Peregrine Trial – Week 6
Comments by Bob Grimes
May 15, 2007 – 8:30 a.m. to 2:45 p.m.
WITNESS PHILLIPP TUROWSKI
Phillipp Turowski is a German accountant who was the Peregrine German division audit engagement partner for the 2001 AA audit of Peregrine Germany. AUSA Bhandari asked Mr. Turowski questions about the fact that Peregrine Germany was considered to be a Material Audit Unit (MAU). When a company has overseas divisions (as Peregrine did), the overseas divisions will be considered a MAU if a misstatement in their financial statement may cause the whole group’s financial statement to be misstated. If a division of a large company is a MAU, that means that it is an important division of significant size and revenue volume.
On direct, AUSA Bhandari brought out the fact that the Arthur Andersen audit team deemed Peregrine to be a high-risk client. This means that the potential for misstatement in their financial statements was higher than normal. Attorney Attanasio elicited from Mr. Turowski that a major percentage of software clients are rated as high-risk or above because the accounting rules governing software are complex and they require a great deal of judgment calls on the part of both management and auditors.
Phillipp Turowski testified that the 2001 Peregrine German division audit did not proceed smoothly. He mainly complained about the lack of documentation upon which to base his final opinion regarding the financial status of Peregrine Germany. In fact, the German AA audit team never sent a final audit opinion to Arthur Andersen US.
The German AA audit team specifically objected to three contracts that were on the Peregrine Germany books. These three contracts added up to $14.6 million, which was more than 50% of all the revenue recognized by Peregrine Germany in fiscal year 2001. The issues which Mr. Turowski had with these contracts were: the payments were extended beyond 12 months, the companies were resellers, and they could not confirm that the software had been delivered. The Government Attorney Bhandari and Defense Attorney Attanasio spent quite a lot of time discussing these three issues.
Accounting principles state that there is a presumption that revenue is not recognizable if the contract payment terms are extended over 12 months. This presumption can be overcome if the company can demonstrate that there is sufficient history of collections. The attorneys in this case have often touched upon this issue of what is sufficient history.
On direct, Phillipp Turowski testified that sufficient history means that the company must show a history of collection and enforcement of such extended payment term contracts with all their extended payment customers. He said that there was no such history at Peregrine Germany. On cross-examination, Turowski said he did not know if Peregrine Worldwide had a history of collecting and enforcing its extended payment term contracts.
On direct, Mr. Turowski said that when a software company has a contract with a reseller, that contract must be closely examined because resellers might want discounts, they might return the product, and/or they might not really be able to pay for the product. On cross-examination, Turowski said that it could be proper to book revenue from a contract with a reseller if certain requirements are met. He insisted that he needed more documentation to determine if the revenue in question at Peregrine Germany could be properly booked.
On cross-examination, Attorney Attanasio pointed out that delivery of the software had occurred on the contracts in question. At that time, Mr. Turowski did not have the documentation that proved that delivery occurred through Peregrine’s Ireland subsidiary.
Phillipp Turowski characterized Peregrine Germany as being unorganized. One of the big problems that Peregrine Germany had was with its software system. The German Peregrine employees did not know how to use the US software system.
In response to all of the problems that the German AA audit team was experiencing in its Peregrine German division audit, Daniel Stulac told Mr. Turowski that revenue recognition would be handled on the group level by Arthur Andersen US. The government views this as part of a purposeful fraud on the part of Daniel Stulac. Daniel Stulac’s attorney characterizes this type of consolidation of an audit as being commonplace.
Phillipp Turowski testified that he would have been surprised that Peregrine Worldwide “signed off” on the Peregrine German division audit if he had known that the revenue for the three German contracts in question had been included in the 2001 Peregrine 10K financial report. AUSA Bhandari represented that the disputed revenue from the three German contracts had been included.
WITNESS DANIEL MAIR
Mr. Mair worked for Phillipp Turowski as the engagement management partner in the Peregrine German division team audit. Daniel Mair testified that he mainly communicated with the San Diego AA engagement partner for Peregrine, Nevanna Sacks. Witness Daniel Mair said that he met Stulac twice, both times at Global Peregrine meetings. Mr. Mair said that Peregrine was the only AA client who held Global meetings for the Arthur Andersen audit teams from around the world to meet in order to discuss audit issues and familiarize themselves with Peregrine policies. This underscores the fact that Peregrine was an important client for Arthur Andersen.
