Comments by Bob Grimes and Dana Grimes
February 12, 2008 – 9:30 a.m. to 3:35 p.m.
This morning, outside of the jury’s presence, Attorney Mike Attanasio moved to preclude Nevanna Sacks from testifying regarding statements allegedly made by Stulac to Arthur Andersen counsel. The government argued that Ms. Sacks’ testimony would not be cumulative of Mr. Vick’s testimony, stating that Ms. Sacks would be clearer in her recollection of the July 23, 2002 meeting (at which the government alleges Stulac said he did not believe in “channel conflict theory”). Judge Whelan ruled that Ms. Sacks would be allowed to testify about the areas of the meeting as to which she had an independent recollection.
Thus, Nevanna Sacks, who was granted immunity on Friday, unhappily took the witness stand this morning. Ms. Sacks, a pretty brunette in a grey suit, testified that she was a senior associate at Arthur Andersen, and had been hired in 1999. She worked for a team underneath Stulac, which included Leslie Sadoff and a few others on the Peregrine engagement. She knew Stulac well, and talked to him almost daily regarding the Peregrine engagement; she referred to him as “Dan” throughout her testimony. AUSA Eric Beste elicited from Ms. Sacks that there were occasions on which she had trouble getting information from the client, and that Peregrine was more comfortable providing that information to Stulac, with whom Peregrine had had a longer relationship.
Through direct examination of Ms. Sacks, AUSA Beste presented various documents (in what was later referred to on cross-examination as “painstaking detail”) to establish that, during Peregrine’s fiscal year 2001, Stulac acted as the Peregrine engagement partner for Arthur Andersen, reviewed Peregrine’s work papers, and was responsible for paying particular attention to complex issues such as revenue recognition. Ms. Sacks testified that Peregrine had adopted the policy or practice of not recognizing revenue on contracts with resellers that had extended payment terms past 90 days. She further stated that because of this, her team of auditors had suggested PAJEs (Proposed Adjusted Journal Entries) to the Peregrine books. She indicated that memos circulated to this effect were reviewed by Stulac.
Ms. Sacks testified regarding the three German contracts about which AUSA Bill Narus had previously questioned Phillip Turowski. As AUSA Narus established during his thorough direct examination last week, Mr. Turowski, the German Arthur Andersen auditor, was concerned that those contracts were being recognized improperly as revenue. With respect to those three contracts (Systematics, Cenit, and GE), Ms. Sacks indicated that it was her view that no revenue should be recognized – she stated she remembers proposing this adjustment because of its size (approximately $12 million). She stated that she remembers Stulac was disturbed by the amount, but that he did not disagree with the PAJE. Ms. Sacks testified that she later learned the adjustment would not be carried out, when Leslie Sadoff told her that Matt Gless had asked Patrick Towle to provide collections information showing a history with those resellers, and Stulac agreed such a history would be sufficient to allow Peregrine to recognize the revenue. Ms. Sacks stated she was “frustrated” by Stulac’s decision to keep the revenue on the books, and she told him so; she said he understood her frustration and told her there were documents from previous years with collections history and he felt comfortable with that. Ms. Sacks did not know whether a history of collections actually existed.
In another line of questioning, AUSA Beste elicited testimony that Ms. Sacks did not think Arthur Andersen would sign off on the April 26, 2001 Peregrine press release without certain third-party confirmation letters that had been sent out, and which Towle was trying to collect without success. Her testimony was that Stulac, pressed because of the approaching sign-off date, picked a large third party and stated that if Arthur Andersen received a confirmation letter back from them, it would be enough support for the press release.
With respect to her email exchange with the auditors in Germany, Ms. Sacks testified that she had expected the German auditors to give an opinion, even without reference to revenue recognition, by the sign-off date. Stulac wrote an email to Ms. Sacks regarding this issue, which stated, “ARE WE GOING TO GET ANYTHING TO SAY WORK WAS DONE?????” She stated that Stulac was satisfied to rely on the preliminary work of Arthur Andersen Germany, without a final audit opinion.
