Presentations you can use and updates on key accounting fraud cases
Updates on Ozy Media and Autonomy and the LSU Presentations on FTX, ESG, Authenticity, and AI/Tax, as well as my own on Tingo/Adani.
Yesterday’s newsletter was a preview of today’s, which is mostly under the paywall because a lot of hard work went into the presentations made at the LSU Fraud and Forensic Accounting Conference. I’ll also provide some comments and suggestions for further scrutiny and/or research after the paywall on the latest from Deep Quarry on amended 10-K filings.
And now for some news.
Two fraud cases I have written about recently came to a conclusions in the courts. In one case all the Big 4 were involved and escaped unscathed. In the other, we have to still ask, “Where were the auditors?” and why didn’t anyone who invested insist on seeing audited financial statements.
Autonomy and Mike Lynch
Via Michael J. de la Merced at The New York Times on June 6, 2024:
Mike Lynch, a British software mogul who was once one of his country’s most celebrated chief executives, was acquitted of fraud on Thursday in San Francisco federal court, clearing him of charges that he had led one of the biggest frauds in the technology industry.
A jury found him not guilty of falsely inflating revenue at Autonomy, the company he founded and led, when he sold it to Hewlett-Packard for $11 billion in 2011.
Mr. Lynch, 58, who faced decades in prison, had initially been charged with 16 counts of fraud and conspiracy, though one fraud charge was eventually dismissed.
Thursday’s verdict, after a trial that began in mid-March, is a milestone in Mr. Lynch’s decade-long odyssey to clear his name.
Yeah, it’s been a long, strange trip for Lynch, his CFO Sushovan Hussain, who was convicted of similar charges and served prison time, and HP which bought Autonomy from Lynch and cried fraud soon after.
From the NYT:
HP acquired Autonomy, paying a 60 percent premium over its stock price, in a bid to transform itself into a high-growth software provider. But questions soon arose about Autonomy’s figures, and before long the California-based tech pioneer took an $8.8 billion accounting charge on the acquisition, citing “serious accounting improprieties.” HP’s stock price plummeted.
A judge found Lynch liable for defrauding HP in a civil trial in the UK in 2022. I wrote:
On January 28, 2022, in the U.K. Justice Robert Hildyard ruled that HPE had “substantially succeeded” in its claim, filed in May 2015 against former Autonomy CEO Mike Lynch and former CFO Sushovan Hussain while Hussain was in the U.S. facing criminal charges brought by the U.S. Department of Justice.
The judge said he would allow “considerably less” in damages than the $5 billion HPE had claimed but issued a damning preliminary decision.
He found that a hardware reselling programme by Autonomy was there to cover shortfalls in software revenue, that it was “dishonest” and that the defendants were “well aware of this”. These “lossmaking transactions were not commercially justified on any basis”, the judge said of the hardware reselling programme. They were concealed because their revelation would have revealed that Autonomy’s software business was not generating the accelerating profits “which heavily influenced its price”.
He found that HPE relied on what was said about Autonomy’s revenue in the accounting material and was induced to pay $11bn for Autonomy.
Also involved over the course of the 13-year-old case, which began with HP’s acquisition of Autonomy in 2011, were all of the Big 4 global accounting firms: Deloitte (auditor for Autonomy in the UK and strategic partner to Autonomy and HP in the US), EY (auditor for HP and its primary tax advisor), KPMG (due diligence advisor for HP in the Autonomy acquisition), and PwC (forensic investigator on behalf of HP of its fraud claims against Autonomy).
Deloitte, in particular, got off relatively scot free. Disciplinary action by UK regulators against the firm — 15 million pounds ($19.4 million) was a record — and its partners — Knights was excluded from membership of the Institute of Chartered Accountants for England and Wales for five years and fined 500,000 pounds and Mercer fined 250,000 pounds and received a severe reprimand — were roughed up but are probably already back signing audits.
