Spy vs. Spy

IT'S ONE OF THE MOST AMAZING board meltdowns in U.S. corporate history. The departures of Hewlett- Packard directors George Keyworth and Tom Perkins, combined with the effective demotion of Chairman Patricia Dunn, have created a sturm und drang that is reverberating through boardrooms across the country.

The story has all the elements of a potboiler thriller. At the behest of Dunn, HP hired a consulting firm whose detectives obtained the phone records of board members under false pretenses and those of their spouses, according to insiders. The investigators even subjected directors to physical observation, according to these sources. And the same investigators went after the phone records of nine reporters who cover HP, resulting in a media frenzy, including a cover story in Newsweek attacking Dunn.

Most directors sided with Dunn. At an off-the-record session in Washington, sponsored by Institutional Investor and cohosted by Directorship, board members said Keyworth had violated his fiduciary responsibility. "The duty of loyalty has been breached," said one. Asked whether a chairman of a board has a responsibility to investigate leaks, most felt the answer is yes. "Patty Dunn followed the rules pretty carefully," said Nell Minow, editor of The Corporate Library, who often criticizes board conduct.

Directors drew a sharp distinction between a whistleblower such as Sharon Watkins at Enron and a director who disagrees with a company's directions. "There's no way a board can function if someone is leaking," said another director on two public company boards. Most directors argued that Keyworth's only option was to resign his seat.

But Keyworth's defenders argued that HP had previously used him to give on-the-record interviews with reporters as well as to give them background that was off the record. Keyworth's camp insisted he had the right to use those relationships with reporters. "The attack on him makes it pretty hard to be an agent for change in the boardroom," said one associate.

When confronted by Dunn in May, Keyworth declined to resign, saying that he worked for shareholders, not other directors. Perkins, a friend, resigned over the episode in a huff, although the company's 8K filing to the Securities and Exchange Commission did not reveal that it was an acrimonious departure.

The event went public when the company felt obliged to make another SEC filing. The firestorm culminated in transcontinental telephone negotiations that lasted until 4 a.m. one morning. Keyworth agreed to resign, and Dunn agreed to cede her title of chairman to CEO Mark Hurd. The transition takes effect in January. "It was pretty clever of Hurd to set it up that way, because she now has to make the apology tour in Washington," one source said. "He can start with a clean slate."

The role of Wilson Sonsini Goodrich & Rosati was hotly controversial. The prestigious Silicon Valley law firm was already of regular counsel to the board. Dunn turned to Larry Sonsini to also act as special counsel in connection with the investigation since she, theoretically, also was a suspect in the leaking. But because she recused herself from parts of the board's deliberations, she left Larry Sonsini to preside. "They have a highly conflicted law firm right now," said Yale School of Management's Jeff Sonnenfeld. "They have separate interests."

Dunn lost the media war. One lesson from the episode is that media perceptions can shape the outcome of boardroom battles, yet very few boards are sophisticated in media relations. Dunn will almost certainly remain a target, and few experts believe she will last past January on the board. "It was an orchestrated campaign against her," says Sonnenfeld. "Perkins personalized it against Patty Dunn."