The Keys to the Kingdom (53 page)

Contrary to custom, stock ownership among the directors was low (four owned none at all), though the board had recently passed guidelines saying that owning at least $15,000 worth of stock was “highly desirable.” The same guidelines included a definition of “independence” broad enough that all twelve of Disney's outside directors met the standard. Nonetheless, the board did not hold a regular planning retreat. The outside directors did not meet apart from the company executives nor did the board give Eisner an annual written evaluation of his performance, as most major corporate boards do.

Eisner's contract negotiation underscored just how unusual Disney's arrangements were. Irwin Russell, Eisner's personal lawyer, was also chairman of the board's compensation committee. During the negotiation, he acted solely as Eisner's counsel. Watson temporarily took Russell's role and acted as compensation-committee chairman. “I agree that that's not a profile you would normally want to see,” Watson conceded to the
Wall Street Journal
. “But you've got to go to the individuals.” Sometimes, he added, Russell's sense of fairness made it “very difficult to tell…whom he did represent.” Russell protested that he would “never do anything that I thought wasn't appropriate.”

But that wasn't enough for many institutional shareholders. Twenty-four of 103 pension funds composing the Council of Institutional Investors, including the Wisconsin State Board of Investments and Calpers (the California Public Employees' Retirement System), decided to withhold votes for Eisner's new contract and for five Disney board members who were up for reelection at the company's upcoming annual meeting in February. Together these funds represented only about 22 million of Disney's 650 million outstanding shares, so their protest was only symbolic. But John Nash, president of the National Association of Corporate Directors, said the Disney board was “living in the Dark Ages,” adding, “It's too beholden to Eisner. There are too many conflicts of interest. There are too many business relationships that could cloud independence.”

The question was whether the company's success entitled it to overlook ordinary good-governance standards. Eisner countered critics by pointing out that the company's market capitalization had increased from $2 billion to $53 billion since he had taken over. “I didn't go to business school, so I didn't have the benefit of two years of intensive training in this area,” Eisner said facetiously. “But what I read about what is expected, I find quite counterintuitive—for me and for this company.” He referred dismissively to “the Wisconsin pension whatever,” and said if Calpers wasn't satisfied, he would gladly buy back its stock.

He would rather have “a teacher who taught my kids telling me about our products” than “have an old-boy crony network of CEOs that just share the same old war stories,” he continued. Most chief executives didn't understand the entertainment business, he said. “If they have so much time to spend on our company,” he said, “what are they doing at their company?” (Eisner himself did not serve on other corporate boards or perform much community service—nor was he apologetic. “It's very worthy and I wish I had time to do it and someday I will do that,” he said. “But it's not the job of the CEO in one of these kinds of companies.”)

Addressing the lack of succession at Disney, Eisner said he regularly wrote memos to Watson offering his ideas of “who I think could go all the way and who I think is overrated.” Such memos often began, “I know I can't dictate this from my grave. But in case anybody wanted to know what Michael Eisner thought, just after the funeral, here is a letter you can read to the board.” Eisner predicted that his eventual successor would come from inside the company, adding, “There's a list of forty, and it could be any one of those forty depending on when I get hit by the truck.”

Eisner said that in one of these memos written just a few months after Ovitz was hired, he had warned Watson that he had made a mistake. “I made it very clear to Ray and a few other people that if I should get hit by this truck, he should not expand my error and continue it. They should deal with it. I made it very clear I had made a mistake way before it became clear to the public and way before I acted.”

So even though Eisner had told Larry King in September that the talk of trouble between him and Ovitz was “baloney,” he now said he had already been preparing the board for the idea that it would be best to pay Ovitz to leave. “I can tell you that my main shareholders were very happy that I was doing it,” Eisner said. “They recognized the economic benefits to the company, not the economic liability. That in the end, we were better off financially by biting the bullet.”

This disclosure prompted the
Los Angeles Times
to reflect on the flagrant mendacity that was routine in Hollywood. “In an interview with the
Times
in September, Eisner used the word ‘ludicrous' four times to describe rumors of a rift between [himself and Ovitz], blaming jealous competitors as the source of such speculation,” the
Times
reported. He had made similar comments to
Newsday, Newsweek,
and the
New York Times.
“It now appears that Eisner was deceiving the news media, his shareholders, analysts and others,”
Times
reporter Claudia Eller wrote. “Some say Eisner was between a rock and a hard place. After all, what could he say? How about a good old-fashioned ‘no comment' for starters?”

