In September 2004, SEC announced securities fraud charges against Computer Associates International Inc, and three of its former senior executives alleging that from 1998 to 2000, Computer Associates routinely kept its books open to record revenue from contracts executed after the quarter ended in order to meet Wall Street quarterly earnings estimates. In total, Computer Associates prematurely recognized $2.2 billion in revenue in FY2000 and FY2001 and more than $1.1 billion in premature revenue in prior quarters.
The issue was timing of recognition of revenue. The former CEO Sanjay Kumar and the former Vice President of Finance David Richards, along with others, allegedly took part in a systemic, company-wide practice of falsely and fraudulently recording and reporting within a fiscal quarter revenue associated with certain license agreements, even though those agreements had not in fact been finalized and signed during that quarter. In the week following the end of fiscal periods, while the books were held open, Kumar and Richards directed CA sales managers and salespeople to finalize and backdate license agreements. Revenue from those falsely dated license agreements was then improperly recognized in the quarter just ended. This practice, sometimes referred to within CA as the “35-day month” or the “three-day window,” violated generally accepted accounting principles and resulted in the filing of materially false financial statements. GAAP states that revenues should not be recorded till both parties have signed the contract, clearly backdating the contracts was in violation of this GAAP principle.
The goal of the 35-day month, was to permit CA to report that it met or exceeded its projected quarterly revenue and earnings when, in truth, it had not. Kumar and Richards allegedly met routinely and conferred with each other during the week following the end of fiscal periods to determine whether CA had generated sufficient revenue to meet the quarterly projections, and closed CA’s books only after they determined that CA had generated enough revenue to meet the quarterly projections.
Moreover, executives at Computer Associates were big shareholders themselves, and many held enormous blocks of stock options. They therefore had a big financial stake in the share price, and thus an incentive to inflate results.
A previous stock option set in 1995 specified that a certain number of shares would vest when CA’s shares sustained a target price. The benchmark was met in 1998, and the three executives combined received nearly $1 billion in Computer Associates stock. Since then, at least four other class-action suits have been filed against Computer Associates. Kumar was compensated handsomely: in 1998, he netted a $330 million bonus, one of the largest paydays of any American executive.
In the first, second, third and fourth quarters of FY2000, respectively, Computer Associates inflated its properly recorded revenue by approximately 25%, 53%, 46%, and 22% by improperly including prematurely recognized revenue. the goal was to meet or beat per-share earnings estimates of Wall Street analysts, a key to keeping a company’s stock price rising.
After Computer Associates substantially refrained from recognizing revenue prematurely from contracts that its customers had signed after quarter end during the first quarter of its fiscal year 2001, the company missed its earnings estimate and Computer Associates’ stock price dropped over 43% in a single day.
The most extreme incident was the second quarter of 2000, when the company reported $557 million in revenues beyond the $1.047 billion it could properly claim. The company thus reported 60 cents in earnings per share, beating the consensus Wall Street forecast of 59 cents. Without the padded revenue, earnings would have been a mere 5 cents per share and the stock price might well have fallen.
The company agreed to pay $225 million in restitution to shareholders to settle a civil case brought by the Securities and Exchange Commission and to defer criminal charges by the U.S. Department of Justice.