In the spring of 1998, Deborah Traficante led a Cisco Systems Inc. team that sold $16 million worth of networking gear to a small Internet-service provider called MegsINet Inc. She also helped arrange for Cisco's financing arm to lend money to the start-up to pay for the purchase.
She earned a lot more than the standard commission. That July, closely held MegsINet arranged for the Cisco vice president to buy 85,714 of its shares for 56 cents each. Ten months later, MegsINet was taken over by another company for cash and stock, earning Ms. Traficante a paper profit of at least $200,000.
A conflict of interest? It wasn't at Cisco, where senior executives frequently invest in or accept stock options from customers, suppliers and partners.
At an airline, insurer or other Old Economy business, investment by an employee in a customer or supplier might trigger loud alarms, since it could give the employee an incentive to favor that company. But such relationships are common among high-tech businesses, including Cisco, the San Jose, Calif., maker of Internet switching equipment widely regarded as an archetype of Silicon Valley success.
Andreas Bechtolsheim, a Cisco vice president, holds stakes in at least seven Cisco suppliers or partners. Cisco's No. 2 official, Executive Vice President Gary Daichendt, was an early investor in Convergent Communications Inc., which is now a big Cisco customer and client of Cisco's finance arm. At least 11 other Cisco executives have invested in or received stock options from companies that do business with Cisco, on terms unavailable to most investors.
Ms. Traficante has been especially active. Last year, she was favored with an allocation of "friends and family" shares in the initial public offerings of three Cisco customers: Rhythms NetConnections Inc., Covad Communications Group Inc. and USinternetworking Inc. Such shares aren't available to most investors.
Cisco says all of these investments were proper because the executives disclosed them to the company and disqualified themselves from decisions involving companies in which they invested. "We absolutely feel that it's OK for people to invest . . . as long as it doesn't create a conflict to their duties at Cisco," a company spokesman says.
But some cracks are opening, following embarrassing revelations about certain employee dealings, including one involving two former members of Ms. Traficante's sales team. The two received $5 million in improper commissions from a Cisco customer, according to allegations in a civil suit in federal court in San Jose. The Federal Bureau of Investigation is investigating the deal. The former Cisco salesmen, Kevin Bennett and Vincent Rotondo, deny wrongdoing and say they were following the example of their boss at the time, Ms. Traficante.
Another Cisco salesman complained to management last year about the propriety of some investments, including Ms. Traficante's. Cisco dismissed his complaint -- after an investigation overseen by someone who reported to Ms. Traficante -- and later fired the salesman. Now he is suing Ms. Traficante and three others at Cisco, claiming they cost him his job. Cisco says he was fired for reasons unrelated to his complaint.
The company also says that Messrs. Bennett and Rotondo in no way represent the norm at Cisco. It says it has "zero tolerance" for unethical actions and thoroughly investigates allegations of a conflict of interest, which its policy defines as "any activity that is inconsistent with or opposed to Cisco's interests, or gives the appearance of impropriety."
Still, Cisco has recently changed its conflict-of-interest policy. Among other things, the company has begun requiring written approvals before employees can invest in customers or accept friends-and-family shares from companies with which Cisco does business. Under the revised policy, Ms. Traficante's investment in MegsINet probably wouldn't be approved, Cisco officials say. Cisco officials say they were revising the conflict-of-interest policy anyway, but acknowledge that some of the changes were prompted by the Bennett-Rotondo case.
What Cisco does about employee investments matters, because the corporation -- the world's second-most-valuable after General Electric -- is widely admired, and its business practices widely copied. In fact, Cisco's views on conflicts of interest are similar to those of many others in the booming high-tech industry, where officials of suppliers, customers and even competitors often serve on each other's boards and invest in each other's companies. Start-ups create "advisory boards" stocked with executives from larger companies with whom they hope to do business, and favor those executives with stock options. Customers lobby for friends-and-family shares when their suppliers go public.
