Shortly after March 20, 2000, the worst day of Michael Saylor's
life, one of his blue-chip Washington lawyers, Brendan Sullivan,
promised him that everything was about to get worse.
This was just after MicroStrategy Inc., the company Saylor led,
had been forced to issue a "restatement" of its recent financial
records, effectively turning two years of profits into two years of
losses; it was after the company's stock price fell from $226.75 to
$86.75 a share in a single day of trading.
"This is going to be like getting on a raft at the top of the
Grand Canyon," Saylor recalled Sullivan telling him. "You're going
to go all the way to the bottom and you're going to hit rapids every
step of the way. And you just gotta hold on."
Still, Saylor was defiant, even after MicroStrategy's
shareholders lost a collective $11.1 billion in a single day.
"Mother Teresa never quit during a down quarter," he told Reuters on
March 20, "and what we're doing is just as important." He maintained
that MicroStrategy's mistakes had been negligible. He told friends
that his company had been the victim of "bean-counter sophistry"
from its auditors, PricewaterhouseCoopers, and from the "jackals" in
the press.
But there was something Saylor feared – the Securities and
Exchange Commission. Its chairman, Arthur Levitt Jr., had placed a
high priority on scrutinizing corporate accounting standards,
especially for the fast-growing technology firms. To have an SEC
investigation pending for months, or years, can kill a young firm,
especially a cash guzzler such as MicroStrategy, which needed to
raise money in the aftermath of its aborted $2 billion stock
offering. The SEC, Saylor would say in his preferred "Star Trek"
parlance, could "vaporize us."
On April 13, MicroStrategy announced that the commission had
begun an investigation into its accounting practices. The same day
MicroStrategy also disclosed that it had overstated revenue for the
previous three years, not just two.
Nearly all SEC investigations end in a settlement. But just the
idea of it ran counter to Saylor's natural impulse to fight. His
attorneys warned that fighting was a bad idea if he wanted the keep
control of his company; MicroStrategy's fate and that of its
founder, they said, would depend largely on Saylor's ability to
abide compromise and show contrition. Whether that was possible was
not yet clear.
The SEC had a team of five lawyers and two accountants working on
the MicroStrategy case. It was led by Gregory S. Bruch, a
Stanford-trained investigator, who is described by a former
colleague as an "aggressive do-gooder" determined to "teach lessons
in the interests of public good."
Bruch (pronounced "Brew"), a former Eagle Scout from
Independence, Mo., often expressed bemusement at the arrogance of
the new-technology zillionaires of the period. During the
MicroStrategy investigation, Bruch read many of Saylor's internal
e-mails and was amazed at some of the things that seemed to
preoccupy the entrepreneur: finding the right person, for example,
to compile his speeches and ideas and write a history of the
company.
Explanation Questioned
After the restatement, Saylor's explanations of MicroStrategy's
accounting problems began to sound increasingly dubious to many of
his own executives. In the first weeks after March 20, executives
recall, Saylor had relied on a simple, two-pronged excuse: "Software
accounting is complicated" and "The auditors were signing off." But
many people within MicroStrategy were beginning to think the company
was wrong, at least on the timing issue – the easy-to-discern notion
that company officials had counted certain deals in quarters that
they knew had ended when the deals were signed.
Saylor himself was on record as saying he knew the practice was
wrong.
"There's a difference between 11:59 and 12:01, the last day of
March," Saylor said in a Washington Post interview in June 1999.
"One of them is you go to jail if the thing gets signed at 12:01
[and you record it the day before]. One of them is the stock is up
$500 million and the other one is you've just torched the life and
livelihood of a thousand families."
It had become apparent, largely through statements from some
MicroStrategy customers in the press, that the company had made a
practice of "turning the clock back" at the end of certain quarters.
Or it was operating by a flawed clock. Either way, not everything
could be blamed on PricewaterhouseCoopers.