The Government ran out of witnesses, so Judge Whelan adjourned early.
May 16, 2007 – 8:30 a.m. to 3:15 p.m.
WITNESS RICHARD CORGEL
Richard Corgel, who was a senior auditor with Arthur Andersen, testified today. AUSAY Sanjay Bhandari conducted the direct examination, and Dan Stulac’s attorney, Mike Attanasio, did most of the cross-examination. Mr. Corgel is a silver-haired, distinguished witness who seemed to be very knowledgeable on audit procedures. He oversaw AA employees in 13 different districts. Dan Stulac was employed by AA as its engagement partner with Peregrine (Stulac was the second of three AA engagement partners to work with Peregrine). Corgel described the duties of an engagement partner and an outside auditor. He testified that revenue recognition in the software industry is complicated. Mr. Corgel was shown an exhibit from the end of the fiscal year ending March 31, 2001, in which $26.5 million in accounts receivable and a $3.5 million note were written off as related to acquisition costs. He said that his recollection is that he was not given the information about this and certain other accounting decisions by the AA engagement team at meetings in which he had participated along with Stulac and other members of the engagement team. He believes that some of this information should have been brought to his attention, so that he could have made sure the engagement team was doing their job effectively.
Witness Richard Corgel testified that he had specifically told Stulac’s team to ask for supporting documents related to CS, after he had received a tip that there could possibly be improper revenue recognition practices between Peregrine and CS. He was shown an exhibit showing that the CS transaction included an addendum to the sales contract as well as a return agreement, and testified that he did not believe that this information had been provided to him at the meetings. He did not remember some of the details of these meetings (which were seven years ago), and he could not remember if Stulac was conducting the meetings or simply participating in them.
On direct examination, Corgel testified to ways that auditors try to detect fraud, including improper revenue recognition. On cross, attorney Attanasio asked Mr. Corgel to describe collusive management fraud, which is much harder for the auditor to detect than fraud involving one person. Auditors rely quite a bit on the representations of management, and the auditors can be deceived by collusive fraud among senior management. Attanasio brought out the difficulties that the auditors faced in detecting the high level fraud at Peregrine which was being conducted by CEO Gardner, CFO Gless, two different controllers, the treasurer and the head of sales and another top person in sales (all of whom have already pled guilty in this case). This testimony on collusive fraud will be argued by the lawyers for Lenz, Reichner, and Towle, as well as Stulac, as supporting the position that Gardner and Gless deceived all of them.
WITNESS TIMOTHY SCOTT VICK
Timothy Scott Vick testified under direct examination by AUSA Eric Beste, and was cross-examined by Mike Attanasio. Mr. Vick is a lawyer whose firm was retained by AA in May 2002 to represent AA in litigation (including shareholders’ suits) involving AA’s relationship with Peregrine. Timothy Scott Vick interviewed Danial Stulac for a total of five days in June and July 2002. Stulac told him that he learned that there could be problems with some of Peregrine’s account receivables, and ultimately $26,500,000 in receivables were written off as related to acquisition costs.
Peregrine management (Matt Gless and BJ Rassam) convinced Stulac that he should approve this write-off, although Stulac was not convinced that this was a proper write-off. Stulac told Mr. Vick that he decided not to fight Gless and Rassam on this point because it would have created “World War III”, over accounting procedures, and Stulac had too many other stressful things going on in his life already. Dan Stulac’s long-term girlfriend had left him, and he was working extremely hard on another engagement as well as the Peregrine engagement. Stulac told Vick that he did not consider the $30 million write-off to be material, since there were write-offs of a billion dollars for that fiscal year, due primarily to the Harbinger acquisition. Stulac also told Vick that he felt sick to his stomach when Gless and Rassam explained their rationale for write-offs in the category of “acquisitions and other”, which involved a complicated explanation of channel conflict. Stulac told Vick that to justify these write-offs in this fashion was ridiculous.
