Is SunnComm a sham or the next, big DRM success?
Original URL: http://www.theregister.co.uk/2004/09/27/sunncomm_death_or_glorry/
Is SunnComm a sham or the next, big DRM success?
From hell to hell and maybe heaven
By Ashlee Vance
Posted in Financial News, 27th September 2004 20:09 GMT
Feature You might expect one of the world's leading digital rights management (DRM) technology makers to have a rich history in either the computing or music fields or both. This is not the case for SunnComm International Inc. Instead, the firm's experience revolves around a troubled oil and gas business, an Elvis and Madonna impersonator operation and even a Christmas tree farm.
SunnComm rose to national prominence in the Fall of 2003 when a Princeton University graduate student managed to undermine the company's CD copy protection technology simply by holding down the Shift key on his computer when inserting an album. Countless news organizations, including this one, mocked SunnComm and music label BMG for distributing such thin CD protection, even though the average consumer would be unlikely to employ the Shift key block. The incident created a tight link between SunnComm and the word incompetence, prompting the company to issue legal threats against the Princeton student.
SunnComm's suggestion of a lawsuit garnered even more negative press, as researchers rushed to point out that the student had every right to examine the DRM technology as part of his computer science studies. This prompted SunnComm to pull back on the lawsuit threat and focus instead on doing business as usual and improving its technology.
A less publicized but more complex battle has been taking place between SunnComm and what seems to be a small group of disgruntled shareholders. These apparent SunnComm investors have filled Internet message boards with detailed information that basically claims the company is at worst a sham and at best a deceptive business. The postings describe a string of odd acquisitions, somewhat misleading financial press releases and dubious product announcements that should have the US SEC (Securities and Exchange Commission) kicking off an Enron-like crackdown, according to the SunnComm haters.
Picture of keyboard with missing shift keysAfter reading hundreds of pages of SEC filings and other SunnComm documents, we were quite shocked when an actual human answered the company's main number. The case made by the shareholders - one of whom has spent four weeks e-mailing us information about SunnComm - made it seem like a stuttering voicemail message would be all the company could afford in the way of a receptionist. Instead, a lass fielded our call with total competence, saying CEO Peter Jacobs was out of town but would return in a couple days.
After significant effort on our part, The Register eventually managed to secure Jacobs on the horn - about a week after the first call. The fact that he even took the call was impressive given our punishing treatment of the Shift key debacle.
"Everyone told me not to talk to you," Jacobs began. "They're afraid you'll do a real hatchet job."
This wasn't the most pleasant way to begin a grueling, accusatory interview, but Jacobs' unease made sense for the obvious reasons. He was well aware of the skewering SunnComm was taking on the investor message boards and beyond that knew that The Register tends to dismiss DRM technology as a type of pointless CD cancer that will stop people from enjoying the free exchange of culture they've come to expect.
With all this in mind, it seemed only natural that Jacobs would try to steer clear of any damaging issues and, like any good CEO, begin rattling off the merits of SunnComm's DRM software. The typical dance of probing journalist and dodging CEO would begin and then end in an hour with little progress made.
Almost disturbingly, Jacobs didn't dodge but immediately confessed to a long string of SunnComm cock-ups - many of which began before he took charge of the company.
"I came into the company like Harvey Keitel came into Pulp Fiction - to fix the deal," Jacobs said.
To be sure, this isn't clean up the two dead bodies in the car type of material, but it is the story of a company - stretched between Arizona and Nevada - with a twisted history. It's the story of a company searching for its identity in the most bizarre of places.
From faux Elvis to DRM in 80 days
SunnComm began life under a different name - Desert Winds Entertainment Corp. This company, headed up by Michael Paloma, provided Elvis and other impersonators for Las Vegas lounge acts and ended up running into serious trouble with the SEC in 1999. Government documents show that Desert Winds was charged with announcing a $25m deal with Warner Bros. when "no such contract existed." It's suspected that numerous insiders sold shares of Desert Winds when the stock rose based on the news of the Warner Bros. deal, and the SEC cracked down on Paloma and another Desert Winds associate Matthew Bardasian.
