The system: Searching for solutions

For years, customers and investors have turned to the courts in an effort

Oracle 9i's benefits over IBM Larry Ellison, CEO, Oracle

The most common types of legal action are breach-of-contract lawsuits, aimed at software manufacturers that promised more than they delivered, and shareholder suits leveled at companies accused of misleading investors about their revenues. But such cases are lengthy and expensive procedures that can forever poison a relationship with a powerful manufacturer.

"The industry is famous for putting out software that is of questionable quality," Forrester analyst Laurie Orlov said, citing previous bug-infested versions of Microsoft's Windows operating systems as one example. "But the software industry seems immune to quality-related lawsuits."

Many believe that the only true hope at changing the system is a complete overhaul of the way software companies do business, starting with the bottom line. Critics say that disingenuous sales pitches and expensive services are just symptoms of a much larger issue: the way investors assess the strength of these companies.

The primary engine driving Silicon Valley's sales juggernaut is on the opposite side of the country, in Manhattan, where financial analysts hold companies accountable for every dollar in revenues and earnings, projected or real. And if either number is missed, the result can devastate a company's stock price and send a chill throughout the rest of the markets.

Even meeting estimates isn't always enough to sate the relentless demands of Wall Street. Instead, growth is the magic word that inspires confidence among investors, however fleetingly--and in an increasingly saturated corporate software market such as databases, that means expanding into new businesses like customer-relationship management software.

Creative accounting
This has led to some "creative accounting" by companies seeking to portray their businesses in the best possible light to investors, especially where growth is concerned. Although shuffling numbers among various reporting categories is not necessarily illegal, accounting irregularities can sometimes lead to investigations by the U.S. Securities and Exchange Commission. In recent months, for example:

• The SEC opened a formal investigation into the accounting practices of Lucent Technologies in February after the telecommunications equipment maker announced it would revise its fourth-quarter revenue figures. Part of the case involves a senior sales executive who gave unauthorized discounts to a customer.

• The SEC began investigating Critical Path that same month after the e-mail software company said it would revise its fourth-quarter results. Like the Lucent case, part of the Critical Path inquiry focuses on possible sales misstatements. The company's stock price, which had hit a 52-week high of nearly $80, now hovers around the $1 mark.

• Legato Systems said last August that SEC regulators would investigate its 1999 financial restatement. The restatement stemmed from Legato's sales team offering unauthorized payment terms to distributors that purchased and resold its data storage software.

Oracle's business practices put it at odds with authorities in 1993, when the SEC filed a high-profile lawsuit accusing the company of double-billing and charging customers for work that was never performed. Without admitting guilt, Oracle agreed to pay a $100,000 fine.

The growth factor is what drives a company to go the extra mile, from its sales practices to accounting procedures.

Typically, companies and investors are drawn to businesses deemed to have high growth potential. For instance,

"CRM is considered one of the highest-growth categories and has been for several years in the software market," said Jim Pickrel, an analyst with J.P. Morgan H&Q. "Oracle has tried to convince Wall Street it's a player in CRM, so its overall growth rates look better."

This type of strategy, however, depends on the eventual success of the product itself.

Slapped with lawsuits
Oracle has been hit with a number of shareholder lawsuits since the start of the year, prompted by allegations that the company maintained a strong financial outlook when it knew its prospects were questionable. Oracle's problems with CRM were cited specifically as a factor in dragging down the company's stock price.

In March, law firm Milberg, Weiss, Bershad, Hynes & Lerach filed a class-action lawsuit in U.S. District Court alleging that Oracle assured investors that its new 11i package required no programming systems integration to get the software to work and that the company had saved $1 billion when it used its own CRM software.

The lawsuit charges that Ellison knew the 11i package was "fraught with massive technical problems, including giant gaps in its CRM modules." The lawsuit also alleges that Oracle's $1 billion in savings resulted from cutting more than 2,000 positions, rather than from using the software. The suit centers on Ellison's sale of nearly $900 million in stock in the two months before Oracle announced its quarterly warning.

The courts have consolidated 19 class-action lawsuits, according to Milberg Weiss, and a joint complaint is expected to be filed by early August. Milberg Weiss, which specializes in such shareholder suits and has taken action against many other Silicon Valley companies, will act as lead law firm in the consolidated complaint.

Attorneys representing Oracle did not return calls seeking comment on this case and others.

