Two Former Finance Execs Charged with Fraud

Ex-CFO and previous senior vice president of finance at Enterasys allegedly engaged in a revenue-recognition scheme to inflate the company's share price.

The Department of Justice has brought fraud and other related charges against two former finance executives and another former executive of Enterasys Network Systems Inc., a computer hardware and software corporation.

The 15-count indictment was brought against Robert Gagalis, former executive vice president and chief financial officer; Bruce Kay, former senior vice president of finance; and Gayle Spence, former vice president and director of internal sales. Enterasys succeeded Cabletron Systems Inc., when the two companies merged in August 2001.

The charges stem from an alleged revenue-recognition scheme that involved altering and backdating contracts, entering into secret side deals, and making false representations in filings to the Securities and Exchange Commission, according to the Justice Department. The false representations were allegedly made in company press releases and to the company’s outside auditors.

To boost the company’s stock price and improve their own status within the company, Gagalis, Kay, Spence, and others caused Enterasys to falsely report that it had met or exceeded internal revenue projections and Wall Street expectations, the indictment alleged.

At the close of the September 1, 2001, quarter, the company’s outside auditors chose a number of transactions for revenue testing, including a transaction with Ariel, a China-based company, the Justice Department asserted. The defendants and others allegedly became aware that the transaction documents contained terms that would negate the U.S. company’s recognition of about $3.5 million in revenue.

Knowing that Enterasys was trying to “make its numbers” for a sixth straight quarter, the three indicted individuals and others allegedly caused the problematic terms to be deleted from one of the transaction documents. They then backdated the document to make it seem that it had been executed before the close of the quarter, according to the Justice Department.

The DOJ accused the individuals and others of altering and backdating the document to be sent to the company’s outside auditors. In addition, they allegedly issued a secret side letter to Ariel, which they withheld from the auditors, that restated the problematic terms.

“The public is entitled to honest books that reflect the real value of a company,” said Assistant Attorney General Christopher Wray. “When corporate executives allegedly cook the books to create the illusion of success, they undermine the integrity of the marketplace.”

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