 

THE COLD WAS
bone-chilling in the Pond ice rink in Anaheim. This was the home turf of Disney's hockey team, the Mighty Ducks. But on February 25, 1997, more than ten thousand shareholders gathered here for Disney's annual meeting. No one expected the normally cheerful mood to prevail this time.

Disney started out with the usual jovial display: spirited singers performing a tune from the upcoming animated feature
Hercules;
there were fireworks and then Mickey Mouse appeared to introduce “my pal, Michael Eisner.”

Eisner spoke about the company's strong performance, which he said was “a direct result of the excellent stewardship of your board.” After running through more figures to underscore the company's robust performance, Eisner jokingly asked, “Do I hear a motion to adjourn?”

It was a vain hope. But if Disney couldn't send shareholders home after a brief and upbeat presentation, it could make them wait—and wait—before they were given an opportunity to ask any questions. First, the heads of various divisions offered lengthy presentations which one shareholder later described as “one of the longest infomercials” ever staged at a Disney annual meeting. Studio chairman Joe Roth, wearing a Dalmatian tie, boasted about the previous Thanksgiving's box-office success of the live-action
101 Dalmatians
—“$1 million for every puppy.” (The film would gross more than $500 million from all sources.) ABC chief Robert Iger talked via satellite with Peter Jennings, who offered a preview of the evening news. The glossy display didn't impress
New York Times
columnist Maureen Dowd, who wrote, “The presentations conjured up a bright, scary world where Disney has no more conflicts of interest because it simply owns everything.”

Then Eisner took the offensive on the Ovitz question, saying, “I'd like to think the mistake thing doesn't apply to me. And at home I make that clear to my children. But in the office, it happens, as in the Michael Ovitz situation. Not good. A mistake. Won't happen again.”

But that was not enough for the crowd. Eisner stepped off the stage, leaving Sandy Litvack to field questions about the Ovitz and Eisner payments. As he tried to respond, he was occasionally booed by his listeners. One woman drew applause when she told Litvack, “I feel that you are being arrogant in your answers.” When Litvack tried to explain that Eisner had a big job and was being rewarded for the company's overall performance, another shareholder chimed in: “He gets paid more than the president of the United States, and look what he runs!”

There was also applause when a shareholder complained that Disney had “a very inside-type board,” and noted that
Business Week
magazine had named Disney's as one of the worst boards at a major corporation. Litvack countered that by any measure, the board was “exemplary.”

Ray Watson rose to defend Eisner's contract: “We are not shy about the fact that we have awarded him a contract that says if you are successful and this company is successful, you will be rewarded well.”

“I have nothing against Mr. Eisner,” one shareholder said politely. “He's done a fine job here at Disney. But it's just a little too lucrative.” Not everyone was as pleasant. Another man was applauded when he pressed the idea that Eisner should pay Ovitz's severance out of his own pocket. Litvack
replied that Eisner was rewarded on the overall performance of the company. “While Mr. Eisner himself said a mistake was made, overall the record speaks for itself,” he said.

Disney scored a lopsided victory when the votes were taken to reelect its board members, with slightly more than 12 percent opposing reappointment. That number was high enough, however, to be considered a significant protest—a shot across Disney's bow. After the voting, Eisner took some more questions from those who had the stamina to remain through the four-hour meeting. Once again, he was pressed about Ovitz. “Be angry, be annoyed,” Eisner said. “God knows I am, but there's nothing I can do about it anymore.” Another woman argued, “You certainly have high-powered attorneys…. Get our money back.”

“We honor our commitments,” Eisner said.

As to his own pay, he again pointed out that his compensation was tied to the company's performance. “I worked for ten years at ABC with stock options, and when I left, they were worth zero,” he said. He and Frank Wells had agreed from the start that they would take lower salaries at Disney and that their reward would be tied to stock performance. “Frank Wells was paid one-fifth of what he would be paid at any other company,” Eisner said. “I was paid about half.”

No one should assume, he added, that the stock would continue to grow as it had over the past years. “This company may not grow at all,” he said. “We've got some problems in prime time. You know what? I wouldn't assume it.” It began to seem as though Eisner was getting testy at the ingratitude of those gathered in the arena. “Somehow people have as much trouble dealing with prosperity as they do with failure,” he said.

