,'' a limited budget and staff have produced only a handful of enforcement actions against Bay Area IPOs over the past six years.

Morrison says the office tries ``to look at the egregious ones'' and ``to bring `message' cases,'' such as the Media Vision prosecution being handled now by the U.S. attorney's office in San Francisco.

That case, though, is six years old, and Paul Jain is not scheduled to be tried until September.

Meanwhile, Kortschak has risen to be managing partner at Summit and turned a $120 million investment in E-Tek Dynamics into a $6 billion profit. Saper recently represented Webvan Group in the online supermarket's IPO, which the SEC delayed after catching Saper's client giving road-show participants information that was not disclosed to the public.

And Aspec has transformed itself into a company that bears virtually no resemblance to the one that went public almost two years ago. It is selling its chip-design business and now makes software that allows companies to collaborate on products by communicating over the Internet.

Except for Chairman Conrad Dell'Oca, no officer remains from 1998. And the company's stock price has rebounded to more than $7 a share.

For all the dramatic changes, though, former shareholders say Aspec still must account for its tainted IPO, and they won't let Saper, Kortschak or any of the other former directors or officers forget that.

``Sometimes you invest in a company,'' says Kassover, ``and the business goes bad because of market conditions or the economy or competition.  Who knows?

``But when you buy a company that tells you everything is great and it turns out they're lying, well,  it leaves a very bad taste in your mouth.''
 

Jeffrey Saper:

After the enormously successful IPO of Apple Computing, Saper became an attorney of choice for the high-tech industry . . . but there were some troublesome deals in his past.

Walter Kortschak:

Kortschak's record in IPOs is the envy of the venture-capital industry, but not all of his deals would go smoothly, including several with Jeffery Saper.

ASPEC TECHNOLOGY'S   TROUBLING IPO

December 1991 Aspec Technology, Inc. is incorporated in California.

May 1996 Venture capital firms invest $20 million in Aspec. In addition to common stock, the firms receive preferred stock redeemable at a premium upon an initial public offering. Jeffrey Saper and Walter Kortschak join the company board of directors.

February 25, 1997 Aspec board of directors authorizes the company to issue stock in an IPO.

March 6, 1997 Aspec files papers with the Securities and Exchange Commission for the sale of 4 million common shares.

June 17, 1997 Auditors Deloitte & Touche warn Aspec directors of accounting problems. That same day, Aspec files letter with the SEC cancelling the IPO.

March 11, 1998 Company's board of directors authorizes the company to issue stock in a new IPO.

March 12, 1998 Auditors Deloitte & Touche again warns Aspec directors of accounting problems.

March 17, 1998 Ignoring the auditors' warning,  Aspec files a registration statement with the SEC for the sale of 6 million common shares

April 27, 1998 IPO occurs with Aspec issuing 6 million shares of common stock for $13 each. Of the $78 million the IPO raises, $18.5 million goes to cash out Saper, Kortschak and other holders of preferred stock.

June 25, 1998 Aspec's quarterly financial report delayed.

August 5, 1998 Deloitte & Touche resigns as company's auditors.

September 29, 1998 Aspec's quarterly financial reports delayed again.

December 17, 1998 Aspec announces restatement of financial results for past 2 1/2 years. Company's stock plunges to just more than a dollar per share.

February 1, 1999 Investors file suit in Santa Clara Superior Court, accusing Saper, Kortschak and other company officials of securities fraud.

Source: Reynolds Holding, San Francisco Chronicle   Page A1    03/28/2000