June 30, 2004

Siebel in Reg FD Trouble Again --
What Were They Thinking?

You probably saw in the business news that Siebel Systems has gotten itself into Regulation FD (Fair Disclosure) trouble again. See the Securities Litigation Watch for a trenchant summary, along with links to the primary SEC documents. My own take on it is in the extended post.

This case fits into the category of "what were they thinking?" According to the SEC's complaint, the Siebel CFO and its investor-relations guy were doing a road show. They met with several different institutional investors.

At one of these investor meetings, the CFO allegedly made comments about the pipeline looking good, and then did so again at a private dinner with six investors, hosted by Morgan Stanley. This was supposedly contrary to the cautious public guidance the company had previously released.

Surprise, surprise: The stock moved up the next day. Apparently, some of the institutional investors bought in (in one case, liquidating a short position and taking a long position).

Rumors started circulating about what the CFO had said. An investor posted a message on a board, saying, "CFO speaking positively on business conditions at an event last night."

Some or all of this attracted the SEC's attention, especially since Siebel had been in Reg FD trouble already, just six months before.

The Siebel IR guy was at all these investor meetings and at the Morgan Stanley dinner. According to the SEC, the IR guy "did not assess whether Goldman [the CFO] had disclosed material nonpublic information at the meeting, did not counsel Goldman not to disclose material nonpublic information about current business conditions, and made no effort to ensure that Goldman discussed only information that had already been publicly disclosed when he appeared at the Morgan Stanley dinner a few hours later."

The SEC is suing the company, the CFO, and the IR guy, for the selective disclosure, and because they failed to follow up with a public disclosure. The SEC is seeking civil penalties against all concerned.

This case will undoubtedly settle. The settlement can be expected to involve a consent decree that requires Siebel Systems to implement stringent controls on its investor-relations program.

Moreover, the company -- and the two executives -- likely will have to disclose the settlement in 10-Ks, proxy statements, and the like for a long time to come.

June 30, 2004 in Embarrassments / Bad Career Moves, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

June 18, 2004

Hang Up the *#*$ Speakerphone

From Securities Liltigation Watch's description of a California appeals court decision:

Three Marvell employees--Marvell's general counsel; its VP of engineering, and in-house patent attorney--gathered to call a person at Jasmine, a company with which Marvell was negotiating to purchase some technology. Using a speakerphone, the three left a message on the Jasmine employee's voicemail. However, after leaving the initial message, they failed to hang up the speakerphone, and proceeded to have a conversation that also was recorded on the voicemail.
. . . As summarized by the California Court of Appeals (Sixth District), the contents of the inadvertent voicemail "demonstrate[d] [Marvell's] theft of Jasmine's trade secret, the potential consequences and the planned cover up."

I once had a close call along somewhat the same lines (although in that case the recorded conversation was essentially harmless). At the time, we had a new phone system which many of us were still learning to use.

A colleague came to my office to call another party from my conference-table speakerphone. We wanted to talk to the other party about a transaction we were negotiating with him.

The other party wasn't there. My colleague left a brief voice-mail message and disconnected the call. (Or so he thought.)

My colleague and I chatted in my office for a few minutes about the negotiation. He left my office; I went back to work at my desk.

A few minutes later, to my shock, I heard a female voice on my conference-table speakerphone. The voice announced, "If you have finished recording, you may hang up, or press 0 to reach an operator."

Damn. We had inadvertently recorded our entire conversation about the negotiation on the other party's voice mail. What to do?

Fortunately, I retained enough presence of mind to realize that the female voice on the speakerphone was familiar: The other party evidently used the same voice-mail system as my law firm.

I quickly pressed the keys to delete the message. With great relief, I heard the voice announce, "Your message has been deleted."

Lesson: After leaving a voice-mail message, make sure you've actually hung up the phone.

