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 15, 2004

Corporate Governance Changes
as Settlement Currency?

An article by Stephen Taub in today's Compliance Week ($) gives some examples of how companies seem to be using their executive compensation and other corporate-governance policies as "settlement currency" to help resolve shareholder lawsuits. The article's list of companies includes Cendant, Citrix, Enterasys, MCI, Sprint., and Siebel Systems.

The article says:

While denying that the actions taken were improper, [Cendant chairman and CEO Henry] Silverman and the other defendants agreed to significantly alter his existing contract. He agreed to move up the expiration date by five years, to Dec. 31, 2007, and reduced severance to no more than 2.99 times the prior year's compensation.

In addition, a significant majority of Silverman's bonus will now be subject to the attainment of certain performance-based earnings per share goals. Also as part of the compromise, the cash compensation portion of a post-employment consulting contract was reduced from life to a period of five years.

(Even the new contract still seems pretty rich to me, but hey, I don't move in those circles....)

We're likely to see more of this phenomenon, according to the article:

"It is definitely a growing trend," says Richard Koppes, of counsel to Jones Day Reavis & Pogue and former general counsel of Calpers. "It's beginning to happen in a fair amount of cases."

"It does seem like something that is gathering momentum," adds Bruce Carton, executive director of Institutional Shareholder Services' Securities Class Action Services.

A couple of years ago, I heard a speaker suggest that the street-smart company will deliberately hold back on some reforms of this kind. That way, if litigation should ever come to pass, the company will still have something to offer in settlement discussions. This was in a panel discussion on the law of sexual harassment, not corporate governance, but the principle would seem to be be the same.

I'm not sure where I come out on that idea: if a particular reform makes sense, I wonder whether you might be better off implementing the reform on your own initiative, before litigation, in the hope that it will help prevent litigation-causing events in the first place.

June 15, 2004 in Litigation, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

June 14, 2004

That $1.45 Million House May Not Look So Great Now

You're a public-company officer. Your company's been having -- or will soon have -- financial troubles. You've had a hankering for a million-dollar home in Florida. You might want to think twice about buying that house. A former officer of Homestore, Inc., who is now a defendant in a variety of securities lawsuits. recently learned that his purchase of a $1.45 million home in Florida could eventually be found to constitute a sheltering of his assets from creditors, which in turn could make him ineligible to have the company advance his defense costs in various securities lawsuits. See the opinion by the Delaware Chancery Court. (Link via BNA Corporate Counsel Weekly [$])

Here's what happened. Homestore.com's corporate bylaws contain a fairly typical indemnification provision. The provision is designed to protect the company's officers and directors if they are sued for their actions or omissions in that capacity. Under that provision, the company is required to indemnify the officer or director, and to advance the defense costs for the suit.

But there's a catch. To be entitled to indemnification, the officer must have "acted in good faith and in a manner which the person reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or Proceeding, had no reasonable cause to believe the person's conduct was unlawful." If the officer is ultimately found not to be entitled to indemnification, he or she must repay the company for the defense-cost advances.

Homestore's former officer, one Peter Tafeen, sued the company to get an advancement of his defense costs in the securities litigation. Homestore contested Tafeen's suit. It noted that, during the time that the alleged securities frauds were supposedly taking place, Tafeen had built a $1.45 million house in Florida. It argued that what Tafeen really had in mind was to shelter his assets, so that, if he were ultimately found not to be eligible for indemnification, he could avoid repayment of the company's advances of defense costs. This, the company said, constituted "unclean hands" that justified the company's refusal to advance defense costs.

The court agreed that this was a possibility. It said it could not determine Tafeen's intent without a trial (presumably including Tafeen's testimony and cross-examination). The court therefore denied Tafeen's motion for a summary judgment.

June 14, 2004 in Litigation, Securities law, SEC regs / actions | Permalink | Comments (1) | TrackBack

June 09, 2004

Adelphia Vendors Motorola, Scientific-Atlanta Implicated in Executives' Securites-Fraud Trial

Today's WSJ ($) reports that, in the trial of two former Adelphia executives, an email and witness testimony have implicated Adelphia vendors Motorola and Scientific-Atlanta as "allegedly help[ing] Adelphia cook its books."

