CA Faces FBI Probe
Sources: Feds looking at possible accounting fraud
By Mark Harrington and Robert Kessler
February 20, 2002
The U.S. attorney for the Eastern District and the FBI have launched a
preliminary investigation of whether Computer Associates International
Inc. violated federal criminal fraud laws through its accounting
practices, according to several sources familiar with the investigation.
The sources stressed that the investigation of the Islandia software giant
is in its initial stages and there is no firm evidence that anything
illegal has occurred.
A former CA employee who was contacted by the U.S. attorney's office
several weeks ago said the questions centered on the way CA has reported
revenue in its financial statements.
CA spokesman Robert Gordon said, "We have not been contacted by the U.S.
attorney's office regarding any investigation.”
An FBI spokesman in New York, Joseph Valiquette, declined to comment, as
did Executive Assistant U.S. Attorney William Muller.
The former CA employee said a representative from the U.S. attorney's
office indicated he was still developing a list of candidates to be
interviewed. The Brooklyn-based U.S. assistant attorney assigned to the
case declined to comment.
Investigators are looking into whether the company has properly
distinguished between revenues it receives from the sale of software and
the fees it charges to service, upgrade and maintain those software
products, according to the sources.
Securities and Exchange Commission rules require companies to make clear
distinctions between the revenues of each, and to equally divide
recognition of maintenance revenue over the life of the service contract,
said John Coffee, a professor and SEC law expert at Columbia University,
stressing he was not familiar with any CA probe.
While CA in the past has acknowledged fielding SEC inquiries, the company
has not been accused of wrongdoing by the agency and has long denied
suggestions of accounting irregularities.
It was uncertain yesterday what role, if any, the SEC was playing in the
probe. An SEC spokesman didn't return a phone call.
Coffee said FBI involvement in the CA probe would indicate any potential
case would be a criminal, not civil, matter.
"The key word is intent,” said Douglas Carmichael, professor of accounting
at Baruch College in Manhattan. "If management intentionally misstated
financial results, that's fraud.”
While fraud can be the basis of both civil and criminal cases, Carmichael
said, pursuit of the latter "would basically mean some belief there may
have been an intentional financial misstatement” that can be proved
"beyond a reasonable doubt.”
Coffee stressed, however, that the contacts appear to be preliminary, and
may not result in any action.
He said the SEC requires software companies to clearly delineate product
and service revenues to give investors an unobscured picture into how they
make their money. Costs associated with performing service are
fundamentally different from the costs tied to developing a product, he
While some former CA employees have severance agreements that prevent them
from discussing company business, other CA employees may not be so
constrained. When it fired hundreds of employees in January of last year,
CA branded most as non-performers and withheld severance payments. Several
who say they are still owed tens of thousands of dollars in back
commissions said yesterday they would be willing to speak with the U.S.
Still, of dozens of former employees reached by Newsday this week, only
one had been contacted by the U.S. attorney's office. Interviews are
expected to be conducted by the FBI, the sources said.
CA's accounting practices have been under a microscope for several years,
but the intensity was turned up when it converted to a new business model
and pro-forma accounting method in October 2000. Under the new model, CA
accounts for all revenues -- both software and service -- on a
month-to-month basis instead of up front. The company maintains the
accounting method gives investors more transparency into its results. When
he launched a proxy battle for control of CA's board of directors last
year, Texas tycoon Sam Wyly accused the company of engaging in "phony
accounting,” charges CA denied.
Though analysts have admitted to a level of difficulty in understanding
the company's complex accounting, the stock has recovered well from its
2001 lows, and it has favorable ratings from most of the more than dozen
analysts who track it.
Just yesterday, Morgan Stanley resumed coverage of CA, upgrading the stock
from neutral to outperform, and explaining the market had "overlooked” and
"poorly analyzed” CA. It expects CA, which yesterday closed down $1.75 to
$25.31, to reach a new target of $48 in the coming year.
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