Option Probes Come at Inopportune Time for Vitesse, and Its Stockholders
CAMARILLO -- Vitesse Semiconductor Corp. was in high gear in 2000. With the fiber-optic industry booming, telecom and networking giants including Cisco Systems Inc. and Lucent Technologies Inc. were snapping up its microchips to use in systems that propel data over the Internet.
The company’s shares topped $100 that year, putting its executives in the chips as well. Its top five officers made $35.5 million on stock options during fiscal year 2000, including $15.2 million for Louis R. Tomasetta, its longtime chief executive.
Tomasetta, an MIT-trained electrical engineer, was enjoying success at a company he had helped start in 1984 and had nursed through several near-collapses. The Bronx transplant had purchased a 42-acre citrus and avocado orchard overlooking the Ojai Valley and was preparing to build a 15,000-square-foot mansion on it.
Six years later, Vitesse is struggling for survival. Since the Internet bust of 2001, sales have shriveled, profits have turned to huge losses and shareholders have become restive as the stock has sunk amid a series of downsizings. And just as Vitesse was showing signs of recovery, another temblor hit.
Vitesse turned up last spring as one of the companies suspected of manipulating stock options to secretly benefit key employees. Tomasetta and two other executives soon were fired over “issues related to the integrity” of option documents. A federal grand jury issued a criminal subpoena for the company’s files. And Vitesse’s largest shareholder is prodding board members to walk the plank.
Under investigation by the Securities and Exchange Commission and the federal grand jury in Manhattan, Vitesse has stopped filing financial reports, warning that its books can’t be trusted back to September 2002 “and possibly earlier.” Corporate leaders have provided only a few details about the problems while a squad of high-priced lawyers and accountants grinds out the internal probe, now in its sixth month.
The silence, analysts say, has hurt morale among the telecommunication chip maker’s 600 employees worldwide -- down from a high of more than 1,400 employees in 2001 -- and has brought investor anger to a boil.
“I wish I could talk to the shareholders -- not being able to report to them is just an awful thing,” said James A. Cole, a 19-year Vitesse director. However, he added, “Our role is to let the investigation go on unimpeded and try to keep the wheels on the company to preserve whatever shareholder value remains, and if possible increase it.”
He declined to wouldn’t discuss the case further, and the rest of Vitesse’s board, along with the current and previous top managers, declined interviews.
Vitesse is among more than 130 companies undergoing federal or internal probes into the possible manipulation of stock option grants to executives and other employees. But few among the companies embroiled in the stock options scandal have been battered as badly by the controversy.
The chipmaker’s stock has plunged 68% since Vitesse announced an internal investigation in April, closing Friday at 99 cents, wiping out more than $460 million in shareholder value. Bondholders are demanding immediate repayment of $97 million, saying Vitesse has violated its agreements with them.
Stock options give recipients the right to buy shares at a set price for a specified period of time. They are intended to link employees’ fortunes with those of their employer: The higher the stock rises, the more the options are worth.
The investigations are examining whether the companies secretly rewarded executives and key employees by backdating grants to days when the stock was trading at a low price, or awarding options just before the disclosure of positive news that would drive up the share price.
The Securities and Exchange Commission and special committees of corporate directors are steering most of the probes. But many of the companies, Vitesse among them, also have disclosed Justice Department subpoenas -- an indication that criminal charges may be brought. The FBI disclosed this week that it was conducting criminal investigations of the stock-option practices of 52 companies, but did not identify them.
On Wall Street, Vitesse is faring worse than the two companies where former executives have been charged with criminal wrongdoing, Brocade Communications Systems Inc. and Comverse Technology Inc. Comverse shares are down 19% this year, closing Friday at $21.44, compared with a 48% loss for Vitesse stock. And shares of Brocade are up 74% since Jan. 1, closing Friday at $7.06, near their 52-week high of $7.10.
Analysts and investors say the scrutiny of options has dealt Vitesse more of a blow for several reasons.
For starters, it is among only a dozen companies where executives have left their jobs in connection with possible manipulation of options. The ejection of Tomasetta, Executive Vice President Eugene F. Hovanec, and Chief Financial Officer Yatin D. Mody indicated from the beginning that Vitesse’s troubles were more serious than most, said Stanford Financial Group analyst Timothy Kellis.
What’s more, Vitesse already was weak and debt-burdened from years of struggling since its stock hit an all-time high of $106.13 on March 1, 2000. The company has burned through half of a $52-million loan obtained with a 14% interest rate in June from Tennenbaum Capital Partners of Santa Monica, Kellis said.
What’s more, he added, shareholders are worried that Vitesse could be forced into bankruptcy proceedings, possibly leaving them with nothing, if it is unable to work out a new repayment deal with its bondholders.
Worst of all from investors’ standpoint, the investigation into Vitesse’s option practices turned up a greater problem. Eight days after giving the executives the boot, Vitesse issued the warning that it might have reported inaccurate revenue figures for three fiscal years back, and perhaps more. It later restated earnings for its latest quarter, reducing sales by 10% and increasing its expenses 8%.
