Wave of Audits

In the wake of the Enron debacle, a cluster of smaller companies are finding that their books are being scrutinized more closely. If Wall Street starts punishing creative accounting, which new economy corporations will be hurt?

by InternetNews.com Staff [February 5, 2002]

A storm of scandal—seething from the nation's capital to the heart of Texas—has focused American attention as tightly as a laser beam on the seemingly pedestrian subject of accounting practices. As the Bush Administration, Congress, regulators and auditors attempt to answer who knew what, when and where, other companies are being asked to open their books to the light of regulatory scrutiny.

One such company is bankrupt voice and data carrier Global Crossing Ltd., which was asked by the Securities and Exchange Commission (SEC) last week to provide corporate documents and a letter written by the company's former vice president of finance.

The letter alleged that Global Crossing and its auditor, Arthur Andersen (the auditor at the center of the Enron debacle), were inflating pro forma values for cash revenue and adjusted EBITDA by including amounts for which cash were not received or where there had been non-monetary exchanges of capacity. The writer, Roy Olofson, said it was not proper for the company to have reported those values because the numbers are not measures of cash receipts or earnings.

Olofson's complaints centered around Global Crossings' swapping of IRUs (Indefeasible Rights of Use), long-term contracts for capacity which carriers frequently swap, allowing them to record a new contract as revenue while reporting the outgoing contract as a capital expense. Olofson's complaints targeted that practice, saying Global Crossing mislead investors by utilizing metrics that downplayed capital and interest costs.

However, Global Crossing maintains that its accounting practices were above-board and that numerous internal reviews and reviews by outside counsel found no merit to Olofson's allegations. It said that in filings with the SEC it disclosed that the company's management used recurring adjusted EBITDA to monitor compliance with the financial covenants contained in its debt instruments and to measure the performance and liquidity of its business segments. The company also said its "press releases and filings with the SEC have disclosed the fact that the company purchased significant amounts of assets from carriers who were also customers of the company." Global Crossing said those disclosures presented the amounts of cash received by the company and included in cash revenue and adjusted EBITDA, as well as the amounts of the cash commitments to those customers.

Global Crossing said it has provided the documents the SEC requested, and released a statement Monday outlining its version of events regarding Olofson.

The company said it received the letter from Olofson, then vice president of finance for the company, in August 2001.

"After a review of the letter and consultation with outside counsel, the company determined that the financial reporting topics raised in the letter had been reviewed by its internal finance and accounting personnel and by Arthur Andersen in connection with the audit of the company's annual financial statements and its review of the company's interim financial statements," the company said Monday. "The company also determined that there had been appropriate disclosure in the company's press releases and filings with the U.S. Securities and Exchange Commission describing how the pro forma numbers were prepared and making it clear that this information should not be considered as an alternative measure of performance defined under GAAP (generally accepted accounting principles). The company also determined that there were reasons to question the motives of Mr. Olofson. Accordingly, no further action was taken in response to Mr. Olofson's allegations."

Global Crossing proceeded to make clear what it felt Olofson's motives were.

"Shortly after Mr. Olofson wrote to the company, and notwithstanding the fact that he was still an employee, the company received a letter from an attorney alleging that Mr. Olofson had been "constructively terminated" from his employment and therefore would no longer be reporting to work," Global Crossing said. "Furthermore, the employee and his counsel demanded, as a condition to dropping his wrongful termination claim, an up-front multi-million payment and a minimum seven-figure annual cash compensation package for a five-year period. After a review of this claim and consultation with outside counsel, the company concluded that this claim was without merit and refused to agree to this demand."

Global Crossing said that Olofson followed those demands with a draft complaint elaborating on the allegations Olofson first expressed in the August 2001 letter, and the attorney added an allegation that the company delayed the announcement of downward revision to its guidance for 2001 earnings due to recent stock transactions by the company's senior executives. The company said it reviewed those allegations, consulted with outside counsel, and again decided the allegations were without merit.

After that, Global Crossing said that over a period of months Olofson's attorney gradually reduced the settlement demand to an amount less than one-tenth the original demand. Also, the company said that on Nov. 30, 2001, it terminated Olofson's employment "in connection with a substantial reduction in its workforce."

"On Jan. 18, 2002, the company received a letter from a different attorney for Mr. Olofson, attaching a revised draft of the initial complaint and containing renewed threats to commence an action for wrongful termination against the company and certain of its officers and directors unless a multi-million dollar payment was made by Feb. 1, 2002," the company said. "The company again refused to agree to this demand.

However, Global Crossing said that due to the increasing attention focused on accounting improprieties due to "recent events not involving the company," it decided to tell Arthur Andersen about the existence of Olofson's letter on Jan. 28, 2002. It said it provided the accounting firm with a copy on the following day, and also told current members of its audit committee about the letter on that day. It said it gave members of the audit committee copies of the letter On Jan. 30, 2002.

"Although the company continues to believe that Mr. Olofson's motivations are questionable and continues to believe that its accounting and reporting are entirely appropriate, at the request of the company's audit committee and Arthur Andersen, it has decided to form a special committee of independent directors, including members of its audit committee, to conduct a further review of the allegations made in the August 2001 letter and related draft complaints," the company said. "The special committee will retain independent counsel and a firm of independent accountants other than Arthur Andersen to review the matter."

Olofson could not immediately be reached for comment.

In related news, Enterasys Networks disclosed two investigations: an internal audit of a $4 million Asia-Pacific contract and an apparently unrelated Securities and Exchange Commission probe.

As a result, the Portsmouth, N.H., telecom equipment maker has delayed the spinout of Aprisma Management Technologies and the release of fourth-quarter and fiscal 2001 financial reports.

The Asia-Pacific inquiry centers on contract inconsistencies and raises questions about whether revenue from the deal can be recognized. Three Enterasys employees have been placed on administrative leave pending an investigation.

Enterasys has instructed its auditors KPMG to review the sale practices and revenue recognition in its Asia Pacific operation, which accounts for 13 percent of overall sales. In addition, a Deloitte & Touche "forensic accounting" team has been called in.

In a development apparently unrelated to the Asia Pacific review, Enterasys said the SEC has issued an order of investigation relating to Enterasys and certain affiliated companies, including Aprisma.

Last of all, ad network L90 is under investigation by the Securities and Exchange Commission, following the sudden resignation Friday of an executive. Although few details are available, L90 said its proposed sale to eUniverse, which is pending regulatory and shareholder approval, would likely be delayed beyond its original Feb. 28 closing date.

In spite of the inquiry, eUniverse said it remained optimistic about its proposed purchase of L90.

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