On cross-examination, attorney Attanasio went directly to the interview where Stulac told Vick that the write-offs were ridiculous. He pointed out that this characterization came on the fifth of the five days on which Stulac was interviewed. At this interview, in the office of Vick’s law firm, Stulac sat at a table with four lawyers (none of whom represented him) and two senior auditors from AA, one of whom was very knowledgeable in the extremely complicated field of accounting for software companies.
Attorney Attanasio brought out the fact that Dan Stulac came to this meeting (which began at 9:00 a.m.) disheveled, with bloodshot eyes, and smelling of alcohol. According to the witness, Stulac’s demeanor in previous meetings had been somewhat variable, but on this date he seemed depressed. He was on medication for depression and anxiety, and the big white pills he was taking were a change from his previous medication. The job of the four lawyers and the two senior auditors at this meeting was to get as much information from Stulac as possible about the accounting and auditing of Peregrine, for the use of AA in defending pending civil actions. They expressed their disagreement with the complicted explanations that Stulac had been given by Gless and Rassam to justify the write-offs of the account receivables that had never been collected. By this time (July 2002), it was public knowledge that Peregrine’s new management had fired both Gless and Gardner. Vick admitted that Stulac’s admission that the write-offs were ridiculous was probably made in hindsight of the fact that Gless and Gardner had been fired, and did not mean that he was admitting to participating in a fraud with Gless, Rassam, and Gardner.
WITNESS KATHERINE PATTERSON
The next witness, Katherine Patterson, worked for Investor Relations at Peregrine from February through June of 2001. AUSA Beste asked her to discuss some press releases by Peregrine. Her direct examination will continue tomorrow.
May 17, 2007 – 8:30 a.m. to 1:45 p.m.
WITNESS KATHERINE PATTERSON (continued)
On cross, attorney Gene Iredale brought out the fact that Ms. Patterson’s Peregrine office was located between the offices of Denise Mastro and BJ Rassam, and yet Patterson does not recall ever being told by Rassam or Mastro that illegal things were going on at Peregrine, or overhearing conversations that indicated that wrongdoing was going on at Peregrine.
Under cross-examination by Thomas Bienert, Katherine Patterson testified that she mainly interacted with Matt Gless and to a lesser extent she also interacted with Mastro, Rassam, and Gardner. Ms. Patterson said that she was sometimes frustrated while working at Peregrine because her immediate superior, Matt Gless, left her out of the loop. Bienert implied that his client, Gary Lenz, was similarily left out of the loop at Peregrine, even though Mr. Lenz held the title of COO/President for several months while at Peregrine.
At her FBI interview, Katherine Patterson stated that Lenz had a reputation at Peregrine as a “do nothing guy.” Through this witness’s testimony, Bienert painted a picture of Gary Lenz as being out of favor with top management.
Katherine Patterson testified that in early 2002 she became concerned that Peregrine might have serious problems. Bienert pointed out that Gary Lenz was fired January 2, 2002. This early firing of Lenz, on the cusp of the troubles at Peregrine becoming known, supports this witness’s testimony that Gary Lenz was not in good standing with top management at Peregrine.
WITNESS DEAN WHITLOCK
Mr. Whitlock was COO of Fujitsu ICL in 2000. On behalf of Fujitsu ICL, Dean Whitlock signed the backdated September 29, 2000 Fujitsu/Peregrine contract that Douglas Powanda testified about earlier. Doug Powanda testified that he personally backdated the contract to indicate that it was executed on September 29, 2000 when in fact it was signed on October 3, 2000.
This contract had two parts. Peregrine was to provide $3.6 million worth of software to Fujitsu ICL and Fujitsu was to be paid $3.6 million over one year in return for professional services. Dean Whitlock testified on direct, by AUSA William Narus, that he talked to Powanda, Spitzer, and Lenz during the course of negotiations of this contract. On cross-examination by Bienert, witness Dean Whitlock clarified that the main negotiators of the contract on Peregrine’s side were Douglas Powanda, followed by Steve Spitzer.