To many, the symbiotic links forged by these relationships play a role in Silicon Valley's success. When information flows relatively freely between suppliers and customers, it can help both to compete efficiently. Qwest Communications International Inc., for instance, says it encourages its executives to serve on suppliers' boards in the hope of influencing the design of telecom equipment. To protect itself, it doesn't let them single-handedly make a purchasing decision involving a company they've invested in.
Aside from the case the FBI is looking at, the investments by Cisco employees don't appear to raise legal issues. But in the eyes of some ethics experts, as well as many companies in the old, "unwired" economy, these kinds of investments raise strong conflict-of-interest concerns. "Any time that someone is potentially on both sides of a transaction, it's a problem," says Charles Elson, director of the corporate governance center at the University of Delaware. "You can argue that it's a fair transaction, but there's always going to be suspicion."
An executive invested in a supplier has incentive to favor that supplier over others in making purchasing decisions. An executive with a potentially valuable stake in a customer could help that customer with higher prices or better service. Cisco says it guards against such conflicts by barring employees who hold stakes in companies from making such decisions about them.
But start-ups can gain other, less-direct benefits by offering stakes to executives at industry leaders like Cisco. Having a Cisco executive as an investor or a board member confers invaluable credibility on a young company, opening doors to other investors, potential customers and other Cisco executives in position to help the start-up.
Cisco has investments in or other links to dozens of small technology companies, in what Chief Executive John Chambers calls its "ecosystem." Tensilica Inc. is part of it. Cisco buys Tensilica's designs for specialized chips and holds a stake in the closely held Santa Clara, Calif., firm.
Cisco's Mr. Bechtolsheim attended graduate school with Tensilica's chief executive, Chris Rowen, and was an early investor in Tensilica. He showed Tensilica's designs to other Cisco engineers, who then chose them for a Cisco product Mr. Bechtolsheim was helping to design, according to Mr. Rowen. A Cisco engineering director who works for Mr. Bechtolsheim sits on Tensilica's technical advisory board and has received what Mr. Rowen calls a "token" number of Tensilica stock options.
Most old-line companies don't do business this way. United Technologies Corp. and Prudential Insurance Co. of America, for instance, say they don't let employees receive stock options from or invest in customers, suppliers or other business partners. And some established Silicon Valley companies have tough rules, too. Hewlett-Packard Co. bars employees and their families from holding financial interests in any supplier, customer, reseller or competitor, says a spokeswoman, because "it might cause the appearance, if not the actuality, of divided loyalty." Intel Corp. doesn't let senior managers invest in companies that conceivably could sell to Intel. Motorola Inc. has similar rules.
But pressure to relax them is building. Jack Bradshaw, Motorola's ethics and compliance officer, fields a growing number of inquiries from employees offered IPO shares or board seats that come with stock options. He has rejected all where he saw the slightest potential for conflict, he says, but adds that some executives "are urging us to rethink" the policy: "They're aware these opportunities exist . . . [and] are saying maybe we ought to let people take the compensation."
John Boatright, head of an academic group called the Society for Business Ethics, says New Economy companies may need to give employees more investing leeway because of competition for talent. The investments might be viewed "as a kind of disguised compensation which ultimately is in the best interest of shareholders," he says.
Cisco executives are in heavy demand for director and advisory-board seats, and some also are active investors. Among them is Mr. Bechtolsheim, a co-founder of Sun Microsystems Inc. who joined Cisco after its 1996 acquisition of his later start-up, Granite Systems Inc. Mr. Bechtolsheim oversees development of switches for corporate networks. He has invested in new companies that make chips, chip-design software and related technologies, companies that sometimes wind up selling to Cisco.
An example is AANetcom Inc., which makes chips for high-speed switches and routers such as Cisco's. AANetcom founder Kal Shastri sought out Mr. Bechtolsheim for advice before incorporating the company in 1997. Mr. Bechtolsheim introduced him to Cisco's investment managers, who provided AANetcom's entire first round of funding with an equity investment in September 1997.
