How Microsoft Busted The Euro Pirates

And how it's stepping up the fight

It was a state-of-the art plant, whose machines turned out shiny silver software disks with dizzying speed. Situated in Digital Park in a village just outside Cambridge, England, PolyMould fit right in among the computer startups and was just down the road from Microsoft Corp.'s new, $80 million research and development center. Within a few months after opening the plant in the summer of 1997, John Staud--a 37-year-old Texan--and his 25 employees were printing the world's most popular software disks, including Microsoft's Office and Windows NT, and shipping them throughout Europe.

It seemed too good to be true, and it was. Staud's plant was a pirate operation. Many of the disks he was shipping were high-quality knock-offs, costing Microsoft tens of millions of dollars in sales. The bonanza ended on a steamy summer day a year ago, when German customs authorities, following a Microsoft lead, pounced on a shipment from Staud's Cambridge plant and seized $60 million of pirated disks. Later, they arrested Staud. On June 15, after nearly a year behind bars awaiting trial, he was convicted of illegally importing counterfeit software and sentenced to four years. It marked Europe's first tough sentence for a software pirate--"a breakthrough case for us," says John Frank, Microsoft's chief counsel in Europe. Staud, in a German jail, refused through his lawyer to be interviewed.

The story of Staud and his factory illustrates how software counterfeiting in Europe is becoming vastly more sophisticated. It also shows how difficult it is for software makers to track down pirates. Together, Eastern and Western Europe represent the biggest market for pirated software in the world (chart, page 19)--some $3.4 billion in lost sales annually, compared to $3.2 billion in North America and $2.9 billion in Asia. Increasingly, software companies suspect, organized-crime groups that have been counterfeiting in Asia and the U.S. are setting up shop in Europe's high-tech heartland. "It's become hugely lucrative for crooks to get into this business [here]," says Allen Dixon, European counsel for the Business Software Alliance, an industry group. Staud has not been linked with organized crime.

JUST IN TIME. From IBM's Lotus division to Apple Computer Inc., the entire U.S.-led software industry is getting hit. But most of the stolen sales, perhaps two-thirds, come out of the hide of mighty Microsoft. The new generation of counterfeiters, including Staud's plant, have perfected ways to produce consumer software disks nearly identical to Microsoft's own. In this underground industry, thieves, forgers, and counterfeiters coordinate to produce startling reproductions, often on a just-in-time basis. They churn out shrink-wrapped products, packaging them with stolen certificates of authenticity and forged user manuals. And like drug lords, they launder money through front companies and offshore bank accounts.

Few would suspect that Western Europe could be such a congenial place to sell pirated ware. But the Continent's so-called gray markets are a dream come true for counterfeiters. In these outlets, from flea markets in Barcelona to trade fairs in Hannover, illegally imported goods, including pirated disks, are sold on the cheap. Even when police crack down on reselling rings, as when Spanish authorities busted 100 software vendors at Barcelona's outdoor market last year, most operators simply fold their tables and mosey down the street, like so many shell-game swindlers.

Technology advances are making it cheaper all the time to get into counterfeiting. Investigators estimate that Staud's plant, for example, cost under $3 million to set up--less than 5% of the retail value of its aborted truckload. Europe's tangled police jurisdictions make it easy to play hide-and-seek with money and product flowing across the region's porous borders. And overworked law enforcement officials--intent on solving burglaries or cracking drug rings--have been slow to tackle software counterfeiting operations.

It was in 1996 that Microsoft began to notice top-notch knock-offs reaching Europe. To company officials, that was a clear sign that Asian crime syndicates, who ran replication plants from California to China, were now lining up business partners in Europe. The European market, like the U.S., was rich with consumers ready to pay full price for certified software. More were opting for new disks rather than cloned copies from friends. Although this trend was beginning to drive down unlicensed sales, Microsoft was worried about sophisticated counterfeiters: If pirates could imitate the real thing nearly perfectly, Europeans would wind up with fake disks, phony guarantees, and no customer service. For the first time, counterfeit products threatened to devastate Microsoft's brand in its No. 2 global market.

Microsoft turned to detective Fred Mathews and dispatched him to Europe. Then 50 years old, Mathews was a 22-year veteran of the San Diego police force. He had plenty of experience battling international crime syndicates shipping cocaine across the Mexico border. Microsoft set Mathews on the trail of Europe's software criminals. In late 1996, he opened up a one-man investigative office in Microsoft's vast complex in Reading, up the Thames from London.

The California detective started by reading transcripts of the few piracy cases already tried in European courts. He quickly came upon a case in Belgium that involved a Luxembourg company--Soft Logistics--owned by Staud. The company had printed manuals for a small-time software counterfeiter. But Staud told police that he was duped and thought his customer was a licensed producer. The argument satisfied Belgian police. But, as Mathews testified in Staud's recent trial in Germany, "it seemed likely to me that Mr. Staud was more involved than originally appeared."

Mathews had little trouble locating Staud's British house. The address--51 Harvey Goodwin Gardens--was a middle-class neighborhood in Cambridge. He learned from police records that Staud was a Texan who came to Germany "as a nobody" in the mid-'80s but managed to build up high-tech companies. Belgian records showed Staud had a business in England. But Mathews couldn't find it. Staud, recently remarried, was spending most of his time in Luxembourg.

