Comments by Bob Grimes
I followed United States of America v. Stephen Gardner, et. al, the federal criminal trial of the former Peregrine employees who had been indicted for criminal activities alleged to have occurred when they worked at Peregrine. The following is a summary of the four criminal trials in that case, held in front of Judge Thomas Whelan. Anyone having additions or corrections or comments please send them to me at email@example.com
BACKGROUND OF THE CORPORATION
Peregrine Systems, Inc., was a software company with its headquarters in San Diego, California. Peregrine developed and sold business software and related services, both directly through its own sales staff as well as through resellers. From its IPO in April 1997 through August 30, 2002, Peregrine was a publicly held corporation whose shares were traded on NASDAQ.
Like many tech stocks in the late 90’s, Peregrine experienced high increase of share value, followed by dramatic decline in stock price related to market forces. Peregrine’s stock price rose from its April 1997 IPO price of $2.25 per share to a high of $79.50 per share which it reached on March 27, 2000. As of June 30, 2001, Peregrine had issued over 162,000,000 shares, which were then trading at approximately $29.00 per share. The market capitalization was approximately $4.7 billion.
On May 6, 2002, Peregrine announced that it was conducting an internal investigation of possible misstatements in previous financial reports, and announced the resignation of CEO Stephen Gardner and CFO Mathew Gless. Peregrine’s stock price dropped to $.89 per share, and on August 30, 2002, Peregrine stock was delisted from NASDAQ, and the company filed for bankruptcy protection on September 22, 2002.
THE FIRST TRIAL
The Office of the United States Attorney for the Southern Distict of California conducted an investigation of Peregrine, and a number of former employees are being prosecuted for alleged criminal activity related to their actions at Peregrine, including Securities Fraud, Wire Fraud, Bank Fraud, Conspiracy, Falsifying Books and Records, and Obstruction of Justice. It was alleged in the indictments that these defendants engaged in fraudulent practices designed to inflate the share prices of Peregrine stock to enrich themselves and others with commissions, bonuses, salaries, stock options and other payments. These fraudulent practices included improperly recording revenue on contracts that were subject to side agreements, recording revenue on supposed sales that were actually barters or swaps, as well as improperly keeping Peregrine’s books open past the end of fiscal quarters, and fraudulently recording sales in one quarter that actually had been completed in a later fiscal quarter.
Twelve people have pled guilty to criminal charges in this matter. In the first trial, four defendants went to trial in front of the Honorable Thomas J. Whelan. The trial began on April 10, 2007. The four defendants in this trial were:
GARY LENZ, who was hired by Peregrine in May of 2000 as an Executive Vice President, later became Peregrine’s President and COO. He previously worked at Arthur Andersen.
Specific allegations by the Government against Lenz included the following:
1. On October 3, 2000, Lenz (along with Cahill and Powanda) induced a deal partner to sign a backdated contract for $3.6 million by promising that Peregrine would purchase services from the deal partner in the same amount, and that Peregrine would assist the deal partner in actually selling the purchased software.
2. On March 31, 2001, Lenz directed a Peregrine official to get a deal partner to sign a software resale contract for over $1 million, knowing that the partner would be promised that it did not need to pay until it finally resold the software.
JOSEPH REICHNER, who was hired by Peregrine in September of 2000 as Senior Vice President of Alliances and Business Development, held this position until January 2002. He previously worked at Arthur Andersen for 31 years.
Specific allegations by the Government against Reichner included the following:
1. On December 20, 2000, Reichner promised a KPMG managing director that, despite the written terms of certain proposed contracts that obligated KPMG to pay Peregrine within 90 days, KPMG would not be held responsible for payment if the anticipated end-users did not purchase the software.
2. On April 1, 2001, Lenz and Reichner asked a deal partner to backdate his signature on contract documents to March 30, 2001.
PATRICK TOWLE, who was Peregrine’s Revenue Accounting Manager from November 1999 through November 2002, was responsible for determining whether license revenue from domestic contracts could be booked, and for consolidating revenue figures from both US and foreign corporations.
DANIEL STULAC, who was previously an accountant at the Arthur Andersen accounting firm, was the Senior Accountant and Engagement partner for the audits of Peregrine’s financial statements during Peregrine’s fiscal years 1999, 2000, and 2001.
