Blood Feud

A bitter battle between two brothers is hurting Cree, a promising LED chipmaker

In years past, Christmas gatherings for the Hunter family were joyful occasions. The three Hunter boys would play football in their yard in Boone, N.C. Their mother, Annabel, would make paper angels for her sons, who would hang them on the Christmas tree. For a while, they had much to celebrate. In 1987, Eric, the middle son, and his younger brother, Neal, founded Cree (CREE ) Inc., a company that makes light-emitting diodes, or LEDs, which are semiconductor devices used to light mobile phones, car dashboards, and other products. Over the next decade, Cree grew to become one of the most successful startups ever to come out of the state's famous Research Triangle Park.

But at Christmas in 1999, the good cheer turned bitter. Eric, who had given up his chief executive post to Neal in 1994, had thought for several months that his younger brother was mismanaging the company. During the holidays, Eric voiced his concerns about the alleged misconduct, according to an affidavit from Eric's wife. The tension boiled over one night after dinner at an aunt's house, when the brothers and their cousins were outside having a snowball fight. Eric pelted Neal, and Neal responded, Eric says, by slamming him to the ground, cutting his leg. "There was blood all over the place," says Eric. Neal declined to comment on the incident.

Since then, the fight has escalated into a high tech family feud. Eric, now 44, has unleashed a blistering attack against his 41-year-old brother, culminating with a lawsuit filed in June that seeks $3.2 billion in damages from Neal and Cree. In the suit, Eric accuses Neal of artificially inflating Cree's revenues by concocting sham transactions with Charles & Colvard (CTHR ) Ltd. (C&C), a gem manufacturer that Eric co-founded in 1995 with his older brother, Jeff. Eric also alleges that Neal filed false financial statements with the Securities & Exchange Commission and made millions selling Cree stock based on nonpublic information. And Eric contends that since he started publicly questioning Neal's activities, he has been followed by strangers and threatened with physical harm. He currently is living in Switzerland -- to protect his family, he says.

Cree and Neal Hunter say these charges are absurd. The company maintains all its dealings with C&C were proper, that its financial statements are sound, and that Neal's stock sales violated no laws. Cree's current chief, Charles M. Swoboda, adds that Cree has never authorized anyone to follow Eric or his wife, Jocelyn. Cree lawyers have asked for Eric's case to be dismissed. "The airing of personal family grievances in the guise of securities fraud and harassment claims against a public company is an improper use of the judicial system," Cree said in a court filing. C&C lawyer Bill Raper says: "The allegations are somewhat outlandish, and we intend to vigorously defend [against] them."

How vigorous the defense will be is becoming apparent. Lawyers for Cree have responded to the legal assault by attacking Eric Hunter's mental health. In nine affidavits, including statements from his mother and brothers, Eric is described as a problem drinker who uses prescription drugs to control his anxiety. The filings, copies of which were obtained by BusinessWeek, include several descriptions of unusual statements by Eric. They include assertions that Eric said he worked for the Central Intelligence Agency, that his family was linked with the John F. Kennedy assassination, and that Cree was involved with someone who threatened to kill former Vice-President Al Gore. "I have watched Eric's mental health decline over the past decade and particularly over the past three or four years," said his mother in her June affidavit.

Eric Hunter says he is not mentally ill. He denies making any of the bizarre statements attributed to him and says he never has been diagnosed with "any psychosis." He admits to taking Quazepam to help with anxiety and Ambien for insomnia. And he says he does not have a problem with alcohol. "Have I been depressed at times and drunk a six-pack of beer? Sure," said Eric, during an interview from Interlaken, Switzerland. "Do I have a drinking problem? No." Dr. John Hand, a professor at the University of North Carolina School of Business, who has gotten to know Eric over the last four years, made an affidavit in which he said he had never seen Eric exhibit "any signs of mental instability," and a private investigator hired by Eric's attorneys testified that "it became very clear to me that the Hunters were indeed being followed."

The saga of Cree and the Hunter brothers is a cautionary tale of how family feuds can dim a company's promise. Since the lawsuit was filed, Cree's stock has tumbled by 39%, to around $14 a share, slicing $700 million off its market capitalization. Short-sellers are swarming: With 33% of its shares sold short, Cree has the second-largest short-interest ratio on the NASDAQ. At least 15 class actions have been filed against Cree, echoing many of the charges outlined in Eric's complaints. On July 10, Cree disclosed in a financial filing that the SEC had opened an informal investigation into the company. And on July 29, the company reported disappointing earnings for the quarter ended June 30.

Strip away the internecine fighting, however, and Cree could have a bright future. The LED market is soaring, and Cree is one of the leading players, along with Nichia, Toyoda Gosei, and Osram. Because LEDs generally use less power and last longer, many scientists believe that as costs come down over the next 10 to 20 years they could replace Thomas Edison's lightbulb and reinvent the $40 billion illumination market. For the fiscal year ending June 30, 2004. Friedman Billings & Ramsey & Co. expects Cree to boost sales 21%, to $278 million, and profits 23%, to $44 million. "We don't think it's unrealistic to go after $1 billion in sales within five years," says Cree CEO Swoboda.