Ms. Sacks indicated that the risk review meeting of June 27, 2001 included senior Peregrine people. Ms. Sacks stated she was told by Stulac not to talk at the meeting, and that when she began to disregard this advice she was “kicked under the table” by Stulac, so she stopped talking. Ms. Sacks testified that Leslie Sadoff had sent Ms. Sacks an email to which she attached a memo regarding how to deal with contracts for sales to resellers with extended payment terms. The conclusion of the memo indicated that certain PAJEs were not necessary because in quarter four Peregrine started to develop a history of collections with customers such as IBM and KPMG. Sadoff stated in her email to Ms. Sacks: “the conclusion is a little sketchy.” When asked about that, Ms. Sacks testified that the conclusion did not appear to be supported by the support provided in the memo. She indicated this memo was forwarded to Stulac.
On direct examination, AUSA Beste elicited testimony that, before going to the June 27, 2001 risk review meeting, Stulac reorganized the binders full of Peregrine materials in a somewhat hectic manner (with the help of the Peregrine audit team at Arthur Andersen). AUSA Beste demonstrated that one memo that ended up in Stulac’s binder at that meeting was different than the one attached to the aforementioned email – the one Ms. Sadoff said had a “sketchy conclusion.” (Ms. Sacks did not remember if this memo was discussed at the risk review meeting.) Attorney Attanasio established on cross-examination that Ms. Sacks saw nothing sinister about this hectic reorganization – during which time he wrote notes asking for clarification of various issues in the binders so that he could be better prepared for the meeting. With respect to the memos not included in the binder after Stulac’s re-organization, Ms. Sachs stated that it was reasonable that items were taken out and replaced with updated versions in order not to overwhelm the Arthur Andersen higher-ups such as Corgel and Shanley with too much information. In the twenty five minutes of cross-examination before the court adjourned for the day, Attorney Attanasio elicited from Ms. Sacks that Mr. Stulac was often stressed and nervous before meetings such as the risk review meeting of June 27, 2001. He generally did not like these meetings, and had the ultimate responsibility for what was presented to the important people in attendance, and his reputation was on the line.
AUSA Beste asked Ms. Sacks about her recollection of meeting with lawyers after the May 2002 announcement that Peregrine was undergoing an internal investigation and that Peregrine’s CEO Gardner and CFO Gless had resigned. During the meeting, Ms. Sacks stated she observed Stulac looking “not so good.” On cross-examination, Attorney Attanasio elicited that Stulac’s eyes were bloodshot, he was in very bad shape, and smelled of alcohol. Ms. Sacks stated she knew Stulac was on prescription anti-depressants, and taking sleeping pills. AUSA Beste established on direct examination of Ms. Sacks that when Stulac was asked at that meeting if he believed in the “channel conflict” justification for writing-off accounts receivable, he looked down and said, “no.” She indicated that Stulac said that Matt Gless had told him they had a “bad channel” which they needed to write-off though the acquisition line item, and that it would be a “one time thing.” When Stulac was asked how he felt at the time, Ms. Sacks recollects him saying he “felt sick to his stomach.”
Ms. Sacks also indicated on cross-examination that she felt the interview conducted by the lawyers after the May 2002 press release had been a “set-up.” She also stated that the “channel conflict” theory had made sense to her.
The cross-examination conducted by Attorney Attanasio began at 3:05 p.m. today, and will extend into tomorrow – testimony will resume at 10:00 a.m.
February 13, 2008 – 10:00 a.m. to 4:15 p.m.
Through cross-examination of Nevanna Sacks, Attorney Attanasio established that Dan Stulac and his engagement team scrambled to prepare for the June 27, 2001 Risk Review Meeting. (Ms. Sacks testified about this meeting yesterday.)
Nevanna Sacks agreed with Attorney Attanasio’s characterization of Daniel Stulac as being over-worked. Ms. Sacks also agreed that software companies are difficult to audit because software accounting rules are complex and ever-changing and because it is common in the industry for most sales to occur in the last few days of each quarter. (This is when buyers know that software may be sold at the greatest discount.)