Even if their practices do not violate any laws, companies routinely walk a fine ethical line in the obsessively competitive corporate software environment, according to ethics professors.

"Generally, the higher the level of competition in an industry, the more incentives salespeople have to cut corners on their ethics, such as telling customers a product will be available earlier than they know it will be, or touting certain qualities they know it may not have," said Manuel Velasquez, executive director of the Markkula Center for Applied Ethics at Santa Clara University. "This is a regular strategy used to ward off competitors. That is why the word vaporware was coined."

That description has been applied to Oracle's marketing practices as well, most recently involving its customer-relationship management software.

Money for vaporware
"When CRM came out, one customer bought a site license, or 'pool of funds' license. They could either use the money to get CRM or database software--however they wanted to slice it up. Oracle announced they had made this major CRM sale, but in the end the customer ended up using it all for database," former Oracle executive Craig Ramsey said. "CRM was absolute vaporware."

The company used this "pool of funds" license in its contract with PurchasePro last year, according to another former Oracle salesman. The condition allowed Oracle to count revenue from the contract even if some of the software could not be delivered or didn't work, as PurchasePro had complained, the source added.

Other former Oracle executives and analysts say such practices are common in the corporate software industry. Pickrel noted that the SEC requires accuracy in the total revenue amount and does not seek a line-by-line breakdown of product, service or geographical sales figures.

As part of their sales packages, some corporate software companies have been known to give away products for free but count them as purchases on the books. The accounting lists other products in the contract with discounted prices, so the bottom-line cost to the customer remains the same. Sources say this practice allows companies to show artificial revenue growth in a product that customers never agreed to pay for.

In another tactic, a software company and a customer agree to buy equal amounts of products from each other. The de facto trades are then counted as sales that contribute to revenue growth tallies for both companies.

"Whether I'm an analyst or a shareholder, I want to know that the business I'm involved in has a future or not. So just knowing the total revenue figure is not good enough," said Fred Isquith, an attorney with Wolf, Halbenstein, Adler, Freeman & Herz in New York. "The problem is there are some honest people, and then there are some less-than-honest people who want to make the company appear more profitable than it is."

Solution in sight?
SEC spokesman John Heine said no specific regulations govern the content of company statements such as press releases but cautioned that broad anti-fraud regulations can be applied if companies go too far. Still, that has proven easier said than done in many cases.

"The solution to this is stronger enforcement of securities laws. That's where the problem has been," Isquith said. "The SEC rules are fairly straightforward, so if accountants aren't abiding by them, tightening them up won't help. Accountants should be held responsible, and the courts need to have greater understanding of how these financial statements are produced."

Beyond accounting, however, others are skeptical about the government regulators' ability to fundamentally change industry practices, saying that dubious product promises, vague service estimates and other corner-cutting measures are a natural part of doing business in this cutthroat environment.

"I don't see how you can do a workable law on vaporware. A company can always claim they thought the software would have those qualities," Velasquez said. "Customers will just have to rely on their memories of how they were treated by these companies."

Joshua Greenbaum of Enterprise Applications Consulting agrees. "Everybody is very desperate to succeed in this market," he said. "The whole industry, to a certain extent, turns a slightly blind eye to these abuses."

Moreover, the same practice can be seen as ethically questionable by some and effectively competitive by others. Greenbaum and others say the best form of protection for customers is doing their homework and viewing every pitch with a skeptical eye. Former sales representatives say that even senior executives put too much faith in product demonstrations that promise the world.

They recommend that customers frequently ask if features presented during a demo are included in the boxed software or if they will need to be customized.

"It's important to say the imperative is always on the buyer to beware," Greenbaum said. "That was true thousands of years ago and is still true today."

News.com's Melanie Austria Farmer contributed to this report.
 

Former enterprise software sales representatives offer advice on steps to take when purchasing software.

• During the demo, frequently ask whether the features are part of the core software or would need to be customized.

• Always seek out demos from more than one supplier. Competition is good for keeping suppliers on their toes.

• Ask for references of customers who have installed the same application and have used it for the same purpose you are seeking. If the supplier doesn't have a list of companies that have successfully implemented the software, that's a red flag.

• After purchasing the software, companies need to realize they usually have to change their business processes--such as relearning a way to enter financial data for a particular type of software--to make it work.

• Beware running upgrade patches if you have customized the core software. Often the patch will break the old software and require a consultant to fix the problem.

Source: CNET research