June 18, 2004 in Embarrassments / Bad Career Moves | Permalink | Comments (0) | TrackBack

October 31, 2003

Alone, Unarmed (maybe), and Uninsured

Here's a story about a software vendor that found out -- in probably the worst possible way -- that its general-liability insurance policy did not have the specific coverage that was probably the most crucial for the vendor's software business. Not a good day for the vendor's risk-management people.


The software vendor was a company called Professional Data Services (PDS). Its software was used to help manage medical clinics.

The customer apparently was an opthamology practice or maybe an optometry shop, Heart of America Eye Care, P.A. I'll just call it "the eye clinic."

The software license agreement dated back to 1995. It was a pretty vanilla agreement, judging from the court's sketchy description of it. The agreement gave the eye clinic a license to use several of the vendor's software programs, and required the vendor to investigate and correct problems with the software.

The Vendor-Customer Dispute

At some point the eye clinic had problems with the software. In April 2002 -- some seven years after it first acquired the software -- the eye clinic sued the vendor, PDS. The eye clinic claimed:

  • that PDS failed to provide the required training, customer service, investigation, and correction of software problems;
  • that PDS improperly maintained the software;
  • that the software was not fit for the purposes for which it was intended [Editorial comment: Most software license agreements expressly disclaim any warranty of fitness for a particular purpose; perhaps this agreement didn't do so];
  • that the software did not satisfy the medical accounting needs of the eye clinic [Editorial comment: Many software license agreements expressly disavow any commitment to satisfy the customer's particular needs]; and
  • that PDS misrepresented the quality of service and support it would provide to the eye clinic. [Editorial comment: Many software license agreements contain an "integration" clause that says, among other things, that neither party is relying on any representation of the other except as expressly set forth in the agreement. It sounds like this agreement didn't say that.]

The Missing Insurance Coverage

The vendor, PDS, apparently figured that its insurance carrier would pay the attorneys' fees for defending against the eye clinic lawsuit. It no doubt was also counting on the insurance to cover any damage award that the eye clinic might receive (up to the policy limits, of course).

The insurance carrier thought otherwise. It filed its own, separate lawsuit against the vendor (and the customer too), seeking a judicial declaration that there was no coverage and no duty to defend.

Right you are, the court said. The applicable coverage in the insurance policy was for "property damage." That phrase was defined in the policy as (i) physical injury to tangible property or (ii) loss of use of tangible property that is not physically injured. Loss of use of a software package and corruption of intangible data doesn't count, at least not when the computer itself isn't damaged or rendered useless. The court cited other recent judicial holdings to the same effect.

So, the software vendor is now facing, uninsured:

  • the expense of defending against the customer's lawsuit; and
  • if it loses, the expense of paying any resulting damage award.

The customer didn't necessarily come out ahead here either, because without insurance coverage, the vendor may not have the assets to pay a damage award.

(Cincinnati Insurance Co. v. Professional Data Services, Inc., No. 01-2610-CM, U.S. District Court, District of Kansas, July 18, 2003)

Possible Lessons

If you're a software vendor:

  • Check your insurance policies to make sure you have coverage for information and network technology errors and omissions -- a general-liability policy may not cut it.
  • Take a look at the warranty disclaimers in your standard license agreements.
  • Remember that disputes can arise even with long-time customers.

October 31, 2003 in Embarrassments / Bad Career Moves, Finances, Litigation, Sales | Permalink | Comments (0) | TrackBack

October 15, 2003

Advertising Heartburn

Sometimes it seems there’s no shortage of object lessons about the troubles that over-enthusiastic advertising can cause. Procter & Gamble (P&G;) ran ads for a new heartburn product, Prilosec OTC. The ad copy read, "One pill. 24 Hours. Zero Heartburn" The ad copy apparently gave Johnson & Johnson heartburn of a different sort – it filed suit against P&G.;

In response to J&J;’s motion for a preliminary injunction, a federal judge in New York found that P&G; had engaged in false advertising. The judge prohibited P&G; from continuing its ad campaign pending a full trial. (Johnson & Johnson-Merck Consumer Pharmaceuticals Co. v. The Procter & Gamble Company, No. 03 Civ.7042(JES) (S.D.N.Y. Sept. 25, 2003).)

