After-the-Fact Contract Changes, Side Letter,
Lead to Federal Fraud Indictments
June 4, 2004
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.
Public Allegation of Copyright Infringement
Leads to $300K Defamation Verdict
April 23, 2004
If you think a competitor is doing something illegal, like infringing your copyright, it’s usually best not to complain to customers about it. If it turns out you’re wrong about the alleged illegality, you could be liable for defamation. A Web site operator named Boats.com recently learned a $300,000 lesson on that subject in a Florida federal district court.
SEC Hammers Company’s Customers
for Securities-Fraud Participation
January 7, 2004
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.
Review Your Unused Sales Tax Permits
November 5, 2003
In late 2001, a Texas lighting-fixtures vendor sued one of its customers, a California company, for breach of contract. The vendor brought the suit in, surprise, Texas. The California customer tried to get the lawsuit thrown out because of lack of “personal jurisdiction.” That means the customer claimed it didn’t have enough presence in, or contact with, the state of Texas to be subject to suit there.
Earlier this year, a federal magistrate judge in San Antonio denied the California customer’s motion to dismiss the suit. Her principal stated reason suggests that companies might do well to periodically review their state sales- and use-tax permits. See Ergonomic Lighting System, Inc. v. Commercial Petroleum Equipment/USALCO, No. SA-02-CA-0031 (W.D.Tex. 03/05/2003).
Alone, Unarmed (maybe), and Uninsured
October 31, 2003
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.
Bye-Bye, Carolina; Hello, California
October 11, 2003
Late last month, a North Carolina customer of Oracle Corporation found itself involuntarily headed for California to pursue its lawsuit against Oracle. This came to pass because the customer — probably without even knowing it — agreed to a forum-selection clause when it bought its Oracle software license.
Backdated Sales Contracts Resurface Years Later
October 9, 2003
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)
Side Letter in Sales Deal Leads to SEC Fraud Suit
September 16, 2003
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.”
Big Fine for Helping Customer Cover Up Business Losses
September 12, 2003
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).
Backdating Contracts Leads to Prison Term —
But It Can Be Entirely Proper
August 23, 2003
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.