So why is Eric Hunter attacking the company he founded -- as well as his own flesh and blood? Eric says he first became upset with his brother in the early 1990s, when he was still Cree's chief executive. Among other things, Eric was distressed by Neal's relationship with a Charlotte (N.C.) stockbroker named Burt Davis. Eric says in his lawsuit that Davis artificially pumped up Cree's stock by promoting it to institutional investors -- a charge Davis denies. Eric resigned as Cree's CEO in 1994 because "I didn't want to deal with all the crap," he says. In recent years, Eric has become increasingly agitated by actions that he thinks are unethical and potentially illegal. "We're just out for justice," he says.

The Hunters were not always at war. They started out as a tight-knit, North Carolina clan. Their father was a doctor, and Mom was a homemaker. But their happy childhood was shattered when their father committed suicide in 1967. "They found him in a graveyard where he cut his wrists," says Eric. To this day, Eric says he does not know why his father killed himself.

The boys remained close. Eric and Neal swam on Watauga High School's relay team together. All three boys attended North Carolina State University in Raleigh in the early 1980s. And when Eric came up with the idea of starting a company based on a new semiconductor technology that he worked with at N.C. State while getting his masters in materials science, he turned to Neal. "We met at a biscuit place in Boone and decided to do the company," recalls Eric. They called it Cree after their old man, Charles Cree Hunter.

Eric ran the company for seven years and took it public in 1993, but he handed the reins to brother Neal in August, 1994. Neal, say several investors and former Cree executives, proved to be a better manager than Eric had been. Over the next few years, sales and profits soared. "Cree would not have been a tenth as successful without Neal Hunter," says Bob Lynch, who served as Cree's vice-president for operations from 1994 to 2000.

Eric took advantage of his decreased responsibilities to start a new business. In June, 1995, he and Jeff founded C3, now known as Charles & Colvard, to create gems out of silicon carbide crystals. They named the company after their father and grandfather, Fred Neal Colvard, who helped raise the Hunter boys after their dad's suicide. Jeff was chairman and president, while Eric was a consultant and the biggest shareholder, with 18% of its stock. Neal was granted 70,000 shares of stock but had no operational role in C&C.

Several years later, Cree and C&C began to have such close dealings that they came in for criticism from Eric. And some analysts and accounting experts say they used unusually aggressive accounting. Off Wall Street, an investment research firm, published a report in December, 1999, calling attention to Cree's dependence on sales to C&C. For the fiscal year ending June 30, 1999, Off Wall Street concluded that sales of silicon carbide crystals to C&C made up 24% of Cree sales and 75% of its operating income. Off Wall Street wrote that Cree's growing sales to C&C coincided with C&C's ballooning inventory. In the quarter ended Sept. 30, 1999, C&C had 977 days of inventory, up from 341 the quarter before. "It is difficult to think that the fact that inventory is rising is anything other than an accommodation to Cree," wrote Off Wall Street. In its 10-K filing for 2001, C&C said the excess inventory was in anticipation of "substantially greater sales growth than we have experienced to date."

Other transactions between Cree and C&C drew fire, too. From 1998 to 2000, Cree sold $6 million worth of equipment to C&C, but the gear never left Cree's premises, and Cree continued to operate it. "Given that Cree is operating the equipment, it sounds like a true sale has not taken place," says J. Edward Ketz, a professor of accounting at Pennsylvania State University. Cree maintains that the transaction was a legitimate deal to add capacity to service C&C and that it had set up a two-person committee to prevent potential conflicts of interest.

About the same time, Eric became concerned about stock sales by his brother. He alleges that Neal sold Cree stock before it was apparent to the public that Cree's December, 2000, acquisition of UltraRF, a wireless chipmaker, would not work out. Trading records show that Neal sold 150,000 shares of Cree stock eight months before Cree disclosed a $76.5 million write-off related to UltraRF in April, 2002. The holdings were worth more than $3 million and made up about 30% of Neal's holdings. In the two months following the disclosure, Cree's stock fell about 18%, to $18. Neal says that his stock sales were part of a broad plan to diversify his assets -- and he points out that he exercised options on 200,000 shares in February, 2002, and held on to the shares until after the April announcement. Columbia University law professor John C. Coffee Jr. says the options exercise "is inconsistent with the normal pattern of insider trading."

Eric says that after he began talking to the SEC in early 2003, the threats picked up, including several phone calls in which people have threatened his life. In June, Eric, his wife, and two children moved to Europe. Now, Eric says he just wants to set things right at Cree and return to a quiet life in the States. "All we want to be is left alone," he says. That won't happen anytime soon: Eric will return to the U.S. for a court hearing on Aug. 14.

By Spencer E. Ante in New York

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