SAN FRANCISCO — In a show of force by the federal government against Silicon Valley, top executives from three Bay Area software companies were charged with accounting fraud Monday. Managers at two of the firms were charged criminally as well.
The charges allege that five executives at Quintus Corp., Unify Corp. and Legato Systems Inc. separately engaged in a laundry list of illegal practices that wildly inflated revenue during the technology boom.
According to the Securities and Exchange Commission, a Quintus executive created false contracts, e-mails and purchase orders, as well as forged signatures and faked the proof of a sale needed by an auditor; Unify managers paid other firms to buy its software; and Legato booked sales on deals that were never consummated.
Also Monday, accounting firm Ernst & Young was charged with civil violations for getting involved in an allegedly improper business relationship with PeopleSoft, a software firm that was its client.
Federal officials are expanding their probes into the technology sector, amid mounting evidence of widespread fraud in the late 1990s. The SEC also is targeting what it believes were inflated revenue figures across a broad expanse of U.S. industry, as managers sought to pump up their stock prices.
"With some tech companies, the key to their fame was thinking outside the box," said Charles Niemeier, head of accounting for the SEC's enforcement division. "That does not work well when it comes to the accounting rules."
At their peak, the three software companies charged Monday had a combined stock market value of about $8 billion. Legato has fallen to $650 million, while Unify trades for pocket change. Quintus went bankrupt and no longer exists.
"We all knew that the bubble was being fueled by massive amounts of hype," said Silicon Valley hedge fund manager Eric Von der Porten. "But even the skeptics didn't imagine just how many maneuvers companies were using to puff up their revenues and make it look like they might justify their market values. It's only now in the post-bubble, post-Enron environment that all the dirty little secrets are starting to be revealed."
Monday's charges were announced simultaneously because "we wanted to send a message to the firms in Northern California that if they play these games, we're going to go after them aggressively," said Helane Morrison, SEC district administrator for the Bay Area. Federal prosecutors simultaneously announced criminal charges against the Quintus and Unify officers.
According to the complaints filed in U.S. District Court in San Francisco, the three companies seemed to expend more energy on faking sales than they did in generating legitimate business.
"The nature of most financial fraud is that it begins subtly and then it grows," Niemeier of the SEC said. "Once a company starts manipulating the numbers, it's almost impossible to stop without revealing the fraud. Once started, the company is pushed to add more fraudulent revenue or earnings in order to maintain the scheme."
Unify, which makes database management software, was founded in San Jose in 1980. It went public in 1996 and saw its stock soar in the Internet boom as it started marketing e-commerce applications. But sales during fiscal 2000 were in danger of falling short of expectations.
As a result, the government charges, Chief Executive Reza Mikailli and Chief Financial Officer Gary Pado resorted to fictitious sales.
In one case, a Panamanian company called Open owed Unify $400,000 on a software contract. Despite this obligation, the SEC says, the Unify executives negotiated a new $1.15-million contract. Open's chief executive warned Unify that he couldn't pay, but the executives told him not to worry, according to the SEC's civil suit.
Unify's auditors refused to record the new sale until Open paid its existing debt, according to the suit. Mikailli wired Open $400,000 of his own money, which Open then sent back to Unify. Open never paid the $1.15 million, but Unify recorded the revenue anyway, the SEC says.
In another episode, according to the SEC, Mikailli was in discussion with the chief executive of Internet company Ichatterbox Inc. about joining the Unify board of directors. There was a catch, however: Ichatterbox had to buy $100,000 worth of Unify software, even though the Internet company had no need for it and very little cash, the SEC says.
Mikailli paid Ichatterbox $300,000, instructing its chief executive that a third of it was for the software and the rest was an investment, the SEC says. Unify then reimbursed Mikailli his $300,000.
Such fraudulent deals, the SEC charges, allowed Unify to report revenue of $39.5 million and net income of $15.3 million for the 12 months ended April 30, 2000. More than half the revenue, or $21.1 million, was fake, the SEC says; as for the profit, it actually was a loss of $7.7 million.