There are so many companies that cook their books to gain the approval of Wall Street. It is perhaps too often that traders and investors alike look to pundits on Wall Street to get information about a company. Some of the problem might be laziness on the part of potential purchasers of a given security. But, I suspect that a lot of the problem for purchases of securities is that the market moves so fast that by the time the real research and analysis is done on a company the company’s stock could have shot up several percent and then taken a nose dive only to shoot back up again. Doing corporate research and background checks is can be used to pick an entry point price to pay for a security but, because of extreme market volatility and the connectivity of our one world economy it is impossible to eliminate the gambling side to Wall Street. If something happens in Indonesia tomorrow it could cause a given company to go bankrupt or make billions. Since most companies are in several different countries keeping track of all the politics and economics in every country a company has ties to may be impossible.
The following is a story released by the SEC regarding Dell Inc. who seemed to consistently meet Wall Street expectations. You might recall the Bernard Madoff story in which he consistently did well for his investors and gave them fantastic returns. The Dell story like the Madoff story is a story of cooking the books so that investors did not panic when they saw that Dell did not meet the expectations of Wall Street gurus. Now Madoff cooked his books strictly to continue getting new investors to keep his Ponzi scheme going. Dell not only wanted to protect itself from investor flight but was also getting kickbacks from Intel to keep Dell from using another company’s CPU. In short, Dell made up for it’s shortfall in earnings from operations by taking bribes from Intel. Please read the excerpt from the SEC web site for details of this somewhat strange story.
“Washington, D.C., July 22, 2010 — The Securities and Exchange Commission today charged Dell Inc. with failing to disclose material information to investors and using fraudulent accounting to make it falsely appear that the company was consistently meeting Wall Street earnings targets and reducing its operating expenses.
The SEC alleges that Dell did not disclose to investors large exclusivity payments the company received from Intel Corporation to not use central processing units (CPUs) manufactured by Intel’s main rival. It was these payments rather than the company’s management and operations that allowed Dell to meet its earnings targets. After Intel cut these payments, Dell again misled investors by not disclosing the true reason behind the company’s decreased profitability.
The SEC charged Dell Chairman and CEO Michael Dell, former CEO Kevin Rollins, and former CFO James Schneider for their roles in the disclosure violations. The SEC charged Schneider, former regional Vice President of Finance Nicholas Dunning, and former Assistant Controller Leslie Jackson for their roles in the improper accounting.
Dell Inc. agreed to pay a $100 million penalty to settle the SEC’s charges. Michael Dell and Rollins each agreed to pay a $4 million penalty, and Schneider agreed to pay $3 million, to settle the SEC’s charges against them. Dunning and Jackson also agreed to settle the SEC’s charges.
“Accuracy and completeness are the touchstones of public company disclosure under the federal securities laws,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “Michael Dell and other senior Dell executives fell short of that standard repeatedly over many years, and today they are held accountable.”
Christopher Conte, Associate Director of the SEC’s Division of Enforcement, added, “Dell manipulated its accounting over an extended period to project financial results that the company wished it had achieved, but could not. Dell was only able to meet Wall Street targets consistently during this period by breaking the rules. The financial results that public companies communicate to the investing public must reflect reality.”
The SEC’s complaint, filed in federal district court in Washington, D.C., alleges that Dell Inc., Michael Dell, Rollins, and Schneider misrepresented the basis for the company’s ability to consistently meet or exceed consensus analyst EPS estimates from fiscal year 2002 through fiscal year 2006. Without the Intel payments, Dell would have missed the EPS consensus in every quarter during this period. The SEC’s complaint further alleges that Dell’s most senior former accounting personnel including Schneider, Dunning, and Jackson engaged in improper accounting by maintaining a series of “cookie jar” reserves that it used to cover shortfalls in operating results from FY 2002 to FY 2005. Dell’s fraudulent accounting made it appear that it was consistently meeting Wall Street earnings targets and reducing its operating expenses through the company’s management and operations.
According to the SEC’s complaint, Intel made exclusivity payments to Dell in order for Dell to not use CPUs manufactured by its rival — Advance Micro Devices, Inc. (AMD). These exclusivity payments grew from 10 percent of Dell’s operating income in FY 2003 to 38 percent in FY 2006, and peaked at 76 percent in the first quarter of FY 2007. The SEC alleges that Dell Inc., Michael Dell, Rollins, and Schneider failed to disclose the basis for the company’s sharp drop in its operating results in its second quarter of FY 2007 as Intel cut its payments after Dell announced its intention to begin using AMD CPUs. In dollar terms, the reduction in Intel exclusivity payments was equivalent to 75 percent of the decline in Dell’s operating income. Michael Dell, Rollins, and Schneider had been warned in the past that Intel would cut its funding if Dell added AMD as a vendor. Nevertheless, in Dell’s second quarter FY 2007 earnings call, they told investors that the sharp drop in the company’s operating results was attributable to Dell pricing too aggressively in the face of slowing demand and to component costs declining less than expected.
The SEC’s complaint further alleges that the reserve manipulations allowed Dell to materially misstate its earnings and its operating expenses as a percentage of revenue — an important financial metric that the company itself highlighted — for more than three years. The manipulations also enabled Dell to misstate materially the trend and amount of operating income of its EMEA segment, an important business unit that Dell also highlighted, from the third quarter of FY 2003 through the first quarter of FY 2005.
Without admitting or denying the SEC’s allegations, Dell Inc. consented to the entry of an order that permanently restrains and enjoins it from violation of Section 17(a) of the Securities Act of 1933 and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1, and 13a-13. Dell Inc. also agreed to enhance its Disclosure Review Committee and disclosure processes, including the retention of an independent consultant to recommend improvements to those processes and enhance training regarding the disclosure requirements of the federal securities laws.
Michael Dell and Rollins settled the SEC’s disclosure charges, without admitting or denying the SEC’s allegations, by each agreeing to pay the $4 million penalties and consenting to the entry of an order that permanently restrains and enjoins each of them from violating Sections 17(a)(2) and (3) of the Securities Act and from violating or aiding and abetting violations of other provisions of the federal securities laws.
Schneider consented to settle the disclosure and accounting fraud charges against him without admitting or denying the SEC’s allegations, and agreed to pay the $3 million penalty, disgorgement of $83,096, and prejudgment interest of $38,640. Dunning and Jackson consented to settle the SEC’s improper accounting charges without admitting or denying the SEC’s allegations. Dunning agreed to pay a penalty of $50,000. In their settlement offers, Schneider, Dunning and Jackson consented to the issuance of administrative orders pursuant to Rule 102(e) of the Commission’s Rules of Practice, suspending each of them from appearing or practicing before the SEC as an accountant with the right to apply for reinstatement after five years for Schneider and three years for Dunning and Jackson.
The SEC’s investigation is continuing as to other individuals.”
The above might be a very stupid crime on the part of Dell executives. After all, perhaps if they had used the CPU’s of an Intel competitor they might have had more sales, more revenues and more profits in which case, their ability to meet Wall Street expectations would have been met or exceeded. In any case, the fines were quite severe. The one problem I have with fining a company for committing fraud on its stockholders is that the stockholders (victims) end up paying for the crime twice. The first time they pay are when they are defrauded by paying too much for a stock and the second time they also pay by a declining stock price due to decreased profits because of large fines that the SEC levies. To levy fines against the victims seems stupid on the face of it and it is stupid. Congress should find a way to fix this problem but, too many of them became politicians because daddy does not trust them to run the family business.
In full disclosure I own shares in Intel but, I do not own shares in Dell. I do own a Dell computer and I have no complaints about the product or company services.
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