According to [prosecution witness Jarmes R.] Brown's testimony in U.S. District Court in Manhattan, Adelphia in mid-2000 realized it was going to miss its earnings targets, in part because of higher-than-expected expenses related to the rollout of new set-top converter boxes -- the equipment that generally sits on top of cable subscribers' televisions -- that it had purchased from Motorola and Scientific-Atlanta.

Mr. Brown testified that Timothy Rigas, one of the former Adelphia executives on trial, suggested capitalizing the marketing and advertising expenses associated with the rollout of the equipment. That would stretch out the expenses and boost Adelphia's earnings.

The article notes that "the Securities and Exchange Commission has taken a harder line on suppliers, customers, bankers and others who knowingly helped companies commit accounting fraud."

See also SEC Hammers Company's Customers for Securities-Fraud Participation.

June 9, 2004 in Criminal Penalties, Finances, Litigation, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

June 04, 2004

After-the-Fact Contract Changes, Side Letter,
Lead to Federal Fraud Indictments

The Department of Justice recently announced that several former Enterasys executives had been indicted for securities fraud and wire fraud. According to the Justice Department, the accused executives altered an already-signed contract to change its terms -- after the close of the quarter -- so that revenue could be recognized in the quarter. One of the executives also allegedly drafted and signed a secret side letter giving a customer an exchange right, and insisted that the exchange right not be referenced in the customer's purchase order, so that revenue could improperly be recognized.

According to the Justice Department press release:

The Indictment further alleges that, several weeks after the close of the quarter and after learning that Enterasys’ outside auditors had selected the Ariel transaction for review, the conspirators allegedly caused the Letter of Agreement to be altered to delete or change the problematic terms. The altered Letter of Agreement was then backdated to create the false impression that it had been executed before the close of the quarter, and a new secret side letter reinstating the deleted terms was issued to Ariel. According to the Indictment, some of the conspirators caused the altered and backdated Letter of Agreement to be sent to the company’s outside auditors in connection with their review of Enterasys’ quarterly financial statements. Neither the original Letter of Agreement nor the side letter were provided to Enterasys’ outside auditors. Some of the conspirators also allegedly caused Enterasys to issue a press release and to make an SEC filing which included the fraudulent revenue and contained related false statements. After the fraud was uncovered, the company restated its earnings and reversed all of the revenue associated with the Ariel transaction.

The Indictment also charges Spence in connection with an additional transaction between Enterasys and SAP AG, a German commercial computer solutions company. According to the Indictment, SAP sought an eighteen month right to exchange $1 million in computer products it was purchasing from Enterasys in the final days of the quarter ending December 29, 2001. Enterasys allegedly agreed to the right of exchange even though it was not consistent with revenue recognition under relevant accounting principles. The Indictment alleges that Spence and a “very senior” Enterasys official insisted that SAP not refer to the right of exchange in its purchase order, promising instead to put that term in a secret side letter. The Indictment further alleges that Spence then drafted and signed such a side letter and sent it to SAP.

The maximum sentences associated with conspiracy, mail fraud and wire fraud at the time of the offenses was five years per count. The maximum sentence for securities fraud is ten years per count. The offenses also carry with them the possibility of substantial criminal monetary penalties.

June 4, 2004 in Criminal Penalties, Finances, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

June 03, 2004

Good News -- I Guess

The Associated Press reports that today the U.S. Attorney's office announced criminal indictments against seven former employees of Symbol Technologies for securities fraud. Symbol's home page announced, "No Criminal Complaint Filed Against Symbol." Imagine being a customer and seeing that on a vendor's home page. (The Symbol home-page item is linked to this press release.)