Despite the debate, his pay package was approved by nearly 90 percent. And at the year's end, he exercised 7.3 million options that had been awarded to him in his 1989 contract, giving him a one-day pretax gain of $565 million. He then sold four million shares, netting a profit of $374 million (about $131 million after taxes). It was by far the biggest stock-option gain in corporate history. With the Ovitz debacle more than a year old, Eisner was taking advantage of a period of relative peace at the company—he wouldn't want to panic other shareholders by selling off a large block of stock at a turbulent time. Wall Street reacted calmly. But once again, the pot was stirred among some institutional shareholders. Considering the gains he was realizing from options Eisner had held before renewing his
contract, “did he really need options for eight million more shares on top of that?” asked Ann Yerger, director of research services at the Council of Institutional Investors. “There probably is a point where it's past bad taste.”

The next year, Disney would hold its annual meeting in Kansas City—far from the madding crowd in Anaheim. The company said it was celebrating the site where Walt began to draw cartoons and was not avoiding shareholders who were once again pressing their case to have a more independent board.

Only about fourteen hundred shareholders showed up for the meeting, compared with the thousands who came to Anaheim. But the discontent with the Disney board clearly had not dissipated. This time, about 35 percent of voting shareholders supported a resolution that called for a more independent board. It was a far higher number than anticipated and close to the record in terms of shareholder support for such a resolution at any company.

Nonetheless, Sandy Litvack said Disney would resist changes sought by unhappy institutional shareholders. He took a conciliatory tone. “We do understand,” he said, “that in this area, perceptions are important.”

O
N APRIL
9, 1996, Katzenberg finally sued Disney in California state court, demanding the lump-sum payment—2 percent of the future income from all projects he had put into production—that he said he had been promised. He estimated the number to be in excess of $250 million. His claim took into account more than just box-office and video receipts from films like
Aladdin, Beauty and the Beast,
and
The Lion King
. Katzenberg said the deal included everything from Disney's
Lion King
on Broadway to its Mickey's Toontown attraction to pajama and lunch-box sales from
Pocahontas
and
Toy Story
(which he had put into production) and even a contemplated
Toy Story
sequel.

Eisner had told the
Wall Street Journal
that Disney didn't grant executives a piece of the pie. “It is not the policy of our company that executives have participation” in movie and television projects, he said. It was a strange statement given that Katzenberg had been collecting steadily increasing amounts from his annual 2 percent participation for the past several years. In 1990, with profits stoked by
The Little Mermaid
and
Pretty Woman,
he got a $3.9 million bonus; in 1993, the company paid him another $4.9 million; and in 1994, $7.1 million.

None of this was public, but it seems unlikely that a bonus that had gone from nothing to more than $7 million could have escaped Eisner's notice. In fact, Disney had secretly been keeping a close eye on what Katzenberg's ultimate 2 percent payout might be. But even when he filed his lawsuit, Katzenberg knew nothing about the project to track his projected final bonus.

Katzenberg had agonized for months about whether to file suit. His attorney, Bert Fields, one of Hollywood's most aggressive litigators, had urged him on, but hoping for a breakthrough, Katzenberg kept postponing the final confrontation. (At one point, when Katzenberg was vacationing in
Africa, he took a satellite phone call from Ovitz, who pleaded with him not to file on the date that Disney was finalizing its merger with ABC in January 1996.) He held off. When he sued in April, Fields gave several interviews in which he put the blame squarely on Eisner. “If Frank Wells were alive, this would never have happened,” he said.

But the court papers contained no provocative rhetoric. Eisner called Katzenberg and thanked him. If in the end Katzenberg won, he said, he would promptly write him a check—no matter how big. But Eisner took the position that Katzenberg had forfeited any payments when he opted out of his contract in 1994 rather than remaining for another two years.

The litigation soon became a game of leak and counterleak. Well before the suit had been filed, Katzenberg's camp had let it be known that there might be a memo written by Frank Wells assuring Katzenberg of his share in the profit even if he opted out of his contract in 1994. And in the weeks leading up to the trial, Fields conceded that Eisner may not have been aware that such a deal had been struck. “It's possible Michael didn't really understand the impact of Jeffrey's contract,” he said. “Frank wanted things to function smoothly, and he probably didn't think Jeffrey would leave anyway. He may have done what agents sometimes do. He may have told both sides what they wanted to hear, using enough ambiguity to keep the operation working well. So each guy thinks his needs have been met. Because Frank managed Michael, and after all, Frank thought he'd always be there to make it come out all right.”

As time went on, however, Fields abandoned this position. If someone had to be depicted as playing fast and loose with facts, it wasn't going to be Wells. It made a better story to say that Wells had negotiated with Katzenberg in good faith. Eisner—alive and defiant—made a much better villain.