"Those were panicked moments," Jacobs said. "I was basically brought in to resurrect a company that was doing a poor amount of business and doing it poorly. I was asked by the stockholders to come in and make it better."
Jacobs took the helm of Desert Winds in March of 2000. Upon his arrival, Paloma agreed to step down, pay a $1m fine and never run a company again. He then left Desert Winds a couple of months later.
As CEO, Jacobs' first order of business was to get rid of 20 employees and to focus the company on a more profitable business than entertaining Vegas lounge lizards.
For a brief time, Jacobs and a consultant looked into buying a record company based in Colorado. (SunnComm's SEC filings are littered with payments to consultants for a host of legal and technical services.) Then a stroke of good luck nailed Jacobs in the face.
Photo of CEO Peter JacobsOne of Desert Winds' employees had decided to leave the company and join a friend in a DRM venture. The friend had discovered a way to alter CDs and confuse them from making illegal copies. This was in April of 2000 - a time before peer-to-peer services such as Napster had really gained much public attention and before record companies were taking average consumer CD piracy terribly seriously.
Jacobs convinced the employee and his friend to stay on, and a new division of Desert Winds was born.
In July of 2000, Desert Winds officially changed its name to SunnComm in a transaction that sent 5m preferred shares and 2m shares of common Desert Winds stock to SunnComm with the deal being characterized as an acquisition. SunnComm then created a unit called Project 1000 - the DRM division - that would concentrate on selling what was called MediaCloQ.
"We shifted from content production to content protection," Jacobs said. "This was to show shareholders that we could be in a business that could be real. The purpose was to transition the company by getting the old people out and attracting enough funds not to have the company go under."
It's at this point that SunnComm began a series of fast and furious business dealings that have some shareholders terribly concerned.
For Jacobs, SunnComm's major mission was to transform into a clean, smooth-running business. He wanted to clear the company's name with the SEC and move from the so-called "pink sheets" to getting listed on a national trading market such as the Nasdaq.
SunnComm, however, ran into a complex set of problems as it applied for status on the OTC (Over the Counter) market. The SEC basically stepped in at the last minute of SunnComm's OTC filing window and made life difficult on the company, presumably because of past incidents. So, it changed up its strategy.
"One idea that our legal staff had was to buy a fully reporting public company," Jacobs said. "Once you merge into (the fully reporting company), no one can unmerge you."
The not so Quiet Tiger
SunnComm found its patsy in Fan Energy.
This firm's past goes back to the 1920s, when it started operations as an oil and gas exploration concern. The company stumbled along all the way until 2001 when it sold off all of its oil and gas assets for a mere $75,777 and acquired of all things a 3.5 inch floppy disk manufacturing firm. Fan Energy valued its disk manufacturing assets at $3.8m, although it never actually produced a disk and the equipment currently sits unused in a warehouse, according to SEC filings. This outcome isn't terribly surprising if you think back to the status of the floppy disk market in 2001. The technology had already been rapidly replaced by smaller disks and was facing CDs as the medium of choice for most PCs.
In a deal best described as unorthodox, Fan Energy agreed to acquire SunnComm's Project 1000 DRM technology for 23.8m shares of its stock. As it turns out, that gave Project 1000 - then a SunnComm subsidiary - the majority ownership (53 percent) of Fan Energy - the very company meant to be acquiring Project 1000. At this point, Fan Energy changes its name to Quiet Tiger and enters the DRM market.
There is where the shareholders get real angry, and things become rather complex.
A complaint allegedly sent to the SEC charges that Fan Energy/Quiet Tiger misrepresented the value of its assets - the $3.8m in floppy disk gear. There's no record that a single disk was ever produced, although Fan Energy does appear to have done one deal as a type of floppy disk reseller, generating only $4,000.
"It is without doubt that Fan Energy (now Quiet Tiger) had no serious business plan to manufacture floppy disks and the equipment was acquired for no other reason than to place an asset in their balance sheet that they could use to bolster the value of the company by misrepresenting its true value," the complaint states. "Additionally, SunnComm fortified the deception by stating they were committing to using 50 percent of the capacity and in turn caused its own shareholders to be deceived in regards to the true intrinsic value of the shares they were to receive as a property dividend."
