In a three- to four-page paper, answer the Preparation Questions for Part A
In a two-page paper, answer the Preparation Questions for Part B.
Cadence Design Systems and Avant! (A)
A NEST OF SOFTWARE SPIES?
The Avant! trade-theft suit could begin to rein in Silicon Valley’s freewheeling ways
Business Week, May 19, 1997
Peter Burrows in San Mateo, California
Cadence Design Systems CEO Joseph B. Costello traces his crusade against rival software maker Avant! Corp. to the day in 1994 when Vice President Gerald “Gerry” C. Hsu resigned. Four top employees had left to create Avant! three years before, so Costello wondered if Hsu planned to cross enemy lines, too. According to Costello, Hsu claimed merely to be taking time off at the beach—but was stone silent when asked if Avant! fit into his future plans. A few days later, Costello’s suspicions proved correct when Hsu answered the phone at Avant! offices in Sunnyvale, California. “So is this the beach, Gerry?” Costello asked. Hsu declined to comment on the conversation.
Thus began what prosecutors now say was the most blatant case of trade-secret theft in the history of Silicon Valley. On April 11 , Hsu and six other former Cadence officials were indicted on breathtaking charges: They allegedly had used stolen software to build a company with a market value that at one time exceeded $1 billion. The news sent Avant! stock down nearly 60% immediately after the arrests, to $9.81, though it has since bounced back up to $16.75. The defendants, who have all pleaded not guilty, each face up to seven years in prison and civil lawsuits.
“Over the Edge”
The tale that prosecutors tell is a sobering illustration of how far some executives will apparently go to gain a competitive edge. Many people are saying it also shows how little respect is accorded to other people’s intellectual property these days in Silicon Valley, where the temptation to cut corners to get a product to market is acute. With engineers changing jobs like shirts, it’s easy to look the other way when a new employee borrows ideas from a previous employer. And with Internet links and laptops, such heists are only a mouse-click away. “There’s no clear border between right and wrong out here, and everyone goes a little over the edge at times,” says Vincent F. Sollitto, CEO of San José-based Photon Dynamics Inc., a Cadence customer. “If Joe is right, this would make an example of someone who went over and didn’t come back.”
The Cadence story, if true, is also an object lesson in the difficulties software companies face trying to protect their intellectual assets. While trade-secret theft is rising by all accounts, busting the pilferers is expensive and time-consuming. It took pit-bull persistence by Costello, lucky breaks, and $10 million worth of lawyers and private investigators to get the case to this point. What’s more, litigation is considered bad form in Silicon Valley, where the honorable way to win market share is through innovation. During the fight, Costello was lambasted in the media as a bully and his board, customers, and friends urged him to give up the chase. Says Costello, “When it’s a solid-steel case, you have to do something about it. But there’s so many things moving against you. It’s uphill all the way.”
Naturally, Avant! (pronounced Ah-VON-tee) sees things differently. Lawyers for the company insist it never received stolen software code and point out that the company even removed some suspicious code from its products to be sure it was clean. In written comments to Business Week, Avant! CEO Hsu suggests the conflict is more about personalities than felonies. “[Costello] seems intent on attacking me personally—particularly in the press. I can understand why he would prefer to talk about me instead of Cadence’s… software products: Avant!’s are vastly superior to Cadence’s tools, and chipmakers are voting with their pocketbooks,” says Hsu.
Avant! backers claim Costello’s crusade is little more than a dangerous vendetta against a small, nimble rival. If he succeeds, they say, it could have serious implications for startups, the lifeblood of Silicon Valley. In fact, Avant! claims Cadence is the one fighting dirty. It has countered Cadence’s civil suit and seeks hundreds of millions of dollars to compensate for the company’s swooning stock price. Among other things, Avant! claims Cadence employees have shorted Avant! stock and spread negative rumors to drive it out of business. Costello says these are diversionary tactics to take the focus off the evidence.
Santa Clara (California) county prosecutors, who have heard both sides of the tale, believe Cadence’s version. According to those prosecutors and court documents filed by Cadence in connection with its civil suit, this is no mere case of an employee grabbing a diskette or two on the way out the door. Rather, they allege that Hsu and the other indicted Avant! executives are guilty of a multiyear conspiracy to steal the “source code” to key Cadence “place-and-route” programs, used by microchip designers to arrange circuits on a slice of silicon. “We don’t file unless there’s a high sleaze factor,” says District Attorney Julius Finkelstein. “We want people actually walking out the door with property, and that’s what we got.”
