Exemption for Idealab Targeted

Some of Idealab Inc.’s investors asked the Securities and Exchange Commission on Tuesday to rescind the firm’s exemption from rules governing investment companies, a move that could force the Pasadena Internet incubator to return some of the hundreds of millions of dollars the investors gave it.

The move is the latest salvo in the increasingly bitter battle between Idealab and owners of its so-called preferred shares. The group includes more than three dozen mutual funds, investment partnerships, companies and individuals that include Dell USA, T. Rowe Price Science & Technology fund and Travelers Insurance Group.

In a petition filed Tuesday, the investors said Idealab executives misled federal securities regulators two years ago when they claimed the firm was exempt from rules governing investment companies, the formal term for mutual funds.

Specifically, the shareholders asked the SEC to cancel a special exemption to the Investment Company Act of 1940 that the agency gave Idealab in 2000.

If the SEC finds that Idealab is really a mutual fund, the disgruntled investors would have the right to a full refund of their initial investment, said Skip Miller, a Century City attorney for the shareholders.

The petition alleges that Idealab launched a “carefully orchestrated sham” to mislead the SEC in order to get its exemption from the law. Had the firm been classified as a mutual fund, it would have faced a more difficult time planning an initial public stock offering.

Idealab had planned to go public, a key reason so many large investors poured more than $1 billion into the company in the heyday of Internet stocks.

The preferred-stock investors cited an e-mail to Idealab employees in October 2000 from founder Bill Gross and his wife, Marcia Goodstein, the company’s president. It reads: “At times over the past year, we digressed from our original business model. We used cash to preserve our ’40 Act position (to retain over 25% ownership) in a few companies, and we invested in some later-stage companies that are out of our sphere of influence. Our efforts were well worth it, as last week we received a permanent exemption from the SEC. With this issue behind us, we have recently returned to our core strategy.”

Doug McPherson, Idealab’s general counsel, said he hadn’t seen the petition, but said the e-mail was “taken completely out of context.”

The SEC, which is reviewing the filing, declined to comment on the matter.

Earlier this year, the disgruntled investors filed suit in state court against Idealab to liquidate the company and recoup at least some of their more than $700-million original investment.

The shareholders, a diverse group that includes William Morris Agency, Alanis Morissette producer Guy Oseary and Internet poster girl Cindy Margolis, claim that Idealab executives are keeping the firm alive for their personal gain.

The investors say they want the company dissolved before its estimated $400 million in remaining assets are spent.

In a statement, Idealab said the petition was based on distortions and fabrications, and dismissed it as an attempt to force Idealab to settle the suit with shareholders, who own 9% of the company’s voting stock.

Founded in 1996 by Gross, Idealab has helped finance dozens of companies, including such start-ups as now-defunct EToys Inc. and Ticketmaster Online-City Search Inc.

Idealab’s plan for success centered on reaping huge capital gains by bringing many of its companies public and eventually offering shares in itself.

But the plan was dashed by the collapse of Internet stocks beginning in 2000, as the public’s appetite for Net shares evaporated.

At one point Idealab was valued at nearly $10 billion.

The shareholders initially filed suit against Idealab in Los Angeles County Superior Court in January.

In late July, the shareholders filed a second amended complaint, adding new charges to allegations of breach of fiduciary duty and fraud.

Gross has called the suit “completely and totally baseless.”