If the parties don't settle before trial, P&G; may find itself staring down the barrel of a big damages award for corrective advertising, under precedent such as one of my favorite case stories, that of U-Haul v. Jartran.

Literally False Claims

First let's take a quick look at the law of false advertising from 10,000 feet. It's actually pretty straightforward -- as Judge Sprizzo noted in the J&J; v. P&G; case, “To prevail on a false advertising claim, a plaintiff must establish that defendant's advertisements are either (1) literally false or (2) although literally true, likely to deceive or confuse consumers.”

Judge Sprizzo zeroed in on the first prong of this test, i.e., whether the P & G ads were literally false. That seemed to be a no-brainer, at least to the judge:

[T][he claim advanced by P & G's advertising--essentially, that 24 hours heartburn relief can be achieved with one pill of Prilosec OTC--is literally false. "One pill. 24 Hours. Zero Heartburn" simply does not equal "One pill. Wait 5 hours. Only then Zero Heartburn for the next 24 hours."
(Emphasis added.)

Coming Soon: J&J;’s Quest for a Damage Award?

P&G;’s legal troubles almost surely aren’t over. It likely will have to face J&J;’s claim for sizeable monetary damages. On that subject, I used to like to tell clients the story of the U-Haul v. Jartran case from the 1980s. Jartran was found liable for false advertising that compared its rental trucks and trailers to those of U-Haul. In the wake of the ad campaign, Jartran's sales had boomed, and U-Haul's sales had slumped. The court awarded damages to U-Haul in the amount of $40 million, representing:

  • the $6 million cost of Jartran’s ad campaign, on the theory that Jartran must have derived at least that much benefit from its ad campaign; plus
  • the $13.5 million cost of U-Haul’s corrective-advertising campaign; plus
  • another $20 million (in effect doubling the award) as a kind of punitive damages permitted by the Lanham Act in exceptional circumstances. The increase in damages presumably was motivated by what the trial court described as Jartran's “deliberately false comparative [advertising] claims.”
The $40 million damage award was upheld by the appellate court. U-Haul Intern., Inc. v. Jartran, Inc., 793 F.2d 1034 (9th Cir. 1986).

Possible Lessons

It doesn't take a rocket scientist to figure out the lessons here:

  • Be careful about the factual statements and implications that you put in your advertisements and other marketing materials.
  • Be even more careful if you're going to run ads comparing your products or services -- even implicitly -- with those of a competitor.

October 15, 2003 in Communications, Embarrassments / Bad Career Moves, Marketing | Permalink | Comments (0) | TrackBack

October 13, 2003

How Much Would Actual Subscriptions Have Cost?

MSNBC reported last week that money-management firm Legg Mason was hit with a $20 million jury verdict for copyright infringement, for internally distributing a stock-market newsletter when they had only paid for a single subscription. Thanks to TechLawAdvisor for the tip.

October 13, 2003 in Embarrassments / Bad Career Moves, IT Management, Intellectual Property | Permalink | Comments (0) | TrackBack

October 09, 2003

Backdated Sales Contracts Resurface Years Later

The CFO of software giant Computer Associates was forced to resign, along with two other senior financial executives of the company -- and who knows what else now lies in store for those folks -- because several years ago the company "held the books open" to recognize revenue for sales contracts signed after the quarter had ended.

According to CA's press release of yesterday, in the fiscal year ended March 31, 2000, the company took sales into revenue in Quarter X even though the contracts weren't signed until after the end of the quarter. See also these stories from Reuters, the AP, and Dow Jones.

(Continued below)

CA stressed that the sales in question were legitimate and that the cash had been collected; the issue was one of the timing of revenue recognition. The Audit Committee was still looking into whether the company's financial results would need to be restated. In the above-cited news stories, outside observers speculated that the company was attempting to position itself to minimize the SEC penalties that were likely to be imposed.

