Thursday, June 14, 2007

Options Backdating: Sue the Auditors

Photo Sharing and Video Hosting at Photobucket In prior posts (most recently here), I described various attempts to shift the blame for alleged option grant manipulations to company gatekeepers. In the latest development, Vitesse Semiconductor announced on June 13, 2007 (here) that it has sued KPMG, its former auditing firm, seeking $100 million in damages and alleging that the firm failed to properly provide auditing and other services to the company.

On December 19, 2006, Vitesse announced (here) the results of a review conducted by a special committee of its board of directors that had been organized to look into allegations of possible options grant manipulations. The special committee "found evidence that members of Vitesse’s former senior management team backdated and manipulated the grant dates of stock options issued over a number of years, utilized improper accounting practices primarily related to revenue recognition and inventory, and prepared or altered financial records to conceal those practices." The special committee estimated that the total additional expense to Vitesse from the stock grant manipulation is approximately $120 million since 1995.

The special committee identified a number of accounting issues, some of which "appear to have been used on certain occasions to manipulate revenues for accounting periods in consideration of Wall Street expectations." Among the practices identified were: the failure to properly account for returned inventory; use of false sales invoices to increase revenue; and improper revenue recognition practices, including channel stuffing and improper recognition of consignment sales.

The company’s December 19, 2006 press release also stated that Vitesse’s board had "dismissed KPMG LLP based on its lack of independence." However, in a December 22, 2006 press release (here), Vitesse clarified its prior statement about KPMG’s dismissal, noting that "the dismissal was as a result of Vitesse’s consideration of potential claims it may have with respect to KPMG, which would impair its independence, rather than any finding that KPMG lacked independence with respect to Vitesse prior to the date of the Special Committee’s report." A CFO.com article regarding the clarifying press release can be found here.

The Vitesse lawsuit against KPMG follows the lawsuit that another former KPMG client recently filed against the firm. KPMG was named, along with PricewaterhouseCoopers, as a defendant in a lawsuit that Collins & Aikman Corp. filed against its former CEO, David Stockman, and other former company executives. The Collins & Aikman lawsuit (about which refer here) alleges that the accountants "turned a blind eye to accounting improprieties" at the company.

The Vitesse and Collins & Aikman lawsuits are only the most recent of KPMG’s litigation woes. KPMG also was targeted in the Department of Justice’s investigation of tax shelters KPMG developed and sold between 1996 and 2002 (refer here), in settlement of which KPMG agreed to make payments totaling $456 million.

Vitesse itself and several of its former directors and officers face securities class action litigation (here) based on allegations of stock option manipulations. At least one of the securities class action complaints filed against Vitesse (here) also named KPMG as a defendant.

Vitesse is not the first company having uncovered options backdating to sue its former auditor. As discussed in an earlier post (here), Micrel sued its former auditor, Deloitte and Touche, for allegedly faulty advice regarding the company’s options practices. Deloitte settled the case for a payment of $15.5 million.

French Accent: "Vitesse" is of course the French word for "speed. " The D & O Diary associates the word with the French TGV trains ("train à grande vitesse") which SNCF, the French rail company, operates. The TGV Eurostar train goes through the Chunnel from Paris to London. On April 4, 2007 (refer here), a modified TGV train set the conventional train speed record, clocking in at 357.2 mph. (To my knowledge, Vitesse Semiconductor has nothing to do with the TGV.)

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