While his attorneys, particularly Jonathan Klein, the company's
general counsel, told Saylor to stop talking to the press, Mark
Bisnow, the Washington political veteran who became Saylor's
personal publicist, told Saylor that candid apologies would be his
best strategy and the quickest route to rehabilitation.
Bisnow cited the example of Sen. John McCain (R-Ariz.), who was
then challenging George W. Bush for the Republican presidential
nomination. After McCain was tainted in the Keating Five scandal of
the early 1990s, he transformed himself into what Bisnow called "the
gold standard of integrity." McCain achieved this by repeatedly
admitting his mistakes, Bisnow said.
"Everyone knows you're brilliant, but the one thing everyone
comments on is your need for humility," Bisnow wrote in an e-mail to
Saylor in April 2000. "A lot of people, especially in the high tech
industry, know that accounting issues are complicated. . . . Now is
the time to show that this is a time of great education for you,
that you are prepared to emerge a new person from this
experience."
Saylor enjoyed the McCain parallel, Bisnow said. But Bisnow
became frustrated that Saylor ignored the part about admitting
wrongdoing. Saylor himself said he never felt the comparison was
fully "appropriate" to his own situation.
Saylor saw himself as an outsider snared by the Washington
culture. "I come from a naive, sort of a lower-middle-class family,"
he said later. "I didn't understand the media. I didn't understand
politics. If I were a Kennedy, I would get it." He told one
associate that "Janet Reno would not rest" until she indicted
him.
Before appearing at a shareholder meeting that June, Saylor
became furious at a speech that had been prepared for him by
MicroStrategy's vice president of marketing, Joe Payne. The speech
had a penitent tone and included an apology to shareholders.
"I'm not saying this," Saylor said to Payne, shaking his head.
"It makes it look like I did something wrong."
But Saylor read the speech verbatim, in a flat monotone like a
hostage forced to speak on TV. Shares of MicroStrategy jumped $3.88
that day, closing at $42.44.
Running Out of Cash
Meanwhile, his company was running out of cash. Within a few
weeks of MicroStrategy's restatement, the company fell out of
compliance with the conditions of a credit line it held with Bank of
America. This forced Saylor to personally guarantee the terms of the
company's lending, an unusual move by a chief executive, and also a
sign of Bank of America's unease with MicroStrategy's financial
status. The previous fall, Saylor had liquidated $42 million of his
stock assets – his only personal stock sale to that point. The sale
provided a thin cushion for MicroStrategy, which needed $6 million
just to meet its payroll every two weeks, according to a company
source.
Saylor, despite his enormous stock holdings, was vulnerable to
personal bankruptcy unless the company could raise money fast – and
ongoing SEC investigations are no selling point.
In June, MicroStrategy sold about 4 percent of its outstanding
shares and accepted a $125 million investment from a group led by
Promethean Asset Management LLC of Chicago. But the Promethean
investment hurt MicroStrategy in the long-term because of a
provision that allowed Promethean to gain more shares if the
company's stock price dropped after the purchase date – which it
steadily did. In investment circles, such provisions have been
called "death spirals" because a firm's stock price often falls
after taking on such financing, and as the price drops, the company
has to issue more stock. MicroStrategy was eventually forced to
renegotiate the deal.
But in June 2000 the Promethean deal provided MicroStrategy with
a temporary life jacket. Saylor, however, was increasingly scared
for his job.
Bruch was convinced that MicroStrategy's top executives should be
held responsible for the accounting problems that led to the
restatement of results. "This was not a case of incompetence," Bruch
said in an interview, referring to Saylor, MicroStrategy co-founder
Sanju Bansal and Chief Financial Officer Mark Lynch. "These were not
bumblers. They're smart guys. If there were errors made, you expect
there to be a random distribution of errors. It wasn't." Rather, he
said, there were consistent "errors" made in the company's
favor.
