Posted on 05/06/2003 12:02:03 PM PDT by NativeNewYorker
Pasadena, California, May 6 (Bloomberg) -- Jack Welch, who
ran General Electric Co. for 21 years and was Fortune magazine's
''manager of the century,'' also made a successful investment in
an Internet company: His $1.87 million was returned as 48 other
shareholders lost what they say is $725 million.
A complaint filed by shareholders in Idealab, a firm that
spawned such Web flameouts as Etoys Inc., claims Welch helped
founder Bill Gross cover $50 million in personal loans with
Idealab's funds. Meanwhile, the company returned the money Welch,
an Idealab director, had paid to exercise stock options when the
company's initial share sale was shelved in October 2000.
Through assistant Rosanne Badowski, Welch, 67, declined to
comment after receiving three phone calls and an e-mail.
The lawsuit may come to trial in Los Angeles Superior Court
this year. To some experts in corporate governance, the dealings
show how the Internet frenzy swept up even business leaders like
Welch, a one-time skeptic of the craze who called stock prices of
Internet companies ''wampum'' in March 1999.
''Is it illegal? Probably not,'' said Alan Johnson, president
of New York-based pay consultant Johnson Associates, after he
reviewed the complaint. ''But if you're holding yourself up as the
shining knight of American capitalism, it's kind of
embarrassing.''
Depositions of Gross and other Idealab officers may start as
early as this month. The plaintiffs include the investment arm of
Dell Computer Corp.; T. Rowe Price Associates Inc.; Brad
Silverberg, the developer of Windows 95; Guy Oseary, who owns
Maverick Records with the pop singer Madonna; and Cindy Margolis,
an Internet model.
Cash and Securities
They are seeking to liquidate Idealab, a closely held
Internet ''incubator'' that today develops wireless networks,
solar cells and other new technologies, over what they charge is
fraud and self-dealing. They want to use a sale to get what they
can of their $725 million investment back.
Welch left Idealab's board in September 2001. He isn't a
defendant in the suit against Gross, his wife Marcia Goodstein,
Idealab's chief operating officer, and other Idealab executives.
Welch might be added later as more evidence is gathered, said Skip
Miller, the lawyer representing the investors.
Gross, 44, an engineer trained at the California Institute of
Technology who started Idealab in a Pasadena warehouse in 1996,
called the suit a nuisance brought by investors who expected to
get rich quick. They're only after Idealab because it still has
$350 million in cash and securities, he said. Idealab has filed a
motion to dismiss the claim.
''They've basically told us they want a divorce and they want
to extort as much money as they can,'' Gross said. ''I'm
separately still creating new businesses here.''
'Mega News'
Among them: A $500 robot controlled by laptop computer and a
flower-shaped sun reflector to produce solar energy.
It was Gross who brought Welch to Idealab in March 2000.
Welch was that year preparing to leave General Electric, as a
bidding war for his memoirs reached $7 million and a closely
watched succession race named Jeffrey Immelt to follow him as
chairman and chief executive officer.
Gross, too, was riding high. Wired magazine lauded him for
turning ''brain waves into mega news.'' Idealab backed early hits
such as Web-access service NetZero Inc. and search engine
GoTo.com. In January 2000, Gross had sold 10 percent of Idealab to
Dell, Margolis and other investors in a private placement that
valued the company at $10 billion.
At the time, shares of Internet companies were hot, often
tripling or quadrupling in their first day of trading.
Paid Cash
Idealab filed for a $300 million initial public offering in
April 2000. Welch got options on 1 million Idealab shares at a
price of $1.87 apiece and paid cash to exercise them early,
according to Idealab spokesman Steve Chadima. Welch and Ben Rosen,
the co-founder of Compaq Computer Corp., were then Idealab's only
outside directors. Rosen, an early Idealab investor, didn't get
any options, Chadima said.
Welch's grant set him up for an ''extraordinarily large''
potential windfall, especially compared with the 18,000 options
that General Electric awarded directors in its last fiscal year,
according to Brian Foley, an executive pay consultant in White
Plains, New York.
''There's quite a buzz associated with Jack's name,'' Foley
said. ''You could see his involvement as a way to help everybody
cash in.''