A year later, Cisco upped its investment. Mr. Bechtolsheim also invested personally, Mr. Shastri says. Meanwhile, Cisco's investment managers opened doors for AANetcom to Cisco design engineers, who eventually included AANetcom chips in several Cisco products. Mr. Shastri calls Mr. Bechtolsheim his "angel at Cisco" but says he never asked him for help in selling to Cisco, and Mr. Bechtolsheim never offered any. "Andy would not get involved in those things," Mr. Shastri says.
When Canadian chip maker PMC-Sierra Inc. acquired AANetcom for $600 million this year, Cisco and Mr. Bechtolsheim reaped windfalls. Cisco's roughly $2 million investment grew to $95 million. Mr. Bechtolsheim now owns almost 214,000 shares of PMC-Sierra, worth $45 million. Cisco accounted for more than 10% of PMC's revenue last year, according to filings with the Securities and Exchange Commission.
Mr. Bechtolsheim -- who Cisco says declines to be interviewed -- also is an investor in Mirapoint Inc., a closely held Sunnyvale, Calif., firm that makes computers for processing e-mail. Mirapoint Chief Executive Satish Ramachandran, who knew Mr. Bechtolsheim from Sun, recruited him as an investor shortly after launching Mirapoint in 1997. Charles Giancarlo, a Cisco senior vice president overseeing sales to small and medium-size businesses, also decided that year to become a Mirapoint investor and director.
Cisco began buying Mirapoint's servers in January 1999. Seven months later, Cisco chose Mirapoint to deliver e-mail to its 10,000-plus engineers. Mr. Ramachandran says he contacted Cisco on his own and didn't tell Mr. Bechtolsheim or Mr. Giancarlo until the sale was complete. "None of those folks even had a clue," he says.
Mr. Giancarlo says he invested in Mirapoint only after Cisco had declined to, and partly because e-mail seemed far from Cisco's business. "It seemed like something I could invest in in high-tech that would not be a conflict," he says, adding that he doesn't talk to the CEO of Mirapoint about its business with Cisco.
Mr. Bechtolsheim has invested in at least four other companies that do business with Cisco. One is Brocade Communications Systems Inc. in San Jose, whose equipment connects machines that store computer data. At the time of Brocade's IPO last year, Mr. Bechtolsheim owned a split-adjusted 4.67 million shares of Brocade stock, most of which he got for a split-adjusted 75 cents a share.
In June, Cisco and Brocade did a technology-development deal that sent Brocade's stock up more than $11 in one day. If Mr. Bechtolsheim still held all his shares, he made $50 million on paper that day. Through a Cisco spokesman, Mr. Bechtolsheim declines to say how many Brocade shares he now owns.
Cisco and Brocade say Mr. Bechtolsheim didn't work on the technology-development deal. But he remains active in storage-networking technology and has represented Cisco on storage-networking issues before industry groups. He was one of a group of individuals who invested $6 million in August 1998 to create SAN Valley Systems Inc., a Campbell, Calif., firm that makes gear complementary to Brocade's.
Mr. Bechtolsheim also became a SAN Valley director and introduced the company to other Cisco executives, says Sandy Helton, SAN Valley's CEO. Cisco itself invested in SAN Valley in July and is jointly developing products with the start-up. People familiar with the matter say Cisco recently considered taking over SAN Valley, but ultimately acquired a SAN Valley competitor.
Mr. Helton says he is glad to have Mr. Bechtolsheim on his board but figures he brings divided loyalties. "Andy owns more Cisco stock than he owns SAN Valley stock. He's going to do what's in his own best interests," Mr. Helton says.
Meanwhile, Cisco's chief information officer, Peter Solvik, owns equity in two closely held firms, Asera Inc. and Agillion Inc., that help companies streamline operations using the Internet. Cisco also has invested in them, and both list Cisco as a "partner." Mr. Solvik also serves on the advisory boards of, and has received stock options from, two other Cisco partners.