Months later, poring over business registries online, Mathews came upon six businesses in Staud's name. He couldn't locate most of them, but there was no hiding PolyMould. The reconverted grain store stood on the edge of Longstanton, a rural village down the road from Cambridge. The plant, which started producing compact disks in August of 1997, was loaded with technology. In a 1998 interview with a British trade publication called One to One, Staud described digital cameras poised over the production lines so that customers could watch their orders being processed over the Internet.

Mathews suspected that Staud's factory was a pirate haven. But he had no evidence. That's why Cambridge police, he says, showed little interest in pursuing the matter. (Cambridge police, citing an ongoing investigation of Staud, decline to answer questions on the case.) So Mathews put Staud's plant under surveillance. He talked to Staud's neighbors but kept clear of employees for fear of alerting Staud.

Meanwhile, all across Europe, bootleggers, using new CD-recorders, were putting together compilations of pirated programs and marketing to a vast public through the Web. Others were buying sophisticated "jukeboxes"--machines able to "burn" hundreds of disks simultaneously. In a Copenhagen bust last year, Danish police seized 125,000 disks, each containing Adobe, Autodesk, Corel, Microsoft, and Symantec software--a treasure trove selling for a mere $50.

But compilation disks could never pass for the real thing. They were often golden instead of silver and packed with a potpourri of products. Thus they left the software companies' brands essentially untarnished. What's more, they reached a consumer underclass that in all likelihood wasn't ready to shell out for authentic, copyrighted goods.

MOVING UPSCALE. Nevertheless, plenty of pirates, Mathews learned, were moving upscale. At least one ring of digital buccaneers in Europe, for example, conspired with warehouse workforces to steal software CDs packaged with new computers and sell them on the black market. Other rings burglarized plants in Europe that made Microsoft products, taking guarantee certificates to make a pirated disk pass for a legitimate one. A 1996 heist in Ireland and two break-ins in Scotland in 1997 supplied Europe's underground with years' worth of legitimate guarantee certificates. With such documents, wholesalers such as Britain's Backslash Distribution Ltd. pieced together packages mixing real and counterfeit items and sold them over the Web. Backslash, sued by Microsoft in civil court, was ordered on July 2 to compensate the company for lost sales and court costs.

At the same time, superior counterfeit software--including Microsoft Office--was hitting the top end of the market. Mathews suspected some of it was manufactured in Cambridge. In early 1998, he contacted legitimate suppliers who were printing manuals and manufacturing plastic cases for Staud's plant, which also produced licensed music and software. In late July, one supplier provided a crucial lead: A big shipment was headed to Germany. The goods, the supplier believed, could be counterfeit.

MANPOWER SHORTAGE. Cambridge police promised to follow the truck. But late July was vacation season, and the police force was short of manpower. To Mathews' dismay, the truck was making its way out of Britain unobstructed. He learned from shippers that it was headed to Germany by way of the Netherlands. Frantically, he called on police in Britain and Germany. No luck. "My interest was to get the police talking to each other," he says. "But they have a problem with protocol."

Finally, Mathews called a customs inspector in Cologne. The Germans agreed to intercept the truck outside Aachen, near the Belgian border. On July 31, they stopped the truck and inspected it. Inside they found 75,000 CDs and 55,000 manuals--all of it, they later learned, counterfeit. Hours later, Staud arrived on the scene in his BMW to check out the shipment. He was promptly arrested.

Now, it was a race to capture evidence in the Cambridge plant. Mathews asked Cambridge police to launch a raid. They told him they were too busy. So Mathews and Microsoft lawyers rushed to London, where they applied to a judge for a civil search warrant. They reached the court in late afternoon, got the papers, and headed back to Cambridge. Near midnight, they reached the silent plant. But not until 1 a.m. did the Microsoft team persuade the PolyMould guards to let them in.

The next day, Staud's employees found their factory shuttered. Two weeks later, Microsoft says, Cambridge police dispatched 20 officers to oversee evidence gathering. British law bars Staud's ex-employees and the police from commenting.

At his trial in Aachen in June, Staud sat impassively as his two lawyers tried to punch holes in the Microsoft case. The defense argued that Staud, living in Luxembourg, was a victim of pirating colleagues in Britain. He had no reason to believe, they argued, that his plant, which also made legitimate licensed music and software, wasn't also licensed for Microsoft. They lamented the evidence still under lock and key in Britain. "We never got a look into the details," says Uve Lehmbruck, his lawyer, who is appealing the case.

Staud's intercepted shipment, of course, represented just a fraction of pirated software in Europe. But the case was important as the first to draw attention to software counterfeiting in the region--and to punish it harshly. Now, European Union officials in Brussels are weighing continentwide standards to combat piracy. But the problem won't get any easier as the EU expands to the East. "Bulgaria alone has enough plants to supply all of Europe," says Kevin Lara, European legal counsel for Autodesk Inc., a U.S. software company.

In Microsoft's Reading office, Mathews doesn't have time to savor his victory in the Staud case. He's grappling with a growth industry, just as he was in his cocaine-policing days on the Mexican border. In fact, with two new assistant investigators, he's busy pursuing 120 new cases for Microsoft. But as the technology grows more sophisticated, so do the criminals. Software counterfeiting shows no signs of slowing down, in Europe or elsewhere--not so long as information is worth money.

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