Fan Energy's description of its floppy disk business is certainly questionable. In various filings, the company suggests that it could be a major player in a multi-billion dollar market and churn out as many as 6m disks per month. Given that the company never actually produced a single disk and that it admits at times to having no employees, it seems the investors have a point about Fan Energy not being a serious floppy disk contender.
Jacobs, however, insists that Fan Energy was intent on being a real technology company and was just searching for its niche. As soon as SunnComm/Project 1000 took control of Fan Energy, it wrote down the $3.8m in floppy disk assets to just $100,000.
"When we took it over, we were not in a position to question how they audited their stuff," Jacobs said. "As soon as we got in, we devalued those assets as fast as we could."
Quiet Tiger - the failed oil and gas / floppy disk maker - now functions as a DRM marketing company, hawking SunnComm's MediaMax technology. Quiet Tiger pays its owner SunnComm more than $100,000 a quarter to remain the "exclusive" dealer of MediaMax and covers all selling expenses for the technology. Bill Whitmore, SunnComm's former President, now runs Quiet Tiger, although Jacbos held the position of CEO for some time.
While SunnComm's critics charge that Quiet Tiger is more or less a fictional operation, Jacobs presents it more as a division that benefits both Quiet Tiger and SunnComm investors, which are more or less one and the same these days.
"We had to come up with ways to create value that were not traditional," Jacobs said. "Because of the profile SunnComm realized, Quiet Tiger has increased their volume, and its share price has gone up from a couple of cents to 8 or 10 cents. It's been a positive experience for them. They had no prospects before."
Millions today, nothing tomorrow
Beyond Quiet Tiger, SunnComm has had odd dealings with a number of other companies.
In 2000, it announced a $20m agreement to provide a Taiwanese CD-maker called Will-Shown with its DRM technology. Here, the disgruntled types charge that SunnComm made the arrangement sound like a done deal - a move that inflated SunnComm's value in the public eye. SunnComm, despite having almost no revenue, would later pull out of the lucrative contract, saying it wanted to focus on the "domestic market" first before expanding overseas - a rationale that doesn't sit well with its critics.
Behind the scenes, however, the deal went awry as SunnComm became concerned about entering the Chinese CD market. It was advised by government officials and a consultant that certain groups in China and Taiwan would likely try to break SunnComm's DRM technology.
"We went over there and had numerous discussions," said Anthony O'Brien, a one-time consultant for SunnComm. "My advice was not to do anything because the technology would only be used by companies to break it and abuse it. Everything was murky over there then, and no one could guarantee it could be protected."
This advice prompted Jacobs to pull out of the deal.
"Once we learned that, we told (Will-Shown) we were not ready to expand internationally. At worst, it's the worst example of our work to date," Jacobs said.
SunnComm's critics question whether or not Will-Shown even exists, but those interviewed for this story have documents detailing negotiations with the firm.
Another deal that has some concerned was a licensing arrangement between SunnComm and Dstage. The press release for this deal reads, "SunnComm, Inc. (OTC:SUNX), a leader in digital content security for optical media, today announced that it has licensed its Proprietary Copy Management Technology to Dstage.com, Inc. (OTCBB:DSTG) for a one-time fee of $4,000,000."
This statement makes the $4m sound like a cash pay out, but, in actual fact, SunnComm received shares of Dstage - a low volume, penny stock. SunnComm would later reveal this in another statement.
While SunnComm seems to have a dubious flair for aggressive language in its press releases, this deal again checks out with Jacobs' overall strategy of returning value to SunnComm shareholders. They received a piece of Dstage as a dividend - small dividend as it may be.
The most recent questionable SunnComm deal came in February of this year when it announced a planned purchase of the UK's Dark Noise. The British firm apparently had the technology needed to plug the Shift key problem, which SunnComm refers to as the "analog hole." This deal was covered in the mainstream press with Jacobs giving the Dark Noise technology a top notch rating.
"This stuff works," he told CNET. "The science is real. You can't hear it (the DRM technology) when (a piece of music) is being used properly, and you can do nothing but hear it when a song is copied improperly."