Idealab spent $600 million from November 1999 to January
2000, mostly to boost stakes in CarsDirect.com and GoTo.com. It
started now-defunct companies such as entertainment Web site
Z.com. Then the Nasdaq Composite Index crashed, falling 51 percent
from its peak of 5048.62 on March 10, 2000, by year's end. Idealab
canceled its share sale that October.
Welch's money was returned the same month, Chadima said.
About 100 employees who had signed notes for loans from Idealab to
exercise options had them forgiven, he said.
'Going Broke'
''This company is all about self-dealing, supporting,
helping, bailing out Bill Gross and his cronies,'' said Miller,
the investors' lawyer.
Miller filed a 46-page complaint against Idealab in January.
It says Gross and Goodstein got unauthorized bonuses, tripled
their pay as losses mounted, used a corporate jet to vacation in
Hawaii and hid the true state of Idealab's finances.
Just as Welch joined the board in March 2000, Goodstein wrote
to Gross: ''I can't even think of words strong enough to express
how fast we are going broke,'' according to an e-mail cited in the
complaint.
Returning Welch's money ''doesn't seem fair at all,'' said
Ann Yerger, the research director of the Council of Institutional
Investors, which represents 120 pension funds with $2 trillion in
assets. ''The whole point of an option is that there's supposed to
be risk.''
Idealab says it did nothing wrong.
Including Bonuses
The company canceled its option program for all employees and
directors when the share sale was shelved. Welch was the only one
who had paid cash, so he was the only one whose money was
returned, Chadima said.
''You can make it sound horrible, but there's nothing wrong
with it,'' he said.
The company also says all the compensation for Gross and
Goodstein was approved by directors. Gross earned $767,000 and
Goodstein $617,000 last year, including bonuses, Chadima said.
To Gross's supporters, the lawsuit is sour grapes.
''It's real easy to beat the hell out of someone when they're
a bud with a new idea,'' said Martin Pichinson, a turnaround
specialist at Sherwood Partners in Los Angeles who advises many of
the largest venture-capital firms. ''Everyone else didn't do that
well either.''
Buyout Offer
The loan accusations revolve around a buyout offer that
Idealab made in 2001 to investors in the private placement.
Gross at the time faced a personal debt to Bank of America
that the plaintiffs estimated at $50 million, citing bank
documents. He had borrowed $30 million to buy Idealab stock in the
private placement; the investors claim the rest paid for a
Gulfstream jet and four lots in Pasadena near the Rose Bowl.
The lawsuit says a Bank of America official told colleagues
in an e-mail that Welch and two other directors, Compaq's Rosen
and former AT&T Corp. executive Robert Kavner, formed a special
committee to negotiate a ''solution'' to Gross's loan problems
that met ''the red-face test.''
The actual e-mails and loan records, obtained during
discovery by the plaintiffs, haven't been released to the public.
'Garbage'
Idealab later offered a buyback of 10 cents on the dollar to
the investors, including Gross, which helped him raise almost $2
million to service the loan, the plaintiffs say.
''It's clear from the evidence in the complaint what the
tender offer was all about: Give money out to Bill Gross,'' Miller
said.
Rosen declined to comment in a telephone conversation. Kavner
called the claims ''garbage.''
There never was any special committee, Gross said. The Bank
of America loan totals $42 million, all of it for buying Idealab
stock at various times, and there's no pressure to pay it back, he
said. Some of the plaintiffs themselves proposed the buyback as a
way to salvage some cash, Gross said.
''This has been construed as something that I did for me,''
Gross said. ''We made the offer to everybody.''
A Bank of America spokeswoman declined to comment.
The investors face obstacles getting their case to trial.
California law requires shareholders hold a third of a
company's equity before they can seek a breakup. Idealab says the
plaintiffs, with less than 10 percent, don't qualify. Miller
argues that they put up almost 60 percent of Idealab's cash, so
they meet the test.
Until a judge decides, Gross and his investors are stuck with
each other.
Welch, for his part, has commented on the fallout only once,
in a December 2001 Business Week article about the collapse of
Internet incubators. His advice to the investors: ''Tell them to
get good advisers.''
Given Jack's already immense wealth, I am unable to rationally devine why he would do this.
Knowingly using ones' "good name" to entice unwary Joe Sixpacks to invest crosses a bright ethical line in my mind.
Personally, I run in the other direction when I see that kind of hype. NO ONE is that good.
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