Ordinarily, place-and-route programs take years to develop. Not at Avant!. By stealing from Cadence on three separate occasions, prosecutors allege, Avant! was able to bring products to market with implausible speed. In the process, its sales soared from $39 million in 1994 to $106 million in 1996. In all, Costello figures Cadence has lost as much as $100 million in sales to Avant!.
According to Finkelstein, Avant! (then called ArcSys Inc.) from its very inception was built on stolen code. Avant! denies the charge. Finkelstein points to an electronic log found during a joint FBI and police raid on Avant!’s offices in December, 1995, that suggests Avant! founder Stephen Tzyh-Lih Wuu spent his final weeks as a Cadence research and development manager in 1991 copying a basic place-and-route program called Symbad. That, court documents say, is how Avant! was able to launch its first place-and-route offering, called ArcCell, in just two years—versus the six years it took Cadence to finish Symbad. Wuu says the 47,000 lines of code mentioned in his log were original work that he completed in 19 days. But Cadence disputes this claim, arguing that 100 lines is a normal day’s work.
Prosecutors claim that in 1994, Avant! persuaded former Cadence engineer Mitsuru “Mitch” Igusa to commit the second theft. This time the target was allegedly a key enhancement to place-and-route software—a so-called area-based program that lets the computer do more of the grunt work in chip design. While Igusa never took a job at Avant!, prosecutors allege that indicted Avant! executive Shiaoli Huang paid him at least $15,000 for stealing Cadence code. The money allegedly came from a shell company Huang was administering called the Saurus Fund, which was set up by some of the indicted executives purportedly to fund future startups. [In 1995, Hsu asked the board of directors to reconsider hiring Igusa. The board refused to hire someone who was under criminal investigation, but the suggestion was made that while Avant! could not give financial help to Igusa, individuals could.2 ] Igusa now faces six felony counts for theft, stemming from a raid on his home in November, 1995, in which police found a hard drive full of Cadence source code, much of it stripped of the company’s copyright notices.
Avant! says that the money it gave Igusa was for a potential startup project, and that the company never received stolen code from Igusa. For his part, Igusa has pled not guilty and could not be reached for comment. But once again, the speed with which the company released an area-based place-and-route program strikes at least one competitor as suspicious. About a year before Avant! released the product, Hsu allegedly approached rival Silicon Valley Research Inc. about a merger to bring in such technology—and was turned down. One Silicon Valley Research manager was shocked when Avant! later released the software: “They miraculously developed it overnight.” Avant! Chief Financial Officer John Huyett declined to comment directly on the company’s dealings with Silicon Valley Research but said that “Hsu has talked to just about everyone with something to offer in our industry.”
The third theft allegedly occurred in January, 1995. According to prosecutors, on his next-to-last day at Cadence before leaving for Avant!, engineer Chin-Liang “Eric” Cheng copied a program he had written over the previous two years onto a file he named “byebye” and stored it on a backup tape. Called V-Size, the program lets designers figure how big a chip must be to handle a given number of circuits. While Avant! never marketed the product, it had planned to do so in 1996, according to documents seized by the FBI, which has been working with Santa Clara county prosecutors since 1994. Avant! denies any wrongdoing, and Cheng declined to comment.
In retrospect, Costello finds it shocking how little loyalty his former employees appear to have had to the company. “The same people came into my house three times and stole some of my most valuable belongings. It’s not right, and we can’t live this way,” he says. By his own admission, Costello learned of the alleged thefts remarkably slowly. Originally, he wasn’t alarmed when Avant!’s founders and other employees refused to sign forms promising to respect Cadence’s trade secrets. But he reconsidered after a surprising discovery in August, 1995. A Cadence engineer was on a routine visit to a customer when he happened to look at some of their Avant! software. He spotted a tiny flaw he had unintentionally written into a Cadence product years before—a misaligned edge of a rarely used screen that made it appear fuzzy. To confirm the engineer’s hunch, Costello asked a customer to compare the two products. The results: 4,000 identical lines of code and even identical grammatical mistakes. Avant! denies that any theft took place.