This trial resulted in a hung jury as to all four defendants. Charges were then dismissed as to Reichner, and Lenz pled guilty to one count of making a false statement to a federal official.
THE SECOND TRIAL
After a retrial of Stulac and Towle, a second jury was also unable to reach a verdict, and a second mistrial was declared. The Government then dismissed the indictment as to Stulac and Towle.
THE THIRD TRIAL
Shortly before the third trial, Jeremy Crook and Richard Nelson accepted plea bargains, and former Peregrine General Counsel Eric Deller went to trial alone. The jury in this trial could not agree on a verdict, so another mistrial was declared. The Government wisely decided to dismiss the indictment against Deller, rather than having another trial.
DEFENDANTS WHO HAVE PLED GUILTY
Twelve defendants have pled guilty to criminal charges in this matter. The defendants who have pled guilty are:
STEPHEN GARDNER, who was hired by Peregrine in 1997 as a Vice President, became President and CEO in April of 1998. In July 2000, Gardner was named Chairman of the Board of Directors. Gardner was responsible for the overall financial performance of Peregrine. Gardner, who has an MBA from Harvard University, had considerable experience as a high level corporate officer before being hired by Peregrine. Before and during his tenure at Peregrine, he was widely respected as a very capable CEO. It is the position of the US Attorney’s Office that Gardner was the mastermind and ring leader of the fraud at Peregrine.
On March 13, 2007 Gardner pled guilty to Conspiracy, Securities Fraud, and Obstruction of Justice with a maximum exposure of 20 years in prison. In the plea agreement he specifically refers to Cahill, Crook, Lenz, Nelson, Reichner, Gless, Spitzer and Powanda as his “co-schemers”. Gardner admits that he and his co-schemers routinely caused Peregrine to keep its books “open” past the end of the fiscal quarter, and backdated contracts to make it appear as if the contracts had been executed before the end of the fiscal quarter. He gives specific dates and transactions where this occurred.
Gardner’s plea agreement does not include a cooperation agreement. However, it is very possible that he will reach a cooperation agreement and testify against the co-defendants who are going to trial, in an effort to obtain a reduction of his sentence.
Steve Gardner was sentenced to 97 months in federal prison.
ANDREW CAHILL, who began working for Peregrine in May of 2000 as Vice President for Worldwide Sales, and who was named Executive Vice President for Worldwide Sales in October 2000. On February 27, 2007, he pled guilty to one count of Securities Fraud, which has a maximum penalty of ten years in prison, and he has agreed to cooperate with the Government. In his plea agreement, Cahill admitted to very specific conduct with specific co-conspirators. He states that he worked with Co-defendants Gardner, Crook, Lenz, and Reichner and other “co-schemers” to cause Peregrine to book new deals for software license sales, and to address problems associated with deals that had been booked by Peregrine in prior fiscal periods.
Beginning in 2000 and continuing to May 2002, Cahill says that he knowingly participated with his co-schemers in a fraudulent scheme to misstate material facts from public reports of Peregrine’s financial condition, to fraudulently inflate the price of Peregrine stock. When Peregrine was unable to make its revenue numbers for certain fiscal quarters, the co-schemers would cause Peregrine to enter into backdated contracts with KPMG that purported to bind KPMG to purchase software from Peregrine. In fact, KPMG would not have to pay for this software, and Peregrine would be responsible for finding an end user to purchase the software that had supposedly been sold to KPMG. Cahill says that he and his co-schemers, including Co-Defendants Gardner, Reichner, and Lenz, knew Peregrine would be improperly recognizing revenue on these transactions. Examples of such improperly booked deals include:
a. A contract signed on July 7, 2000, backdated to June 30, 2000, purporting to bind KPMG to purchase $2.285 million of Peregrine software for resale to AVNET;
b. A contract signed on October 3, 2000, backdated to September 29, 2000, purporting to bind KPMG to purchase $11.5 million of Peregrine software for resale to Morgan Stanley; and
c. A series of contracts signed on or about December 22, 2000, purporting to bind KPMG to purchase over $3.7 million of Peregrine software for resale to Boeing and Honeywell.
