InfoSpace insider largesse sparks lawsuit

When
InfoSpace tapped its bulging treasury to send shareholders a
half-billion dollars in special dividends in 2007 and 2008, did the
Bellevue company's executives and board members arrange an improper $49
million gift for themselves? That's the allegation in a recent lawsuit
in Sunday Buzz.

By Rami Grunbaum

Deputy business editor, and Seattle Times Business staff

When
InfoSpace tapped its bulging treasury to send shareholders a
half-billion dollars in special dividends in 2007 and 2008, did the
Bellevue company's executives and board members arrange an improper $49
million gift for themselves?

That's the allegation in a recent lawsuit that claims "the board
devised a sweetheart deal" to benefit from the return of money to
shareholders.

The dispute, like so many things at technology companies, revolves around stock options.

InfoSpace's option holders — chiefly board Chairman and Chief
Executive James Voelker and other insiders — were awarded special
"compensation" payments parallel to the $15.30-per-share in dividends
that went to stockholders. And the option holders got something
shareholders didn't: millions in cash to offset the taxes on their
windfall.

The lawsuit, filed last month in federal court in Seattle, demands
that the insiders repay the money to the Internet search company. The
suit against InfoSpace's directors and officers argues that instead of
paying out tens of millions of dollars, the board should have used the
"fair and time-honored way" and simply adjusted the price of
outstanding options, as Microsoft did when issuing its massive $30
billion one-time dividend.

At the time, InfoSpace said its approach was "appropriate." The
company this past week said that it's still reviewing the suit and
couldn't comment, adding that "our CEO, executives and board members
are absolutely committed to acting in the best interests of our
shareholders."

InfoSpace, of course, is no stranger to controversy. Its brash
founder, Naveen Jain, boasted his dot-com creation would be bigger than
Microsoft; at the height of the Internet bubble, it was worth $33
billion. When the party was over, after acquiring several online
businesses with its inflated stock, InfoSpace spiraled earthward.

Jain was removed in 2002, and years later he and other insiders paid
the company $90 million to settle suits claiming they unjustly enriched
themselves at shareholder expense. That money joined a cash hoard that
grew, with the sale of some business units, to more than $500 million.

InfoSpace's new board, led by Voelker, in 2007 was arm-twisted by a
big shareholder into distributing much of that stash to the
stockholders. But the side deal, in which company insiders holding
millions of unexercised InfoSpace options got a piece of the pie, was
branded by one software-industry pundit "the great shareholder robbery
of 2007."

When $15.30 in dividends is paid out, the company's share price will
drop by a similar amount. Shareholders come out even because they got
the dividend. But the value of a stock option is going to drop.

At Microsoft, option holders were told that "to ensure you are not
negatively impacted" by the huge dividend, the number and exercise
price of outstanding options would be adjusted. Microsoft sought
shareholder approval for that change before making its dividend payout.

Charles Schwab likewise adjusted its stock options when distributing
to shareholders a $1.2 billion special dividend in August 2007.

InfoSpace, however, created a "compensation program" in which the
option holders got cash for the drop in the value of their options:
$21.6 million to Voelker and $10.1 million to other executives and
directors, according to the suit. Another $17.7 million was spent on
"gross-up payments" to cover their taxes on the option money.

The insiders could have converted their options into stock, either
by paying the exercise price or in a cashless transaction that reduced
the number of remaining options. Had they gotten in on the big dividend
that way, the suit contends, "the InfoSpace treasury would have
received more than $100 million in cash or equivalent value."

Instead money flowed the other way, from the company treasury to the
insiders — cash equal to 25 percent of the company's post-dividend
current assets, the suit claims.

If the generous payments were intended to retain the company's top management, they didn't accomplish that.

For instance, after receiving $1,794,153 in options "compensation"
and $978,348 in gross-up money on top of other salary and benefits,
chief financial officer Allen Hsieh left on Dec. 31. So did executive
Vice President Brian McManus, who also reaped millions on the
unexercised options; two other top exec left even earlier.

And Voelker is stepping down as CEO and president this year, though he'll stay chairman.

Hedge-fund manager Bill Burnham of Menlo Park-based Inductive
Capital, who early last year dubbed the move a "shareholder robbery" in
a long analysis on his technology-finance blog, still energetically
denounces the transaction as "pretty much indefensible."

He gives the board credit for getting good prices for the online-directory business and mobile-services businesses it sold

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