It all reminds me of an old Navy joke: A ship was visiting a foreign port after a long stretch at sea. On liberty, the captain imbibed a bit too freely. Returning to the ship, he stumbled across the gangway, gave a slurred acknowledgement to the young seaman who had the gangway watch, and staggered off to his cabin. The seaman dutifully recorded in the ship's log, "The Captain returned to the ship drunk." The seaman's supervisor, a grizzled chief petty officer, chastised him for his lack of discretion. Two nights later, the captain went on liberty again but, having learned his lesson, he drank only tea and made an early night of it. As luck would have it, the same seaman had the gangway watch again. He, too, had learned his own lesson -- this time he recorded in the log, "The Captain returned to the ship sober."

June 3, 2004 in Criminal Penalties, Finances, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

February 11, 2004

Compuware: Hit By Its Own Torpedoes

In my Navy days I was a carrier sailor, not a submariner. But I still heard the story about the valor of the submarine USS TANG, sunk in the middle of a furious battle in 1944 by one of its own faulty torpedos with the loss of all but nine of its crew. TANG's skipper, Richard O'Kane, was one of the most successful U.S. sub skippers of WW II; he was awarded the Medal of Honor after he and his surviving crew were released from Japanese captivity at the end of the war.

(In re-reading this essay before posting it, I wonder whether I'll be guilty of poor taste in using TANG's epic saga as a motif for a far less-heroic tale. But many of you will have never heard of either TANG or O'Kane, and you should, so here goes.)

Compuware, a mainframe computer software vendor, seems to have been hit by several of its own torpedoes. In 2002, it launched a copyright- and trade-secret lawsuit against IBM, its former alliance partner. Not long afterwards, CompuWare's own assertions were re-directed at them, as part of a class-action securities lawsuit. Last week, Compuware's motion to dismiss the class-action lawsuit was denied in part, leaving the unfortunate Compuware to the tender mercies of the securities plaintiffs' bar. See In re Compuware Securities Litigation, _ F. Supp.2d _, 2004 WL 231464 (E.D. Mich. Feb. 3, 2004) (link via Securities Litigation Watch.)

A Rocky Alliance

IBM was and is a major player in the market for mainframe computers. Compuware is a software vendor in the mainframe market. It was (formerly) a "tier one" alliance partner of IBM; as such, it enjoyed access to IBM source code and other proprietary information. One might think of them as sailing in IBM's wake.

IBM, however, allegedly became dissatisfied with the pricing of Compuware's software. So, beginning in 1999 and 2000, it developed its own competing software, much to Compuware's displeasure. In 2002, Compuware filed a copyright- and trade-secret lawsuit against IBM.

Unhappily, just a few weeks later, Compuware pre-announced what the class-action complaint delicately describes as "disappointing financial results." Its stock price dropped 25% in one day on heavy volume.

A securities class-action plaintiff seized on Compuware's allegations against IBM. The plaintiff claimed that Compuware had admitted that it knew for a long time that its relationship with IBM was deteriorating -- and that it had wrongfully failed to disclose that deterioration.

Torpedo 1 Away: A 1999 Press Release

The class-action plaintiff focused on several of Compuware's press releases, but one of them stands out. In a press release from 1999, Compuware's CEO was quoted as saying "I see no significant trends or impediments that would negatively affect our prospects." (Emphasis added.) No doubt that sentence was actually written by some marketing type, seized by the enthusiasm of the late 90s tech bubble. (Incidentally, Compuware's executive VP for corporate communications and investor relations was named as one of the individual defendants in the class-action suit.)

But according to the class-action plaintiff, the CEO either knew, or recklessly failed to know, that IBM was a'coming, and therefore his statement was deceptive. Judge Taylor concluded that the plaintiff had made out a plausible case in that regard, commenting that:

Plaintiffs have alleged and provided the most plausible inference that Defendant [and CEO] Karmanos knowingly stated that he saw "no significant trends or impediments" to Compuware's growth while being fully aware that a company [i.e., IBM] accounting for one-third of the company's business was becoming increasingly dissatisfied with Compuware's price structure and that an all-important relationship may well disintegrate at any time, absent correction.