Cahill further states in his plea agreement that he and his co-schemers, including Gardner, Crook, Lenz, and Reichner, knew that in late 2000, Peregrine was negotiating with British Telecom (“BT”) over the sale of $10 million British Pounds of Peregrine software for resale to end users. Co-schemers caused a backdated contract with BT in this amount to be faxed from the United Kingdom to San Diego. Despite the fact that BT could cancel the contract for any reason within 30 days, the co-schemers caused Peregrine to intentionally book revenue from this transaction in the fiscal quarter ending December 31, 2000.
Cahill decribes another fraudulently booked contingent deal and backdated deal with Fujitsu in which he says Gardner and Lenz were involved. He goes on to state that Peregrine improperly recorded revenue on large transactions with customers who did not have the ability to pay, and that he and Gardner, Crook, Lenz, and Reichner knew that these deals were booked in order to make up for other deals that had not closed in the quarter planned.
Andrew Cahill was sentenced to 27 months in federal prison.
BERDJ RASSAM, who was hired by Peregrine as Controller in November 2000, was promoted in September 2001 to Vice President of Finance and Chief Accounting Officer. He was hired by, and reported to, Peregrine’s CFO Mathew Gless. Rassam pled guilty to one count of Securities Fraud, which has a maximum sentence of ten years. He has agreed to cooperate with the Government.
In his plea agreement, Rassam states that he communicated regularly with Peregrine’s auditor, Arthur Andersen, LLP, including Defendant Daniel Stulac, the partner in charge of the Peregrine account. He also communicated at times with Defendant Patrick Towle, the Revenue Recognition Manager for Peregrine. Rassam states that in Spring 2001, he participated with Defendant Stulac and others in a fraudulent scheme to manipulate and misstate facts in public reports of Peregrine’s financial condition, in order to fraudulently inflate the price of Peregrine’s stock. He states that he and Stulac understood that Peregrine would not write off Peregrine’s uncollectable account receivables as bad debt, because this would alert securities analysts and the investing public to the large uncollectable receivables. In April 2001 and October 2001, he says that he conspired with Stulac and others to improperly remove the receivables from Peregrine’s balance sheet by writing them off as part of unrelated acquistion and other costs.
BJ Rassam was sentenced to 24 months in federal prison.
DOUGLAS POWANDA, was hired by Peregrine as Senior Account Executive in February of 1992, and later became Vice President of Sales and then Vice President of Worldwide Sales. In July of 2001, he began serving in the Office of the Chairman of the Board, and reported directly to Defendant Stephen Gardner. He stayed with Peregrine until May of 2002.
In July of 2006, Powanda pled guilty to one count of Conspiracy to Commit Wire Fraud and one count of Securities Fraud, with a total possible exposure of up to 15 years in prison. He admitted to participating with his co-conspirators in a fraudulent scheme to inflate the value of Peregrine’s stock, and making false statements to, and concealing material information from, the SEC, and the shareholders of Peregrine. His guilty plea includes details of specific fraud deals, including the Barnhill acquisition. Powanda states that in February of 2000, he discussed with Co-Defendant Gardner and others the fact that Barnhill owed millions of dollars to Peregrine based on the fraudulent deals that had been executed the prior year. Powanda further states that he and his co-conspirators decided that Peregrine would acquire Barnhill in order to deceptively retire the millions of dollars in accounts receivable owed by Barnhill to Peregrine. He states that Co-Defendant Danny Whitt (the president and principal shareholder of Barnhill Associates, Inc.) participated in the fraudulent contracts between Peregrine and Barnhill in 1999.
Douglas Powanda was sentenced to 78 months in federal prison.
MATHEW GLESS, was hired as Peregrine’s Corporate Controller in 1996. From November 1, 2000 until May 5, 2002, he served as CFO and was a member of the Board of Directors. In April 2003, he pled guilty to one count of Conspiracy and one count of Securities Fraud, with a total exposure of up to 15 years in prison. He admitted that he conspired with other Peregrine executives, Peregrine employees, and individuals to pursue a variety of schemes to inflate the value of Peregrine stock. He admitted to making false statements to Peregrine’s auditors, the SEC, and the investing public.
Matt Gless was sentenced to 63 months in federal prison.
