Family Feuds Don't Get Nastier Than This

EDS is suing the former CEO of its A. T. Kearney unit, who's throwing some ugly punches of his own

On Aug. 5, Frederick G. Steingraber, the former CEO of A.T. Kearney Inc., walked into a conference room in the consulting firm's swank Chicago offices. Greeting him were lawyers for Electronic Data Systems Corp. (EDS ), Kearney's parent company. A week earlier, they had summoned Steingraber via e-mail to a meeting to discuss an employee's misconduct--but they didn't say who the worker was.

The mystery didn't last long. In a six-hour meeting, EDS lawyers accused Steingraber of bilking the company of $100,000 in phony expenses while serving as Kearney's top manager, according to court records. Dumbstruck, the 64-year-old ex-consultant denied the charges. It hardly mattered: In a Sherman (Tex.) courthouse 950 miles from the tense Chicago conference room, EDS was suing him for fraud. The next day, he was fired from his post as chairman emeritus. Says Steingraber's lawyer, Lewis S. Rosenbloom: "It was an ambush."

Whether EDS was inventing an excuse to oust Steingraber, as he claims, or exposing a corrupt executive, as it insists, won't be known unless the fight goes to trial. But it's already providing evidence of a more serious rift: Nearly eight years after EDS and Kearney came together in a marriage of high-tech outsourcing and high-priced management consulting, the two are at war. A big falloff in consulting sales has forced EDS to cut consultants' pay and autonomy. Meantime, Kearney's old guard is convinced it can do a better job of running the show and has unsuccessfully tried to buy the firm back. "The relationship is gruesome," says a former Kearney exec.

For EDS, there's more at stake than the integrity of its expense forms--as well as big risks the lawsuit could backfire. Wielding inside knowledge, Steingraber is threatening to reveal details of EDS's accounting just as the Securities & Exchange Commission has upgraded a probe of the company's finances to a formal investigation. In an angry response filed in October, Steingraber accused EDS CEO Richard H. Brown of "an aggressive campaign to artificially inflate...revenues and profits," including booking revenue before it was billed and failing to disclose the risks of some contracts. Already battered by a series of missteps by Brown, including a huge earnings shortfall in September and a losing bet on EDS's own shares that wound up costing $225 million, the stock has swooned 10% since the SEC announcement.

An EDS spokesman denied Steingraber's allegations as "false and malicious." Kearney CEO Dietmar Ostermann says that he's "the first to admit that we weren't quite successful" initially. But he says that "the relationship has never been better." As evidence, he notes that Kearney consultants collaborated on 42% of EDS's major sales pursuits in 2002, up from just 16% in 2000.

Things weren't always this antagonistic between EDS and Kearney. An offshoot of McKinsey & Co., Kearney opened its doors in Chicago in 1926 and had a sleepy reputation. Steingraber, a cerebral career consultant, rose to CEO of Kearney in 1983 and led an ambitious global expansion that helped its billings grow tenfold. The firm repaid him by endowing a chair in his name at the University of Chicago. When EDS came calling, he insisted that the company preserve Kearney's partnership-style culture and compensation system.

EDS initially agreed to do so. Its plan was to market its outsourcing services to Kearney's blue-chip clientele while fattening the bottom line with profits from lucrative consulting gigs. At first the deal was a huge success, with Kearney expanding revenues from $320 million in 1995 to more than $1 billion in 1998. But as many other companies have learned, including Ernst & Young LLP and Cap Gemini since their union in 2000, melding the privileged culture of a partnership with the bottom-line mentality of a big public company is hard to pull off.

EDS and Kearney soon clashed, according to interviews with more than a dozen current and former insiders. Kearney consultants chafed at sharing clients with EDS and fretted about jeopardizing their status as independent advisers to boards. EDS employees, meanwhile, were suspicious of the generous perks and arrogance of a unit that generates only about $1 billion of EDS's $21 billion in annual sales. "They were from Mars, and we were from Venus," says Gary Fernandes, EDS's former vice-chairman.

When Brown arrived in late 1998, the consulting market was slowing, and EDS was in disarray. An aggressive turnaround artist who had revived H&R Block Inc. and Cable & Wireless, Brown wanted to slice $1 billion from EDS's expenses. He suggested that Kearney relocate to EDS headquarters in Plano, Tex. Steingraber, a fixture in Chicago business and social circles, refused. Instead, he urged Brown to maintain the previous management's hands-off approach.

Brown, who fancies himself a tough, Jack Welch-style manager, didn't back down. In November, 2000, he replaced Steingraber with Ostermann, a dark-horse candidate for the job who had been elevated to run Kearney's European operations just six months earlier. German-born Ostermann moved fast on Brown's agenda, moving Kearney's headquarters to Plano and replacing key Steingraber lieutenants.

Kicked upstairs to a largely ceremonial role, Steingraber continued at Kearney. Then early in 2002, while investigating allegations of misconduct by another employee, EDS claims it learned that Steingraber had been reimbursed for personal trips and dinners at his home, that he gave his son a company laptop to take with him to college, and that he billed Kearney for the cost of traveling to board meetings for Maytag Corp. (MYG ) and other companies where he was a director--expenses those companies already paid him for. In early 1995, Steingraber was also reimbursed $37,428.66 for a sumptuous 50th birthday party for his wife, complete with a magician and surprise visits from her sisters, who were flown in from Germany.

In his legal response, Steingraber acknowledges that he may have erred in reporting some expenses, but he says they were unintentional, totaling only $6,600, a pittance for a CEO expected to entertain clients and employees around the world. The birthday party was attended by executives from scores of Kearney customers who would go on to ring up $170 million in bookings, he claims, and the dinners were business functions of top Kearney executives and clients. He says EDS trumped up the charges to avoid having to pay out millions of dollars worth of restricted stock and options owed to him. Steingraber and his attorney, Rosenbloom, declined further comment on the dispute.

Steingraber goes even further in his response, accusing EDS of cooking the books. Discovery hasn't yet begun in the federal lawsuit, which is slated for trial in November if it can't be resolved through mediation. But damning details could emerge. BusinessWeek has learned that Kearney executives have raised concerns about overly aggressive revenue recognition by EDS under Brown. An EDS spokesman says the firm's accounting is proper and calls Steingraber a "disgruntled former employee."

Insiders say the litigation has increased the bad blood on both sides. In early January, Consulting magazine named Kearney the industry's most stressful place to work. More than a dozen top consultants have hired attorneys to negotiate their exits, and the firm is losing key people to rivals. "EDS has driven this great firm into the ground," laments Jess Scheer, who tracks the industry for Kennedy Information Inc.

Soon after the Consulting article appeared, scores of Kearney's 270 officers had an impromptu gripe session at their annual confab in Dallas. The next day, they took their concerns--from confusion over the firm's role within EDS to the disappearance of Christmas cards for clients--to Ostermann and Brown. The duo vowed to address the complaints by mid-February. But this rancorous relationship may be beyond repair.

By Andrew Park in Plano, Tex.

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