Torpedo 2 Away: The IBM Litigation

Compuware's 2002 copyright- and trade-secret suit alleged that IBM had started its competing activities back in 1999 and 2000. When Compuware filed its complaint, it also issued a press release that said, among other things, that "We have been considering this distressing issue for quite some time . . . ."

The class-action plaintiff regarded these statements as admissions that Compuware knew about its problems with IBM and had failed to disclose them.

(Shameless Plug Department: For more information about copyrights and trade secrets in computer software -- as well as software patents, software licensing, export controls, and related topics -- see my one-volume treatise, The Law and Business of Computer Software, published by West Group. Last year I turned over the editing and updating responsibilities to the publisher, but I'm still sentimentally attached to the book.)

The Cautionary Language in
Compuware's SEC Filings Wasn't Enough

In its motion to dismiss, Compuware pointed out that it wasn't as if they hadn't included cautionary language about IBM in their SEC filings. Some of those filings had listed a number of significant competitors (not including IBM), then mentioned that IBM also made competitive products and there could be no assurance IBM would not offer significant competing products in the future.

Judge Taylor didn't buy it, at least for purposes of determining whether the plaintiff was entitled to keep working toward an eventual jury trial:

With regard to future events, uncertain figures, and other so-called soft information, a company may choose silence or speech elaborated by the factual basis as then known -- but it may not choose half-truths. [Citations and internal quotation marks omitted.] IBM's introduction of the Fault Analyzer and File Manager programs not only signaled the release of directly competing products, but were accompanied by a staunch refusal to share indispensable source code information. Clearly, a good relationship had ended.

In light of this, Defendants' choice to disclose anything about that relationship in its press releases and SEC filings mandated full disclosure concerning the benefits, as well as the impediments, to realizing the full potential of that relationship.

* * *

Defendants' statement that "there can be no assurance that IBM will not choose to offer significant competing products in the future," implied that IBM's development of competing software was a possibility as opposed to an actuality, and therefore, this statement does not qualify as meaningful cautionary language. The court finds that the 10-K filings did not satisfy Defendants' obligation to warn investors of risks and negatives as significant as those which were actually realized.

(Emphasis and paragraphing edited.)

Motion to Dismiss Denied

The judge denied Compuware's motion to dismiss the class-action lawsuit in most respects. The denial order said:

Contrary to the assumptions underlying Defendants' arguments, the relevant issue here is not what Plaintiffs can prove, but rather whether what they have alleged creates a plausible inference that Defendants acted or spoke with the requisite state of mind. . . . [I]n this instance, it is hard to imagine a complaint that could better withstand a motion to dismiss. The court finds that Plaintiffs have submitted a well-crafted, well-pled complaint, stating sufficient facts to create a plausible inference that Defendants knowingly misstated or omitted material information. Therefore, Defendants' Motion to dismiss must fail.

(Citations omitted.)

Possible Lessons

In the classic book The Right Stuff, Tom Wolfe recounts that whenever a test pilot crashed and burned, his surviving colleagues -- bathed as they were in the certainty of their own infallibility and immortality -- often reacted along the lines of: How could he have been so stupid?

We might be tempted to say the same about Compuware. But can we? What could Compuware have done differently? That's hard to say. Here are some thoughts:

Press releases: Obviously it would have been better if Compuware's press release hadn't had the CEO saying he saw no significant negative trends. That's an example of a categorical statement, which you're usually better off avoiding when possible. (All categorical statements are bad, including this one.) But at the time, Compuware's CEO may well have genuinely believed that he saw no negative trends.

SEC filings: Obviously, you have to do your best to make a full and fair disclosure of known material information in your SEC filings. But for all we know, at the time, Compuware's executives might have been genuinely optimistic that they could patch up their relationship with IBM. Moreover, they had to face the choice of just how much to disclose about their relationship with IBM. Conceivably, if they had disclosed more than they did, the mere act of disclosure might have damaged the relationship even further, possibly causing more harm than good to the company and its shareholders.

