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Lucent Technologies: A Study in Fraud and Earnings Management.

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Presentation on theme: "Lucent Technologies: A Study in Fraud and Earnings Management."— Presentation transcript:

1 Lucent Technologies: A Study in Fraud and Earnings Management

2 American Institute of CPAs This presentation is intended for use in higher education for instructional purposes only, and is not for application in practice. Permission is granted to classroom instructors to photocopy this document for classroom teaching purposes only. All other rights are reserved. Copyright © 2003, 2005 by the American Institute of Certified Public Accountants, Inc., New York, New York.

3 American Institute of CPAs Outline Background of Lucent Timeline of events Perpetration of fraud Opportunities

4 American Institute of CPAs Company Background Was spun off from AT&T on September 30, 1996 At the time, largest IPO Nation’s most widely held stock in Dec Maintained reputation as a growth company CEO pushed 20% sales growth Sold software and hardware to phone companies and network operators Software to detect cell phone fraud Accused of aggressive accounting long before restatement Pension fund accounting Acquisition accounting

5 American Institute of CPAs Timeline – Selected events Pre-Restatement Jul. 20, Warns 4Q will miss Oct. 11, Q estimate revised downward again Oct CEO fired, 1Q ’01 warning, board learns of reporting problems and informs SEC Nov Internal investigation conducted Dec Paul O’Neill resigns from audit committee to become Treasury Secretary, Dec Lawsuit filed against Lucent claiming Nina Aversano was fired for disputing unrealistic sales targets

6 American Institute of CPAs Timeline—Restatement Dec. 21, Restates 4Q revenue -$679 million restatement Restatement result of internal investigation, not SEC Lucent claimed that $125 million represented improper recognition, while the rest represented subsequent agreements with vendors

7 American Institute of CPAs Timeline—Post Restatement Jan. 24, Reports sales have fallen 28% and restructuring charge announced Feb 8, SEC investigation formalized Nov. 1, WSJ article Reports SEC investigation far broader than Lucent disclosed -Investigating earnings manipulations as far back as 1996 and role of audit committee -Looking into management’s earnings projections -Examining potential overstatement of restructuring charge Lucent claims SEC investigation is almost complete

8 American Institute of CPAs Recap Revenue recognition Restructuring charges Pension fund accounting Acquisition accounting

9 American Institute of CPAs Revenue What the restatement consisted of: $452 million—Equipment shipped to distributors but never sold (channel stuffing) $199 million—Credits offered to customers $28 million—Partial shipment of equipment Documentary red flags: The $125 million of “improper” revenue was attributable to false documents Analytical red flags: Fiscal 1999 revenue grew 20%, while receivables grew 49% Bad debt reserves decreased while accounts receivable and sales grew

10 American Institute of CPAs Restructuring Charge $2.6 billion right before AT&T spin-off The issue—Using “cookie-jar” reserves to meet expectations by reversing the charge when needed From 1996 to 1999, Lucent reversed $540 million (28%) The result—Lucent met expectations in three quarters that it otherwise would not have Similar to Xerox except for better disclosure

11 American Institute of CPAs Audit Committee Paul Allaire - Former chairman and CEO of Xerox Franklin Thomas - Lucent director and Alcoa board member Betsy Atkins - Cofounder of Ascent Communication (a Lucent Acquisition) Paul O’Neill - Alcoa CEO Donald Perkins - Committee chairman until Feb. 1999

12 American Institute of CPAs See Any Possible Red Flags? Significant insider influence All but Allaire are insiders Potential ethical implications Xerox Peculiar timing of turnover Why did Perkins leave

13 American Institute of CPAs Who Cooked Who’s Books? Fred Moldfoski posted “earnings releases” on Yahoo Finance on March 22-23, 2000 The fraudulent releases were designed to look like official Lucent releases The releases stated that Lucent would miss expectations The impact: Lucent’s stock opened at $ and traded as low as $ The irony—from what we know now, it is possible that Lucent had indeed missed expectations

14 American Institute of CPAs Charges included: December breach of contract suit filed by Nina Aversano May 17, SEC against Lucent and 10 individuals changing them with fraud and violation of GAAP during reporting for fiscal 2000 $511 million revenue prematurely recognized; $637 million should not have been recognized [total $1.148 billion] $91 million pre-tax income prematurely recognized; $379 million should not have been recognized [total $470 million (16%)]

15 American Institute of CPAs Settlements included: Lawsuit filed by Nina Aversano – details undisclosed Shareholder lawsuits totaling $568 million Without admission or denial of charges, Lucent settled with SEC. As SEC believes Lucent did not fully cooperate, a $25 million civil fine was imposed.


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