Pixelon Misled Investors, Exec Admits

Baldwin Louie — Sun, 14 May 2000 15:00:00 -0700

Pixelon, the company that raised $28 million before its founder was exposed as a convicted con artist and a fugitive from the law, passed off widely available technologies as its own exclusive, proprietary software, The Standard has learned.

The San Juan Capistrano, Calif.-based startup claimed to have developed a proprietary format of digital video that was significantly more efficient at broadcasting video over the Internet than those made by rivals Microsoft (MSFT) or RealNetworks (RNWK). In fact, Pixelon was using a generic format available to anyone over the Internet, according to Russell Reeder, Pixelon's VP of product development. Three former Pixelon employees have elaborated on Reeder's admission.

The revelations come a month after fugitive David Kim Stanley surrendered to the Virginia authorities who had been closing in on him. After Stanley's arrest, it became clear that he had raised millions of dollars for Pixelon under the name Michael Adam Fenne.

Reeder confirms that on several occasions Pixelon intentionally misled the public about the capabilities of its technology. One instance came in August during a demonstration held for investors. At that time, Pixelon claimed it was using proprietary technology - comprising an encoder and playback software called the Pixelon Player - to broadcast the Iowa straw poll. In fact, Reeder now says, Pixelon was relying on software made by Microsoft because Pixelon's own technology wasn't up to the job.

"The [Pixelon] Player was an adaptation of Windows Media Player because it (the video) was streamed using Windows Media as a streaming format," he says.

Reeder also acknowledges that Pixelon misrepresented its technology in press releases and white papers the company distributed to investors and the public. "We use a revolutionary set of capturing techniques that revolve around seven proprietary sampling procedures," proclaimed a white paper that was posted on Pixelon's Web site during the second half of 1999. The company also suggested it had a proprietary "codec," or mathematical formula, for encoding files. Reeder confirms that none of the video Pixelon was distributing at the time was using any such techniques and that, to this day, Pixelon relies on a video format that is available to anyone.

In a recent interview from jail, the 39-year-old Stanley claimed to have written the code from scratch during the several months he lived in the back seat of his car after fleeing authorities. "I knew I was on the frontier of a totally new area and I got real, real, real excited," he told The Standard. "I knew I had found the way home."

In 1989, Stanley pleaded guilty in Virginia and Tennessee to 51 counts of fraud and embezzlement. Prosecutors said Stanley had used his status as the son and grandson of preachers in the Appalachian town of Wise, Va., to talk fellow parishioners and neighbors into handing their money over to him so that he could invest it for them. Virginia police estimate he swindled his victims out of more than $1.5 million. Stanley was ordered to pay restitution and serve eight years in prison, but he fled in 1996 with restitution only partially paid. Using the alias Michael Fenne, he founded Pixelon in 1998. Pixelon has vowed to conduct a financial audit to ensure that Stanley did not pocket Pixelon funds.

Pixelon showed signs of trouble almost from the beginning. According to a prospectus that was provided to potential investors, Pixelon spent $16 million on a launch party held last October that featured a reunion by The Who and performances by other top artists including the Dixie Chicks, Chely Wright, Faith Hill, Kiss and Tony Bennett. Company executives justified the outlandish price tag at the time by saying that the event would allow Pixelon to showcase its unique ability to broadcast live, full-screen video at 30 frames per second. Pixelon's technology was unable to broadcast the event live, however, except to a handful of viewers who had exceptionally fast broadband connections.

That's because Pixelon's technology is based on the open standard MPEG 1, a video format that is known for producing enormous files. The format was popular in the days when CD-ROMs were the primary medium for digital video distribution. MPEG 1 has fallen out of vogue, however, because the increasing use of the Internet to deliver video has placed a premium on files that are small enough to be transmitted quickly.

WASHINGTON - The Federal Trade Commission published a financial-services privacy rule on Friday, setting forth new regulatory guidelines that will for the first time regulate the information-sharing practices of some Internet sites. The new rule could provide a clue as to the tenor of the testimony that the commissioners will give before Congress on the broader question of online privacy in coming weeks.