There have never been any charges against the firm in the US for the Autonomy fiasco even though Autonomy had two headquarters, one in UK and one in Silicon Valley.
I first wrote about the case in November 2012 for Forbes:
HP, in the understatement of the year, says it is “extremely disappointed” to find out some former members of Autonomy’s management team inflated Autonomy’s underlying financial metrics – GAAP and non-GAAP. HP boldly called it a “willful effort to mislead investors and potential buyers”.
That’s PR-speak for fraud.
Why was Deloitte UK never named as a defendant in the HP lawsuit against Autonomy in in the UK? The firm indirectly paid HPE $45m and agreed to hand over its Autonomy workpapers in return.
Although HPE and Deloitte signed a confidentiality agreement over the $45m, its main details were hiding in plain sight inside the last ever accounts filed by Autonomy Corporation Ltd (ACL) before it was merged away into HPE's corporate structure, becoming known as ACL Netherlands BV.
A letter previously sent by HPE's lawyers to Deloitte in 2014 alleged "there is evidence that Deloitte was complicit in aspects of the misstatements in Autonomy's published information".
That allegation would never be tested in court…
ACL's [Autonomy] last ever annual accounts revealed how the Deloitte settlement came about. HP had, legally speaking, threatened to sue wholly owned subsidiary ACL for $4.55bn. The accounts explained that ACL (naturally) accepted liability, leading to the next steps:
HP Vision BV recognised that the company [ACL] does not have the means to discharge its estimated liability to HP Vision BV and requested that the company take steps (including litigation) to recover its losses from the parties responsible for the publication of the information described above.
That information was Autonomy's pre-buyout accounts, which HPE claimed contain deliberate inaccuracies.
Accordingly, on 30 September 2014 the Company sent a pre-action letter to its former auditors, Deloitte LLP, in respect of losses suffered by the Company (including its liability to HP Vision BV under [the Financial Services and Markets Act]).
On 27 April 2016 the Company reached a satisfactory settlement with Deloitte LLP, including a payment by Deloitte LLP of $45,000,000 (£31,245,660). Following the settlement with Deloitte, the Company reimbursed HPE for legal costs of $8,741,549 (£6,069,677) previously funded by HPE. Also, on 31 August 2016, the Company made a partial settlement of the claim from HP Vision BV, in the amount of $35,293,502 (£26,576,432).
Deloitte also agreed to cooperate with the U.S. DOJ, according to The Register:
Deloitte's former principals on Autonomy's accounts have all signed cooperation agreements with the US Department of Justice. As we previously reported, these men are former lead auditors Richard Knights and Nigel Mercer, along with Lee Welham and Tom Murray.
During cross-examination in the High Court in 2019, Lynch's barrister Robert Miles QC asked Welham: "Do you recall that during 2015 the American DoJ were looking for cooperation from Deloitte?" to which the auditor replied "Yes".
"And," continued Miles, "Deloitte had some concerns about agreeing to testify while the civil claim was still out there; do you recall that?"
Welham said he didn't know for sure. Miles went on to show him a copy of the cooperation agreement, which was signed in 2016 as detailed in ACL's accounts.
The Register has obtained a copy of that agreement from the High Court proceedings. Deloitte agreed to make a dozen auditors available for interview by HPE's lawyers and, "so far as it is in Deloitte's power to do so to procure that each Deloitte Interviewee" should provide:
... such assistance and co-operation in those interviews as if they were being interviewed by Deloitte, including providing testimony as to their recollection of events and comments upon (a) whether particular facts were or were not known to them; (b) whether particular documents were or were not shown to them during the course of their audit work, and (c) where such facts or documents were not known or shown to them (whilst not expressing an expert opinion, consistent with their status as witnesses of fact) whether such facts or documents were in their opinion relevant to their work and the potential impact of such facts or documents on their work...
So much for that…
For more on all of the Big 4 involvement in the case over the years, go here.