Asera founder Vinod Khosla, a partner at venture-capital firm Kleiner Perkins Caufield & Byers, recruited Mr. Solvik for Asera's board in mid-1998. A year later, Cisco made the first of two investments in Asera, which now total $9 million. Now the two companies promote each other's products. Asera CEO Warren Weiss says he negotiated that deal with executives in a Cisco unit that reports to Mr. Solvik, but Mr. Solvik himself wasn't involved in the talks. Cisco says Mr. Solvik declines to be interviewed.
Mr. Daichendt, Cisco's executive vice president, invested $310,000 in Convergent Communications beginning in the fall of 1996, at the suggestion of a stockbroker friend who was raising money for the then-closely-held telecom-service provider. About a year later, Mr. Daichendt says, he urged Convergent officials to buy Cisco equipment. He hosted a briefing for Convergent at Cisco headquarters but left early after saying he couldn't participate in contract negotiations or price discussions.
By April 1999, Convergent had agreed to buy $100 million in Cisco gear, and Cisco had agreed to provide as much as $103.5 million in financing. Cisco also holds warrants to buy Convergent stock. Mr. Daichendt's stake is now worth $409,000.
Since the initial 1997 meeting, Mr. Daichendt says, he has had no involvement in Cisco's dealings with Convergent. He says he doesn't think his investment poses a conflict because it was "nothing more than what I would do on the stock market." Yet he turned down an invitation to join Convergent's board, which he says he would "perceive . . . as a conflict."
As Cisco's executive vice president, he says, he tries to hold himself to a higher conflict-of-interest standard. But "I'm not going to make a judgment call on what other people do."
Carlos Dominguez, a Cisco sales vice president, invested $50,000 early last year in network-consulting firm Greenwich Technology Partners Inc. He has been "very helpful in pointing us to the right people inside Cisco," says Greenwich CEO Joseph Beninati, and serves as a reference when Greenwich competes for clients that may not have heard of the firm. "It's nice to have a senior person at Cisco" to vouch for Greenwich, he says.
Mr. Dominguez says he served as a Greenwich reference only once, for a customer Cisco was trying to win from a competitor. He says he hasn't offered any business advice to Mr. Beninati since joining the board of Thrupoint Inc., a rival consulting firm in which Cisco owns a 14.5% stake, in May 1999. Greenwich recently filed to go public.
Even Cisco's old conflicts policy says employees shouldn't recommend to Cisco customers that they use vendors in which the employee holds a stake. A Cisco spokesman says Mr. Dominguez didn't violate the policy because he disclosed his Greenwich investment both to a Cisco lawyer and to the potential customer.
Cisco says the investments by its executives are all acceptable because they were disclosed and the executives didn't make decisions involving the companies in which they invested. In particular, it says Ms. Traficante did nothing improper by accepting the offer to buy thousands of low-priced shares in a customer.
But the problems in her sales division show what can go wrong. She headed the company's Network Service Provider sales group from 1995 until last April, and was valued for the group's success in selling equipment to Internet-service providers and start-up phone companies.
MegsINet, in Chicago, hoped to break into the local phone business when it agreed in the spring of 1998 to buy $16 million of Cisco gear from her group. Working with MegsINet CEO Michael Henry, Ms. Traficante helped arrange for Cisco's financing arm to lend MegsINet $20 million to cover the purchase and for working capital, according to SEC filings and Cisco officials.
In July 1998, MegsINet arranged for Ms. Traficante and five members of her sales team to buy 425,714 of its shares for 56 cents each. Shortly thereafter, MegsINet was selling shares to other investors for $1.50.
Around the same time, Ms. Traficante was lobbying Cisco's financing arm to extend added credit to MegsINet so it could buy still more Cisco gear. In a July 31, 1998, e-mail to officials at Cisco Systems Capital Corp., Ms. Traficante said she didn't want to "lose" MegsINet to a rival and urged the financing unit to take a "proactive versus reactive approach" to financing start-up phone companies. As it turned out, Ms. Traficante didn't get this sale.