When Dean Whitlock was asked by AUSA Narus about the fact that the contract that he signed on October 3, 2000 was backdated to read September 29, 2000, the witness visibly hesitated and stumbled over his response. Whitlock did admit he was aware that the contract was backdated when he signed it. Whitlock testified that from Fujitsu’s perspective it was unimportant that the contract was backdated because Fujitsu would be paid over 12 months and therefore the date of execution was not material. Whitlock testified that Powanda explained that since the September 29, 2000 date had already been typed into the first part of the contact, and Whitlock had signed the first part (the SLA), Peregrine wanted to keep the dates the same on the service agreement, which was the second part of the contract. Dean Whitlock also justified his backdating of the contract by stating that since the main negotiations had occurred the week before the actual signing, he assumed that the date September 29, 2000 was a “carry-over” from the contract negotiations the week before. Dean Whitlock tesitifed that he did not think he was lying when he signed the backdated contract, and it was his impression that no one in the room thought that there was anything wrong with the fact that it was backdated. He recalls an open but brief discussion of the backdating and remembers the fact of the backdating as being inconsequential.
Thomas Bienert, attorney for Lenz, asked more questions about the nature of the Fujitsu/Peregrine contract. Whitlock testified that the contract was a “real” deal. Both parties were obligated under the contract terms. Both parties were eager to get the deal done and develop future business between them. Bienert brought out the fact that this was Lenz’s first big deal because he was new to Peregrine. Lawyer for Gary Lenz, Thomas Bienert, implied through his questions of this witness, that the government began to steer the witness towards implicating Lenz once the other 11 defendants pled guilty. For example, Bienert pointed out that four years ago, Whitlock told the FBI that Powanda was the main negotiator for the Fujitsu/Peregrine deal. But today when AUSA Narus asked Whitlock who was involved in the negotiations, Whitlock named Lenz right along with Powanda and Spitzer as if they were all equally involved (he testified later that Powanda was clearly the main negotiator).
WITNESS WILLIAM ROWE
William Rowe is currently employed at Bank of America. In 2000, Mr. Rowe worked for Fleet Bank, which has since been purchased by Bank of America. William Rowe testified regarding various types of credit that Peregrine had with Fleet Bank. AUSA Narus offered an e-mail into evidence which was written by Patrick Towle to employees of Fleet Bank in order to help Peregrine establish a revolving line of credit. Towle’s e-mail represented Peregrine’s Year-Over-Year Organic Growth percentage as being very high.
Outside the presence of the jury, Attorney Iredale brought a motion to exclude some new evidence, which AUSA Bhandari was seeking to admit. The government claims this new evidence links Joseph Reichner to side deals made between Peregrine and some Japanese company. Mr. Iredale pointed out that the Japanese company has never been on the list of companies (there are 21) that are supposed to be discussed during this trial. Iredale raised the issue of timeliness and relevance. Judge Whelan was troubled by the fact that the Government has never mentioned this Japanese company in any of its motions prior to this date and he indicated that based on what the Government was showing him today, he thought it was insufficient evidence.
May 18, 2007 – 8:30 a.m. to 1:45 p.m.
AUSA Bill Narus contined the direct examination of William Rowe of Bank of America regarding the $150 million revolving line of credit given to Peregrine by the Fleek Bank group. Rowe testified that part of the security for the line of credit was the accounts receivable for Peregrine, and that he was never advised that many accounts receivable were being eliminated through accounting that was not GAAP approved. Mr. Rowe stated that in making the loan to Peregrine his bank also relied on the fact that an outside auditor, AA, was auditing Peregrine. Rowe mentioned that corporations typically give more conservative quarterly projections to banks than they give to Wall Street analysts.
Joe Reichner’s attorney, Gene Iredale, noted that that witness had dealt primarily with the treasurer John Benjamin, and CFO Gless and not with Reichner (John Benjamin pled guilty to Conspiracy to Commit Wire Fraud, specifically related to the deal with Fleet for the revolving line of credit in the amount of $150 million). Iredale further pointed out in his cross-examination of Mr. Rowe that the entire loan from Fleet to Peregrine was repaid, and Fleet made money on the transaction. Patrick Towle’s attorney, Kate Leff, pointed out in her cross-examination that although Towle’s name appeared on some e-mails that Rowe received, Mr. Rowe did not recall Patrick Towle. She also brought out that Peregrine might have been experiencing some difficulties in their financial record keeping due to the implementation of new “People Soft” software.