Ozy Media and Carlos Watson
Via Danielle Kaye at The New York Times:
A federal jury on Tuesday found Carlos Watson and Ozy Media, the digital media company he co-founded, guilty of trying to defraud investors and lenders to promote the start-up venture.
The jury deliberated for three days after an eight-week trial in which the prosecutors accused Mr. Watson of conspiracy to commit securities and wire fraud. Many of the government’s witnesses revealed new details about deception at the company, including an impersonated phone call, fabricated contracts and misleading claims about Ozy’s earnings.
“Watson knew the company was failing, but he was determined to turn Ozy and himself into the next big thing, and he wasn’t going to let the truth stand in his way,” Gillian Kassner, a prosecutor, said during closing arguments in U.S. District Court in the Eastern District of New York.
Mr. Watson now faces up to 37 years in prison.
Quite a different fate for Mr. Watson versus Mr. Lynch. Ozy Media and Watson are more like Theranos and Elizabeth Holmes than like Autonomy and Mike Lynch.
I wrote in October 2021:
In a column after the column that broke Ozy Media, Ben Smith of The New York Times invokes that other charismatic founder and CEO, now on trial in San Francisco for criminal fraud:
There’s an irresistible temptation, in this age of scams and hype, to obsess about the man or woman at the center of a company’s implosion. Theranos’s Elizabeth Holmes was the subject of an HBO documentary, and is now the center of a high-profile trial. And when Ozy Media collapsed on Friday, less than a week after The New York Times reported on a series of misleading statements and actions, all eyes turned to the man at the center of the company, Carlos Watson, an ambitious dreamer who seemed to believe in what he was selling. When he spoke with me over Zoom from a California backyard on Sunday, he conceded nothing.
In addition to orchestrating the impersonation of a YouTube executive on a call about an investment with a Goldman Sachs executive, Watson was accused of taking “fake it until you make it” a bit too far into fraud territory. From the NYT:
Several of the prosecution’s witnesses also testified that Mr. Watson had misrepresented his company’s finances to secure investments, inflating revenue figures and presenting misleading claims of commitments from the likes of Oprah Winfrey and Live Nation Entertainment.
Prosecutors presented the jury with evidence showing that Mr. Watson had sent emails to investors claiming Ozy made $12 million in 2017 — while Ozy’s tax return for that year listed less than $7 million in gross sales. When pressed about the emails during the prosecution’s cross-examination, Mr. Watson again pointed a finger at Mr. Rao.
“Samir drafted these,” Mr. Watson testified. “I would never draft something with that level of specificity.”
Leading up to the trial, a lawyer for Mr. Watson argued that the government’s allegations involved the same “puffing and bluffing” practiced by the founders of BuzzFeed and Vice but that prosecutors had singled out Mr. Watson for punishment because he is a Black man. In April, a judge rejected Mr. Watson’s motion to dismiss the charges on the grounds of discriminatory prosecution.
Similar to the behavior of investors in Theranos, apparently no one investing in Ozy Media asked for audited financial statements. There is no mention of any auditor in any news stories. (I have not yet gone through the trial transcripts.)
The NYT piece mentions that “puffing and bluffing” was a common tactic among startup founders when talking to investors, and media, and media startup founders followed the example of tech and other founders. Business Insider highlighted that even those who are seen as media’s saviors sometimes stumble over all the puffing and bluffing.
For all the journalism rescue missions, there have also been some flops, most notably the recent ignominious downfall of Ozy Media, the digital-media startup whose cofounder was accused of impersonating a YouTube executive while fundraising from Goldman Sachs. Emerson was an early investor in Ozy in 2013, and Powell Jobs sat on its board until 2017. (Insider's parent company Axel Springer was also an investor.)
I’ve written about the blindspot journalists have for media startups here.
After the paywall, a discussion of Olga Usvyatsky’s latest on amended 10-Ks and a digest of great presentations from the LSU Fraud and Forensic Accounting Conference last week.