Plaintiffs' lawyers always have the benefit of hindsight. Executives, in contrast, have to make actual business-judgment calls, usually on the basis of limited information.

But even so, companies -- especially their marketing people -- would do well to keep Compuware's troubles in mind when they're drafting press releases and SEC filings.

February 11, 2004 in Intellectual Property, Litigation, Marketing, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

January 07, 2004

SEC Hammers Company's Customers
for Securities-Fraud Participation

The SEC has again gone after customers of a company for allegedly helping to perpetrate the company's securities fraud by "round-tripping," i.e., creating fictitious transactions that were reported as revenue. As part of the settlement, the customers' principals, as well as the company insiders who were involved, were barred from serving as an officer or director of a publicly-held company.

The SEC announced today that it had reached a settlement with the former controller, former operations manager, and several former customers and vendors of Suprema Specialties, Inc., a now-defunct cheese manufacturer based in Paterson, N.J. customers in question. According to the SEC press release:

The SEC's complaint alleges that defendants Quattrone [Ed: Robert Quattrone -- if it had been Frank Quattrone, surely we would have heard more about it before now] and Vieira, using the private companies they controlled, knowingly entered into numerous circular round-tripping transactions with Suprema from at least 1998 through early 2002, and that defendant Fransen similarly entered into such transactions with Suprema from at least 2000 through early 2002.

The complaint further alleges that, during the respective time periods, Quattrone, Vieira, and Fransen each signed false audit confirms that were provided to Suprema's independent auditors, and each received kick-backs for their participation in the scheme.

According to the complaint, the round-tripping transactions involving Quattrone, Vieira, Fransen, and their companies collectively resulted in overstatements of Suprema's reported revenues by approximately 5.75%, 7.41%, 14.25%, 19.51%, and 19.48% in fiscal years 1998, 1999, 2000, 2001, and the first quarter of 2002, respectively.

(Paragraphing added for readability)

(Link via Securities Litigation Watch.)

January 7, 2004 in Accounting, Litigation, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

October 14, 2003

Mother Always Said, Don't Brag

The exuberance and assertiveness of marketing people can make enormous contributions to a company. They can also put the company in a deep hole. Here's an example of the latter: Some not-atypical, faintly boastful language in a company's press releases language, of a kind your marketing people might well have used themselves, kept the company mired in a securities class-action lawsuit, when the lawsuit might otherwise have been dismissed.

A Sad but Familiar Tale

Log On America (LOA) was a Rhode Island-based Internet access provider for residential and commercial customers. From 1992 to early 1999, LOA grew into a company with nine full-time employees and revenues of just under $760,000, but it never once turned a profit.

Despite this decidedly less-than-stellar track record, LOA decided to go public. In April 1999 it went out at $10, the price spiked to $37 on the first day of trading, and closed at $35 per share. LOA went on a buying spree, using its capital and its publicly-traded "currency" (shares) to acquire various New England internet service providers, growing its customer base from 1,000 to over 30,000.

The Fateful Press Releases

During those exhilerating days, LOA issued press releases and interviews that would come back to haunt them in the subsequent securities class-action lawsuit. The company said, for example, that:

  • LOA was the "premier provider of high-speed DSL services in the Northeast corridor";
  • LOA was "a Northeast Regional [CLEC] and Information Internet Service Provider (IISP) providing local dial-tone, in- state toll, long distance, high speed Internet access and cable programming solutions . . . to residential and commercial customers through the Northeast";
  • LOA was "one of New England's leading providers of bundled communications services";
  • LOA was "in a dominant position in the market for integrated data and voice services" and "a dominant super regional communications player."
(Emphasis added.)

The Lawsuit

In an all-too-familiar story, LOA's rapid post-IPO expansion resulted in exploding net losses, which in turn caused the stock price to drop. And then, in early 2000, the tech bubble burst. LOA's stock dropped even more, down to a low of $0.10 per share. NASDAQ eventually delisted the stock.