Attorney Mike Attanasio brought out that as part of Fleet’s due diligence into Peregrine’s creditworthiness, Fleet relied, in addition to Arthur Andersen, on MHKG, firm of outside consultants who went to Peregrine to interview people and look at records. MHKG identified a potential problem with KPMG (there has been considerable testimony in this trial regarding revenue improperly booked through channel deals with KPMG). Rowe discussed this KPMG potential problem with Matt Gless, who persuaded Rowe that the collection of outside revenue on accounts receivable was probable. In late September of 2001, Gless told Rowe that delay in collecting some accounts receivable was due to the impact of the 9/11 tragedy on some Peregrine clients, although this later turned out to be a lie on Gless’s part.
Attorney Attanasio pointed out that even somone as sophisticated as Rowe, who is a top-level banking official, would rely heavily on the word of the highest-ranking financial officer in the company, and that Gless seemed persuasive and believable even to someone of Rowe’s vast experience. Outside of the presence of the jury, AUSA Bhandari argued to Judge Whelan that it was improper for Mike Attanasio to “smear” Matt Gless with reference to 9/11, and asked the court to prohibit Attanasio from questioning Gless on this subject during Gless’s testimony or refer to it in his closing argument. The court ruled that since the reference to the 9/11 tragedy was specifically referred to in an e-mail from Gless to Rowe, it was a fair comment by Attanasio to refer to it.
WITNESS PETER O’BRIEN
Peter O’Brien worked for Peregrine from January 1999 until August 2002. He was hired by Spitzer to “establish relationships” with companies like KPMG, and other alliance partners to encourage them to market Peregrine products. He had a previous longstanding professional relationship with Spitzer in the software industry. After Joe Reichner was hired at Peregrine in September 2000, O’Brien reported directly to Reichner, although O’Brien and Spitzer worked out of the Irvine office, and Reichner was in the San Diego office.
O’Brien testified at length regarding a transaction in which Peregrine sold software to KPMG, with Honeywell and Boeing being the end-users. Mr. O’Brien testified that he and Joe Reichner had a conference call with Jim Murphy of KPMG during which Reichner offered incentives to Murphy to “take the paper” for a software sale of Peregrine software to end-users Boeing and Honeywell for a total amount of close to $6 million. During this call, O’Brien said that Reichner offered Murphy steep discounts and $250,000 in marketing funds. When Murphy expressed concern that the deals might not close, O’Brien testified that Reichner told Murphy “we’re not going to track you down” or “we will not come after you.” Even though KPMG was signing this contract to sell the Peregrine software to end-users, the Peregrine direct sales force were still the ones who continued to attempt to close the sales with the end-users. The ultimate sales fell far short of the $6 million that KPMG had agreed to pay pursuant to the contract, and Peregrine took no action against KPMG.
Peter O’Brien testified that there were other occasions toward the end of a quarter, when it appeared that contracts with end-users were not going to be closed in time for the quarter’s end, that Peregrine sales people would “take it to a partner.” The channel partner would sign a contract known as “partner paper” under which the channel partner agreed to pay for the Peregrine software that would be sold to the end-user, so that the revenue could be booked in that quarter. Witness O’Brien testified that there was water-cooler talk among the sales staff regarding keeping the books open, and staff would sometimes refer to dates such as “December 35.”
When Peregrine booked the revenue, there was no assurance that they would be paid because of “out clauses” given to the channel partners. O’Brien said that even though these types of practices made him feel uncomfortable, he felt the company’s foundation was “rock solid.” O’Brien testified that when he first spoke to lawyers for Peregrine conducting an internal investigation in May 2002, he lied in two separate interviews. He lied again the first time he was questioned by the FBI in early 2004, in an attempt to minimize his involvement in the fraud at Peregrine. O’Brien said that lying during the investigation was the worst mistake he had ever made in his life. (Perhaps a close second was his involvement in the fraud at Peregrine?)
AUSA Bhandari elicited from O’Brien the fact that O’Brien pled guilty to a felony as a result of his participation in the Peregrine matter. It is safe to assume that this matter will be re-visited on cross-examination by attorney Gene Iredale on Tuesday.