Fraud Charges for Gateway’s Former CFO

Schemed to ''close the gap'' between analysts' expectations and company's results, alleges the SEC. Also: Xerox settles cash-balance retirement lawsuit; guilty verdict for former Dynegy tax exec; even in bankruptcy, Enron is a big spender; and more.


The Securities and Exchange Commission filed charges in federal court in San Diego against three former executives of Gateway Inc. for fraudulently manipulating earnings to meet Wall Street analysts’ expectations. The commission also accused the trio of making false statements and concealing from the investing public important information about the success of Gateway’s personal computer business in the second and third quarters of 2000.

The three former Gateway executives are John J. Todd, former senior vice president and chief financial officer; Robert D. Manza, former controller; and Jeffrey Weitzen, former chief executive officer and a member of its board of directors. Gateway fired the three executives in 2001. In February 2001 and April 2003, the company authorized the restatement of financials related to those transactions.

The SEC seeks antifraud injunctions, civil monetary penalties, disgorgement of illegally obtained gains, and orders permanently barring the defendants from serving as officers or directors of public companies.

In a separate administrative proceeding, Gateway settled fraud charges with the SEC. Without admitting or denying the commission’s findings, the company agreed to cease and desist from violating the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws. The SEC assessed no penalty or fine against the company.

“We are very pleased to put this issue from our past behind us,” said Gateway chairman and CEO Ted Waitt, in a statement. He had relinquished his management role at the company in late 1999 and returned as CEO in early 2001.

The SEC’s complaint alleges that defendants misrepresented or failed to disclose significant trends in Gateway’s business; that PC sales growth was declining; that, by the end of the third quarter, only a small percentage of net income was associated with PC sales; and that revenue and earnings included various one-time transactions.

More specifically, the commission alleges that around May 2000, when the trio realized Gateway’s results were going to come in short of Wall Street expectations, they embarked on a fraudulent scheme to “close the gap” between analysts’ expectations and the company’s actual revenue and earnings.

According to the complaint, in the second quarter of 2000, the scheme included contacting individuals whose credit applications had previously been denied by the company, and offering them pre-approved financing to facilitate sales. The sales campaign to high-risk customers contributed more than 5 percent of Gateway’s second-quarter revenues.

When Todd, the former CFO, recognized that he could not close the gap simply by increasing the amount of PC sales to high-risk customers, he allegedly authorized a wider variety of improper accounting actions, all of which failed to comply with generally accepted accounting principles.

These included reducing loan loss reserves, recognizing revenue from a consignment sale, recognizing revenue from a purported bill-and-hold sale, accelerating purported revenue from payments by America Online Inc. for bundling its Internet service with a Gateway PC purchase, recording revenue from the sale of the company’s fixed assets, and making additional undisclosed accounting adjustments to meet analysts’ earnings estimates.

As a result of the improper accounting actions, Gateway announced that for the third quarter of 2000, it exceeded analysts’ expectations for revenue by $30 million, met analysts’ expectations for earnings per share of 46 cents, and experienced year-over-year revenue growth of 16 percent.

Those statements about Gateway’s financial performance were false and misleading, the SEC charges. The actions by the three executives caused Gateway’s net income for the third quarter of 2000 to be overstated by more than 10 cents, or 30 percent, and inflated reported revenue by $154 million, or 6.5 percent.

“This action illustrates the harm that can result when corporate executives measure success by meeting the short-term expectations of Wall Street analysts,” said Randall R. Lee, director of the SEC’s Pacific Regional Office, in a statement. “The former Gateway executives the commission charges today were preoccupied with meeting analysts’ expectations, to the extent that they fraudulently reverse-engineered Gateway’s financial results to do so.”

Xerox Settles Suit Regarding Cash-Balance Retirement Plan

Xerox Corp. announced that it has settled a lawsuit regarding the calculation of pension benefits, according to The New York Times. The settlement, which still awaits court approval, would pay an additional $239 million to employees who retired during the 1990s.

Xerox took a pretax charge of $300 million in April to cover possible damages. A Xerox spokeswoman cited by the Times said that the company would restore $61 million to its pretax earnings once the settlement is approved.

The lawsuit concerned Xerox’s cash-balance plan — a type of retirement plan in which the sponsor makes contributions that are evenly spread out over an employee’s time with the company. By comparison, in a traditional defined-benefit plan, employees receive a greater credit to their plans in their final years of service.

When a company converts from a traditional plan to a cash-balance plan, younger workers have more years to accrue interest on those contributions than do older workers, merely by virtue of their age.