Now armed with what he considered conclusive evidence that Avant! had ripped off Cadence code, Costello declared war. But even as his legal case was jelling, he found little support in tight-knit Silicon Valley. Industry reporters and customers alike accused him of using the courts to beat up on a feisty rival. A customer at chipmaker S3 Corp. sent him a heated e-mail message saying “this posturing in the courts is a waste of everyone’s time,” Costello recalls. Wall Street analysts urged him to stop mentioning the affair at financial meetings—it was detracting from their Avant! stock sales pitches. Through it all, customers continued to snap up Avant! software—usually without even investigating Costello’s charges. “The thing that’s mind-boggling is how people tried to dismiss it,” says Costello. “It’s like, ‘So, they stole some things.’ ”
As the heat rose against Cadence in mid-1996, even personal friends and backers questioned Costello’s judgment. Nervous about the expense and bad publicity, members of Cadence’s board began to reconsider their support of the lawsuit. Says one Cadence manager, “Our board just didn’t want to go to the mat.” Friends and trusted advisers at Motorola Inc. and Siemens wrote off the issue, predicting that “you’ll end up settling,” Costello says. And as former Cadence colleague Prabhu Goel planned to sell his company, Frontline Design Automation Inc., to Avant! in late 1996, Costello couldn’t even get Goel on the phone to discuss the ethical implications. Goel says he had made a “judgment call” that Hsu was innocent and didn’t want to do anything that could scotch the deal.
Others questioned Costello’s motives. After all, Avant! was winning away key customers, and Costello, a slick marketer, wasn’t above playing dirty pool to hurt his rival’s reputation, they said. Before the indictment, “I thought this could have been without cause—just two companies and two men fighting with each other,” admits Walden C. Rhines, CEO of Mentor Graphics Corp. in Wilsonville, Oregon.
Now the indictments have given Costello at least partial vindication. But the story is hardly over. On April 30, a determined Hsu vowed at an industry conference to “take the offensive” against Cadence with an aggressive marketing and advertising campaign. “We are not going to stop until we win completely,” said Hsu. Hsu went on to project that Avant! would quadruple in size by 2000. But for that to happen, he’s going to have to keep himself and his executive team out of jail. Win or lose, Avant!’s tangle with Cadence has been a wake-up call to the rest of Silicon Valley.
Venture capital firms invested a total of $7.8 million in two rounds in ArcSys/Avant!. The venture capital firms were the following:
Advanced Technology Ventures
Amerindo Investment Advisors
Sutter Hill Ventures
In June 1995, ArcSys/Avant! raised $31 million with its IPO.
Board of Directors (1997)
Gerald C. Hsu, Chairman—Avant!
Eric A. Brill, Secretary
Y. Eric Cho—Avant!
Tench Coxe—Venture Capitalist, Sutter Hill Ventures
Charles St. Clair
The Case Against Avant!
How software maker Avant! allegedly stole trade secrets from rival Cadence—and got nabbed—resulting in one of the computer industry’s biggest espionage prosecutions.
March, 1994: Gerry Hsu quits Cadence, reportedly telling CEO Joe Costello that he would probably leave high tech altogether. A few days later, Hsu emerges as CEO at competitor ArcSys, Avant!’s predecessor.
September, 1994: Key Cadence engineer Mitch Igusa quits. Subsequent investigation reveals that Igusa allegedly e-mailed four crucial files containing trade secrets to his home PC before leaving.
May, 1995: ArcSys, allegedly using stolen Cadence technology, goes public. Its market value quickly surpasses $1 billion.
August, 1995: Igusa is charged. Private investigators for Cadence discover an alleged “slush fund” set up by Avant! to pay him for his efforts.
December, 1995: FBI officers raid Avant!’s offices.
May, 1996: Cadence files for a preliminary injunction to prevent Avant! from selling possibly tainted software. In March, the injunction was denied, but the presiding judge suggested there was evidence that at least some Cadence code had been stolen.
April, 1997: Six Avant! managers are charged with trade-secret theft and conspiracy.
Fight to the Death
After six Avant! managers were charged in 1997 with conspiracy and theft of trade secrets from Cadence, Hsu responded by declaring war on his former employer. “He’d say, ‘I’m going to fight this to the death. They don’t know who they’re dealing with,’ ” recalls one former executive.
Fight he did. On the legal front, Hsu assembled a defense dream team that included many of the Bay Area’s top criminal lawyers. The attorneys ran a scorched-earth… campaign. Using a variety of tactics, the attorneys managed to get three judges in a row to leave the case. They also made three unsuccessful attempts to disqualify prosecutor Finkelstein. “The defense left no legal stone unturned,” says Finkelstein.
Hsu also worked the public-relations angle. He launched an advertising campaign to turn public opinion. Avant! hired media consultant Mark Fabiani, who had helped the Clinton administration through the Whitewater scandal. That October, the company ran a full-page newspaper ad headed “The Ugly Truth,” with a grotesquely morphed photo of Costello, claiming Cadence was using the courts to hurt a nimble competitor.