These revenue-recognition problems came to light during an Audit Committee inquiry triggered by a joint investigation by the U.S. Attorney's office and the SEC. It just goes to show that past sins can come to light years after the fact, possibly as a domino effect of unrelated events.

A May 2001 column, The Fraud Beat, by Joseph T. Wells, in the Journal of Accountancy, has a readable explanation of this so-called "cut-off fraud" and how it can be detected. The column recounts a couple of interesting war stories, including one about a Boca Raton company that programmed its time clocks to stop advancing at 11:45 a.m. on the last day of the quarter. The company would continue making shipments -- with the paperwork time-stamped by a stopped clock -- until sales targets had been met, at which point the time clocks would be restarted.

As I observed in a previous post, backdating a contract can be perfectly legal in some circumstances, but -- as illustrated here -- not when it comes to recognizing sales revenue.

It remains to be seen what else will happen to the three former CA financial executives. It can't be a good thing for their peace of mind that the Justice Department and SEC are already involved.

October 9, 2003 in Accounting, Contracts, Embarrassments / Bad Career Moves, Finances, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

October 01, 2003

Will Your PPT Slides' Footer Help Lose a Lawsuit Too?

Last week a court poured out * Storage Technology's corporate-raiding lawsuit against Cisco. One of the nails in the coffin was the way that Storage Tech had protected -- or more accurately, failed to protect -- the alleged trade secrets that Cisco had supposedly misappropriated. While that alone didn't lose the case for Storage Tech, it didn't help, and it likely has triggered some internal recriminations at Storage Tech.

* When a lawsuit is "poured out," it generally means the lawsuit was dismissed, in this case, by the granting of summary judgment.

Here's the story:

The Lawsuit

The parties to the lawsuit are well-known players in the tech sector. Storage Technology makes various disk- and tape storage devices, as well as equipment for storage networking and management. Cisco is "the worldwide leader in networking for the Internet," according to its Web site. In late 1999 and into 2000, several of Storage Tech's employees left to join NuSpeed, Inc., a start-up company that opened in January 2000. In September 2000, Cisco bought out NuSpeed for some $450 million in Cisco stock.

(Wait a minute -- in September 2000, long after the tech bubble had burst, the NuSpeed guys got $450 million in stock for their nine-month old company? Wow. Don't be too envious, though. As this chart shows, Cisco's stock price joined the plunge in the months following the acquisition. Depending on how long the lock-up was for -- I couldn't seem to find the acquisition agreement in Cisco's SEC filings -- the NuSpeed people probably didn't net nearly as much as they had hoped.)

Anyway, Storage Tech sued Cisco shortly after the acquisition closed. The gravamen of the lawsuit was that Cisco allegedly had interfered with the noncompete, nonsolicitation, and nondisclosure provisions in the employment contracts of the former Storage employees who had gone to NuSpeed. Three years later (viz., last week), the judge granted summary judgment for Cisco on all counts, largely because Storage Tech had failed to come forward with evidence of actual damages.

Storage Tech's Secrecy Problems

At one point, the judge zeroed in on Storage Tech's supposedly-cavalier treatment of what it was claiming to be trade-secret information:

As to the requirement of reasonable efforts to maintain the secrecy of the information, the [Minnesota Uniform Trade Secrets Act] requires neither the maintenance of absolute confidentiality nor the implementation of specific measures to maintain the secrecy of a trade secret. A plaintiff asserting a misappropriation claim must demonstrate that it undertook some effort to keep the information secret.

Here, Storage used general employee-confidentiality agreements, but such agreements are insufficient to satisfy the statutory requirement. [Editorial comment: That doesn't seem like a correct statement of the law, but maybe the judge was making a specific statement about these particular circumstances.]

