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Peregrine Indictments Reveal a Tangled Conspiracy

Last week’s federal grand jury indictments of 11 individuals allegedly involved with the massive fraud at San Diego-based software maker Peregrine Systems aimed squarely at the reason behind the accounting scandal: to boost the company’s financial results so its stock could continue climbing.

“The indictment charges these defendants with a massive conspiracy that had its core one corrupt goal: to hit the numbers quarter after quarter, no matter what,” said Attorney General John Ashcroft in a press statement accompanying the Oct. 6 indictment.

Once one of San Diego’s largest public companies with more than 4,500 employees, the accounting fraud first revealed in May 2002 ultimately caused Peregrine’s bankruptcy the following year. A reorganized Peregrine emerged from Chapter 11 in August and continues to operate, but with a pared-down staff of about 600.

The latest criminal indictments follow plea bargain agreements from four former Peregrine officers, including Chief Financial Officer Matt Gless.

Federal prosecutors said their investigation, which has been ongoing for more than two years, is continuing.

Assistant U.S. Attorney Eric Beste said he could not reveal whether Peregrine’s former chairman, San Diego Padres owner John Moores, is still a possible target or whether he or other former Peregrine directors have been interviewed.

“The investigation is ongoing so it wouldn’t be appropriate for me to reveal the investigative steps taken,” Beste said. “I am not able to say where the investigation is going, who’s been spoken to, and who’s been looked at.”

Moores, also a regent for the University of California, was the chairman of Peregrine from 1990 to mid-2000, when he resigned. He returned in May 2002, when Peregrine first announced its own internal investigation into what was termed “accounting irregularities.”

A call to Moores for a comment on the indictments was not returned.

The federal indictments last week include former Chief Executive Officer Stephen P. Gardner, 50, who took over as chairman of the company after Moores left in July 2000. Gardner faces 45 felony counts, including securities and bank fraud; conspiracy to commit fraud; wire fraud; and falsifying books and accounts. Each felony count carries maximum prison sentences from five to 30 years.

Along with Gardner, the criminal indictment includes seven other former Peregrine executives: Douglas S. Powanda, former executive vice president of worldwide sales; Andrew Cahill, former executive vice president; Jeremy Crook, former vice president for emerging markets; Gary Lenz, former chief operating officer; Berdj Rassam, chief accountant; Joseph Reichner, senior vice president; and Patrick Towle, former revenue manager.

The grand jury also indicted Daniel Stulac, a CPA who worked for now-defunct Arthur Andersen LLP and was an auditor of Peregrine from September 2000 to September 2001.

Also indicted were two outside business customers of Peregrine: Larry Rodda, former KPMG Consulting managing director, and Michael Whitt, former president of Barnhill Management Corp.

In addition to the criminal charges, eight of the Peregrine executives face civil fraud charges filed by the Securities and Exchange Commission. One defendant, Peter O’Brien, a former Peregrine sales manager, pleaded guilty last week to one count of obstructing justice.

The government’s case contained in the indictment reveals more details about how company employees inflated sales by booking millions of dollars in revenues through non-binding agreements with Peregrine’s resellers.

In February 2003, Peregrine restated its financial results for the prior two fiscal years, reducing the previously reported $1.3 billion by more than $507 million.

Among the methods used to inflate sales figures were keeping the books open beyond the end of the quarter; recording revenue on sales that were actually barters or swaps; backdating contracts and creating other false entries in books; and offering partners in the fraud with kickbacks concealed as “marketing funds” or “finders fees.”

According to the government’s case, Peregrine would regularly create agreements to boost the company’s sales near the end of a quarter. The non-binding agreements that showed up as sales but were really uncollectible receivables were referred to as “parked deals.”

When some of the parked deals grew to a large figure, Peregrine officers arranged to sell the receivables (which were fabricated) to banks. Then, to prevent the banks from discovering the sales were fraudulent, Peregrine would repurchase the receivables. To complete the circle of fraudulent accounting, and with the complicity of its accountant, Peregrine then wrote off some of the repurchased receivables, according to the SEC complaint.

“Peregrine’s lead outside accountant, then a partner at Arthur Andersen LLP, was an indispensable contributor to Peregrine’s fraudulent accounting,” the complaint states.

Ken Bender, managing director for the Software Equity Group, a San Diego-based software investment bank, said orchestrating the size of the inflated revenues detailed in the Peregrine case would be difficult without the knowledge of the outside accountant.

While the practice of padding revenues by public companies near the end of a quarter is nothing new, Bender said many companies in hardware, software and other high-tech industries did it to some degree.

“It’s been going on for years,” he said. “It’s not widespread, but more than a few companies were doing it.”

Bob Slapin, the executive director for the San Diego Software Industry Council, said although channel stuffing was rumored to be done by other software firms, the scale of what was done at Peregrine was far beyond anything he knew about.

The SEC civil case against Peregrine executives charged that the defendants who received stock options unloaded the company’s stock when it was rising, thereby enriching themselves.

According to the SEC document, Gardner exercised stock options and stock totaling about $11 million. Powanda sold more than $24 million in stock, and Lenz received options, salary and bonuses during the period, as well as an $800,000 interest-free loan from the company.

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