Then, in 1998, Hsu set up the Avant! Foundation, which bombarded Silicon Valley residents with syrupy radio ads offering to give away everything from college scholarships to free PCs for the elderly. According to state records, the Avant! Foundation spent almost $1.4 million promoting itself in 1999 and 2000, nearly twice what it had given away. Matt Lipschultz, the foundation’s director of operations, said the promotions were necessary to find candidates for funding and that it was spending “more on programming.”
Avant! and Six Executives Cop a Plea
A long protracted legal battle ensued as Hsu and his partners in crime brazened it out. They proclaimed innocence and blamed their predicament on Cadence. They stalled the prosecution with a variety of tactics that stretched the law to the limits. But the prosecutors were persistent and they eventually got their day in court. Trial proceedings began May 14, 2001.
On May 22, 2001, Avant! and six current or former employees and/or directors entered pleas of no contest to conspiracy to misappropriate trade secrets, two counts of trade secret misappropriation, and a violation of California corporate securities law. In connection with the plea agreement, Avant! agreed to pay a fine of $27 million and to pay restitution in an amount to be determined by the court. On July 25, 2001, the court fixed the total restitution amount to be paid to Cadence at $195.4 million, any unpaid portion of which accrued interest at the statutory rate of 10% beginning July 25, 2001. In addition to the plea by Avant!, the individual defendants resolved the charges against them in the following manner:
— Gerald Hsu pleaded no contest to conspiracy to misappropriate trade secrets, failure to return stolen property, and a violation of California corporate securities law and agreed to pay a $2.7 million fine.
— Leigh Huang, Y.Z. Liao, and Eric Cho pleaded no contest to trade secret conspiracy and a violation of California corporate securities law. Huang, Liao, and Cho agreed to pay fines of $0.1 million, $2.7 million, and $0.1 million, respectively. Huang was sentenced to three years’ probation. Liao and Cho were each sentenced to three years’ probation and one year in county jail.
— Stephen Wuu pleaded no contest to trade secret misappropriation and a violation of California corporate securities law. Wuu agreed to pay a $2.7 million fine. Wuu was sentenced to two years in prison and three years’ probation.
— Eric Cheng pleaded no contest to trade secret misappropriation. Cheng agreed to pay a $27,000 fine and was sentenced to three years’ probation and 364 days in county jail. Effective July 25, 2001, Cheng resigned his position at Avant!.
— All charges were dismissed against former Avant! executive Mike Tsai.
— Mitch Igusa, who was never an Avant! employee, pleaded no contest. He was fined $27,000 and sentenced to one year in the county jail.
Joe Costello (Former Cadence CEO), May 20014
Joe Costello in an interview with Electronic News hoped that the successful prosecution of the Avant! executives would encourage district attorneys throughout the country to pursue others who steal corporate trade secrets. He also hoped that companies would stand up and not put up with corporate theft.
He was still appalled at the number of companies that had turned a blind eye to Avant!’s behavior. Costello said, “That’s the most interesting part of the story at this point: All of these people who told me to just drop it and go out and compete in the market… who told me they didn’t want to hear it. I was there saying, ‘Hey, none of that makes it right to steal!’”
“It really surprised me. I’d say 10% to 15% of the customers, people like T.J. Rodgers [Founder, President, and CEO, Cypress Semiconductor Corp.], said it’s stolen property, and we won’t buy it. Then another 10%, or 15%, these people just said they didn’t care. And I’m not talking about low-level engineers; I’m talking high-up executives said this. I’d ask them, ‘Would you buy a stolen car?’ They were just brazen about it. Nearly 70% were in between the two. They’d say this is between you and Avant!”
Avant!’s admitting to three separate thefts of Cadence’s property had Costello waiting to see how customers would respond. Now he would find out if they had been sincere when they previously vowed never to use Avant!’s software were it proven to have been stolen. He was not optimistic. One customer had just sent him an e-mail that more or less said that the crime did not bother him. “If that is how we feel about this, we have got a sickness in our high-tech society,” Costello observed.
Maybe We Need Corporate Death Penalty
Dan Gillmor is a noted American technology writer and former columnist for the San José Mercury News. He was so outraged by Avant!’s admission that it stole trade secrets that he posed a provocative question: “Should there be a corporate death penalty?” He continued, “It’s worth asking that question in the wake of the stunning news Tuesday that Avant!, its chief executive, Gerald Hsu, and five current or former executives had copped [a plea] to criminal behavior. The bottom line was simple. These guys had created a computer-aided design company with software code they stole from the company several had recently left, Cadence Design Systems, and used the code to compete with their former employer.”