Cisco officials say Ms. Traficante's lobbying of the finance arm was appropriate because Cisco salespeople are supposed to go to bat for customers that need financing. Her investment was proper under conflict-of-interest rules at the time, the officials say, because she disclosed it to senior executives and didn't determine the price of equipment or make the decision to extend financing.
Gerald Feffer, her attorney, says Ms. Traficante did nothing wrong and wasn't out to make a windfall on MegsINet and the other IPO deals. He says she hasn't sold any of the shares she got in these IPOs. "She did not buy them to speculate," he says, adding that "this woman has made a fortune" on Cisco stock and commissions.
In February 1999, MegsINet announced it would be acquired by CoreComm Ltd., a New York telecom company, in a stock-and-cash deal, which was worth roughly $5.87 a share when it closed, or 10 times what the Cisco people paid for their shares. (There were restrictions on when they could sell the stock.)
At that time, a Cisco salesman named Howard Kamerer was trying to sell equipment to MegsINet on his own. But people who worked with Ms. Traficante were urging him not to close the sale, saying MegsINet's deal with CoreComm prohibited such purchases. Then he found out some of his colleagues owned MegsINet stock. He suspected that they feared a sizeable MegsINet order at this key juncture could spoil the CoreComm takeover and deprive them of a windfall.
Mr. Kamerer never completed his sale, and CoreComm went ahead with its MegsINet acquisition. Ms. Traficante and five of her colleagues reaped paper profits totaling more than $2 million.
By then, Mr. Kamerer was complaining to his boss and other Cisco executives that his colleagues' investments in MegsINet violated Cisco's conflict-of-interest policy. It barred employees from receiving "payments of any sort" from customers or "favored personal treatment" from either suppliers or customers. A Cisco spokesman now says the old policy was "ambiguous" about whether it barred salespeople such as Ms. Traficante from investing in closely held customers or buying friends-and-family stock at an IPO.
Cisco executives have said repeatedly over the past year that the company doesn't let employees accept offers from Cisco business partners to buy friends-and-family shares. In an interview last year, Michelangelo Volpi, senior vice president and chief strategy officer, likened such a practice to bribery. Now a Cisco spokesman says Mr. Volpi was talking about rules that applied solely to his department, which handles Cisco's acquisitions and investments.
Cisco assigned the investigation of Mr. Kamerer's complaints to Roy Gross, a Cisco human-resources official. Soon after he started his inquiry, Mr. Gross began working for Ms. Traficante. His new position wasn't immediately announced within Cisco, as is customary. Mr. Gross says there was no conflict of interest because he had already received the new assignment in Ms. Traficante's group and she was only a small part of Mr. Kamerer's complaint.
A Cisco spokesman also says there was no conflict. Ms. Traficante initially wasn't named when Mr. Kamerer complained to the company, the spokesman says, and when the complaint came to involve her, Mr. Gross was allowed to continue because he already knew the issues. In any case, an outside lawyer did most of the actual investigating, Cisco says. Mr. Kamerer insists he objected to Ms. Traficante's role from the outset.
Mr. Gross found "no merit" in Mr. Kamerer's objections. He sent Mr. Kamerer a two-page letter addressing some of his allegations -- and accusing the salesman himself of improper behavior toward colleagues and MegsINet. In November, Cisco fired Mr. Kamerer for insubordination.
In an interview, Mr. Kamerer says that Cisco managers "had the opportunity to do the right thing and proactively made the decision to deny and cover up what was going on."
He sued Mr. Gross, Ms. Traficante and two other Cisco people in July, alleging intentional interference with employment. The damage suit in Cook County, Ill., circuit court asserts that in Ms. Traficante's sales group, "the lure of huge short-term capital gains has created a gold-rush mentality of greed, strong-arm tactics, covert dealings, under-handedness" and potential violations of securities laws. Cisco, which isn't a defendant, says that isn't the case.
Cisco says Ms. Traficante has since been reassigned. It won't say to what. She continues to represent Cisco on the advisory board of Thrupoint and make public appearances for Cisco.