Beltway securities lawyers tend to be an incestuous group, often
moving freely between the SEC and private practice. A prime example
is Harvey L. Pitt. Pitt represented Saylor before the SEC and is now
its chairman. Ralph Ferrara, a securities law expert who represented
the firm and had shared an office with Pitt at the SEC in the 1970s,
also interviewed with the White House for the job, according to
sources familiar with those discussions.
Unlike many dealings between competing legal interests, SEC and
private lawyers are often cooperative. A company's legal team will
conduct an investigation of the firm it is representing, then
present its findings to the SEC. A lawyer's credibility with the SEC
is vital, especially because the attorney could be working with the
agency, or for the agency, again.
Between April and June of 2000, Bruch and Ferrara oversaw
parallel investigations of the company. They scrutinized several
years of MicroStrategy documents – filings, contract drafts, memos
and, most compellingly, e-mails. The most incriminating were from
Lynch, who would use terms like "scorching the earth," often in
response to pressure from Saylor to achieve "maximum results," said
an SEC source who had viewed the e-mails.
In June, Ferrara and his partner John Tuttle met with Bruch to
discuss their mutual findings. In the following weeks, the parties
held a series of discussions about settling the case. Ferrara argued
– and Bruch became convinced – that barring Saylor and Bansal from
the company would probably kill it and would only hurt shareholders
more. Still, Bruch was prepared for a long fight, even though it was
far from certain that he could win a case against the three
executives if it went to trial. PricewaterhouseCoopers' role would
be a "litigation risk," he said in an interview, meaning that a jury
would be likely to view the accounting firm's advice as a mitigating
factor in assessing MicroStrategy's guilt.
As he negotiated with Ferrara, Bruch asked variations on the same
question: "How do I get comfortable leaving these guys in here?" A
recurring point of contention involved a single word: "fraud."
SEC officials believed this was a case of fraud, while Ferrara
argued against including the word in the SEC's complaint. Bruch used
a favorite term whenever Ferrara threatened to refuse a settlement
that included a fraud charge. "If you do that, then we'll unleash
the hounds," Bruch would say, meaning that the SEC would expand the
scope and tone of the investigation, and that could take years.
As it turned out, Ferrara was able to avoid a charge of fraud
against the company – but not Saylor, Bansal and Lynch as
individuals. This was an important point for Ferrara. If the company
had been cited for fraud, it would have become even more difficult
for MicroStrategy to raise money. The company also agreed to add an
experienced outsider to the audit committee of its board of
directors – something it had said it would do before, but never
had.
But before he agreed to anything, Bruch needed Saylor, Bansal and
Lynch to answer detailed questions about how the accounting fiasco
happened. They needed to explain the fine print of some of their
contracts, what they meant by certain colorfully worded e-mails. "I
need to be convinced that these guys "get it," Bruch told
Ferrara.
Saylor, Bansal and Lunch each had his own counsel, his own
concerns and his own grievances: Bansal felt unfairly targeted,
given that his main charge at the company was to bring in deals, not
record and account for them. Lynch said he felt squeezed between
Saylor's ambitious revenue demands and PricewaterhouseCoopers'
willingness to approve the company's numbers.
Saylor complained in various private forums about Lynch, saying
things like "My CFO didn't do his job," or that Lynch was "too
aggressive." But he was also worried that Bansal and Lynch could
quit, breaking up their circle and opening up the possibility of
lawsuits between them that could further damage the company.
Bruch insisted that Saylor, Bansal and Lynch had to sign on to
the final settlement together. Lynch was the most conflicted, but in
the end all three agreed. The contours of a deal were set that would
allow Saylor to keep control of his company, but with a big
qualifier: He would have to explain to the SEC that he understood
his company's mistakes and how they had happened.
On the night before his appearance before the SEC in November
2000, Saylor went home early, around 8 p.m. He called his mother. He
tried to soothe himself, sat down at his piano and played
Beethoven's Moonlight Sonata.