Dark Noise
In a statement announcing the buy, SunnComm presented Dark Noise as a proven player in the DRM market that was currently awaiting the approval of two patents for the analog hole technology. The Register, however, searched UK government filings and found that Dark Noise is a very small firm that has moved from office to office and is currently headquartered in Whitby, Yorkshire well outside of the London address claimed in the press release. We also searched three different patent databases in the Europe and the US and could fine no record of an application or approved patent for Dark Noise.
What's happened to the deal? Well, it appears to be falling through, according to Jacobs.
Dark Noise was unable to remove the "you can't hear it" part of its DRM from the CDs completely. "They had to get that out," Jacobs said. "They said it could be done, and we believed them."
SunnComm now believes the Shift key problem can be solved in-house and plans to do so by the fourth quarter, but it has made similar claims in the past. SunnComm has its Quiet Tiger arm simply licensing the Dark Noise technology instead of acquiring the company and then has researchers in Israel and at the University of Miami fixing the Shift key issue.
Beyond all of these deals, SunnComm's past and present are riddled with characters who have had various run ins with the SEC. For example, a July 2000 press release advises investors to call Mario "Ike" Iacoviello about SunnComm's shares, and Iacoviello is also listed as a contact in the Will-Shown press release. He's also quoted as a SunnComm spokesman in another CNET story about SunnComm.
In 1999, the SEC announced charges against Iacoviello for violating "the antifraud provisions of the federal securities laws while employed as a registered representative with the San Diego branch office of La Jolla Securities Corp. by accepting undisclosed compensation for recommending and selling stock in RMS Titanic, Inc. to his clients." Iacoviello never admitted or denied wrongdoing.
Think of me as Santa Claus
Nothing presented to Jacobs during our multi-hour interviews came as a shock. SunnComm maintains that it's well aware of these investor complaints. Company executives would show up to meetings with the likes of BMG and often find glossy packages outlining the aforementioned gripes about SunnComm waiting for them, Jacobs said.
"I will disavow normalcy at every step of the way here," Jacobs said. "The first three years were like hell in the market."
To this day, Jacobs believes that that vast majority of large SunnComm shareholders have only benefitted from his actions, unorthodox as they might seem. He accused the angry mob of Internet posters as trying to short SunnComm's stock and take the company down for any number of reasons.
"What these people have done is gone from witnessing a traffic accident to causing a traffic accident," Jacobs said. "These people are not vested shareholders in the company, and they don't like how long it takes for a company to go away."
"I agree that much of the stuff could be read two ways," counters one of the SunnComm haters. "I think there are just too many incidents in their short history to put it all down to just bad management."
That said, most of those against SunnComm are primarily angered by the company's inability to get its DRM business moving. It has been promising major deals with labels for years.
Over this past year, SunnComm's DRM technology was found on the number one album in the US - the BMG produced Velvet Revolver release. Industry sources interviewed by The Register say it's very likely that 2005 will see every single release sold by BMG ship with SunnComm's technology. Jacobs also hints at a similar deal with another major label.
Some insiders within the industry say that SunnComm's DRM technology is far superior to that of MacroVision in that it allows for more customization into how many times a CD can be copied onto a PC or moved to a portable device.
Jacobs, who has a past running a successful Christmas tree farm in Oregon and was one of the first to sell prepaid phone cards in the US, is convinced that the next year will be a boon for SunnComm. He admits that DRM technology might not be the most attractive pursuit in consumers' eyes, but says there is no way to avoid it in this day and age.
After years of toiling, he expects SunnComm to end up owning the vast majority of Quiet Tiger and to have his fully-reporting dream fulfilled, which should please investors with Quiet Tiger appearing on a major exchange. This day will come when SunnComm can sign up the elusive "two majors" for its DRM software.
Jacobs comes off as a rare breed for a CEO. He came into a tough situation and admits many mistakes. All along, however, he believes SunnComm stuck to its vision and has just had a difficult time reaching its end goal.
Should SunnComm finally sign up a pair of major labels, then it would seem the company could be deemed a success. But until that happens, it will continue to be reamed across the Internet as a sham and a vacant shell of a business. ®
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