Attorney Attanasio introduced a Peregrine management representation letter into evidence. The letter was signed by CFO Farley and was written to Arthur Andersen. Mr. Attanasio reviewed the pertinent language in this letter in order to illustrate that during an audit, the company being audited is responsible for supplying the data that the auditors use to conduct their audit.
Daniel Stulac’s attorney, Mike Attanasio, returned to the issue of the three German contracts which Ms. Sacks testified about yesterday. Today, Nevanna Sacks explained that the German auditors saw the revenue recognition rules “in black and white.” Ms. Sacks said that Arthur Andersen San Diego viewed revenue recognition differently. Witness Nevanna Sacks agreed with Attorney Attanasio’s statement that the ultimate decision to recognize the revenue on the three German contracts was not a violation of GAAP, but was a change in Peregrine’s internal business practice of not recognizing revenue in contracts with extended payment terms over 90 days. Sacks testified that she was frustrated by the decision to recognize the revenue on the three contracts not because she thought it was fraudulent but because she did not like “the last minute change” in Peregrine’s policy allowing the company to recognize revenue in contracts with extended payment terms. When Ms. Sacks expressed her frustration to Mr. Stulac about this issue, she testified that Dan explained that the companies had a history of paying Peregrine on contracts with extended payment terms without concession. Nevanna Sacks agreed with Attorney Attanasio, that “at the end of the day, she was comfortable recognizing the revenue on the three German contracts.”
Mike Attanasio introduced a memo written to the files of AA by Nevanna Sacks which re-stated the above “history of collections, with no concessions” argument for allowing revenue recognition. Ms. Sacks’ memo also mentioned that Peregrine often “sells the paper” in these extended contracts and that gives the auditors additional comfort. Nevanna Sacks testified that she also relied on Peregrine’s written policy that every employee who offered concessions would be fired. Ms Sacks said that while she worked on the Peregrine engagement team she knew of two employees who were fired for this reason.
Nevanna Sacks testified about the various methods that her engagement team used to conduct a thorough audit of Peregrine. She described various types of revenue testing procedures. Ms. Sacks also said that confirmation letters were sent to Peregrine customers, to gather third party evidence that Peregrine’s contract terms were exactly as described by Peregrine’s financial documents and to ensure that there were no side agreements.
Attorney Kate Thickstun asked Nevanna Sacks if Peregrine always followed the adjustments that the AA engagement team suggested. Ms. Sacks answered that sometimes Peregrine made the suggested adjustments and sometimes they did not. Nevanna Sacks testified that when Peregrine did not follow the auditors’ suggestions, she did not suspect that it was because Peregrine was involved in fraudulent activity.
On re-direct, AUSA Beste asked Ms. Sacks to characterize Daniel Stulac’s relationship with Peregrine’s upper management. Ms. Sacks said that Mr. Stulac was “friends” with Peregrine executives and that she was outside the friendship circle.
AUSA Beste also pointed out the fact that there were two memos in the work papers dated April 20, 2000, yet one of the memos had a paragraph added that seemed to be a justification for revenue recognition. AUSA Beste asked Ms. Sacks if she added the paragraph and she did not remember doing so. AUSA Beste seemed to be implying that Daniel Stulac doctored the work papers by adding the extra paragraph.
AUSA Beste showed Ms. Sacks a confirmation letter which referred to the fact that there was a concession granted. She acknowledged the letter but offered no explanation for the fact that her engagement team had not investigated it.
AUSA Beste showed Nevanna Sacks a testing record of Accounts Receivable that she and her team conducted while working at the Peregrine engagement. The A/R testing indicated that KPMG owed Peregrine approximately $21 million in overdue accounts receivable. AUSA Beste asked Ms. Sacks how she could have believed that this data showed a history of collection. Ms. Sacks had no explanation. AUSA Beste finally rested and Ms. Sacks was excused (the afternoon session had run 45 minutes behind schedule). Nevanna Sacks walked off the witness stand, visibly shaken, with tears running down her face.
