Enterasys prosecution details ‘lying, deception’

When the government opened the monthlong trial of five former Enterasys Networks executives in US District Court in Concord, its case, prosecutors said, involved “cheating and lying.”

In Thursday’s closing arguments, prosecutor Colleen Ann Conry said it boiled down to “lying, deception and choice.”

It was a choice, she said, of whether to “play by the rules” in order to meet Enterasys’ revenue goals in the crucial quarter in 2001, when the company spun off from Rochester-based Cabletron Systems.

By changing “cheating” to “deception” and “choice” the prosecution was doing more than playing with semantics.

The word “cheating” emphasized the actual act of breaking accounting rules, rules that some of the testifying accountants could not agree on – something the defendants’ lawyers capitalized on during their questioning and their closing arguments thus far.

Conry’s argument was a long discussion of accounting rules known that often may have made the jurors feel like – as one defense lawyer put it – they were “watching paint dry on a building”.

The word “choice” emphasized a state a mind to engage in a conspiracy. It matters less whether the rules were actually broken (though the prosecution still insists they were) but whether the defendants were, in Conry’s words, conspiring to “painting picture different from what was going on inside Enterasys.” The overall deception was more important than any particular rule.

Conry said that a day after Bob Gagalis, former chief financial officer, told investors that Enterasys was going to hit its revenue target of $240 million, Jerry Shanahan, chief operating officer, informed him in an e-mail that there was a “serious disconnect” between the “revenue forecast and where we have to be.”

But, said Conry, Gagalis went on a road show, giving investors the opposite impression. And through a number of specific deals, all of the defendants, each in their own way, contributed to that false impression.

They became “so obsessed with hitting the numbers, they made unfair choices with very serious consequences,” she said. “Beyond all doubt, they knew what they were doing.”

She said that the first deal — the “deal that launched a thousand ships” toward the investigation that eventually resulted in the trial, as well as the guilty plea of four other Enterasys executives — was with Asian distributor Ariel International.

Although it only amounted to $4 million, when auditors discovered two different contracts, with the same date, and a “secret side letter,” it became “huge deal,” that — when publicized — caused the stock price to plummet, Conry said.

Conry traced Enterasys’ reaction when Anthony Hurley, a former Enterasys comptroller who later pleaded guilty to one count of wire fraud, saw the agreement signed on Aug. 31, 2001, with two problematic terms: one giving primary responsibility for Enterasys to sell Enterasys products after they were already sold and the other doubling the credit terms to 150 days.

The first term in particular “screams out that we are responsible for selling meaning we haven’t really sold it yet,” wrote defendant Bruce Kay, vice president of finance, and since the company “can’t afford” to lose the revenue he ordered defendant David Boey, who headed the Asian Pacific sales force, that it be “fixed by tomorrow.”

Boey, said Conry, responded by telling Ariel that “the auditors cannot accept this” so they changed the agreement, but the terms were then put into a side letter.

Conry said that Gagalis‘ executive assistant, Gayle Spence, told Boey (on Gagalis’ orders, she had testified) to “make certain the date on the letter coincides” with the document. Boey made the changes, telling Kay that the “cumbersome language was off the main agreement” implying, said Conry, that Kay also knew about the side letter.

In his closing argument, Boey’s attorney, William Cintolo, said that Hurley’s entire premise was mistaken: There was nothing wrong with the original Ariel agreement when it came to revenue recognition. Only poor wording resulting from imprecise translation would trouble the auditors.

The side letter – written to satisfy Ariel – didn’t materially change anything, and it wasn’t secret, since it was in a file available to auditors, he said. Boey didn’t back-date the document, said Cintolo, adding that it was Hurley, not Boey, who backdated the document.

It was up to the jury to decide whether Boey was a “hard-working loyal employee asked to do something who did it” or whether he would leave the “footprints of a felon” for what he did during those three days in September.

Bruce Singal, Kay’s attorney, echoed Cintolo’s theory.

Kay, Singal said, was only trying to get back to his original understanding of the agreement. He noted that in one e-mail auditors were told that the deal was being negotiated a week after the quarter ended, but nobody seemed to be upset by that fact. As for the side letter, Kay denies ever knowing about it, said Singal. The implication of one e-mail is a “pretty thin reed indeed” to rest a case on, he said.

Kay was “putting on the brakes,” hardly fulfilling the role of someone desperate to inflate revenue, Singal said.

The rest of the prosecution’s closing argument primarily centered on deals featuring the other three defendants, who will be making their closing arguments today.

The $3 million Tech Data deal featured a similar side letter authored by Shanahan. This side e-mail reinstated two other troublesome clauses, the primary one exempting the Canadian distributor from having to pay for what it hadn’t sold in 90 days, said Conry.

Finally, Conry said, there were the “three-corner deals” — investments in which Enterasys would supply cash that was immediately used to buy products through a distributor. Yet auditors were not told that the sales were related to the investments. One auditor had testified that he had previously told several executives (including Kay) that such deals should be “collapsed.” Gagalis knew that they were “sensitive” and wanted to “sign off” said Conry, quoting from his e-mails.

“It’s sensitive because they were recycling cash,” Conry charged.

But as it seemed increasingly unlikely that Enterasys would make its target — and with “auditors breathing down his neck” – four days before the quarter ended Gagalis “concocted this loophole theory” that as long as the investee was not required to buy Enterasys products in the contract, the deals didn’t have to collapse.

“This is made-up fabrication, Alice in Wonderland,” Conry said. “If you honestly believe this, why don’t you tell the auditors?”

After the remaining closing arguments, the prosecution’s rebuttal and expected lengthy jury instructions by Judge Paul Barbadoro, the jury should begin deliberations, either late Friday afternoon, or on Monday. – BOB SANDERS

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