lucent technologies: a study in fraud and earnings management

Lucent Technologies:A Study in Fraud and Earnings Management

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.


Outline

Background of Lucent

Timeline of events

Perpetration of fraud

Opportunities


Company Background

Was spun off from AT&T on September 30, 1996At the time, largest IPONation’s most widely held stock in Dec. 1999Maintained 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


Timeline – Selected events Pre-Restatement

Jul. 20, 2000 - Warns 4Q will miss

Oct. 11, 2000 - 4Q estimate revised downward again

Oct. 2000 - CEO fired, 1Q ’01 warning, board learns of reporting problems and informs SEC

Nov. 2000 - Internal investigation conducted

Dec. 2000 - Paul O’Neill resigns from audit committee to become Treasury Secretary,

Dec. 2000 - Lawsuit filed against Lucent claiming Nina Aversano was fired for disputing unrealistic sales targets


Timeline—Restatement

Dec. 21, 2000 - 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


Timeline—Post Restatement

Jan. 24, 2001 - Reports sales have fallen 28% and restructuring charge announced

Feb 8, 2001 - SEC investigation formalized

Nov. 1, 2002 - 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


Recap

Revenue recognition

Restructuring charges

Pension fund accounting

Acquisition accounting


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


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


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


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


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 $62.125 and traded as

low as $60.375

The irony—from what we know now, it is possible that Lucent had indeed missed expectations


Charges included:

December 2000 - breach of contract suit filed by Nina Aversano

May 17, 2004 - 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%)]


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.

lucent technologies: a study in fraud and earnings management

Documents

sec lucent

complete slide

earnings management

q revenue

lucent technologies

sec investigation formalized

improper revenue

aggressive accounting