The 159-page rule outlines mandates some "financial institutions" to notify customers about the collection of personal information and to offer some a choice as to how that data is shared. Issued under authority granted by the Financial Services Modernization Act of 1999, the FTC's rule covers businesses such as online mortgage brokers, real estate brokers and tax preparers, which aren't already covered under similar rules issued under the same law by other federal agencies, such as the Federal Reserve. The FTC's rule is scheduled to take effect July 1, 2001. (For a PDF version, click here.)

As early as next week, the commissioners will release to Congress a broad new online-privacy report. Last summer, a majority of commissioners recommended that Congress let industry keep policing itself for the time being, but since then, the commission has launched several privacy probes into leading Internet sites such as Amazon.com and Yahoo.com.

Furthermore, an internal survey of Web sites' privacy policies conducted in March is expected to provide grist for a change in the commission's stance. Only 20 percent of the Web sites surveyed comply with the FTC's standards for fair-information practices, and FTC staff members are reportedly now telling the commissioners that they should ask Congress for new legislation. While not rejecting continued industry self-regulation outright, the commissioners are expected to heed the advice of their staffs and tell Congress that it should enact new laws aimed at governing Internet privacy.

In Friday's rule, the FTC used a broad definition of financial services based on banking laws that include a host of activities "closely related" to banking, such as financial-data processing, sales of financial software and property-appraising services.

The rule applies to data collected as part of the sale or provision of a financial product or service. Companies covered by the rules are required to give notice to consumers as to what personal, nonpublic information is collected. The companies also must reveal with whom they share the data. Covered information includes data collected by a "cookie" file that tracks a consumer on the Web, according to the rule. In another example, the rule also covers information a person provides when applying for a mortgage loan online, even if the loan isn't granted.

A company like Intuit that sells financial software directly to consumers would be covered, as would a Web site that offers its own branded credit card or leases cars directly to consumers. Companies that give consumers access to their credit card bills or other financial data online would be covered as a financial-data processor, according to the rule.

The rule also requires that the notification policy simply can't be posted on a Web site. Rather, the company must verify that consumers have seen it. For example, companies might require that the consumer click on a button acknowledging the policy before they can purchase a financial product.

Finally, the rule states that consumers must be given the right to prohibit sharing of their personal information with unaffiliated third parties. The limit applies only to information gathered as part of the sale of the financial product or service, and only to information that is not otherwise publicly available. The rule makes an exception for data such as financial-account numbers that are provided to third-party marketers selling products or services on behalf of financial institutions.

Pixelon has updated its Web site to remove any claims that it uses a proprietary compression scheme. Since August, Reeder says, Pixelon has spent more than $1.5 million updating its encoding technology, allowing the company to generate high-quality pictures using smaller file sizes than any other competitor. Compressing the size of video files is crucial, because it could take hours or even days to deliver conventional video files using the typical Internet connection. Reeder says that Pixelon's current video technology still relies on generic, or "open," standards, but that the company has taken proprietary steps to make the files smaller than other techniques on the market can make them.

"If you look closer at it (a Pixelon file) you will notice that it's higher quality with a lower encoded rate," Reeder says.

However, two digital video experts who examined files generated by Pixelon said they were comparable to those created by competing technologies.

While Reeder would only admit that Pixelon had misrepresented its technology in isolated situations, three former employees claim that the practice was widespread during their tenure at the company. Gary Devore, who was in charge of video encoding at Pixelon from May 1999 to November of that same year, says that Pixelon had designed none of the technology he used in his job. Instead, he explains, the company told him to capture video off of a satellite feed and run it through video-encoding technology produced by FutureTel, a company based in Sunnyvale, Calif. "Every piece of video that was encoded there was encoded with an MPEG encoder from FutureTel," Devore says.