But the controversy surrounding her sales group didn't stop. In April of this year, Cisco filed suit in federal court in San Jose seeking repayment of money its financing arm lent to Worldwide Web Systems Inc., a Miami software firm, and American MetroComm Inc., a New Orleans company run by the same Mr. Henry who ran MegsINet.
Cisco alleges that two members of Ms. Traficante's sales group -- Messrs. Bennett and Rotondo -- set up separate companies that each received a 20% stake in Worldwide. Mr. Bennett had worked on the earlier MegsINet sale, and his wife had gotten 300,000 MegsINet shares at the same 56-cent price Ms. Traficante paid. Then Messrs. Bennett and Mr. Rotondo sold $50 million of Cisco equipment to Worldwide and American MetroComm. The two also helped arrange for Cisco's financing arm to extend the buyers more than $50 million in credit.
Each time the companies drew on the credit, Cisco alleges, Worldwide made payments to firms associated with the two men, payments that eventually amounted to $5 million. Worldwide sued Messrs. Bennett and Rotondo last December alleging extortion. In the suit in federal court in Miami, Worldwide alleges that the men threatened to disrupt Worldwide's relationship with Cisco, and that later, when the payments stopped, they threatened violence.
Through their lawyers, the two men deny any wrongdoing and say their superiors at Cisco, including Ms. Traficante, encouraged them to invest in customers. Mr. Bennett resigned from Cisco the month the suit was filed, and Mr. Rotondo was fired. Ms. Traficante's attorney says she knew nothing about the Worldwide investment.
Cisco followed four months later with its suit against Worldwide and arbitration claims against Messrs. Bennett and Rotondo. Worldwide is now operating under Chapter 11 of the Bankruptcy Code.
Cisco officials say it's wrong to link the investments of any Cisco executives to those of Messrs. Bennett and Rotondo. "You've got to make a distinction between a legal, ethical action, fully disclosed, and an unethical action," the company spokesman says.
Cisco revised its conflict-of-interest policy in March. The policy still allows employees to invest in companies that do business with Cisco and to serve on their advisory boards or boards of directors. But it adds a proviso. It now says employees "may not invest in companies that are Cisco customers, partners or suppliers with whom the employee acts for Cisco without disclosure to and written permission from the Cisco vice president for their organization."
More specific than the old rule, this adds the reference to "customers" and the requirement for written permission from a vice president. Regarding start-ups, Cisco also added language barring employees from accepting offers to buy friends-and-family IPO shares in "a company where the Cisco employee is now or is likely to become involved in the evaluation, recommendation, negotiation or approval of current or prospective business with that company." The spokesman says Cisco will continue to review and update the policy "to make sure employees have a clear understanding."
---
Playing the Field
Executives of Cisco Systems Inc. frequently take stakes in Cisco
business partners through private investments, or through stock
options granted to board and advisory- board members. Here are some
examples:
Tie To Company Its Tie
Target Co. To Cisco
Gary Daichendt (Exec. VP)
Investor Convergent Comm. Customer/finance
client
Peter Solvik (Sen. VP, CIO)
Investor/adv. Agillion Partner*
bd. member
Advisory Akamai Tech. Tech development*
board member
Investor/board Asera Strategic partner*
member
Advisory board Oblix Partner*
member
Andreas Bechtolsheim (VP)
Investor AANetcom/PMC-Sierra Supplier
Investor Brocade Comm. Development
partnership
Investor/board Magma Design Auto. Supplier*
member
Investor Mirapoint Supplier
Investor/board SAN Valley Sys. Product development*
member
Investor Synplicity Supplier
Investor Tensilica Supplier
Deborah Traficante (VP)
Investor MegsINet Customer/finance
client
Investor USinternetworking Customer/finance
client
Investor Rhythms NetConn. Customer/finance
client
Investor Covad Comm. Customer
Carlos Dominguez (VP)
Investor Greenwich Tech. Consulting partner
Partners
Kevin Bennett (salesman)
Investor MegsINet Customer/finance
client
*Cisco holds a stake
Sources: Company reports, Securities and Exchange Commission filings,
WSJ research