For years, Dell Inc. shareholders, the investing public
and the markets were told that the company had a superior business model. The
company met street expectations quarter after quarter and year after year with
such consistency that a skeptical analyst might have wondered about the
results. Apparently nobody did.
Dell's picture perfect results began to unravel in 2007
with an internal investigation and eventually disclosures of wrongful conduct
and a restatement. The story took a further turn last month when the company,
its founder Michael Dell and others, settled an enforcement action with the
SEC. There, the Commission's complaint focused on a scheme which took place
from 2003 through 2007. It concealed the fact that large parts of the company's
revenues came, not from superior products and management, but from payments
some might consider anticompetitive - Intel paid Dell not to use the products
of a competitor. Whatever the propriety of these payments, investors and the
market were entitled to know that a significant portion of Dell's revenue came
from them, not superior management as claimed, according to the Commission.
The company, Mr. Dell and others settled. The settlements
were generally based on claimed violations of Securities Act Sections
17(a)(2)&(3), a kind of negligent fraud, and various books and records
charges as discussed
here. There were, of course, penalties.
On Friday, another chapter in the Dell accounting saga
unfolded. Settled enforcement actions were filed against Robert W. Davis and
Randall D. Imhoff. SEC v. Davis, Case No. 1:10-cv-01464 (D.D.C. Filed
Aug. 2, 2010); SEC v. Imhoff, Case No. 1:10-cv-01465 (D.D.C. Filed Aug.
27, 2010). Mr. Davis, a CPA, served as Dell's Vice President of Corporate Planning
and Reporting beginning in 2001. In November 2002, he was named V.P. of
Corporate Finance and Chief Accounting Officer. He held this position until
February 2005, when he left the company to become CFO of Computer Associates,
Inc. Mr. Imhoff, also a CPA, joined Dell in 2000 as Corporate Assistant
Controller and was named Finance Director for U.S. Small and Medium Business in
September 2003. From November 2005 through April 2007 when he left the company
he served as Finance Director for Global I/T.
The two complaints, although not identical, essentially
detail a scheme to improperly boost revenues and meet street expectations
beginning as early as 2001 and continuing through at least 2005. The complaint
against Mr. Davis, for example, claims that beginning in fiscal year 2002 and
continuing through fiscal year 2005 the company utilized "cookie jar" reserves
and other manipulations to achieve its financial objectives. During the period,
Dell maintained excess accruals in multiple reserve accounts. Those excess
accruals were used to offset the financial statement impact of future expenses.
One reserve manipulated was known as the Strategic or "Strat Fund." It was a
subset of account 24990 called "Corporate Contingencies." Generally, it was
used to reduce operating expenses by making releases to cover unforeseen or
unplanned expenses. According to the SEC, "Davis planned and issued
instructions regarding Dell's build-up and use of Corporate Contingencies."
The other reserves manipulated included: 1) Relocation
accruals; 2) Corporate restructuring reserve; 3) Several reserves in one of
Dell's overseas business units; 4) Bonus and profit-sharing accruals; and 5) an
under-accrued restructuring Las Cimas reserve.
The manipulation of these reserves permitted the improper
management of revenue. It also fundamentally altered key metrics and ratios.
Dell, for example, highlighted for investors its OpEx ratio - a ratio of
operating expenses as a percentage of revenue. The company told investors that
the ratio remained flat or continued to "record low" which meant that its cost
reduction initiatives and focus on controls was successful. In fact, the ratio
varied greatly from period to period when computed with the correct data.
Mr. Davis settled with the Commission, consenting to the
entry of a permanent injunction prohibiting future violations of Securities Act
Sections 17(a)(1) & (2), Exchange Act Section 13(b)(5) and from aiding and
abetting violations of Exchange Act Sections 13(a) and 13(b)(2)(A) & (B).
He also agreed to disgorge $19,080 along with prejudgment interest and pay a
civil fine of $175,000. Mr. Imhoff consented to the entry of a permanent
injunction prohibiting future violations of Exchange Act Section 13(b)(5) and
from aiding and abetting violations of Sections 13(a) and 13(b)(2)(A) &(B).
He also agreed to disgorge $12,852 along with prejudgment interest and to pay a
civil fine of $25,000. Neither defendant was barred from serving as an officer
or director. There is no indication in the papers that either defendant will be
barred from practicing before the Commission under Rule 102(e) as an
accountant, although it is possible such actions will be filed later.
Reading all of the Dell actions together it is clear,
according to the Commission, that shareholders and the markets were furnished
with materially inaccurate financial information from as early as 2001 through
2007. Those inaccuracies were bolstered by company and management statements
attributing the consistently good results to management expertise and good
controls. In 2007, an internal investigation by the company found otherwise. It
uncovered the accounting irregularities and wrong doing, disclosure was made
and eventually there was a restatement correcting the financial statements. The
Commission investigated, found years of wrong accounting, manipulated reserves
and incorrect statements, but no intentional fraud.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.