Devore, 34, currently produces a television show about fishing called Angling Adventures Magazine. He says he was fired from his Pixelon job in August after Fenne complained that Devore was not performing his duties. "When I was fired I brought all of this to the attention of Paul Ward," Devore says. Ward, Pixelon's current CEO, could not be reached for comment.

Phillip Bruce, an employee hired by the startup to encode footage from Anaheim Angels baseball games, agrees that the encoding process used no proprietary Pixelon technology. Bruce and Devore say that Pixelon built a special box to house the FutureTel device. In order to prevent employees from discovering the true contents, they say, Stanley told them that the box was equipped with a special "acid pill" that would explode if anyone removed the cover. Stanley explained to employees that he had taken this step in order to prevent reverse engineering. A third employee who worked at Pixelon for 10 months confirms the account. "From the start I knew that we didn't have our own proprietary compression codec," says the employee, who spoke on the condition of anonymity.

Devore and the anonymous source say that other technologies were doctored, too. Specifically, they say, features in the Pixelon player that were supposed to let viewers see ads targeted to their specific demographics and provide feedback to a database never worked. Before a demonstration to representatives of the Web site Cindycrawford.com, Devore says, Stanley told him to run a series of ads that would appeal to women, so it would appear that the technology was targeting users of the Crawford site. Reeder says the targeted ad feature only became functional in late November, and that he had no knowledge of the demo. "I wasn't there, but I could see how that would happen," he says.

Devore says that even before he was fired, he had suspicions that Pixelon's technology was merely a collection of off-the-shelf hardware and software made by other companies. But he was lured by Stanley's promises that the company would complete an initial public offering in April 2000 and would have a market cap rivaling that of Broadcast.com, the company Yahoo purchased last year for $5 billion. "Michael would say in meetings that everybody in this company is going to be a millionaire in a short period of time," Devore says. "It was always the possibility that by this time next year you'll have $10 million."

A principal with Advanced Equities, the Chicago brokerage that raised $28 million for Pixelon in a private placement, says that the firm had no reason to doubt the company's technology. "We brought technical people out there (to San Juan Capistrano) to look at the product," says Keith Daubenspeck, who is also a member of Pixelon's board of directors. "Not only did they confirm that they thought the product was excellent, but one of them invested $50,000 in the deal." Daubenspeck declines to identify the technical consultants by name.

Daubenspeck said Advanced Equities has helped fund several other technology companies since it was established last August, including Universal Access (UAXS) for $5.5 million, VPNet for $12 million and Shopnow.com.

Reeder acknowledges that Stanley regularly oversold Pixelon's potential to employees and investors, but says that he and other executives from the company resisted the con. "David Stanley had no compunction about stretching the truth," he says. "I have a lot of bitterness about it. I always resisted the scam portions of his directives."

"If you look closer at it (a Pixelon file) you will notice that it's higher quality with a lower encoded rate," Reeder says.

However, two digital video experts who examined files generated by Pixelon said they were comparable to those created by competing technologies.

Despite Pixelon's earlier misrepresentations, Reeder says that a newer version of Pixelon's encoder does in fact rely on proprietary technology that puts the company on the cutting edge of Net video. "We have the most refined MPEG on the Internet," Reeder says, explaining that Pixelon uses patent-pending technology to slim down video before it is encoded. Reeder says that Pixelon worked with an outside company to design hardware that could replace the FutureTel equipment, but declines to name the firm.

Reeder says that the average MPEG file on Pixelon's site was encoded at rates below 500 kilobytes per second, or Kbps, which puts them on the lower limits of current MPEG 1 capabilities. Two MPEG experts, however, estimate the rates to be between 580Kbps and 800Kbps. "From what I can tell, [Pixelon's] videos are still encoded around 800Kbps," Marc Carver, an employee at Pixelon competitor Load Media, wrote in an e-mail to The Standard.

Reeder says that future versions of Pixelon's technology will rely on a compression technology known as MPEG 4, which is by far the most popular format used by Internet broadcasters.

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Pixelon Misled Investors, Exec Admits