 

ALONG THE WAY
to trial, Disney lost some major legal skirmishes. In June, Katzenberg forced the company to disclose some financial data. But this turned out to be something of a Pyrrhic victory because Disney filed documents showing a dismal performance of its live-action slate under Katzenberg. Now the public was informed that
Billy Bathgate
had lost $55.9 million, while the musical
Newsies
lost $42.8 million.
Blame It on the Bellboy
lost $10.8 million and
Passed Away
went nearly $19 million into the
hole. Katzenberg responded that those numbers were misleading because they didn't include money from foreign release or video.

The documents also purported to show that though Disney had profited hugely from rereleases of animated classics (a 1992 release of
Fantasia
brought in $184.4 million, for example), the new animated films, such as
Beauty and the Beast,
had barely kept the overall movie slate profitable.

Then in September, Disney made a bid to have the court oust Katzenberg's legal team. This relatively rare and hostile move was based on Disney's contention that Helene Hahn, the former Disney business-affairs executive and attorney who now worked at DreamWorks, had obtained a memo from another former Disney executive that was a “road map” to Disney's internal accounting practices. The memo purportedly outlined ways that Disney might have hidden profits to reduce the company's potential obligation to Katzenberg. Disney complained that this information was ill-gotten, and tainted all of Katzenberg's lawyers. Fields argued that the memo included no secret or stolen information, and revealed nothing that he didn't already know. The judge agreed.

Fields also revealed that Katzenberg's attorneys had logged nine thousand expensive hours on the case thus far. Considering that Katzenberg had mortgaged himself to start DreamWorks—and with Fields alone known to charge $750 an hour—the litigation was proving to be an especially big pain in the wallet.

Much of the material in the lawsuit was under seal, but a smattering of documents was made public in September 1997. Among them was an excerpt from a deposition of Eisner that had been taken by Katzenberg attorney Herbert Wachtell. The snippet indicated that Katzenberg's team was angling to confirm that Disney had tried to conceal some profits that might have been due to Katzenberg. Wachtell asked Eisner about a secret operation called “Project Snowball.” Eisner replied that he had no knowledge of “some secret project called Project Snowball.”

“Were you aware that there was a secret project going on under Frank Wells's aegis stimulated by the fact that Mr. Katzenberg's 2 percent in 1990 started to run at far higher levels than previously anticipated?” Wachtell asked.

“No,” Eisner said, “because I would say that I doubt whether a project was put into work stimulated by the fact that his 2 percent was higher than anticipated.”

Nothing further was revealed publicly about Project Snowball at the time. But there had been a “very confidential” project, according to former Disney employee Cheryl Fellows, who worked on it starting in January 1991 (Snowball was already under way at the time and its exact start date remains murky). Fellows was instructed to keep this aspect of her work, aimed at tallying the ultimate value of Katzenberg's final bonus, secret even from Katzenberg. And if Eisner had never heard of it, it was not because Frank Wells hadn't kept him in the loop. Wells had sent at least two memos to Eisner with “Project Snowball” written on every page. Fellows had also briefed Eisner on the project.

 

AS KATZENBERG'S ATTORNEYS
probed the fraud issue, they got some encouragement from a ruling in a separate case. In 1989, Eisner had fallen in love with a European cartoon character, Marsupilami, during a trip to Europe. Disney bought the rights to the character, which was unusual because the company preferred to develop its own cartoon figures. But the U.S. District Court for Central California found that Disney had broken its promises about making Marsupilami a star in the United States. (For example, the company made no effort to put him on television.)

The court ruled that Disney executives had engaged in “fraudulent concealment” of their plans to drop the European cartoon. According to Marsu attorney Patricia Glaser, there were memos “up the wazoo” proving that Disney deliberately broke its word. Eisner was copied on these memos, although he claimed in his testimony that he was all but ignorant of Marsupilami's fate. Finding that Disney had “knowingly and in bad faith failed to perform its contractual duties,” the court socked the company with a $10.3 million judgment. “We made a valiant effort to settle this beforehand for less than [the judgment],” Glaser said. “Disney did not respond with a remotely respectable number.”