That news was hard to forgive, Kellis said, because it suggested that executives might have cooked the books to boost the stock price, then enriched themselves by manipulating stock options on top of it. Without reliable accounting for sales, it’s impossible for investors to trust a company, he said.
“It’s a level of corporate immorality far beyond the options problems,” he said.
Kellis said key technical and sales employees, discouraged by the problems and by Vitesse’s business prospects, have been leaving the company.
Robert Chapman Jr., whose El Segundo-based hedge fund has become Vitesse’s largest shareholder with 8% of its stock, said he believed the company would soon sort out its dispute with the bondholders, and predicted strong sales of its new product line. But Vitesse needs new blood at the board level, he said.
Vitesse directors were too cozy with management in the past, enjoyed millions of dollars in stock-option profits themselves, and now have used the ousted three executives as scapegoats for their own failures, Chapman said.
“At best what happened here is lax board oversight of an undisciplined management team,” Chapman said in a recent interview. “At worst, it’s complicit directors enriching themselves and their good buddies the executives at the expense of the owners of the company.”
A check of Vitesse proxy filings with the SEC shows that Tomasetta made more than $60 million cashing options in from 1996 through 2001, and Hovanec made nearly $22 million during that time. Tomasetta made only $236,024 and Hovanec $1,377 in option profits after 2001, when the stock tumbled.
Mody, who replaced Hovanec last year as CFO, isn’t listed in the proxies among executives cashing in options, but Chapman, citing figures from other regulatory filings, said Mody had made more than $2 million on options.
The money has helped the three executives purchase enviable homes in Ventura County, property records show. Mody, 43, last year sold a house in Agoura Hills for $1.38 million and is completing construction on a larger home worth at least $2.49 million, county records show, in Hidden Valley Estates, a Westlake Village area of new mansions.
Hovanec, 54, lives in a six-bedroom, 7,256-square-foot home in a gated enclave in Westlake Village. Property records show that the home, beside the private North Ranch Country Club, was valued at more than $2.8 million last year.
And Tomasetta, 57, who lives in a hilltop home in Thousand Oaks with sweeping mountain views, is continuing construction on the Ojai mansion, 2 miles up a narrow private road at the base of Chief Peak.
Vitesse had told investors it awarded options in the usual way, allowing employees to buy the company’s stock in the future for its market price on the day they got the options.
But Jay Coughenour, a University of Delaware finance professor who examined Vitesse’s stock returns at the request of The Times, said the shares showed a series of extraordinary price jumps in the days after the options were granted. He said the pattern was “consistent with back-dating or consistent with the approval of grants immediate[ly] prior to the release of positive information.”
A “best practice” to guard against chicanery is to issue options on the same date each year, said Paul Hodgson of shareholder research firm Corporate Library. That process would tend to pick high- and low-priced trading days at random, averaging out the effects of run-ups and drops in stock prices.
That policy wasn’t in effect at Vitesse. Six times in the past 10 years, the company granted options in October, the first month of its fiscal year. But the dates varied widely, from Oct. 2 to Oct. 27, and during the other four years the grants were dated on Jan. 1, Jan. 23, March 19 and April 6.
In 1996, 1997 and 1998, the options were dated near the stock’s low point for the fiscal year, and in 1999 and 2000 they were dated on the day of its lowest close for the fiscal year, a Times review of trading records showed.
Indeed, the pattern of option grants when the stock was low followed by double-digit run-ups in Vitesse’s stock in subsequent weeks is so pronounced that there’s less than one chance in 10,000 that the grant dates during the 10 fiscal years from 1996 through 2005 could have been selected at random, Coughenour said.
Hedge fund manager Chapman contends that only one viable course of action remains: cleaning up the company for sale in two or three years, including canceling any improperly granted stock options.
In a letter to Vitesse Chairman John C. Lewis, which he attached to a Securities and Exchange Commission filing in July, Chapman advised Lewis to step down before angry shareholders forced him out.
“It may have seemed like an expeditious exercise in denunciation to fire the Three Stooges,” Chapman wrote, “but expulsion to their respective cages after they committed their allegedly improper acts is no substitute for fulfilling your duty of due care to prevent them from happening in the first place.”
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String of gains
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Vitesse shares posted extraordinarily large gains in the days after top executives were granted stock options, a pattern that suggests the options were either “backdated” to precede the jump in price or “springloaded,” a practice in which the company releases positive news after granting options.
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*--* Option grant date 1-date stock spike Spike date Jan. 23, 1996 15% Feb. 6 March 19, 1996 16% March 20 Dec. 31, 1997 14% Jan. 13, 1998 Oct. 5 1998 12 Oct. 6 14 Oct. 14 16 Oct. 16 Oct. 19. 1999 10 Oct. 28 11 Oct. 29 April 6, 2001 16 April 10 21 April 11 20 April 15 17 April 20 Oct. 2, 2001 11 Oct. 10 10 Oct. 11 12 Oct. 12 Oct. 17, 2002 13 Oct. 24 18 Oct. 25 12 Oct. 28 31 Oct. 31 Oct. 20, 2003 4 Oct. 27 5 Oct. 28 Oct. 27, 2004 5 Oct. 28
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Sources: Jay Coughenour of the University of Delaware, Times Research