February 14, 2008 – 9:00 a.m. to 3:35 p.m.
AUSA Bill Narus called witness Michael Garcia to the stand this morning. Mr. Garcia worked in the billing department at Peregrine and reported to Patrick Towle. Mr. Garcia invoiced “Schedule A’s,” (contracts between Peregrine and customers). Mr. Garcia is a pleasant man, and when an attorney would ask him to explain a certain concept to the jury, he would quite literally do just that – he would swivel in his chair, look at the jurors and talk to them.
Mr. Garcia testified that at Peregrine keeping the books open past the quarter’s end was more the norm than the exception. AUSA Narus elicited that Mr. Garcia remembers booking contracts into previous quarters (usually one to two days later) at Towle’s direction. He testified that he did not know if this was done for revenue recognition purposes. AUSA Narus attempted various times to impeach this witness or refresh his recollection with interviews he had four years ago with FBI Special Agent Cook. After reading the notes from those interviews, Mr. Garcia disagreed, stating that his language was not accurately reflected by the FBI, or that the context to which AUSA Narus was applying his former statements to Special Agent Cook was incorrect. For instance, Mr. Garcia testified that he recalls telling the FBI that certain transactions with resellers didn’t make sense, but stated that he never told the FBI that everyone at Peregrine knew they would not collect. He maintained that he never suspected that the KPMG transaction or any other deals were “bad deals” while he was booking them.
On re-direct, AUSA Narus asked Mr. Garcia if he remembered telling Special Agent Cook that he knew certain revenue recognition was wrong, and that Patrick Towle understood it was wrong. Mr. Garcia said that he was referring to his belief that Towle should have enforced an internal procedure that he and Towle had put in place because at the end of each quarter they were inundated with revenue from contracts from the sales representatives. Mr. Garcia stated he believed that revenue was being recognized properly despite the fact that their internal procedure process was not being followed, particularly because, when he was first hired at Peregrine, he was told by higher-ups that they were a company which aggressively recognized revenue. Mr. Garcia remained very relaxed throughout frequent confrontations with AUSA Narus regarding his recorded statements made during FBI interviews four years ago. (Before ending direct examination, a skeptical AUSA Narus elicited from Mr. Garcia that he is Towle’s friend to this day.)
On cross-examination, Attorney Kate Thickstun asked the witness to clarify that by “keeping the books open,” he meant that the billing department was making sure to book all Schedule A’s, and that even though some of the contracts came in after the quarter’s end, all were for contracts completed in the previous quarter. Attorney Thickstun also asked Mr. Garcia questions regarding his knowledge of “side letters” (which were side deals whose terms might defeat the ability to recognize revenue on an original contract). He indicated that at the time he was invoicing, he had no knowledge of any side letters, and became aware toward the end of his job that there was such a thing and that they were forbidden. Mr. Garcia also testified that there was friction between the billing and collection departments of Peregrine, partially due to the fact that sometimes sales would send collections an unsigned contract, and collections would “take it upon themselves” to invoice it out, when the item should have gone to Towle’s team first.
Attorney Thickstun presented an e-mail to Mr. Garcia from Felicia Alpren, a Peregrine collections manager; he testified that he and others had tried numerous times to explain the concept of “channel burn” to her (whereby channel partners were billed upfront and then would “burn through” their contract amount with sales to end-users), but she never understood it. Attorney Thickstun elicited from Mr. Garcia that, while he was employed at Peregrine, he had no idea that fraud was taking place, he trusted his co-workers, and Patrick Towle never asked him to do anything dishonest.
Next, AUSA Beste called Felicia Alpren to the stand. Ms. Alpren was a collections manager during her time at Peregrine; she stated she was hired with the understanding that she would be in the finance department, but equal to Patrick Towle in the accounting department. Ms. Alpren testified, in a somewhat disgruntled manner, that she was never treated as Towle’s equal, and was not even treated as the equal of Michael Garcia (the previous witness).
