The Securities and Exchange Commission (SEC) this week filed civil fraud and related charges against six former senior officers of San Diego-based Peregrine Systems, Inc. who orchestrated and attempted to cover up a massive accounting fraud at the company.
According to the Commission's complaint filed in the United States District Court in San Diego, the Peregrine defendants fraudulently inflated the product revenue Peregrine reported in its filings with the Commission and elsewhere. The defendants employed deception and lies to portray Peregrine as a company with constantly growing sales while covering up Peregrine's persistent failure to fulfill revenue forecasts. At the same time, some of the Peregrine defendants unloaded Peregrine stock into an unsuspecting market, enriching themselves, in some instances by millions of dollars, at the expense of the investing public.
In February 2003, Peregrine restated its financial results for eleven quarters during fiscal years 2000, 2001 and 2002, reducing previously-reported revenue of $1.34 billion by more than $507 million.
The Commission's complaint names: Stephen P. Gardner, Peregrine's former Chairman and Chief Executive Officer; Gary L. Lenz, the former President and Chief Operating Officer; Douglas S. Powanda, the former Executive Vice President of Sales; Berdj J. Rassam, the former Controller; Joseph G. Reichner, the former Senior Vice President for Alliances and Business Development; and Peter J. O'Brien, the former Director of Strategic Alliances.
The Commission also charged Daniel F. Stulac, a certified public accountant and former Arthur Andersen LLP engagement partner on the Peregrine audit, with fraud, and Larry A. Rodda and Michael D. Whitt, former principals of two Peregrine channel partners (customers), with aiding and abetting Peregrine's fraud.
Stephen M. Cutler, the SEC's Director of Enforcement, stated, “The accounting fraud at Peregrine permeated the corporation. It involved the active participation and complicity of Peregrine's most senior management, its outside auditor, and some of its customers. Today, the Commission has taken a substantial step toward holding these individuals accountable for their misconduct. This action demonstrates that the Commission will not tolerate senior management's participation in accounting fraud. The Commission will also hold third parties who assist in the fraud accountable for their wrongdoing, and will continue to aggressively pursue outside auditors and other gatekeepers who are co-opted and join in the fraud.”
According to the Commission's complaint, the heart of Peregrine's fraud was the recording of millions of dollars in revenue on the improper basis of non-binding arrangements with resellers (channel partners) – companies that purchased software from Peregrine for resale to end-users. Peregrine's senior management would determine near the ends of quarters how much additional revenue the company needed to meet or exceed analyst expectations. They would then enter into sham deals with channel partners (including backdated contracts and contracts made contingent by oral or written side agreements). Peregrine executives arranged a number of these fraudulent deals with defendants Rodda and Whitt.
Peregrine improperly recorded the resulting “revenue” in order to mislead investors into believing that Peregrine's financial condition was significantly better than it was and to inflate artificially Peregrine's stock price.
Gardner, the former CEO who was actively involved in the fraud, and Powanda, the former Executive VP of Sales who devised many of the sham deals, sold over $11 million and $24 million worth of Peregrine stock, respectively, during the fraud, resulting in millions of dollars in profits.
The complaint further alleges that, as the uncollected receivables from the fake channel sales swelled on Peregrine's balance sheet, senior officers at the company devised a temporary solution to make it appear that Peregrine was collecting cash on a timely basis.
Uncollectible receivables were purportedly sold to banks and removed from Peregrine's balance sheet. These receivable financing transactions, however, were in reality loans and not sales because, under the terms of the deals, the banks had recourse against Peregrine if the customers did not pay. Peregrine's removal of the receivables from its balance sheet was therefore fraudulent.
The United States Attorney's Office for the Southern District of California also announced criminal charges against the nine individuals named in the Commission's complaint, and others who participated in Peregrine's financial fraud. The Commission's investigation of the financial fraud is continuing. Former Peregrine officers and others are cooperating with the investigations.