Dell has agreed to pay $100 million to the Securities and Exchange Commission to settle accounting fraud charges against the computer maker.
The SEC formally charged Dell with failing to disclose material information to investors and using fraudulent accounting to make it falsely appear that the company was consistently meeting Wall Street earnings targets and reducing its operating expenses on Thursday in announcing the settlement.
The SEC alleges that Dell did not disclose to investors large exclusivity payments the company received from Intel Corporation to not use central processing units manufactured by Intels main rival, Advanced Micro Devices. It was these payments rather than the companys management and operations that allowed Dell to meet its earnings targets. After Intel cut these payments, Dell again misled investors by not disclosing the true reason behind the companys decreased profitability.
The SEC charged Dell chairman and CEO Michael Dell, former CEO Kevin Rollins, and former CFO James Schneider for their roles in the disclosure violations. The SEC also charged Schneider, former regional vice president of finance Nicholas Dunning, and former assistant controller Leslie Jackson for their roles in the improper accounting.
Dell Inc. agreed to pay a $100 million penalty to settle the SECs charges. Michael Dell and Rollins each agreed to pay a $4 million penalty, and Schneider agreed to pay $3 million, to settle the SECs charges against them. Dunning and Jackson also agreed to settle the SECs charges.
Accuracy and completeness are the touchstones of public company disclosure under the federal securities laws, said Robert Khuzami, director of the SECs Division of Enforcement, in a statement. Michael Dell and other senior Dell executives fell short of that standard repeatedly over many years, and today they are held accountable.
Christopher Conte, associate director of the SECs Division of Enforcement, added, Dell manipulated its accounting over an extended period to project financial results that the company wished it had achieved, but could not. Dell was only able to meet Wall Street targets consistently during this period by breaking the rules. The financial results that public companies communicate to the investing public must reflect reality.
The SECs complaint, filed in federal district court in Washington, D.C., alleges that Dell Inc., Michael Dell, Rollins, and Schneider misrepresented the basis for the companys ability to consistently meet or exceed consensus analyst EPS estimates from fiscal year 2002 through fiscal year 2006. Without the Intel payments, Dell would have missed the EPS consensus in every quarter during this period.
The SECs complaint further alleges that Dells most senior former accounting personnel including Schneider, Dunning, and Jackson engaged in improper accounting by maintaining a series of cookie jar reserves that it used to cover shortfalls in operating results from FY 2002 to FY 2005. Dells fraudulent accounting made it appear that it was consistently meeting Wall Street earnings targets and reducing its operating expenses through the companys management and operations.
According to the SECs complaint, Intel made exclusivity payments to Dell in order for Dell to not use CPUs manufactured by its rival Advance Micro Devices, Inc. These exclusivity payments grew from 10 percent of Dells operating income in FY 2003 to 38 percent in FY 2006, and peaked at 76 percent in the first quarter of FY 2007.
The SEC alleges that Dell Inc., Michael Dell, Rollins, and Schneider failed to disclose the basis for the companys sharp drop in its operating results in its second quarter of FY 2007 as Intel cut its payments after Dell announced its intention to begin using AMD CPUs. In dollar terms, the reduction in Intel exclusivity payments was equivalent to 75 percent of the decline in Dells operating income.
Michael Dell, Rollins, and Schneider had been warned in the past that Intel would cut its funding if Dell added AMD as a vendor. Nevertheless, in Dells second quarter FY 2007 earnings call, they told investors that the sharp drop in the companys operating results was attributable to Dell pricing too aggressively in the face of slowing demand and to component costs declining less than expected.
The SECs complaint further alleges that the reserve manipulations allowed Dell to materially misstate its earnings and its operating expenses as a percentage of revenue an important financial metric that the company itself highlighted for more than three years.
The manipulations also enabled Dell to misstate materially the trend and amount of operating income of its EMEA segment, an important business unit that Dell also highlighted, from the third quarter of FY 2003 through the first quarter of FY 2005.
Without admitting or denying the SECs allegations, Dell Inc. consented to the entry of an order that permanently restrains and enjoins it from violation of the securities laws. Dell Inc. also agreed to enhance its Disclosure Review Committee and disclosure processes, including the retention of an independent consultant to recommend improvements to those processes and enhance training regarding the disclosure requirements of the federal securities laws.
Michael Dell and Rollins settled the SECs disclosure charges, without admitting or denying the SECs allegations, by each agreeing to pay the $4 million penalties and consenting to the entry of an order that permanently restrains and enjoins each of them from violating the securities laws and from violating or aiding and abetting violations of other provisions of the federal securities laws.
We are pleased to have resolved this matter, said Michael Dell in a statement. We are committed to maintaining clear and accurate reporting of our periodic results, supporting our customers, and executing our growth strategy.
Sam Nunn, presiding director of the Dell board, said, The board believes that this settlement is in the best interest of the company, its customers and its shareholders, as it brings a five-year SEC investigation to closure. Dells board reaffirms its unanimous support for Michael Dells continued leadership, and the management team in its ongoing commitment to transparent accounting, integrity in financial reporting and strong corporate governance."
Schneider consented to settle the disclosure and accounting fraud charges against him without admitting or denying the SECs allegations, and agreed to pay the $3 million penalty, disgorgement of $83,096, and prejudgment interest of $38,640.
Dunning and Jackson consented to settle the SECs improper accounting charges without admitting or denying the SECs allegations. Dunning agreed to pay a penalty of $50,000. In their settlement offers, Schneider, Dunning and Jackson consented to the issuance of administrative orders pursuant to Rule 102(e) of the Commissions Rules of Practice, suspending each of them from appearing or practicing before the SEC as an accountant with the right to apply for reinstatement after five years for Schneider and three years for Dunning and Jackson.
The SEC said its investigation is continuing as to other individuals.
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