Accounting Fraud Charges Snag Dell Computer and Execs

by Kurt Schulzke

Is the SEC on a roll or just looking over its shoulder at salivating securities whistleblowers? On the heels of settling with Goldman Sachs last week for $550 million, the SEC yesterday announced its $111+ million take from settling accounting fraud charges against Dell Computer and several current and former Dell executives including Michael Dell, Kevin Rollins and James Schneider.  The three will pay the SEC $4M, $4M and $3M, respectively, to settle.  Assuming the facts are as stated by the SEC, they’re fortunate.

The allegations center on misleading disclosures about Dell’s revenue sources and “cookie-jar reserves” by means of which, the SEC alleged in its complaint in the U.S. District for the District of Columbia, Dell and its executives led the market to believe Dell’s financial performance was much better than it actually was:

… Dell Inc., Michael Dell, Rollins, and Schneider misrepresented the basis for the company’s ability to consistently meet or exceed consensus analyst EPS estimates from fiscal year 2002 through fiscal year 2006. Without the Intel payments, Dell would have missed the EPS consensus in every quarter during this period.

… in one internal 2004 email to Michael Dell … Rollins noted that Dell’s reliance on Intel payments was a strategic “problem,” stating that “for 3 qtrs now, Intel money has made the qtr. A bad way to run the railroad.” …

… Dell’s most senior former accounting personnel, including Schneider … engaged in improper accounting by maintaining a series of “cookie jar” reserves that it used to cover shortfalls in operating results from FY 2002 to FY 2005… [making] it appear that it was consistently meeting Wall Street earnings targets and reducing its operating expenses through the company’s management and operations…

[Allegedly], Intel made exclusivity payments to Dell in order for Dell not to use CPUs manufactured by its rival – Advance Micro Devices, Inc. (AMD). These exclusivity payments grew from 10 percent of Dell’s operating income in FY 2003 to 38 percent in FY 2006, and peaked at 76 percent in the first quarter of FY 2007. The SEC alleges that Dell Inc., Michael Dell, Rollins, and Schneider failed to disclose the basis for the company’s sharp drop in its operating results in its second quarter of fiscal 2007 as Intel cut its payments after Dell announced its intention to begin using AMD CPUs. In dollar terms, the reduction in Intel exclusivity payments was equivalent to 75 percent of the decline in Dell’s operating income. Michael Dell, Rollins, and Schneider had been warned in the past that Intel would cut its funding if Dell added AMD as a vendor. Nevertheless, in Dell’s second quarter FY 2007 earnings call, they told investors that the sharp drop in the company’s operating results was attributable to Dell pricing too aggressively in the face of slowing demand and to component costs declining less than expected.

… the reserve manipulations allowed Dell to materially misstate its earnings and its operating expenses as a percentage of revenue … for over three years. The manipulations also enabled Dell to misstate materially the trend and amount of operating income of its EMEA segment, an important business unit that Dell also highlighted, from the third quarter of FY 2003 through the first quarter of FY 2005.

Floyd Norris and I don’t often see eye-to-eye on accounting issues.  However, taking the SEC’s allegations as true, it’s hard to argue with Norris that the fines imposed fit the crimes alleged.  Dell Computer will pay $100 million to settle its part of the case.  Hypothetically speaking, if the Dell case were subject to the new SEC whistleblower program, the whistleblowers would be legally entitled to between 10 and 30 percent of the more than $110 million the SEC will collect from the defendants.

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