Gillmor echoed the words of the district attorney that Avant!’s entire existence was a fraud, founded on criminal acts. He suggested that in a case as egregious as Avant!’s, “you have to ask whether the system would be improved with an ultimate corporate penalty—a sanction that would truly deter such misconduct.”
The Avant! Saga: Does Crime Pay?
The inside story of a company that stole software code
Business Week, September 3, 2001 by Peter Burrows in San Mateo, California
In early 1993, at a team-building exercise at the posh Claremont Hotel in Berkeley, California, executives from software maker Cadence Design Systems Inc. were asked to draw an image that described themselves. While many people pondered what to draw, division president Gerry Hsu—a talented artist, according to two attendees—quickly dashed off a picture of a big, powerful bird flying off into the distance, droppings falling all the way. “I always know where I’m going, and I get there very fast,” he explained at the time, “but I tend to leave a trail of s behind me.” Who could have predicted he would leave behind this much of it?
Since departing Cadence for Avant! Corp. in 1994, Hsu has transformed the tiny software boutique from a $2 million-a-year startup into a roaring profit machine that earned $70.9 million on sales of $358 million in 2000. But on May 22 , Hsu and five top managers pleaded no contest to charges that they conspired to steal Cadence software. Now the company has been struggling to come up with enough cash to pay $195 million in additional criminal penalties. And the worst may be yet to come because Avant! is facing a potentially crippling civil suit by Cadence. From May 21 to August 22, the share price has tumbled from $18.55 to $7.55.
The Avant! case is probably the most dramatic tale of white-collar crime in the history of Silicon Valley. Hsu & Co. parlayed a product containing purloined code into a thriving 1,500-employee public company, with a gleaming, modern office complex in Fremont, California, and a highly visible charitable foundation that has blanketed the Bay Area with radio ads. “What makes the case unique is that you have a large, publicly traded company that was founded and built on stolen property,” says Santa Clara County Deputy District Attorney Julius Finkelstein, the one-time computer-science graduate student who prosecuted the case.
That’s bad enough. But in a month-long investigation, Business Week has learned that the problems at Avant! go beyond the issues raised in the criminal case. Hsu has been running the company almost as if it were his family business—seemingly without regard for many common tenets of corporate governance, according to more than a dozen former co-workers and customers. He pays CEO-level salaries to his son and a former flight attendant, though former employees say that both have limited business backgrounds. Under Hsu’s watch, Avant! has also invested or made business deals with at least four other companies in which he has personal stakes. “To Gerry, every system is made to be manipulated. You push the line as far as it can go—hopefully without breaking it,” says one associate.
Hsu, 56, declined repeated requests for interviews and did not respond to written questions. But in court, his lawyers have said that the software in question was unimportant and that the company made every effort to remove stolen code. As for questions of improper governance, Avant! executives say employees are paid appropriately, that all the deals with companies owned by Hsu have been negotiated at arm’s length, and that the primary reason for Avant!’s success is its innovative engineering—a point echoed by others in the industry. “Avant! is a leading company with very strong products,” says Bernd U. Braune, CEO of Get2chip Inc., a rival design software company. “Some individuals made some mistakes, and they are going to have to pay. But if someone says they were only successful because they stole some code, I think that’s definitely wrong.”
Avant! Cleans Up?
Avant! is also making an effort to clean up its image. On July 25, the company announced that Hsu would pass day-to-day control to former Chief Operating Officer Paul Lo, who would replace Hsu as president. Lo’s first move: to issue a public apology. “Avant! Corp. is sorry for the events of the past,” he wrote in a public letter. “We pledge to work hard to deserve the trust and support of our industry.”
But few outside the company believe there has been any real change—and they point to Hsu as the main reason. Although he pled no contest to securities fraud, conspiracy to steal trade secrets, and failure to return stolen property, Hsu managed to avoid jail time, largely because there was no evidence that he directly participated in the thefts, according to Finkelstein. By contrast, co-conspirators Mitch Igusa, Eric Cheng, and Stephen Wuu were caught with Cadence code.
To alleviate the sting of the criminal proceeding, the board is paying Hsu’s entire fine as well as all of his legal expenses. More important, he is remaining as the chairman of Avant!’s board and its chief strategist—roughly akin to Bill Gates’… title and role at Microsoft Corp. Despite all the rogue behavior, fellow board members seem untroubled by Hsu’s record. When the company announced his new role, it cited a mild heart attack as the reason, with no mention of the Cadence case. According to board member Daniel Taylor, a retired U.S. Forest Service park ranger, directors never considered asking Hsu to leave. “He’s too precious,” Taylor says.
