Federal authorities are trying to determine whether
Computer Associates International Inc. wrongly booked over $500
million in revenue in its 1998 and 1999 fiscal years as part of a scheme
to enrich the company's senior managers.
The Computer Associates probe, which is being conducted
jointly by the Justice Department and the Securities and Exchange
Commission, is one of many in which the government is examining the
revenue-recognition practices of leading companies. Last week, Computer
Associates acknowledged that the investigation had widened to include
subpoenas to third parties. Its accountant for the 1998 and 1999 fiscal
years, Ernst & Young LLP, said it has received such a demand and was
cooperating with authorities.
Rising revenue was an important part of the logic that
propelled Computer Associates shares on an upward arc in the 1990s, as
the company appeared to be growing faster than rivals in selling
software to big corporate customers. In May 1998, because the shares had
reached a trigger price of $55.13 and stayed there for a sustained
period of time, the company's three top managers -- Charles Wang, then
its chief executive and now the current chairman; then-President Sanjay
Kumar, who is the current CEO; and head of research Russell Artzt --
received a special incentive stock award then valued at $1 billion.
Today, the stock trades at about $18.
Now, investigators want to know why the company
overstated its revenue for the period immediately preceding and
following the stock grants. They are focusing, among other things, on a
little-noted action the company took in May 2000 to shave $1.76 billion,
or more than 10%, off the revenue it had previously reported for the
three fiscal years that ended in March of that year. The downward
revision, made when the company filed its 10K annual report with the
SEC, included hundreds of millions of dollars retroactively taken away
from the top line in the 14 months before the May 1998 stock award to
the senior management -- including $513 million for the year ended March
1998, and some portion of the $587 million taken away from the following
Earnings were unaffected by the revision, which the
company refers to as a "reclassification," not a restatement, as the
lost revenue was offset by a commensurate downward revision in expenses.
In a footnote to the 2000 annual report, the company attributed the
revision to a change in the way it accounted for software leases, but no
further explanation could be found in the company's disclosure
documents. Computer Associates declined repeated requests in recent days
The retroactive decline in revenue has also been a
central topic in a shareholder class action against Computer Associates
in U.S. District Court in Central Islip, N.Y., near its headquarters in
Islandia, N.Y. In that case, plaintiffs have alleged revenue was boosted
to help Messrs. Wang, Kumar and Artzt receive their award, some of which
they were later forced to give back as part of a separate legal action.
The plaintiffs' theory in the Islip case, also being explored by federal
investigators, is that Computer Associates was routinely booking too
much software licensing revenue in long-term contracts before it
received the money -- even though many of the contracts were canceled
before their term ran out and replaced by contracts of lesser value.
In a statement Sunday, Computer Associates said it
intends "to defend against unwarranted allegations in court," but
otherwise declined comment on the lawsuit. It has previously said there
is nothing wrong with its accounting.
Most of the court record in the shareholder's lawsuit
-- including depositions from Messrs. Wang and Kumar -- has been sealed.
But transcripts of arguments between the two sides over pretrial matters
indicate that the revenue revisions were prompted by its auditor, KPMG
LLC, which replaced Ernst & Young as the company's accountant in June
1999. In early 2000, KPMG made a presentation to Computer Associates
executives expressing concern about revenue recognition, the transcripts
indicate, in an account supported by people familiar with the matter.
The KPMG presentation was detailed and had been
prepared using PowerPoint software commonly used to create a
computerized type of slide show for displaying charts and figures,
plaintiffs say in the lawsuit. But Messrs. Wang and Kumar, in their
sealed depositions, have given testimony saying they don't recall any
KPMG concern over revenue booking, according to comments in the
transcript from both sides and the presiding federal magistrate. A KPMG
spokesman declined to comment on the matter.
In arguments before the judge hearing the civil case,
the company's outside lawyers at Solomon, Zauderer, Ellenhorn, Frischer
& Sharp have portrayed Messrs. Wang and Kumar as arm's-length managers
who only casually reviewed regulatory filings such as 10K and 10Q annual
and quarterly reports, and left the complex details of licensing
accounting to subordinates in the finance department.
Last week, acting on a motion by Computer Associates,
the magistrate ordered a further, more restrictive sealing of documents
in the case, including portions of certain court transcripts already
reviewed by The Wall Street Journal. The class action, expected to go to
trial by year's end, is being pursued by two New York firms that
specialize in shareholder suits -- Milberg, Bershad, Hynes & Lerach LLP
and Stull, Stull & Brody.
The revisions contained in the 2000 annual report
covered audited results for fiscal 1998 and 1999 and also made changes
in the previous, unaudited results the company had reported in its press
release for the 2000 fiscal year. For fiscal 1998, for example, revenue
was marked down to $4.21 billion, some $513 million, or 11% less, than
the $4.72 billion the company had previously reported. In announcing the
original 1998 results in May 1998, Mr. Kumar announced "record" revenue
and earnings that he attributed to "strong worldwide demand for CA
software." In fiscal 1999, the downward adjustment totaled $587 million,
also about 11.2%; and the $663 million taken off in 2000 amounted to a
In July 1998, Computer Associates stock climbed above
$60 a share. But later that month, Mr. Kumar warned that the effect of
Asian economic turmoil and year-2000 computer-bug fears "leads us to
believe that our revenue and earnings growth will slow over the next
several quarters." On July 22, Computer Associates shares took a hit,
dropping to $39.50 from $57 a share.
In October 2000, Computer Associates adopted new
software-licensing accounting. Beginning in October, it said it would
begin booking software leases under a "radical" new "business model"
built around a "subscription-based" method for selling its products
under shorter-term contracts. The company said the new method would help
both customers and pressured sales agents.
Write to Jerry Guidera at
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Updated May 20, 2002 1:05 a.m. EDT