Autonomy and Hewlett Packard: A How To from Fortune

January 16, 2017

I read “How Autonomy Fooled Hewlett-Packard.” The article was written by Jack T. Cielsielski, who is president of R.G. Associates, Inc. in Baltimore, Maryland. Mr. Ciesielski’s company publishes “The Analyst’s Accounting Observer, which is described as “a research service for institutional investors.” The company offers this example return on a $1 million investment:

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The caption for the chart is “All performance data is net of advisory fees.  3, 5, 10 year returns are annualized total returns.  Inception is the annualized total return since 12/31/1992.  S&P 500 Total Return sourced from www.standardandpoors.com.  Past performance is not indicative of future results.”

I am not sure if the write up is a Fortune-edited article, a Fortune-commissioned article, or an inclusion in Fortune which an entity purchased. For the purposes of Beyond Search, I will assume that the article is an example of “real” reporting and spot on in its objectivity and accuracy. I recognize that depending on where one sits and the tools and information available will affect what one perceives. This is the viewshed problem, which is illustrated below. Each color shows what the respective observer “sees.”

Image result for viewshed

I was interested in the write up because the legal dispute between the “old” Hewlett Packard and executives of Autonomy is on going. Obviously neither Mr. Ciesielski  Fortune does not want to find itself in the legal crossfire. My assumption is, therefore, that Fortune’s “real” journalists have figured out some of the nuances of the HP-Autonomy matter. I would point out that these nuances were overlooked or misinterpreted by HP’s executives, Board members, advisers, lawyers, and accountants. Too bad neither HP nor Autonomy had Fortune-caliber experts assisting when the $11 billion deal was conceived, executed, understood, and prosecuted. Some outfits have smarter, more thorough investigators, researchers, and analysts.

The write up points out that the former top dog of Autonomy USA (Christopher Egan) had to pay $800,000 in November 2016 he garnered from the HP buy out. The prime mover in this check writing was the US Securities & Exchange Commission. The Fortune article states:

HP relied on figures he had helped inflate. The facts of the case are now public.

Here’s the method used by Autonomy as reported by Fortune:

Autonomy’s UK-based senior managers directed a program swelling revenues by almost $200 million. Autonomy sold its software through “value-added” resellers, legitimate businesses providing additional services and support to product end users while also selling Autonomy’s software. Just five resellers, in 30 transactions, provided services to Autonomy that couldn’t be called legitimate.

Then

When Autonomy was negotiating a sale to an end user, but couldn’t close the sale by quarter’s end, Egan would approach the resellers on or near the last day of the quarter, saying the deal was nearly done. Egan coaxed the resellers to buy Autonomy software by paying them hefty commissions. The resellers could then sell the software to a specified end user – but Autonomy maintained control of the deals and handled negotiations with the end user without the resellers’ aid. There’s no way these transactions could be revenue.

Fortune points out that Autonomy, not the resellers, “retained risks, rewards, and ownership of the goods.” Fortune adds:

These transactions “grew” Autonomy’s revenues by as much as 15% in some periods. They were critical: they enabled the firm to report financial results within the boundaries of analyst expectations.

Autonomy was, therefore, able to hit analysts’ targets.

What was the role of Autonomy UK? Fortune reveals:

Between 2009 and 2011, after a quarter’s close, Autonomy’s most senior finance executive directed Egan to procure backdated purchase orders from resellers; once, the executive obtained the dirty documentation personally.

“Dirty documentation” delivered revenue and was “a falsification of facts.”

How did Autonomy US and UK move the money to resellers? Fortune explains:

The illusion was created with round-trip reseller transactions. Autonomy purchased various surplus products from the resellers, with nearly simultaneous payment by the reseller back to Autonomy on debt owed to them. The round-trip transactions were improvised by Autonomy’s senior-most finance executive, and they amounted to at least $45 million of phony paybacks to Autonomy.

Christopher Egan (Autonomy US) handled interactions with the resellers, motivating them to play ball “by paying them hefty commissions.” The Fortune write up explains that Mr. Egan was a “pawn.”

The reason the specialists involved in reviewing Autonomy’s financials were fooled boil down to these factors:

  1. Transactions were often outside the US, and the transactions were supported by “doctored financial statements”
  2. Christopher Egan explained how the procedure worked
  3. Autonomy auditors missed the fake transactions but “probably” should have identified them because “odd transactions” turned up at the end of quarters prior to the sale of Autonomy to HP
  4. The transactions were the result of “the intent of the players involved.”

How many parties to the process participated? Fortune points out that that there were five resellers. There were Autonomy US and UK executives. There were Autonomy accountants, lawyers, and auditors. There were sundry HP executives, Board members, lawyers, accountants, and advisers. But no complete tally is included in the write up.

Perhaps a motivated analyst/journalist will write a book about this remarkable event, the individuals involved, and the details of the thought processes of the story. When the legal matters are resolved, more information will become available.

Fascinating. The multi-year activities, the executive decision making, and the sums involved make this deal memorable. One interesting fact was reported by Bloomberg in “Ex-Autonomy CFO Pleads Not Guilty in Case Over HP Buyout”:

The U.K.’s Serious Fraud Office has said there was insufficient evidence for a prosecution of Autonomy officials. In the U.S., Christopher Egan, the former chief executive officer of Autonomy’s U.S.-based subsidiary in San Francisco, agreed in November to pay $923,000 to settle an administrative proceeding in which the Securities and Exchange Commission accused him of participating in an accounting scheme. Egan, who left the company in November 2012, didn’t admit or deny the regulator’s findings.

The amount Mr. Egan paid is different in each source; that is, $800,000 vs. $923,000, almost a 15% swing. What other items of information are orthogonal? Numbers and interpretations of Autonomy-related matters seem to present different viewsheds.

Stephen E Arnold, January 16, 2017

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