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MCM Accounting Scandal
MCM Accounting Scandal
Lernout & Hauspie was founded in 1987 by Jo Lernout and Pol Hauspie. After a difficult start, it
quickly grew, and, in 1995, it went public on the NASDAQ. Its headquarters were in Ieper,
Belgium, and in Burlington, Massachusetts. L&H had 143 million shares of common stock
outstanding as of August 2000 and its stock price hit a high of $65 per share on March 14, 2000,
giving the Company a market capitalization of almost $9 .3 billion at its peak. It went bankrupt
in 2001. The company was seen as a representative of the new Flanders (A region divided
between Belgium, France, and the Netherlands), focused on new technology rather than old
industries. In 1993, American telecoms giant AT&T invested 7.5 million in L&H. In 1997
Microsoft took up an 8% stake in the company for a price of $45 million (34.5m), by which
L&H got world s attention, but which also brought it under closer study and ultimately led to its
downfall.
This assignment is about the massive accounting fraud at Lernout & Hauspie Speech Products,
from its first quarter of fiscal year1998 through its first two quarters of fiscal year 2000; L&H
overstated all publicly reported revenues by total of $377 million. The Company's financial
statements for 1998, 1999 and the first two quarters of b 2000 have been completely restated.
publicly reported revenues and benefit L&H's major shareholders - FLV, n Mercator and the
Senior Officers.
The accounting irregularities at L&H "began at the top of the company with a culture that
pressured individuals to prematurely recognize revenue, to engage in backdating of contracts or
swapping of contracts in other words, creating revenues freely where none should have been
recognized."
That statement by L&H's outside counsel, Lanny Davis, made in a December 19, 2000 interview
on CNN, is a summary of the massive, systematic, far-reaching accounting fraud that was L&H.
Starting of Scandal
In 1995, L&H completed its initial public offering and commenced trading on NASDAQ. From
1987 through 1995, the Company had never been profitable and had only produced a few million
dollars in annual revenues.
Beginning in the third quarter of 1996, L&H expanded its business primarily through a dizzying
array of acquisitions, to reach its goal of becoming the leading international provider of
advanced speech and language technologies, products and services.
As a result of the Companys new focuses, L&H's sales quadrupled from 1995 to 1996. What
proceeded was a period of unprecedented growth for L&H, making the Company an
International success story and the pride of Belgium.
From 1997 to June 2000, L&H reported incredible revenue growth -bolstered by a number of
acquisitions, related -party transactions, and fraudulent accounting. In 1997, the Companys total
revenues increase 220% to $99.4 million from $31 million in 1996. In 1998, L&H's revenues
purportedly rose 113% to $211.6 million, and by 1999, the total revenues were claimed to be
$344 million.
Under Bastiaens'(chairman) leadership, L&H acquired at least 20 companies during the scandal
Period, throughout the scandal period, L&H engaged in numerous schemes that were intended to,
and did, artificially inflate the Companys revenues, earnings and the value of L&H's common
stock. As a result of defendants' far-reaching fraud, L&H would eventual admit that over $377
million of revenue from 1998 through June of 2000 was improperly recorded -- including the
reversal of all revenue recorded in Korea from September 1999 through June 30, 2000.
Irregularities of L&H
L&H repeatedly recorded revenue from barter or exchange transactions where no cash changed
hands. A former channel sales manager from the Burlington office of L&H said barter/swap
transactions were widespread at L&H Burlington and a standard practice within the whole
company, absolutely from the top down. It was the way things were done." "Everybody knew
about it. Everybody acted like it was some kind of genius scheme to book revenue." The former
channel sales manager understood that Bastiaens was responsible for implementing the crossquarter deals and barter transactions.
L&H also inflated earnings by prematurely recognizing revenues where no contract was signed
or where the terms of the contract were not finalized. Throughout the scandal Period, defendants
repeatedly booked sales, even though negotiations were still ongoing and the "customer" was
under no binding obligation to purchase the product.
Finally, in a document dated April 27, 2001, and filed with the SEC on May 3, 2001,
L&H reported its sales in 1998, 1999 and the first half of 2000 were overstated by $373
million mean that the Company admitted that all of the Korean revenue from September
1999 through June 30, 2000 would be restated and removed.
The Audit Committee Report concluded, in part, that: (a) L&H had improperly recorded as much
as $277 million in revenue during 1998, 1999 and the first half of 2000; (b) that the Company
should reverse all of its Korean revenues recorded during 1999 and 2000, amounting to
approximately $182 million; and (c) that software license revenues from twenty-four of the thirty
start-up companies were incorrectly booked because those companies were not buying software
from L&H, but rather, were paying L&H employees to develop future products - in effect,
funding L&H's research and development.
Outcome of Scandal
Lernout and Hauspie were found guilty of fraud and given the maximum sentence requested by
the prosecution - five years imprisonment, although two years of that is suspended. They were
each fined 24,789. Directors Nico Wilaert and Gaston Bastiaens were given the same sentences,
although three years of Bastiaens' sentence were suspended. Tony Snauwaert, responsible for
helping to build up the network of fictitious clients who made LHSP look so attractive to
investors had received two years, with one suspended, and was fined 2,478
The company's former financial director Carl Dammekens received a six-month suspended
sentence and was fined 2,478. Eight other executives were acquitted. Auditors KPMG,
likewise, were found not to be responsible. However, their representative William Van Aerde
was found to have been "careless" in his handling of the matter and fined 2,478. KPMG paid
$115 million in a similar case in 2004. This is not the first time KPMG has shelled out money to
settle a shareholder lawsuit stemming from its audit work. In March 2003, the firm agreed to pay
$125 million to settle class-action lawsuits related to its audit of Rite Aid, which in the late 1990s
overstated earnings by $1.6 billion.
KPMG Belgium, a member of KPMG Int'l, is a public accounting firm, employing 950 partners
and staff in six cities in Belgium. L&H became an audit client of KPMG Belgium after it
acquired the accounting firm of Behets, Boes & Co., which had been auditing L&H since the late
1980s.
KPMG effectively served as an adjunct to L&Hs accounting department during fiscal years
1998 and 1999. KPMG auditors and consultants were present at L&H at the end of every quarter
during the scandal Period and worked closely with L&H on the preparation of the quarterly
financial statements.
Moreover, given the fact that KPMG was making the final decision regarding which entries
would and would not be recorded, its conduct made KPMG complicit in the preparation of the
false quarterly financial statements.
In a startling breach of its duty to act as the public's "watchdog" KPMG participated in, and had
actual knowledge of, the fraud perpetrated at L&H during the scandal period. In particular,
KPMG advised L&H to backdate contracts to create the appearance that revenue recognition was
appropriate.
Most importantly, KPMG had complete knowledge of one of the most important facts which
ultimately lead to the uncovering of the fraud by The Wall Street Journal: the fact that many, if
not all, of the LDCs had the exact same business addresses. Recognizing that such facts indicated
strongly that the transactions were improper,
KPMG (Klynveld Peat Marwick Goerdeler) knowingly or recklessly violated generally accepted
auditing standards in the United States ("GAAS").
References
http://online.wsj.com/article/SB972508598799909346.djm.html
http://www.dailyfinance.com/2010/09/21/lernout-hauspie-convicted-fraud-speechrecognition-founders/
http://online.wsj.com/article/SB976143929804554337.html