As night follows day, the securities class-action lawyers found their way to LOA. They filed the usual lawsuit accusing LOA's CEO and CFO of securities fraud, alleging that those two officers had engaged in "a massive fraudulent scheme to deceive investors into thinking [LOA] was a successful 'dominant' telecommunications company, when in actuality it was not."

The LOA officers did they usual thing: they filed a motion to dismiss the lawsuit. The judge granted some portions of their motion, but also kept other, significant portions of the lawsuit alive. Why? Because, the judge concluded, some of the statements in LOA's press releases and interviews might well have been material misstatements:

The representation that LOA was the "premier provider of high-speed DSL services in the Northeast corridor," as it was described in a May 17, 1999 press release, is much more than mere puffery: it is a statement of LOA's present status and capabilities, and connotes that LOA is comparatively superior to all other high-speed DSL service providers in the Northeast corridor.

Likewise, the statements that LOA's transaction with Nortel would "help further solidify [LOA's] dominant position in the market for integrated data and voice services," and that LOA's "proven early market entry strategy is positioning it as a dominant super regional communications player," are both actionable: they clearly imply a comparison to competitors and suggest that activities undertaken by LOA as of December 17, 1999 or February 10, 2000 had made or were making it "dominant" over all other competitors in its field.

The same is true for the statement that, by October 28, 1999, LOA had become "one of New England's leading providers of bundled communications services." Assuming that the substance of the statement is untrue (as Plaintiffs have alleged, and as Defendants have conceded for purposes of this motion), this statement is material, as it connotes superiority over the vast majority of other bundled communications services providers.

(Paragraphing supplied.)

Moreover, LOA apparently was never able to offer cable services, even though they had described themselves as a cable-programming provider.

(Scritchfield v. Paolo, 274 F. Supp. 2d 163 (D.R.I. 2003).)

Some Possible Lessons

  • Think carefully before using superlatives like "premier provider" and "dominant player" to describe your business. The judge and jury might view such statements as non-actionable puffery, or they might regard them as false statements. (Indeed, the Scritchfield judge said that the mere fact that the defendants made a puffery argument was a concession that the statements were not true.)

    I'm not a marketing guy. But my personal belief is that superlative language of this kind seldom does you much good in the marketplace. I think customers and investors tend to discount such language. It therefore provides you with little or no benefit, while still increasing your potential vulnerability to a securities class-action lawsuit. Talk about the worst of both worlds.

  • There's another reason that using pharases like "dominant player" is a bad idea. Someday you may want to acquire, or be acquired by, another company. You might have to do a Hart-Scott-Rodino antitrust filing to get government approval for the acquisition. That filing may have to contain your press releases. You really don't want the government's antitrust reviewer to see your own press releases describing you as the "dominant player" in any particular market or submarket -- at the very least, it likely would complicate the approval process.

Thanks to Securities Litigation Watch for the pointer to this story.

October 14, 2003 in Communications, Litigation, Marketing, Securities law, SEC regs / actions | Permalink | Comments (2) | 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 08, 2003

What Did Quattrone Know, and When Did He Know It?

The Frank Quattrone trial proceeds -- see this Dow Jones story, or this search in the Yahoo news files. As has been widely reported, Quattrone received a "let's clean up those files" email and forwarded it to his group at Credit Suisse First Boston. He had recently been told by a CSFB in-house lawyer that the SEC was doing an investigation into some CSFB-related matters. It's in dispute whether he was told enough to make him realize that his own group should suspend any cleaning out of their files.

The jury will have to decide -- more than 3-1/2 years after the fact -- whether Quattrone had the intent to obstruct justice when he forwarded the clean-up email to his group. Even if Quattrone is acquitted, his life and career have suffered major disruption, all because of an email.

(Continued below)

Basic Documentation-Retention Rules

The basic legal principle is simple, at least in theory: Don't destroy documents that might be relevant to impending legal action, at least not without consulting counsel.

But, you ask, when is legal action impending enough to trigger this principle? It depends. As the Quattrone case illustrates, if any legal action is impending, and you destroy documents, then the government might suddenly get very interested in you. If the jury gets the wrong impression, you could find yourself taking an extended sabbatical from your life as you know it.