Given its rejection early in the product development process, very little information about the SAN Appliance exists. What little information does exist was not the subject of reasonable efforts to maintain its secrecy. For example,

  • the author of the slide presentation did not mark it as confidential because he did not believe the design of the SAN Appliance was confidential, proprietary, or a trade secret. None of the limited documentation of the SAN Appliance was marked confidential.
  • Nor did Storage secure the documentation related to the SAN Appliance. Storage admits that it found the documentation on back-up disks left behind by departing employees. [Editorial comment: It's hard to see how this one example weighs against secrecy.]
  • Moreover, upon the resignation of the slide presentation's author, Storage did not inform him of the secrecy of the SAN Appliance. [Editorial comment: This doesn't sound right at all. It doesn't seem reasonable to expect that an employer, in every exit interview, must go through and list every trade secret that the departing employee is expected to keep secret. But again, maybe the judge was referring to the specific facts and circumstances of this case.]

In short, viewed in the light most favorable to Storage, the record reveals that Storage did not subject information about the SAN Appliance to reasonable efforts to maintain its secrecy.

(Emphasis, paragraphing, and bullets added, citations omitted.)

As you can tell from the editorial comments above, I think the judge probably goofed here. It could be that the judge didn't have sufficient evidence presented about Storage Tech's security system. From the discussion in the judge's opinion, it seems to me that if Storage Tech had the usual corporate security systems in place -- locks on the doors, passwords to access the network, etc. -- the judge should have let the secrecy claim go to the jury. But then I have yet to be appointed and confirmed as a federal judge, so my opinion counts for exactly zero.

The overall tone of the opinion suggests that the judge didn't think much of Storage Tech's trade-secret claim concerning a product proposal that it apparently had never even tried to develop. In all likelihood, he was going to pour out Storage Tech in any case.

Possible Lessons

There are several lessons to be had in this case, but here's a big one: Make an effort to label your confidential documents as "Confidential" or "Proprietary." If you don't, a judge might later use that as an excuse to deny your claim that the documents contain trade secrets -- if you didn't treat the documents like trade secrets, why should the court?

(On the other hand, don't go overboard with your confidentiality stamp -- the credibility of your secrecy assertions may well be diluted if you unthinkingly label the menu in the company cafeteria as confidential.)

October 1, 2003 in Embarrassments / Bad Career Moves, Intellectual Property, Marketing, R&D;, Record-keeping | Permalink | Comments (1) | TrackBack

September 25, 2003

Insider Trading is Bad Enough;
Lying to the SEC About It Is Worse

In the latest insider-trading bust, the SEC settled a case with a North Carolina lawyer who was accused of trading on inside information concerning a client of his law firm. The lawyer allegedly netted a whopping $4,272 in profits, which he disgorged as part of the settlement (and in addition he paid an identical amount as a civil penalty). It appears he also got fired.

Mike O'Sullivan notes, in his Corporate Law Blog, that the North Carolina lawyer "has already lost his job at the law firm. It's unlikely he will ever earn a dime with his J.D. ever again -- even if he isn't disbarred, who'd hire him? . . . [H]ow long will it take him to earn back the trust and respect he frittered away?" Bruce Carton points out, in his Securities Litigation Watch blog, that the case is "a reminder that there really is no de minimis exception for persons who would engage in insider trading--if the SEC thinks they have the goods on you, they'll bring the case for deterrent value alone."

* * * * *

It could have been worse -- as a Philadelphia lawyer found out a few years ago in a different insider-trading case.

In that case, the Philadelphia lawyer, via a client, learned some confidential information about an upcoming acquisition. He bought 500 shares of the target company, then sold it after the acquisition was announced.

Here's where it got worse: SEC lawyers called up the lawyer and interviewed him about his stock trade. During the converesation, the lawyer "knowingly and willfully made a false statement when, asked about the reasons for his purchase, he failed to disclose that he had been informed of [the acquisition]."

So, not only did the SEC bring a civil case, it also referred the matter to the U.S. Attorney's office. The lawyer pleaded guilty to a one-count criminal information alleging that he had made false statements to federal officials in violation of 18 U.S.C. § 1001 -- which is a felony punishable by up to five years' imprisonment.

