Investors make companies pay for misleading information -- Part one

Part One: Taking on Big Business

More than a dozen shareholders in Electronics for Imaging want the workstation developer to pay for the 62 percent fall in its stock price since Dec. 12. And they want you to join them, if you owned EFI's stock during the past year.

On paper, it may seem like a pipe dream. After all, investors in the stock market are supposed to understand the risks they take when buying shares in a company.

But these investors believe EFI sat on bad financial data about the company for eight months, when it had a legal obligation to report the information. So does Kaufman, Malchman, Kirby & Squire, LLP, the investors' legal representative. It wants anyone who bought EFI common stock after April 10,1997, to join the suit.

Do these investors stand a chance of recouping their losses? This year, about 85 percent of such cases will be settled out of court. In October, Sensormatic Electronics Corp. settled out of court for $53 million. In February 1997, IDB Communications Corp. settled out of court for $75 million. In 1995, Storage Technology Corp. settled out of court for $55 million. All three were accused of misleading investors.

So the bottom line is that it can pay to lose money in the stock market, but only if you have top-notch legal advice and a company with its hands caught in the cookie jar.

Back to Electronics for Imaging Inc., the San Mateo, Calif.-based developer of workstations for major copying machine and printing vendors. On Dec. 15, it was hit with a class-action suit on behalf of more than a dozen shareholders by New York-based Kaufman, Malchman, Kirby & Squire.

The complaint alleges that EFI executives knowingly withheld potentially disastrous news from shareholders during the period between April 10 and Dec. 11. In this period, EFI's stock rose from $36 per share to a peak of $56.60. But when it reported horrendous quarterly earnings on Dec. 12, the stock plummeted $23.38 per share, or 62 percent, to $15.63.

The suit claims company officials must have known the deteriorating economic climate in Asia would hammer earnings in the fourth quarter since the bulk of its customers are Asian OEMs. During the period in question, EFI executives sold 200,000 shares of stock near the peak price of $56.60 per share.

After the fourth-quarter earnings were announced, most analysts were just as shocked as individual shareholders.

"The magnitude of the earnings and revenue shortfall, judging from what they're saying, really caught me off guard," said Mary Beth Poggi, an analyst at Unterberg Harris. "I think (the) stock price drop is a major overreaction because this market is still growing rapidly and Electronics for Imaging is still the market leader."

In 1997, the Securities and Exchange Commission conducted a record 300 inside-trading investigations. Hardly a week goes by without a class-action suit filed against a publicly traded technology company, usually seeking millions in damages for disillusioned investors who watched their portfolios dwindle as a software or chip-making company's stock price collapsed.

Just last week Oracle Corp. and Cabletron Systems Inc. were hit with class-action suits alleging that company executives withheld negative information in order to artificially inflate their respective companies' stock price. Coincidentally, both companies reported disappointing quarterly earnings results, resulting in a massive sell-offs of their stocks.

While most investors realize technology stocks are inherently risky, securities fraud attorneys insist these companies should do more to prevent shareholders from unexpected disaster. Moreover, they should be held accountable for their actions even if they are too little or too late.

"The problem is technology companies are forced to serve two masters," said Jim Newman, publisher of the Securities Class Action Alert newsletter. "They have to improve the bottom line to keep their jobs but they also have an obligation to disclose negative information. And then there's the selfish aspect because 99 percent of these executives also hold a considerable amount of stock in their company."

There are clear-cut examples of technology companies doctoring their books or hyping nonexistent products, better known as vaporware, to create demand for the stock. These practices include stuffing a sales channel with inventory in the last few weeks of a quarter to boost revenue totals, knowing that most of the products will be returned and, therefore, hurt earnings in subsequent quarters. Sometimes, companies report sales made on a contingency basis with a customer. If the sale pans out, everything is above board. If it doesn't, well, the numbers are adjusted down the road.

Perhaps the best-known case of vaporware came when Storage Technology Corp. settled out of court for $55 million in November 1995 after it allegedly misled investors. Company officials claimed a new storage system that would revolutionize the storage and retrieval industry would be available within three months. Subsequent investigations found that only 50 percent of the code was ever written.

But in the meantime, the stock price reacts to the earnings figures supplied at the end of each quarter. Analysts base their recommendations on this information and pass along instructions to their brokers. The brokers, in turn, push the stock to investors. When the truth is unearthed, the stock price falls and investors buying stock on these recommendations take a beating.

"There has to be accountability," Newman said. "I believe these companies make a conscious, financial decision to mislead investors. The bottom line is always money."

Tomorrow: A text-book example of a class-action suit.