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14. How can upgraded items get a lower Defense than the item had before?

Upgrading items does not guarantee higher stats. All it does is take a normal base item to exceptional status, or an exceptional item to elite status. The end stats depend on the stats of the upgraded base item.
Vampire Gaze is probably the most famous example.
Grim helms have a defense range of 60-125. All Vampire Gaze Grim Helms have a defense of 252. This is due to the fact that when armors spawn with the enhanced defense mod, the defense is invariably set at max +1. When we are dealing with a Vampire Gaze, the base item's defense of 126 receives a 100% bonus = 252 defense.
However, when the item is upgraded, the base defense is rerolled. The defense range of Bone Visages is 100-157. Which means that a Vampire Gaze with a base item defense of 126 has a very good chance of being turned into a Bone Visage with a lower defense. In case of the worst roll imaginable, your 252 defense Vampire Gaze would go down to 200. Not good.
Adeyke's upgrade calculator shows how upgrading will affect the various unique items.

Note that in the 1.10 patch, ethereal armors would lose their ethereal defense bonus when upgraded, in addition to having their defense rerolled. This is no longer the case, ethereal items now retain their defense bonus (although the hack fix implemented had most unfortunate side effects). Adeyke's page still shows ethereal upgraded items with the same defense as non-ethereal ones, but nevertheless, this has been fixed.

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38. How does the "Eth Glitch" work?

In Diablo 2 version 1.11 and 1.11b, there is a bug regarding the socketing of ethereal armors. Ethereal armors are assigned a 50% bonus to their base defense rating when dropped. This is normal. What is not normal is the fact that when sockets are added to an ethereal armor using the Horadric Cube, that ethereal defense bonus is applied again. The result is an armor with an absolutely impossible defense rating. Enhanced defense modifiers are then added to that base defense rating, so the difference in end defense is rather huge.
This bug appeared as a side-effect when the 1.10 ethereal armor upgrade bug was fixed (the bug is described in section 14). In order to fix that bug, a defense bonus of 50% was simply crammed into the ethereal unique armor upgrade formula. Unfortunately that fix also affected the ethereal armor socketing formula, making armors now gain a second defense bonus when socketed.

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It is not debatable whether this is a "bug" or an "undocumented feature". It is obviously a result of a programming flaw, making it a bug. Ask anyone who has looked at the code, ethereal armors gaining defense when socketed is NOT intentional. Not a chance.

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