This lawyer had been the head of the corporate department of a Philadelphia-based law firm. He also was on the board of directors of the client that had disclosed the confidential information to him. What was he thinking?

I wasn't able to find out whether the lawyer went to prison. He did get suspended from practicing law for one year (he was later reinstated). I couldn't find him in the Martindale-Hubbell on-line database of attorneys, which makes me wonder whether he's still in practice.


1. If you trade on inside information, the SEC won't care how small your trade was or how little money you made.

2. If SEC investigators think you've lied to them, or withheld information from them, the range of possible bad things that could happen to you will expand dramatically.

3. Trading on inside information is a Bad Career Move. It likely won't matter what a stellar performer you were before -- as one of my Navy shipmates once said, "ten thousand attaboys can get wiped out in an instant by one aw-sh_t."

September 25, 2003 in Criminal Penalties, Embarrassments / Bad Career Moves, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

September 24, 2003

Hide Outside Comp, Forfeit Your Salary?

Last week the Second Circuit federal court of appeals in New York really dropped the hammer on an investment banker. The banker was a nominal partner in a small investment banking firm.

The banker had received stock, options, and cash compensation from certain of his firm's client companies that he was personally involved with. That was a problem: Under his employment agreement with his firm, all of that compensation was to have gone to the firm. Moreover, it seems the banker never mentioned to his firm what he was getting from these companies.

The banker left his firm to join one of the client companies as chairman and CEO. It was an amicable parting -- at first. But as he and the firm tried to sort out what the firm owed him, the firm tumbled to some of the outside comp that he had been receiving. That didn't go over very well.

Both sides filed lawsuits. When the dust settled, the appellate court held that, under New York law, the banker had been a "faithless servant" for receiving, and failing to disclose, his compensation from the client companies. Because the disloyalty had been so extensive, the court said, the banker had to forfeit all compensation paid to him by the firm -- including his salary -- from the time of his first act of disloyalty.

You can read the court's opinion at the Second Circuit's Web site -- look up case no. 02-7928, Phansalkar v. Andersen Weinroth.

September 24, 2003 in Embarrassments / Bad Career Moves | Permalink | Comments (0) | TrackBack

September 16, 2003

Side Letter in Sales Deal Leads to SEC Fraud Suit

Last week the SEC announced that it had filed a civil lawsuit against a former Logicon executive who allegedly placed a $7 million order with Legato Systems that included a secret side letter giving Logicon the right to cancel its purchase. According to the SEC, the Logicon executive not only knew that Legato planned to fraudulently misstate its financial results, he even advised Legato's sales people how to conceal the cancellation right from the Legato finance department.

LESSON: The SEC's news release quoted Helane L. Morrison, District Administrator for the Commission's San Francisco District Office, as saying, "Sales executives who book phony deals often rely on assistance from people who work for their customers. Today's action highlights the Commission's resolve to hold such persons responsible when they knowingly assist in fraudulent revenue recognition practices."

September 16, 2003 in Accounting, Contracts, Embarrassments / Bad Career Moves, Purchasing, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

September 12, 2003

Big Fine for Helping Customer Cover Up Business Losses

Insurance giant American International Group was hit with a $10 million fine for doing a deal with one of its customers that was supposed to look like insurance for the customer but in fact was designed to reduce the financial loss reported by the customer. Compounding AIG's problem was that the SEC was reportedly infuriated by AIG's withholding of documents. See the New York Times article (free subscription required).

September 12, 2003 in Embarrassments / Bad Career Moves, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

August 26, 2003

Former Morgan Stanley Exec Should Have
Purged His Blackberry Before Selling it on eBay

Wired magazine has a story about an (unidentified) former Morgan Stanley executive who, some time after leaving the firm, sold his Blackberry email pager on eBay. He didn't seem to realize that he had left a great deal of confidential information on the pager. Some of that information conceivably could have gotten him in trouble with the SEC if the buyer had traded on inside information. His former employer was not pleased.