Earlier this year a federal judge found that IBM’s cash-balance and pension-equity formulas discriminated against older workers; the ruling suggested that most, if not all, cash-balance plans might also be equally discriminatory. According to the Times, however, the Xerox case deals with the calculations of benefits and offers little additional insight into the age-discrimination issue.

(To find out more, read “Rethinking Cash-Balance Plans.” Sign up now for free email alerts on benefits and we’ll notify you when our article is published later this week.)

Guilty Verdict for Former Dynegy Tax Exec

Former Dynegy Inc. tax executive Jamie Olis was found guilty on Thursday of six counts of fraud in connection with charges that he illegally disguised a $300 million debt as income to inflate his company’s finances, according to Reuters.

The jury deliberated for less than two hours before reaching its decision.

In June Olis pleaded not guilty to the securities, wire fraud, and mail fraud charges in a six-count federal indictment, according to reports. Also charged at the time were Gene Foster, former vice president of tax, and Helen Sharkey, a former member of Dynegy’s risk control and deal structure group.

Olis was charged for his role in a deal called “Project Alpha.” Government prosecutors claim the three executives borrowed $300 million and then attempted to disguise the loan as cash flow from operations, instead of accounting for it as debt. “They created a picture of the company that was not real,” Assistant U.S. Attorney John Lewis said in his closing argument, according to Reuters.

Alpha also allowed the company to improperly cut taxes by $79 million, according to the wire service.

Defense attorney Terry Wayne Yates said Olis relied on accounting firm Andersen’s advice and reminded jurors that it was Andersen’s tax experts who pitched the idea that became Alpha in the first place, according to the report.

Olis faces up to 35 years in prison when he is sentenced on February 19.

Even in Bankruptcy, Enron Is a Big Spender

The Enron bankruptcy is poised to set the record for the largest amount of money spent confirming a Chapter 11 bankruptcy plan.

Enron claims the legal and accounting costs of its bankruptcy will exceed $1 billion by 2006, according to the Houston Chronicle. The company has already spent $500 million — billed by more than three dozen law firms and a handful of accounting and consulting firms — since the company filed for reorganization on December 2, 2001.

Even after Enron gains approval for its reorganization plan — expected sometime next year — the company estimates it will spend $156 million in the second half of 2003 on professional fees, $229 million in 2004, $112 million in 2005, and $68 million in 2006, according to the Chronicle.

Legal fees in a bankruptcy typically drop dramatically after a company receives approval for a reorganization plan. “It’s shocking,” Lynn Lopucki, a law professor at the University of California at Los Angeles law school who studies bankruptcy professional fees, told the paper.

The budget estimate is buried in one of 18 appendices and more than 1,000 pages of amended documents Enron submitted to its bankruptcy court Thursday in support of its plan of reorganization, the paper pointed out.

In a related story in the Chronicle, a special Enron grand jury returned a sealed indictment Thursday that could supersede an earlier 218-count indictment against seven former Enron executives.

The paper added that it appears no defendants were added to the Enron Broadband Services indictment. But citing one lawyer as its source, the Chronicle also noted that charges of money laundering may have been added against one or more defendants to allow federal officials to freeze more assets before a trial next year.

Those charged in the indictments include Kenneth Rice and Joseph Hirko, former Enron Broadband co-CEOs; Kevin Hannon, former chief operating officer; Scott Yeager and Rex Shelby, former senior vice presidents; and Kevin Howard and Michael Krautz, former executives.

All have pleaded not guilty to charges of exaggerating the potential and technological capability of Enron Broadband Services, and thus the value of Enron stock. They are also accused of then making millions of dollars selling their stock.

Short Takes

  • The Xerox Corp. said its pension plan will pay former workers $239 million to settle a lawsuit. In April, Xerox said it reported a first-quarter pre-tax charge of $300 million to cover any potential pension-funding shortfall should the plan be required to pay damages in this case.
  • Computer storage product maker SanDisk Corp. said it delayed the filing of its latest quarterly financial report because it needs more time to investigate the alleged “theft” of shares held for it by a Taiwanese firm. In October, SanDisk said a senior associate at its Taiwanese law firm fraudulently sold $100 million in stock of another company held on SanDisk’s behalf by the law firm.
  • Nearly half of companies in Europe and the United States are considering outsourcing part of their procurement operations within three years, more than double the 22 percent of respondents who said they currently outsource aspects of procurement, according to a survey by Accenture.
  • Telefonos de Mexico issued $1 billion of five-year senior unsecured notes in the private placement market, led by Credit Suisse First Boston and J.P. Morgan. The notes were priced to yield 4.549 percent, 115 basis points over comparable Treasurys. They were rated A3 by Moody’s and BBB-Minus by Standard & Poor’s.

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