Possible Lessons

If in any doubt whether you should destroy particular documents, you likely will sleep better if you consult counsel first. The mere fact that you consulted counsel, standing alone, could later help you refute any allegation of criminal intent.

You might want to get written confirmation of what counsel says, even something as simple as an email exchange. That's a little bit of extra work, but it's worth it. Months or years later, you, or your counsel, may not remember what transpired. Moreover, it's widely believed that juries tend to give credence to contemporaneous written documents, possibly more so than to after-the-fact witness testimony.

October 8, 2003 in Communications, Criminal Penalties, Record-keeping, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

September 26, 2003

Altered (Document) States

The SEC continues its enforcement efforts, yesterday announcing that criminal charges had been filed against a former E&Y; accountant for allegedly altering and destroying documents to obstruct an investigation. The SEC's press release pretty much speaks for itself (bold-faced emphasis is mine):

Thomas C. Trauger, a former Ernst & Young partner who allegedly altered and destroyed audit working papers, was arrested this morning by FBI agents on criminal charges for obstructing investigations by both the Office of the Comptroller of the Currency and the Securities and Exchange Commission. * * *

. . . The complaint contains two counts: one count charging Mr. Trauger with obstructing the examination of a financial institution and one count charging falsification of records in a federal investigation in violation of the Sarbanes-Oxley Act of 2002. * * *

According to the allegations in the criminal action, . . . Mr. Trauger . . . began to alter and destroy copies of working papers related to E&Y;'s audit work for its client NextCard, Inc. . . . The document destruction allegedly occurred after the working papers had been completed and during an OCC examination of NextCard's banking subsidiary, NextBank. * * *

. . . Finally, the complaint alleges that in April 2003, Mr. Trauger gave sworn testimony to the SEC related to NextCard where he allegedly concealed his alteration and destruction of documents when questioned about his role in the production of E&Y;'s audit working papers to the OCC. * * *

In announcing the charges, U.S. Attorney Kevin V. Ryan said, "This is one of the first cases in the country in which an auditor has been accused of destroying key documents in an effort to obstruct an investigation. . . . The U.S. Attorney's Office will bring those professionals to justice who join in the criminal acts they are supposed to uncover and expose."

September 26, 2003 in Accounting, Criminal Penalties, Securities law, SEC regs / actions | Permalink | Comments (0) | 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 19, 2003

Why Shareholders Should Come Third - Great Post

There's a great post today on Mike O'Sullivan's Corporate Law Blog. It summarizes former Medtronic CEO Bill George's recent Fortune magazine article about why CEOs should concentrate on pleasing customers, then employees, then shareholders. Not to be missed.

September 19, 2003 in Litigation, Securities law, SEC regs / actions | 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 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 22, 2003

Insider Trader Convicted --
And He Wasn't Even an Insider

Today's National Law Journal has a story that illustrates yet again how vigorously the SEC goes after people it thinks are trading on on "inside" information. This one involves a stock broker who was convicted by a jury of insider trading.

The broker had learned that certain companies were about to be mentioned in the "Inside Wall Street" column of a business magazine. He got this information second-hand, from a colleague who in turn had a contact at the business magazine. The SEC got suspicious when the stock prices of companies mentioned in the column started going up before the publication dates.

I thought four things were particularly interesting about the story: First was the reminder that the SEC monitors stock prices to sniff out possible insider trading. Second, the broker wasn't an insider at any of the companies whose stock he traded. Third, the guy ended up spending about $75K in legal expenses and is now working as the manager of a donut shop -- honorable work, and nothing to be embarrassed about, but probably not what he expected to be doing for a living. Finally, the judge apparently wasn't totally sure that what the broker did was a crime, but he felt that he had to sustain the conviction; then, when the SEC asked that the broker be ordered to disgorge his profits (about $5K), the judge said "enough is enough," and awarded the SEC $1. (The story doesn't say whether the broker will face any prison time.)

August 22, 2003 in Criminal Penalties, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

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)