Questioned at SEC
The next day, Pitt told lawyer jokes as he and Saylor rode in a
Lincoln Town Car to the SEC. Saylor kept taking deep breaths and
worried about his ability to remain disciplined and contrite over
several hours. In the commission's basement hearing room, Pitt sat
on Saylor's left, Ferrara on his right.
Pitt, undeterred by a "No Eating" sign, spread out a smorgasbord
of Diet Cokes, bottled water, fruit, sandwiches, chips and a
five-pound tin of deluxe nuts, which he offered to everyone in the
room.
Across from them were the seven SEC officials who had worked on
his case. Bruch sat in the middle, flanked by Laura Josephs, a
seasoned investigator, and Jay Balacek, a former Harlem beat cop.
Josephs, sick with pneumonia, asked general questions to start, then
drilled down to the fine points of contracts and internal e-mails.
Her questions came in a methodical flurry, interrupted by a hacking
cough.
The interview began at 9:30 a.m. and ended at 6:30 p.m. with a
45-minute break for lunch. Sources on both sides said Saylor was
deferential and earnest, admitting he had not put the "financial
infrastructure" in place to manage a company growing as fast as
MicroStrategy. One person in the room described him that day as
"almost elfin."
Saylor recapped the story of MicroStrategy, how he always wanted
it to be a force for a better civilization and how he was sorry for
all the pain he had caused his shareholders. Again and again he
apologized, saying that as CEO, he bore responsibility for
everything that happened. He asked to be allowed to learn from his
mistakes.
As he finished speaking, Saylor's voice cracked and his eyes
welled with tears.
Saylor Keeps Job
It could have been an act – SEC officials were fully open to that
possibility. Saylor seemed so well-prepped by his lawyers, "like a
guy who needed to be trained in how to talk to people as equals,"
said an SEC source who was in the room. But Saylor had demonstrated
the requisite contrition. He gave good answers on small points,
didn't stonewall or argue. He could keep his job.
Still, the SEC's findings, issued in mid-December, provided a
detailed account of how Saylor, Bansal and Lynch were complicit in
manipulating MicroStrategy's financial reports. "Each knew, or was
reckless in not knowing, that MicroStrategy's financial statements
were materially misleading." At the end of each quarter, the SEC
said, "Saylor, Bansal and Lynch discussed, within a range, the
financial results they would like to report in the just-ended
quarter and whether to forestall recognizing some revenue.
"To maintain maximum flexibility to achieve the desired quarterly
financial results, MicroStrategy held, until after the close of the
quarter, contracts that had been signed by customers but had not yet
been signed by Saylor, Bansal and Lynch. Only after Saylor, Bansal
and Lynch discussed the desired financial results were the unsigned
contracts apportioned, between the just-ended quarter and the
then-current quarter, and signed by either Bansal and Lynch and
given an 'effective date.' In some instances, Bansal and Lynch
signed contracts without affixing a date, allowing the company
further flexibility to assign a date at a later time."
In other instances, the SEC said, Saylor, Bansal and Lynch
knowingly booked revenue from deals before the contracts were
signed.
Saylor, Bansal and Lynch agreed to pay fines of $350,000 to
settle the SEC's charges of civil accounting fraud – the largest
fines that the SEC had ever levied in a case that did not involve
insider trading.
The executives also agreed to "disgorge" a combined $10 million
of what the SEC labeled "ill-gotten gains" on stock sales – $8.3
million by Saylor, $1.6 million by Bansal and $138,000 by Lynch.
Lynch, who had already resigned as chief financial officer to become
vice president of business affairs, was barred from practicing
accounting before the SEC for at least three years.
In agreeing to pay the fines, Saylor, Bansal and Lynch did not
admit or deny wrongdoing. Saylor, Lynch and Bansal all declined
comment on their SEC settlement.
On the day the settlement was announced, MicroStrategy's stock
closed at $15.38.
Next: Aftermath.
•
Reporter Mark Leibovich
discusses the Saylor series