In fact, the board will increase Hsu’s $1.6 million salary by 5% a year through 2008, according to documents filed on July 25. That’s five times more than Lo’s $310,000 annual pay. The board is even trying to cement a continued role for Hsu with a new “poison pill.” According to new employment contracts also unveiled on July 25, any decision by shareholders not to reelect Hsu as chairman would be deemed a “change in control.” That, in turn, would allow many managers to cash out their options, thereby raising the cost of any hostile attempt to oust Hsu.
All of this conduct raises red flags with corporate governance experts. Despite conduct that would be completely unacceptable at most public companies, Hsu has skated through the Cadence debacle without any meaningful punishment. And though the stock has plummeted, most analysts believe Avant! will ultimately survive. “The Number 1 question is why they didn’t fire the guy,” says Nell Minow of the Corporate Library, a shareholder rights Website. “There’s something really, really wrong here.”
Public Company or Sole Proprietorship?
Based on Hsu’s assurances that the charges against him were bogus, investors ponied up $31 million in a June, 1995, initial public offering. Profits soared, and the share price zoomed from $13 to $45 by late July. Hsu cashed in on the company’s success by embarking on a 13-company, $230 million acquisition spree, enabling Avant! to take on rivals Cadence and Synopsys Inc.
Even as a public company, though, Avant! was run almost like a sole proprietorship. According to several present and former employees, many family members have always been on the payroll. Hsu’s son, John H. Hsu, is head of Avant!’s Asia operation, though he only received his master’s degree in marketing from Loyola Marymount University in 1998. According to company documents, John was 27 as of July 27, and earned $209,996 in salary and a $778,629 bonus in 2000. “He’s a nice kid, but he’s extremely inexperienced,” says one former executive. “He’s a good softball player,” says another. John Hsu did not respond to repeated requests for comment.
The second-highest-paid executive at the company is Noriko Ando, who earned $1.46 million in salary and bonuses in 2000. Previously a Japan Airlines flight attendant, Hsu hired her when he was at Cadence to help him arrange travel in Asia and coordinate meetings with executives from big Japanese customers, say several Cadence sources. Fiercely loyal to Hsu, she quickly rose through the ranks to become head of operations.
“She’s good at doing what Gerry tells her to do,” says a former Avant! executive, who adds that Ando’s salary and power have become a source of bitter controversy within the company. “She doesn’t know anything about technology,” says another source. Ando declined to comment on her salary or qualifications. Since Lo became president, Ando and John Hsu have been moved to new positions, but there has been no change in their compensation, says a company spokesman.
So far, the board of directors has let Hsu get away with such actions. Of the six members other than Hsu, five have connections to Avant! insiders. Former park ranger Taylor is a friend of Hsu’s sister. Also on the board are a venture capitalist in whose fund Avant! has invested $10 million, a former Avant! customer who now runs one of its distributors, and a former Avant! manager. The board has always been generous with Hsu. Thanks to a $2.8 million bonus in 2000, Hsu made twice as much as the CEOs of rivals Synopsys and Mentor Graphics Corp., although both of those companies are bigger than Avant!, and their stocks have performed much better. The company’s general counsel, Clayton Parker, says, “Avant! is far and away the most profitable company in the [electronic design] industry. Perhaps it should be no surprise that the CEO is well compensated for that.”
Hsu may get along well with the board, but he has had a harder time with outside auditors. In 2000, Avant! dismissed KPMG as its outside auditor. Not long afterward, the auditor filed a legally required document with the Securities and Exchange Commission in which it expressed concerns about fiscal years 1999 and 2000, including “incomplete and missing contract documentation,” “inadequate internal communications in connection with recording revenue,” and “lack of timely and accurate account reconciliations in a number of areas, including cash, unbilled accounts receivable, prepaid commissions, and investments in affiliates.” KPMG won’t comment further. While not necessarily an indication of fraud, says David F. Larcker, an accounting professor at the Wharton School, such a long list of grievances is unusual and indicates that KPMG may have believed its auditors were not getting sufficient information from the company. Avant! Finance Chief Viraj J. Patel denies any impropriety. “We’re not cooking the books.”
Critics say Hsu’s history with the board and the KPMG incident are troubling, given Avant!’s history of making deals with other companies that Hsu has invested in. In 1997, for example, he, Ando, and a few others created a new Japan-based company called Maingate Electronics to distribute Avant! software. Hsu personally owns 50% of Maingate, with the rest held by Ando and an investment fund in which other Avant! insiders are investors.