STEVEN SPITZER, who was hired by Peregrine in August 1997 as a Vice President in its Sales Department, was in charge of developing Peregrine’s relationships with indirect sales partners. From August 1997 through April 2000, he worked on building sales alliances with entities that could serve as promoters of Peregrine’s products in North America. These entities were sometimes referred to as Peregrine’s “Channel Partners.” From April 2000 through April 2001, he focused on North American sales of Peregrines “Get.It!” product. Thereafter, he focused on direct sales to managed service providers, until he left Peregrine in June 2002.
Steven Spitzer was sentenced to one year and one day in federal prison.
PETER JAMES O’BRIEN, who from 1998 through August 2002 was an employee of Peregrine’s Channel Sales Department, and at one time had the title of Director of Alliances. He worked on building sales with entities such as KPMG Consulting, LLC, who could serve as promoters and resellers of Peregrine’s products in North America. In his plea agreement, O’Brien stated that in December 2000 he participated in communications between himself, Peregrine Senior Vice President of Alliances Joseph Reichner, and a representative of KPMG, wherein the KPMG representative was promised that if he signed certain sales contracts as a purported reseller to certain designated end-users, Peregrine would not enforce the written terms of the contract. If the designated end-user sales did not occur as Peregrine hoped, Peregrine would not require payment from KPMG within 90 days, as the contract stated. O’Brien stated that Reichner further promised the KPMG representative that Peregrine would supply him with $250,000 in marketing funds.
O’Brien pled guilty to Obstruction of Justice, admitting that in May 2004 he participated in interviews being conducted by the SEC and the FBI, and that he provided inaccurate information, with the intent to obstruct and impede the investigation. Obstruction of Justice carries a maximum penalty of five years in prison. O’Brien has agreed to cooperate with the Government.
Peter O’Brien was sentenced to probation.
ILSE CAPPEL, began working in Peregrine’s accounting department in 1993. After Peregrine went public in 1997, she became the Treasury Manager, and was responsible for cash management and accounts receivable, among other things. When she left Peregrine in June 2002, her title was Assistant Treasurer. She pled guilty to Conspiracy to Commit Bank Fraud. She admitted that she conspired to improperly manipulate Peregrine’s DSO (Days Sales Outstanding) by creating fictitious invoices with various transaction partners that were sold to the bank as if they were enforceable accounts receivable. She admitted that she and others fabricated a Peregrine invoice to KPMG Consulting, LLC, dated June 29, 2001, for $19,580,596 that was sold to Wells Fargo HSBC Bank as if it were a valid and enforceable account receivable.
Ilse Cappel was sentenced to probation.
JOHN BENJAMIN, was hired by Peregrine as Treasurer in August 1999, and held that position until June 2002. He pled guilty to Conspiracy to Commit Wire Fraud, in relation to a revolving line of credit (the “Revolver”) in the amount of $150,000,000 with a syndicate of banks led by Fleet Bank. The credit agreement for the Revolver required Peregrine to maintain certain financial covenants tied to Peregrine’s quarterly earnings. On January 2, 2002, Peregrine announced a weak fiscal quarter for the period ending December 31, 2001, resulting in a violation of several covenants contained in the Revolver. In order to prevent the Revolver being closed, Benjamin requested from Fleet a waiver of the loan covenants. To persuade Fleet to agree with this waiver, Benjamin provided to Fleet a copy of Peregrine’s SEC Form 10-Q filed for the period ending December 31, 2001, which contained false information about Peregrine’s revenue, cash and DSO figures. He also provided to Fleet documents with inflated figures of Peregrine’s cash position and cash projections. Benjamin has agreed to cooperate with the Government.
John Benjamin was sentenced to probation.
LARRY RODDA, was a managing director of KPMG Consulting, LLC. He led a team of KPMG personnel providing consulting and software integrating services to other businesses and entities. Rodda pled guilty to Conspiracy to Commit Securities Fraud and Wire Fraud. In his plea agreement, Rodda admitted that he had signed license agreements with Defendants Steven Spitzer and Douglas Powanda that purported to obligate KPMG to purchase software from Peregrine. In one of these transactions, Rodda signed a license agreement with Peregrine on October 3, 2000, at the request of Spitzer and Powanda. This agreement purported to obligate KPMG to purchase $11.5 million in software in connnection with another anticipated software transaction with another end-user. The license agreement, when received by Rodda from Powanda, had the date of September 29, 2000 already typed in below the line for Rodda’s signature, and Rodda signed the document on or after October 3, 2000.
