I do not make this stuff up. Of course one has to recognize that “best practices” are defined to favor the larger players, and the larger players are very interested in things like import-export pricing fraud and other less than ethical tax avoidance strategies. But the idea that the Big Four do not consider it part of their job to detect fraud when evaluating companies for acquisition, I find reprehensible. In addition, Hewlett-Packard was insanely cavalier at multiple levels, not least of all in assigning $6.6 billion as the intangible asset value of “good will” in the purchase of Autonomy — for that alone everyone at HP who signed off on the deal should be walking the plank. What troubles me as I continue to reflect on the importance of transparency, truth, and trust, is that fraud is so heavily embedded into our politics and economics that the Big Four feel absolutely no shame in adopting such an outrageous position. As a society, we are broken.
Forbes, 20 November 2012
You can bring a Big Four audit firm to court for missing a major accounting fraud but it’s much harder to bring the auditor to justice.
Deloitte was the auditor of Autonomy, a UK software firm acquired by HP in 2011 for $11.7 billion. HP announced today it is writing down more than $5 billion, or almost half of the acquisition price, because of “serious accounting improprieties, misrepresentation and disclosure failures”.
HP, in the understatement of the year, says it is “extremely disappointed” to find out some former members of Autonomy’s management team inflated Autonomy’s underlying financial metrics – GAAP and non-GAAP. HP boldly called it a “willful effort to mislead investors and potential buyers”.
That’s PR-speak for fraud.
So what is alleged to have happened? For one thing, Autonomy, as HP tells it, was selling some hardware at a loss. During a period of about eight quarters prior to HP’s acquisition, Autonomy sold some hardware products that had a very low margin or on which it may have even taken a loss. It then allegedly turned around and booked those hardware sales as high-margin software sales. At least some portion of the cost on these products, Whitman said, was booked as a marketing expense, not as cost of goods sold.
There’s a second piece of the puzzle, where HP says that Autonomy was selling software to value-added resellers — the middlemen in so many technology transactions — in which there are ultimately no end users. That, too, inflated apparent revenue.
Third, there were some long-term hosting deals — essentially, Autonomy hosting applications for its customers on a subscription basis — that were converted to short-term licensing deals. Future revenue for software subscriptions — that should have been deferred or recorded as coming in the future but not yet booked — were stripped out and booked all at once.
Autonomy’s founder told The Wall Street Journal today that his management team depended on Deloitte to get the accounting right. HP’s CEO Meg Whitman told CNBC her company depended on Deloitte’s audited financial statements of Autonomy when they performed their due diligence during the acquisition process.
So, why would it be hard to prove Deloitte missed something big and should be held accountable? It would be easier if auditors, as an industry, agreed it was their responsibility to detect fraud and material misstatements of the financial statements.
HP chose another global audit firm, PwC, as an independent forensic consultant to investigate the claims of a whistleblower. (The FT says Autonomy founder Mike Lynch was fired.)