Expert: Enterasys fraud cost stockholders nothing

While the prosecution claims that the fraud committed by former Enterasys Networks executives cost stockholders $144 million, a defense expert hired has countered with another estimate: zero.

Accountant Bala Dharan spent most of a 45-page report – filed Monday at the U.S. District Court in Concord – debunking the prosecution’s estimate, which was filed last month. A hearing on these dueling estimates is scheduled for June 27 in order to form a basis for the sentencing of the four executives, which is scheduled the following day.

In December, the jury convicted the four former executives of conspiring to inflate revenue in 2001, when Enterasys was spun off by Rochester-based Cabletron Systems, once the state’s largest employer.

The defendants awaiting sentencing are former chief financial officer Robert Gagalis, Bruce Kay, once vice president of finance, Robert Barker, a member of the investment team and David Boey, sales director of the companies Asia Pacific Division.

The jury could not reach a decision on a fifth defendant, Jerry Shanahan, who is scheduled to be retried in September.

In April, Laura Stamm argued for the plaintiffs that the stock price was severely affected after it was revealed that revenue was misrepresented and that the Securities and Exchange Commission was investigating the firm. She said that the effect on the stock price would not have been as great if the executives had been honest in the first place about the company’s financial difficulties.

But Dharan said that Stamm was attributing too much of the loss to the alleged fraud.

First, he said, the stock actually went down after the initial inaccurate revenue reports were released.

Second, there were a number of other important factors that drove the price down. Prices were going down sharply in the entire industry before any restatement of revenue. Other factors were the company’s involvement in a complex spinoff and changes in its accounting practices.

Finally, any estimate should take into account the sheer “randomness” of stock value fluctuations.

On Feb. 1, 2002, Enterasys’s stock price dropped from $10.80 to $4.20 per share, a loss of approximately 61 percent, or a $1.3 billion decline in value. The stock never recovered, and the company was eventually sold to private investors for less than $1.50 a share.

But when taking all these factors into account, Dharan said, “the starting point for loss analysis that any possible causation inflation inferred from the February 1 2002 disclosures on revenue misrepresentation is zero,” Dharan said.

Dharan added that any additional loss following disclosures in the following few days would not be “statistically significant.”

Defendants paid Dharan $450 an hour for his services. The prosecution paid its expert $525 an hour. – BOB SANDERS