HP and Autonomy: Material Writedown With A Side Of Serious Fraud

I wrote something quick and dirty today at Forbes about HP’s allegations of “willful misstatements” by former executives of its acquisition Autonomy. The accusations were made to partly explain an $8 billion writedown – yes, that’s a really big number – including more than $5 billion of goodwill related to the acquisition.

It’s crazy!

There’s tons more to write about this and I will write more over the holiday. A good sum up of all the writing today, an unexpectedly busy day after the announcement was made, can be found at GoingConcern.com.

My post at Forbes starts like this:

You can bring a Big Four audit firm to court for missing a major accounting fraud but it’s much harder to bring the auditor to justice.

Deloitte was the auditor of Autonomy, a UK software firm acquired by HP in 2011 for $11.1 billion. HP announced today it is writing down more than $5 billion, or almost half of the acquisition price, because of “serious accounting improprieties, misrepresentation and disclosure failures”.

HP, in the understatement of the year, says it is “extremely disappointed” to find out some former members of Autonomy’s management team inflated Autonomy’s underlying financial metrics – GAAP and non-GAAP. HP boldly called it a “willful effort to mislead investors and potential buyers”.

That’s PR-speak for fraud.

The Wall Street Journal’s All Things D blog has a good summary of all the revenue recognition related allegations that HP is making against Autonomy.

So what is alleged to have happened? For one thing, Autonomy, as HP tells it, was selling some hardware at a loss. During a period of about eight quarters prior to HP’s acquisition, Autonomy sold some hardware products that had a very low margin or on which it may have even taken a loss. It then allegedly turned around and booked those hardware sales as high-margin software sales. At least some portion of the cost on these products, Whitman said, was booked as a marketing expense, not as cost of goods sold.

There’s a second piece of the puzzle, where HP says that Autonomy was selling software to value-added resellers — the middlemen in so many technology transactions — in which there are ultimately no end users. That, too, inflated apparent revenue.

Third, there were some long-term hosting deals — essentially, Autonomy hosting applications for its customers on a subscription basis — that were converted to short-term licensing deals. Future revenue for software subscriptions — that should have been deferred or recorded as coming in the future but not yet booked — were stripped out and booked all at once.

Autonomy’s founder told The Wall Street Journal today that his management team depended on Deloitte to get the accounting right. HP’s CEO Meg Whitman told CNBC her company depended on Deloitte’s audited financial statements of Autonomy when they performed their due diligence during the acquisition process.

So, why would it be hard to prove Deloitte missed something big and should be held accountable? It would be easier if auditors, as an industry, agreed it was their responsibility to detect fraud and material misstatements of the financial statements.

For more please go to my column at Forbes, Accounting Watchdog, for “Hewlett-Packard’s Autonomy Allegations: A Material Writedown Puts All Four Audit Firms On The Spot”.

5 replies
  1. bob
    bob says:

    There’s a huge number of advisors involved with the transaction and due diligence. HP paid a whopping 80% premium to share value for this company, and many thought that they grossly overpaid. Over a year after the acquisition, HP says that they were duped.

    What happened in November 2012 for HP to catch this supposed fraud?

    Why didn’t HP restate their December 2011 quarter for this writedown?

    HP finds more and more ways to fritter away shareholder value.

  2. Mark K
    Mark K says:

    Pauline – great article.

    I agree that this raises a host of issues and it sure looks like the write-down should have been taken sooner. One would speculate the actual results of this business missed its projections in a big way each and every quarter from day 1 and impairment indicators were present immediately. In addition to the shortcomings of the accountants, the investment bankers who wrote their “Fairness Opinions” on the price paid for the deal also have egg on their faces.

    It sure looks like HP was desperate to do this deal and seek a magic bullet to right some of their recent history. For every lier, there needs to be someone willing to believe the lie, and HP fit the bill in spades.

    Despite the auditor’s wiggle room with the audits not being designed to detect fraud, you wonder about the due diligence work. Its more than a little trusting to accept the financials at face value of the guy your are giving $11 billion to.

    I wonder if their is a closing balance sheet mechanism or any reps and warranties in the deal that will enable HP to claw some $ back from the seller?

  3. Clive
    Clive says:

    As Krugman would say in this situation “Wonkish” — the following is for nerds only. But then, that’s why you’re here isn’t it ? 🙂

    One nuance in this is that for the auditors UK operations, these are now sometimes constructed as LLPs or Limited Liability Partnerships.

    Straightforward partnership firms have had a legal framework governing the rights and obligations of partners since the late 19th Century. Therefore case law is very well settled for what happens in disputes between partners. But LLPs are a relatively new invention, permitted under legislation only enacted since 2000. While some aspects of the partnership agreements in place at these firms inherits existing precedents, some don’t.

    A good example of the kinds of problems that can ensue for LLPs is a recent case of whistleblowing by a partner in a LLP — Clyde & Co LLP v Bates Van Winkelhof. The full Court of Appeal ruling (if you’ve got the strength) is http://www.bailii.org/ew/cases/EWCA/Civ/2012/1207.html and again, for wonks, brings out many interesting aspects of LLP “employees” under UK law.

    A shorter easier to read summary is http://www.thompsonstradeunionlaw.co.uk/information-and-resources/lelr/weekly-296.htm (you have to scroll down to the end).

    Where am I going with this ? Well, if you were a partner in an LLP constituted under UK law, would you want another partner signing off on anything given the potentially ambiguous responsibilities ? And if you weren’t happy about something that you thought failed the smell test, what, exactly, would you be able to do about it ?

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