The Maingate deal is legal, to be sure. But it does create an opportunity for abuse. For example, Avant! has refused to disclose what price Hsu and other insiders paid for shares of Maingate recently bought back from Avant!. That raises a question of whether Hsu, with the support of the board, granted himself a low purchase price. And given Hsu’s big stake in Maingate, it could be in his interest to pay Maingate overly cushy commissions—a potential means of shifting profits from U.S. shareholders to Maingate’s owners. “The CEO should never be investing alongside the company,” says Corporate Library’s Minow. “That’s just terrible. The temptation is too great to have the company prop up your investment.”
Apparently, Maingate isn’t an anomaly. When Avant! decided in 2000 to spin off its Taiwan operation into a new entity called Avant! Hi Tech Inc., Hsu ended up with a 5% share and his son John got 3%, making John the second-largest owner. Avant! would not say what price per share the Hsus paid for their stakes. And in 2000, Hsu invested $1 million of his own money in SMIC, a China-based startup that will build semiconductors on a contract basis. Later that year, Avant! committed $100 million. Since that corporate investment came in a later round of financing, the company could have paid a higher price per share. The company declined to provide detailed information on Maingate, Avant! Hi Tech, or SMIC.
Down but Not Out
Avant! still faces a civil suit filed by Cadence, which will probably seek damages of more than $1 billion but is likely to take at least another year before it’s resolved. Some customers, worried about Avant!’s financial picture and angered by Hsu’s prior insistence on his innocence, say they may look to newer design software companies with hotter technology. The biggest concern: that many of the top-notch engineers who believed Hsu’s claims may now leave Avant! to escape the legal cloud.
But few people are willing to count Hsu out entirely. He’s nothing if not a survivor. “Gerry’s favorite book has always been Sun Tzu’s The Art of War,” says his old nemesis, former Cadence CEO Costello. “Well, the general is a little bit down and has lost a few battles. But he’s still alive.” No doubt. But if history is any guide, Hsu will simply regroup and prepare for the next fight.
1.What is your opinion of the behavior of the following actors:
a. Joe Costello
b. Gerry Hsu
c. Former Cadence employees that went over to Avant!
d. Customers and potential customers of Cadence and Avant!
e. Avant!’s auditors
f. Avant!’s lawyers
g. The prosecutors
2. What is the responsibility of the venture capitalist(s) who funded ArcSys (Avant!)?
3. What is the responsibility of the underwriter who handled ArcSys/Avant!’s IPO?
4. Evaluate Avant!’s board of directors.
5. Should there be a corporate death penalty as Dan Gillmor proposed?
Cadence Design Systems and Avant! (B)
Avant! Pays Fines and Legal Costs of Six Current and Former Employees, August 20011
In connection with the plea agreement, Avant! agreed to pay a fine of $27.0 million and to pay restitution in an amount to be determined by the court. On July 25, 2001, the court fixed the total restitution amount to be paid to Cadence at $195.4 million, any unpaid portion of which accrued interest at the statutory rate of 10% beginning July 25, 2001. Avant! recognized the resulting expense of $222.4 million in the second quarter of 2001. During the third quarter of 2001, Avant! paid the $27.0 million fine and made restitution payments to Cadence totaling $170.0 million. Avant! made a final payment of $26.5 million to Cadence on October 3, 2001, to conclude payment of the restitution owed to Cadence. These payments included $1.1 million of interest.
As part of the settlement, Avant! agreed to indemnify all of the current and former Avant! employees named in Exhibit 13.1, with the exception of Mr. Cheng, for the fines assessed against them, and indemnify them for the taxes levied as a result of this indemnification. Avant! recognized the resulting expense of $14.1 million in the second quarter of 2001. Under the applicable law, Avant! was authorized to pay the defense expenses and fines of its officers, directors, and employees if the Avant! board found that “the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.” The Avant! board, having determined that these criteria were met, paid, or agreed to pay, the amounts shown in Exhibit 13.1 in litigation expenses and fines for the listed individuals in connection with the Santa Clara criminal action.
Litigation and Related Expenses
Gerald C. Hsu
Amounts do not include amounts to indemnify each of the individuals for any actual tax liability attributable to amounts received from or paid on their behalf by Avant!.
Amounts include litigation expenses related to both the Santa Clara criminal action and the Avant!/Cadence litigation. On July 25, 2001, Eric Cheng, Y.Z. Liao, and Stephen Wuu resigned from Avant!. Eric Cho, Leigh Huang, and Mike Tsai were former Avant! employees.
All told, Avant! engaged 10 high-powered law firms and paid them $30 million; in contrast, the government case was initially led by Finklestein on his own; later, he was joined by two associates.