Quotable quotes:

  • "Paige Steinbock, a partner in headhunting agency Korn/Ferry International, called the database of Morgan Stanley employee names and home phone numbers 'a virtual gold mine of information.'"
  • "The VP who sold the BlackBerry said he had no idea data could remain on a device long after the battery was removed."
  • "Judging from the windfall of info captured on the VP's BlackBerry, the financial expert interviewed for this story said he could only imagine the wealth of information people could gather if they placed ads for used BlackBerries online and waited for the devices to roll in."

August 26, 2003 in Embarrassments / Bad Career Moves | Permalink | Comments (0) | TrackBack

August 25, 2003

Doctors Have to Explain Joke
Chart Notations on Witness Stand

The BBC's Web site reports that many doctors are being more cautious about the notes they write in their patients' medical records. Why is that? Because the doctors are starting to realize that someday, on the witness stand, they might have to explain their abbreviations and slang. Here's a sampling:

  • CTD: Circling the Drain [i.e., the patient is not expected to live long]
  • DBI: Dirt Bag Index
  • LOBNH: Lights On But Nobody Home
  • TTFO: Told To [Go Away] -- see the BBC story to read the "save" by the quick-thinking doctor who was asked about that one in court.

Sorta makes me glad my writing isn't funny.

August 25, 2003 in Embarrassments / Bad Career Moves, Litigation | Permalink | Comments (0) | TrackBack

August 23, 2003

Backdating Contracts Leads to Prison Term --
But It Can Be Entirely Proper

From the notes I took while getting ready to start this blog:

A former public-company CFO was recently sentenced to three and a half years in federal prison. His company, Media Vision Technology, had inflated its reported revenues, in part by backdating sales contracts. Because of the inflated revenue reports, the company’s stock price went up – until the truth came out, which eventually drove the company into bankruptcy. (We've all seen that particular movie in the past couple of years, eh?)

The judge noted that the CFO had an otherwise-exemplary record. If the new, stiffer penalties of the post-Enron sentencing guidelines had applied, however, the CFO likely would have faced more than 10 years in prison. (The Recorder, Apr. 8, 2003; see archived story.)

But backdating a contract is not necessarily illegal, depending on the circumstances.

Let's look at a hypothetical example. Suppose that:

  • Jones is an end-customer from Customer Corporation. Smith is a sales rep from Vendor Corporation.

  • While playing golf together one Saturday, Jones and Smith start talking about a potential sales deal. (That’s why I keep telling myself I should learn to play golf.)

  • During their conversation, sales-rep Smith tells Jones about some features that will be in Vendor Corporation's next product release; he asks Jones to keep the information to himself, because it's still confidential. Jones says "no problem."

  • Monday morning, sales-rep Smith starts getting nervous about having disclosed his company's confidential information to Jones. He calls his company's lawyer. The lawyer drafts a nondisclosure agreement (NDA), which states that it is “executed to be effective as of” the previous Saturday.

  • Smith takes Jones out to lunch. While they're waiting for their food, he and Jones sign the NDA.

    (Whether Smith and Jones had authority to sign contracts under their companies' respective policies is another question -- many companies have internal policies that restrict who is allowed to sign what kind of contracts. But chances are that Smith and Jones each had apparent authority, vis à vis the outside world, and that may well have been enough to create a binding contract.)

So far, so good – the backdated NDA very likely will be deemed to be effective during Jones’s and Smith’s conversation on the golf course. There's no deception involved; the written NDA simply memorializes and fleshes out the oral confidentiality agreement that Smith and Jones entered into. (There's another lesson here, which is that oral agreements can sometimes be entered into very casually.)

Now change the facts a little, and the possibility of jail time looms into view:

  • Customer Jones and sales-rep Smith continue with their discussions. It ends up being a big-dollar deal. Smith, the sales rep, starts shopping for the new car that he intends to buy with his commission check. Jones and Smith work hard to get the sales contract executed by March 31, the last day of the first (calendar) quarter.