And just a few weeks before the Katzenberg trial was to begin in November 1997, as a team of judges was scrambling to negotiate some kind of settlement, Fields was trying another suit against Disney. This one was brought by MGM, which was still trying to recover from the deal it made years earlier when it licensed its name to Disney for use at its theme parks in Florida and elsewhere. According to the deal, if Disney failed to develop an MGM attraction in any territory within nine years, the rights would revert to MGM. Now nine years were up and MGM said Disney had for
feited the right to use its name outside of Florida. MGM's attorneys were surprised that Disney had never asked for an extension of the nine-year deadline. When MGM approached Disney to resolve the matter, Sandy Litvack repeatedly rebuffed the company. When the issue went to court, Disney argued that it still retained its claim to use the MGM name in Western Europe because it had spent $100 million or more designing various MGM-related attractions for Disneyland Paris. MGM countered that preparing a plan wasn't the same as developing an attraction. On November 5, the jury rejected Disney's argument and MGM salvaged something from a bad piece of business.

 

OVER THE COURSE
of several months in 1997, Katzenberg scored a major blow. After a series of skirmishes, he forced Eisner to turn over notes for a book about his experiences in business. The book, written with the help of former journalist Tony Schwartz, had long been in the works. Now it was scheduled for publication in October, just a month before the start date in the Katzenberg case. (Eventually, Eisner delayed the book so that it wouldn't be published so close to the trial.) The project was dear to Eisner's heart. Just days after Katzenberg had filed his suit in April 1996, Eisner and his wife had attended a Random House sales conference in Scottsdale, Arizona, to give a pep talk to sales personnel. After his talk, he went from table to table, chatting up the crowd.

At first, Disney claimed the notes were irrelevant to the Katzenberg case. Eisner even testified in a deposition that the book only covered events through his heart surgery. (By the time it was published, however, it went further than that.) But under pressure from Katzenberg's legal team, the company started to produce some material. These disclosures provided Katzenberg with powerful ammunition against Eisner—material seemingly so damaging that Katzenberg and his attorneys might have expected Eisner to go to considerable lengths to prevent it from getting into the public record.

 

DISNEY AND KATZENBERG
had agreed that the case would be split in two parts. First, there would be a trial to determine whether Disney owed Katzenberg any money at all. If the answer was yes, then there would be an arbitration to determine the amount. The trial was set for November 17.

All over Hollywood, executives were praying that the suit would not be
settled, as seemed inevitable in a situation like this. A courtroom brawl between Katzenberg and Eisner could be far more entertaining to Hollywood than any film that was in production. There was hope that Disney might be forced to open its books and that all manner of linen would be laundered. The Los Angeles Superior Court was being besieged with media requests for passes to the trial. Court TV requested permission to broadcast it live.

As the start date approached, the rhetoric got hotter. The
New York Observer
reported that Disney had taken depositions from Spielberg and Geffen. “Both Katzenberg and DreamWorks will go on trial,” boasted a Disney source. “We're going to put David and Steven on the witness stand and conduct an examination of their company as well.” It was unclear how relevant such an examination would be to Katzenberg's claim, but Disney was rattling its saber, threatening to prove that any of DreamWorks successes came from Geffen and Spielberg, and not from Katzenberg. Nor was Katzenberg making much money, the Disney camp hinted, because the principals had delayed taking profits out of the company for several years.

DreamWorks—or someone—struck back by leaking a report to
Variety
that two mock juries assembled by Katzenberg's legal team had ruled in his favor. The Wells memo was said to be a significant factor in their reasoning. The report came on the same day that attorneys returned to court for a mandatory settlement conference—the last step before trial was to begin. A DreamWorks insider maintained that the pretrial exercises showed that jurors were inclined to dislike Disney as a corporation and Eisner as an individual. “The only reason that they don't dislike Jeffrey,” a Disney lawyer quipped in response, “is they don't know him well enough.”

 

JUDGE JOHN OUDERKIRK
had been laboring mightily to bring the parties to a meeting of the minds. Two of his associates, Owen Kwong and Enrique Romero, had been working all along to effect a resolution. Sometimes, when Fields emerged from his then-ongoing MGM trial versus Disney, Judge Romero would be sitting outside his courtroom, encouraging him to be “flexible.” The court ordered the parties to meet repeatedly but they made no progress.

On Halloween evening—a Friday night—the adversaries gathered in the Intercontinental Hotel in downtown Los Angeles. In a last-ditch effort to reach a settlement, the court insisted that Eisner and Katzenberg sit down
together. They had barely spoken since their rupture in 1994. Both sides were clinging to their own analyses of how much the 2 percent payment was worth and they were about $200 million apart. Their respective positions still seemed irreconcilable.