Securities Class Action Claims (March–April 2001)
On December 15, 1995, Paul Margetis and Helen Margetis filed a securities fraud class action complaint against Avant! in the United States District Court for the Northern District of California. This lawsuit alleged securities laws violations, including omissions and/or misrepresentations of material facts related to the events and transactions which are the subject of the claims contained in Cadence’s civil lawsuit against Avant!. In addition, on May 30, 1997, Joanne Hoffman filed a securities fraud class action in the United States District Court for the Northern District of California on behalf of purchasers of Avant!’s stock between March 29, 1996 and April 11, 1997, the date of the filing of a criminal complaint against Avant! and six of its employees and/or directors. The plaintiffs alleged that Avant! and its officers misled the market as to the likelihood of the criminal indictment and as to the validity of the Cadence allegations.
In March 2001, Avant! reached agreement with counsel for the plaintiff classes in both securities actions for a voluntary resolution of the cases. Under that agreement, Avant! paid a total of $47.5 million in exchange for dismissal of the actions and a release of claims by members of the classes. The District Court entered an order on June 22, 2001, that gave final approval to the settlement and dismissed the litigation with prejudice. Avant! paid the full settlement amount of $47.5 million in April 2001. Avant! recognized the settlement as an expense in the fourth quarter of 2000.
Synopsys to Acquire Avant!, December 2001
Mountain View, California—An acquisition that promises to fundamentally alter the EDA landscape unfolded Monday (Dec. 3) as Synopsys Inc. announced its intent to purchase Avant! Corp. Valued at $830 million at current stock prices, the acquisition is by far the largest in EDA history—and likely the riskiest from a legal and financial point of view.
If successfully completed, the acquisition will give Synopsys most of the IC design flow for “power users,” and could possibly unseat Cadence as the EDA market revenue leader. But Synopsys will inherit a civil lawsuit in which Cadence is seeking up to a billion dollars from Avant!, and so far, Cadence is showing no inclination to settle.
“The bottom line is that this merger is a bold move that instantly puts us in the leadership position in IC design automation,” said Aart de Geus, chief executive officer of Synopsys. “It instantly brings the best front- and back-end design tools together under a single roof.”
The acquisition will bring to an end the most controversial chapter in EDA history—the long-running criminal and civil prosecution for source-code theft. Gerry Hsu, the former Avant! president and CEO who pled “no contest” to several criminal charges this spring, will not join Synopsys but will probably receive a payment of around $40 million. [As it turned
out, actual payment to Hsu was $43 million; it was part of the $177 million in severance and other payments made by Synopsys to Avant! employees and board members.4]
“This merger opens up a new chapter in the history of the EDA industry,” said Paul Lo, president of Avant!. “Two acknowledged leaders are joining forces to become what we believe will soon be the preeminent supplier in the EDA business.”
Cadence and Avant! Settle Lawsuit, November 2002
Chip-design software maker Cadence Design Systems agreed to settle its civil lawsuit against rival Avant! for $265 million, closing the chapter on a long-running case that centered on stolen trade secrets.
Under the terms of the settlement, the two companies and individuals named in the suit have agreed to dismiss all pending claims and counterclaims, which date back to 1994. In addition, they agreed to enter into reciprocal licenses covering the intellectual property at the heart of the lawsuit.
The money Avant! must pay in this latest civil settlement is in addition to the amount it was ordered to pay in the criminal case, bringing its total payments to more than $460 million.
Synopsys, a large chip-design software maker that purchased Avant! in June , will pay the money out of an insurance policy from Illinois National Insurance Company, a policy it bought upon completion of the acquisition. Under the terms of the settlement, Cadence will accept $265 million in two installments; $20 million will be paid on or before November 22, and $245 million will be paid on or before December 16.
When it acquired Avant! Synopsys took out an insurance policy to limit its financial exposure in any future settlement of Cadence’s civil lawsuit against Avant!. Synopsys paid a one-time $85 million premium for the policy with a $250 million deductible. If the settlement was above the $250 million deductible, Illinois National would pay the additional amount up to a maximum of $500 million (i.e., a total settlement of $750 million). Hence if the settlement was less than $335 million ($250 million deductible plus $85 million premium), Illinois National would make a profit. As the settlement was for $265 million, Illinois National made a profit of $70 million on the policy. So the settlement cost Synopsys $335 million ($265 million settlement minus $15 million from Illinois National plus $85 million premium for the policy).
Synopsys’s total cost of acquiring Avant! was approximately $1.25 billion.
1.What could Cadence have done to better protect its intellectual property?