Ms. Alpren testified that sales showed up on Peregrine’s books that bypassed the credit-check process, and she would later find out that certain customers who had bought on credit were not creditworthy. She contacted one such customer, and was surprised to learn he was actually a Peregrine employee, and had no intention of paying the company back; appropriately enough, given today’s date, this man’s name was Mr. Valentine. Ms. Alpren said she used this as an example to protest that they needed a credit department at Peregrine, but that Towle never got involved in championing this cause with her.
At Ms. Alpren’s request, Peregrine installed a software program called “Get Paid.” AUSA Beste established through this witness that she was told to hold an instructional meeting for auditors on the use of Get Paid. AUSA Beste also established that she was specifically instructed by Ilse Cappel (a former Assistant Treasurer at Peregrine who previously entered a guilty plea) to show the auditors only how the program worked, but not to let them see any data from customers with problems. Ms. Alpren followed her instructions, and did not show the auditors from Arthur Andersen any customer examples of how Get Paid worked. Attorney Mike Attanasio did not have much to say today because the witnesses were former Peregrine employees. However, he did take the opportunity on cross-examination to highlight that Ms. Alpren was specifically instructed not to tell the outside Arthur Andersen auditors about any customer accounts, and especially not the accounts with problems. Attorney Attanasio then established that in 2002, when KPMG replaced Arthur Andersen, and the same type of meeting was held to teach them about Get Paid software. Ms. Alpren testified that on this 2002 occasion, she “let the cat out of the bag” with the new auditors, because she had representatives in front of her from the very company that was one of her largest problem uncollectible accounts – KPMG. She asked the KPMG auditors whom she should contact to collect on the unpaid bills, and they whispered amongst themselves and then left the meeting. Shortly thereafter, Gless and Gardner announced their resignations.
Felicia Alpren testified that during her time at Peregrine, she became increasingly concerned with channel deals, which were getting bigger and more numerous at the end of every quarter, even though some customers with new deals had still not paid on their original contracts. She put together spreadsheets explaining which deals she believed were uncollectible (such as the deal with Mr. Valentine), and called it a “back-out list.” Other “invoices with issues” included various deals with KPMG; with respect to one such KPMG invoice, she wrote an e-mail stating “we need an act of God to collect.” She presented this information to the accounting department, and tried to convince them not to bill without end-users. She indicated Towle was a part of some of these discussions and e-mails. She felt ignored by the accounting department and Towle, and testified that she found Towle generally unresponsive to her collection complaints.
The next Government witness was Lynn Morimoto, who worked at Peregrine for 13 years, beginning in1991. Ms. Morimoto is not an accountant; she was in charge of putting products and prices in Schedule A contracts before sending them to revenue recognition personnel. Midnight on the last day of the quarter was the last chance for the sales representatives to get their deals in. She testified that quarters were sometimes held open for a few days into the following quarter.
Ms. Morimoto testified that, while she worked in the sales operation department of Peregrine, CFO Gless would occasionally send contracts back to her with instructions to back-date them. Ms. Morimoto testified that Towle instructed her to white-out the dates on fax headers of Schedule A’s. She stated that Towle sometimes called her after quarter end, and would ask if a certain document had arrived (the document, if it had arrived, would bear the fax header of the arrival date). She stated Towle would ask her to white-out the fax header – she would do so and then photocopy the original fax. She stated she was not trying to hide the faxes, and had the originals, white-out and all, in her files because it was her habit to keep track of all of the contracts. She testified she would then send Towle the photocopy. Ms. Morimoto indicated that eventually she began to white-out fax headers without being asked to do so. The Government published two of these fax-original contracts to the jury. Just before the court adjourned for the day, the jury carefully passed around the faxes, holding them up to the light to see the dates, still barely legible under the white-out.
The direct examination of Ms. Morimoto will continue tomorrow morning at 9:00 a.m.
February 15, 2008 – 9:00 a.m. to 1:00 p.m.
On direct examination, Ms. Morimoto testified that her main contact in the Peregrine accounting department was Patrick Towle. Lynn Morimoto remembers that Peregrine’s accounting division told her to white-out documents but she testified she doesn’t remember if it was Patrick Towle who told her to do it. (This statement is a direct contradiction of a statement made to the FBI in August 2003 and her later testimony today.)