Larry Rodda was sentenced to six months federal custody.
MICHAEL WHITT, was an owner of Barnhill Management Group, Inc. From March 1999 through March 2000, Whitt signed Peregrine software license agreements with a face value of over $13 million. In March 2000, Peregrine acquired Barnhill for approximately $32,200,000. In his plea agreement, Whitt admitted that he had an agreement with Douglas Powanda that Whitt would sign software sales contracts that purported to obligate Barnhill to pay Peregrine the amounts in the contracts, but the contracts were subject to undisclosed contingencies and promises. Whitt pled guilty to Obstruction of Justice, and agreed to cooperate with the Government.
Michael Whitt was sentenced to six months federal custody.
GARY LENZ, who was hired by Peregrine in May of 2000 as an Executive Vice President, later became Peregrine’s President and COO. He previously worked at Arthur Andersen.
After his trial resulted in a hung jury, Gary Lenz pled guilty to one count of making a false statement to a federal official. The mail fraud, wire fraud, and conspiracy counts were all dismissed as a result of this plea bargain.
Gary Lenz was sentenced to 90-days home confinement.
HEARINGS PRIOR TO THE FIRST CRIMINAL TRIAL
MOTION HEARING ON FEBRUARY 27, 2007
On this date, the attorneys for Gardner, Lenz, Reichner, Towle and Stulac, and the Government attorneys (Eric Beste, Sanjay Bhandari, and William Narus), argued voluminous In Limine motions that had previously been filed with the court. Gardner was represented at the motions by three lawyers from Washington, D.C. who moved for a continuance of the trial so that they could have more time to prepare. Judge Whelan ruled that Mr. Gardner had been indicted two and a half years ago and his lawyers had had sufficient time to prepare. There were arguments on evidentiary issues, including a motion by Gardner to exclude evidence of a “window washer program.” The Government argued that they have an expert witness who examined Gardner’s laptop computer and found that a window washer program had been installed after Gardner learned of the Peregrine internal investigation, and that information had been removed from the laptop computer, including information from folders that appeared to have contained documents that would have been relevant to the investigation. Judge Whelan ruled that the evidence of this expert witness is admissible.
Judge Whelan ruled that many of the evidentiary issues are best addressed at trial rather than at In Limine motions, because at trial the judge can rule in the context of the evidence presented to that point and not in a vacuum.
STATUS HEARING ON MARCH 14, 2007
This hearing came the day after the plea agreement of lead defendant Gardner. Lenz, Reichner, Towle and Stulac are still scheduled to begin trial on April 10, 2007. AUSA Beste told Judge Whelan that his time estimate for the Government’s case-in-chief is still two months or more. Now that Gardner, Cahill and Rassam have pled guilty there are four defendants going to trial on April 10, 2007 instead of seven (Crook and Nelson will have a separate trial at a later date). However, Beste feels that any decrease in trial time caused by removing these three defendants will probably be offset by the time taken to present their testimony against the remaining four defendants. If some or all of the three who have recently pled guilty testify against the remaining four, Beste expects lengthy cross-examination by the defense.
PRETRIAL HEARING ON MARCH 27, 2007
At the conclusion of the discussion of In Limine motions during the status hearing on March 14, 2007, Judge Whelan directed the parties to try to work out remaining issues regarding disclosure of witness information, and he scheduled a hearing on March 27, 2007 to deal with any remaining disagreements in this area. There was argument about the extent to which the Government should be required to provide the defense with contact information on potential witnesses. The attorneys for Lenz, Reichner, Towle and Stulac were present, as were AUSAs Beste and Narus. The court further ordered that the trial hours be set from 8:30 a.m. to 1:30 p.m., Tuesdays through Fridays. The trial of these four defendants is scheduled to begin on April 10, 2007.
The lawyers for the defendants told Judge Whelan that their experience and research indicates that jurors who are business executives or who own small businesses have a better understanding of the issues in a case like this than most people. According to the defense lawyers’ argument, jurors in this category cannot afford to miss work for a two month trial with a daily trial schedule of 9:00 a.m. to 4:30 p.m. However, they might be able to serve if the trial schedule allows them to work in the afternoons. The prosecution objected to this somewhat unusual trial schedule, but Judge Whelan agreed with the defense. The goal is to afford these defendants a jury of their peers.