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 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

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 17, 2003

Yet Another "You Fired Me Because I Blew the Whistle" Case Settled for Almost $1M

The press is reporting the settlement of yet another wrongful-termination case grounded on a former employee's claim that she was fired for whistleblowing. The employer paid nearly $1 million -- almost half of which goes to the fomer employee's attorney, according to the employer's Web site -- after having spent more than $300K defending the case. See this story at the law.com Web site. This story illustrates the hazards of letting an employee go if the employee had any connection at all with uncovering alleged corporate improprieties.

The story is also a nice opportunity to recall the wisdom of keeping fair and accurate written records to document employee performance. If you're a manager who wants to get rid of a worthless employee, don't believe that your cheery smile and golden voice alone will convince a jury that the employee really did deserve firing. Juries often discount witness testimony, especially by defendants seen as trying to make excuses for their actions. Juries also tend to believe written business records and other contemporaneous documentary evidence. So if you keep decent records about your employees, you'll be better armed if you ever find yourself in a lawsuit -- and good records might even help you be a better boss.

September 17, 2003 in Accounting, Leadership and Management, Record-keeping | 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.

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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

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)