  • Unfortunately, however, Customer Corporation’s legal department is too busy to review the contract before March 31. Customer’s purchasing department refuses to sign the contract without the legal department’s blessing. (Damned lawyers, always screwing up deals . . . .)

  • On April 10, Customer’s legal department blesses the sales contract (finally!), without asking for any changes, so the purchasing department signs the contract – without dating it – and FAXes it back to Smith the sales rep.

  • A happy Smith and his sales director fill in “March 31” on the date line. The sales director signs the contract and sends a copy to Accounting. The company's controller calls up the sales director and says, "it's about time!"

If Vendor’s accounting department books the revenue in the first quarter, that might well constitute securities fraud. The Media Vision Technology CFO undoubtedly knew this. Unfortunately for him, he had the lesson reinforced the hard way, with a prison sentence.

August 23, 2003 in Accounting, Contracts, Criminal Penalties, Embarrassments / Bad Career Moves, Sales, Securities law, SEC regs / actions | Permalink | Comments (0)

August 13, 2003

Rigging a Promotion Costs Coca-Cola Big Bucks
and Triggers Grand-Jury Investigation

From the Career-Limiting Moves Department: Coke agrees to pay up to $21MM to Burger King for rigging results of market testing of Frozen Coke at BK restaurants. Wouldn't you hate to be in the shoes of the marketing managers who did that . . . .

In 2000, Coca-Cola and Burger King ran a promotional campaign to test the appeal of Frozen Coke, a slushy drink, at Burger King restaurants in Virginia. (Burger King is a huge customer for Coke fountain drinks.) If the test was successful, then Burger King would make Frozen Coke a regular offering.

Apparently the initial results of the campaign weren't pleasing to some people at Coke. They took steps to increase the Frozen Coke traffic at the test restaurants. Supposedly, this included paying a man -- without Burger King's knowledge -- to get hundreds of kids to go to Burger King restaurants and ask for the Frozen Coke meal deal. That made sales look pretty good. Burger King started to ramp up its Frozen Coke program.

Then, however, a finance executive in Coke's fountain-drink division was let go. He filed a lawsuit, claiming that he had been fired for whistleblowing. In his lawsuit, he accused Coke of rigging the Frozen Coke promotional campaign.

His accusations touched off investigations by the SEC and by the Justice Department. Coke was subpoenaed by a federal grand jury. Coke's corporate headquarters admitted that some of their employees had rigged the promotional campaign and said that it was cooperating with the investigations.

Needless to say, Coke's customer Burger King was not thrilled. Earlier this week, Coke announced that it had reached a settlement with BK. According to the New York Times, Coke agreed to pay up to $21 million to Burger King and its franchisees. Of course, Coke still has the SEC and the federal grand jury to worry about.

It's not clear what happened to the individual Coke employees who supposedly rigged the promotional campaign. Coke reportedly said it had "disciplined" them. It's safe to say they probably don't have stellar careers at Coke ahead of them. And who knows what punishment the federal prosecutors will demand.

Some possible lessons for corporate managers:

1) Remember the old saying that you shouldn't do anything you wouldn't want to see published on the front page of the New York Times.

2) Your corporate sins can come back to haunt you years later, especially if one of your colleagues leaves the company under less-than-happy circumstances.

3) What you think of as a simple error in business judgment, the Justice Department -- those friendly folks who can send you to federal prison -- might regard as criminal behavior. (And let's not forget the SEC and the private shareholder plaintiffs' bar. )

4) Angering one of your company's biggest customers is seldom a career-enhancing move.

5) Coke's marketing budget for Frozen Coke probably didn't include a $21 million payment to settle the dispute with Burger King. Busting that budget was unlikely to have been a career-enhancing move either.

Sources: New York Times story (free subscription required) and National Post (Canada) story (with more details on the former executive's accusations about the rigged promotional campaign); Google News search.

August 13, 2003 in Criminal Penalties, Embarrassments / Bad Career Moves, Marketing, Securities law, SEC regs / actions | Permalink | Comments (0)