Attorney Kate Thickstun cross-examined Lynn Morimoto. Attorney Thickstun introduced a PowerPoint presentation called “The Sales Booking Process” into evidence. This PowerPoint presentation was given to new sales employees at Peregrine. Patrick Towle and Lynn Morimoto both created and presented it as a training device. This PowerPoint presentation demonstrated that Lynn Morimoto was aware of the basic procedures in the sales booking process while she worked at Peregrine.
Through the introduction of e-mails, Attorney Kate Thickstun was able to show that Lynn Morimoto routinely created Schedule A’s for the sales department based on the data they supplied to her. Ms. Morimoto sent the Schedule A’s back to sales in PDF format so that the contracts could not be changed. It was her practice to fill in the dates, including the date at the signature line. (This is supposed to be the date that the contract is actually executed.) Lynn Morimoto explained that if she prepared a Schedule A shortly after the end of a quarter, she would automatically fill in a “hard” date on the Schedule A to make it appear as if it had been executed on the last day of the previous quarter’s end. This is called a hard date because it cannot be changed on the computer by a word processing program, the date would have to be crossed out (or whited-out) if someone wanted to change it on the Schedule A. Ms. Morimoto testified she knew that she was inserting incorrect hard dates so that Peregrine could book the contracts within a quarter that had already closed.
In addition to her practice of back-dating, Lynn Morimoto also was in the habit of whiting-out the fax header dates which appeared on faxed documents sent to Peregrine. Ms. Morimoto would white-out the fax header, and then make copies of the whited-out document to be used in the normal course of business. Lynn Morimoto kept all of the original whited-out documents in a separate box or area of her office. She said that Matt Gless taught her how to white-out faxes when Mr. Gless was the Controller at Peregrine. When Matt Gless became CFO, she testified that it was Patrick Towle who began to tell her to white-out faxes.
Attorney Kate Thickstun pointed out several issues regarding Ms. Morimoto’s propensity to use white-out on fax headers. First, Attorney Thickstun illustrated that Ms. Morimoto sometimes used white-out on a faxed document when there was no reason for her to do so. Secondly, Attorney Thickstun noted that a fax header on a Schedule A only shows the date that the document was faxed. The date it is faxed is not necessarily the date of execution. Finally, Attorney Kate Thickstun pointed out that even though Ms. Morimoto became aware of Peregrine’s accounting irregularities in May 2002, she did not mention that it was Patrick Towle who instructed her to white-out fax documents until August 2003. Ms. Morimoto testified that she never told anyone about the whiting-out of documents until July 2003 when she told Peregrine’s in-house counsel, Attorney Todd Sulger. Lynn Morimoto testified that Attorney Sulger saw her look in her box of original whited-out documents while they were both looking for a specific document. Ms. Morimoto gave Attorney Sulger the original whited-out document that he had been searching for by pulling it out of her box of original whited-out documents that she had been keeping under her desk. Ms. Morimoto testified that she did not feel like she was hiding anything by keeping the whited-out documents a secret until that moment.
Attorney Thickstun implied that Lynn Morimoto was worried about getting in trouble and therefore she implicated Patrick Towle during her FBI interview in August 2003. Lynn Morimoto testified that she does not remember bringing up Patrick Towle’s name during her FBI interview. She testified that the FBI agents probably asked her if Mr. Towle instructed her to white-out documents, and she answered yes.
Lynn Morimoto seems to be using the Nuremberg defense. At one point in her testimony, Ms. Morimoto claimed that she was not nervous at her August 2003 FBI interview because she knew that she did nothing wrong. She justified her behavior of back-dating and whiting-out contracts by saying that she “was told to do it.” At other times during her testimony, she would admit that she knew these actions were wrong when she did them. Ms. Morimoto’s testimony today was sometimes ambiguous. Lynn Morimoto seemed to be either unwilling or unable to understand the moral implications of her own behavior while working at Peregrine.