It all started one September day in 2003. That's when the hard-drive light on Gabe Newell's PC started flashing at bizarre times. The problem persisted even after he reformatted his hard drive and ran a virus scan. So he sent an e-mail to check if anyone else's PC was on the fritz. "Has anyone seen anything weird going on?" he asked the staff. No one responded.

Then something even weirder happened. A copy of an e-mail between Newell and Valve programmer Dave Riller appeared on the Internet. It was an innocuous e-mail about Counter-Strike. "It wasn't me saying, 'You know, the Doom 3 engine is looking really good right about now,'" Newell jokes. But how did the private e-mail end up online? Newell walked down to Riller's office and asked if he had forwarded it to anyone. Riller said no. "All of a sudden I got this sinking feeling," Newell says. He started to worry that someone had figured out his e-mail password. He quickly changed it. Problem solved? Not quite. "In retrospect we were looking for bruises when our throats had already been cut," he says.

As Newell looked into the situation more closely, he came to an alarming conclusion: "We were f***ed." He found odd software installed on his machine. There were hidden hard-drive partitions. The network activity on Valve's servers showed uncommon spikes. When he began to check other computers, he found at least 13 that had similar software installed. Valve's security had been compromised. Racing around the office, he told everyone to disconnect their computers from the Internet. He started pulling wires out of walls, shutting down computers and effectively cutting Valve off from the outside world.

After hearing of the Source code theft, fans made a poster parody of 'Pirates of the Carribean'

It was too late. As soon as the hacker realized that his access had been cut off he started releasing to the Internet parts of what he had been able to obtain from Valve's network. On October 4, the first bomb dropped: The entire source code to Half-Life 2 was let loose. Newell was furious, but he also didn't know if it was the start or the end of the hacker's plans. "It's not like someone hands you a card that says, 'This is how screwed you are,'" he says.

The source-code leak turned out to be only the opening salvo from a man calling himself "Osama Bin Leaker." (It would later be learned that the hacker was "Axel G," a 21-year-old man in Germany). On October 7, only three days after the source code leaked, the second bomb dropped: A playable version of the game was released, including portions of the E3 2003 demo. Newell didn't know what to think--was the worst over? "It just felt like each day things kept getting worse," he recalls. "First the source code. Then the game. And then people started using the game to compose their own screenshots of Dr. Kleiner performing [oral sex] on Alyx. It's basically your worst nightmare."

Osama Bin Leaker said the E3 demo of Half-Life 2, including this attack by a Hydra, was fake.

The theft of the game and its release to the Internet was a crushing blow for Valve. But it had an even worse aftershock: It exposed the real state of the game's development as of September 19, only 11 days before the scheduled release. In his notes accompanying the release, Osama Bin Leaker said, "I'd like to point out this is what you wanted Valve to release on 9/30/03." And then he added a pithy footnote: "I'd like to point out the E3 demo was one big fake by Valve."

For months Newell hadn't told anyone about the state of the game. Now he was getting his comeuppance--the game was speaking for itself. Those who obtained the illegal release found a game that was nowhere near finished. While it was uncertain if the leaked version fully represented Valve's progress, some insensitive fans took pleasure in the effects of the code theft. Valve got what it deserved for lying to us, they claimed.

Conspiracy theories started bouncing around the Internet. Some fans advanced the theory that perhaps Valve deliberately leaked the code to buy itself more time and deflect attention from the delay. (This, of course, was not true). Still, it was strange that the game leaked only days after September 30. Newell says the hacker's claim that he released the code to prove Valve was lying about September 30 was, as he puts it, "utter bulls***." What triggered the code release wasn't the date," Newell says. "They knew we had discovered them in our network so they were just going to go ahead and release what they had. They just made up a goofy excuse."

The damage had already been done. At Valve no one knew what the code theft meant for a project that had been through its fair share of twists and turns. Would this unthinkable crime derail the game? Newell had no idea how to measure the impact of what had just happened. And worse, the team members--the people who had spent more than four years tirelessly working on the game--were absolutely crushed to see their unfinished work exposed to millions.

One young designer brought his concerns right to Newell in his office. "Gabe," he said, "is this going to destroy the company?"