Former Cabletron-Riverstone officials face SEC charges

The Securities and Exchange Commission has charged six former officials of Cabletron Systems and Riverstone Networks with securities fraud, the federal agency announced Monday.

In a civil complaint filed Friday, the SEC charged that Romulus Pereira, Riverstone’s first CEO, and Robert Stanton, Riverstone’s first CFO, conspired with four other officers to inflate revenue, mislead the SEC and the company’s own auditors. The alleged conspiracy took place between June 2001 and June 2002, when Cabletron was spinning off Riverstone, which was finalized in August 2001.

The charges echo similar allegations made against officials during Cabletron’s February 2001 spin off of Enterasys Networks. Those allegations led to nine criminal indictments. Four of the former officials pleaded guilty, and five are scheduled to go on trial next month.

Not named in the charges against either company is Piyush Patel, Cabletron’s former chief executive officer, who went on to chair Riverstone’s board. Patel, who engineered the spinoffs, was the hand-picked successor of Craig Benson, the former governor of New Hampshire and co-founder of Cabletron. (Patel had previously been notified that he was a target of the SEC investigation, according to bankruptcy papers.)

Those charged do include: L. John Kern, former executive of worldwide sales; Andrew D. Feldman, vice president of marketing; William F. McFarland, vice president of finance; and Lori H. Cornmesser, director of sales operations. All, save McFarland, date their tenure at Riverstone when it was still a Cabletron subsidiary, and all, save McFarland, allegedly enriched themselves at the stockholders’ expense.

All of the former officers allegedly recorded phony sales on the company’s books with numerous companies right before the quarter and hid secret side agreements from regulators that would have discredited the sales. The defendants then lied on reports filed with regulators, the complaint charges.

The complaint cited four examples:

• Riverstone officials allegedly placed a $2.8 million with World Wide Technology Inc., a Missouri-based reseller, on Aug. 28, 2001 — several weeks after the spinoff and days before the close of the company’s first quarter, concealing a side agreement that would have prevented that revenue from being recognized. The officials, despite being informed that World Wide wasn’t paying up, reported the sale as revenue. The single sale counted for more than 5 percent of the company’s revenue that quarter, according to the SEC charges.
• On Nov. 29, 2001, three days before Riverstone’s next quarter, the company booked a $2 million purchase order to Vnetek Communications Inc., a Londonderry-based reseller. Again, the agreement allegedly included a secret side agreement with full return rights that prohibited revenue recognition under accounting rules, but it went through because the officials wanted to get a “clean” purchase, which was needed to “get through the audit,” according to the complaint.
• Because Riverstone could not consummate a deal by the end of the quarter ending in March 2002, Riverstone officials arranged to sell the inventory to Technica Corp., a Virginal-based reseller. Then they repeated the procedure to push up revenue in the next quarter.
• Riverstone allegedly sold $1 million to TM Telecom on May 24, 2002, even though the Florida-based reseller “had no need for the Riverstone product and did not have the independent ability to pay for it,” according to the complaint.

In addition, the complaint briefly cites deals with 13 other companies involving improper revenue recognition.

“As a direct result” of these deals the company inflated revenue by nearly $30 million, the complaint say. When Riverstone announced its investigation by the SEC in 2002, its stock price was cut in half to $7.70 a share — a reduction in of value of nearly $1 billion. When Riverstone eventually restated its earnings in August 2003, the company’s stock price plummeted again.

But before it did, the officials allegedly enjoyed the benefits of the artificially inflated price.

Pereira, according to the complaint, profited the most, with $1.2 million in gains from stock sales.

Riverstone, which has long since moved to California, never fully recovered. The company filed for bankruptcy in February, and the SEC halted trading shortly afterward. Although it was purchased by Lucent Technologies in May for more than $200 million, it initially was only able to return to the shareholders $1.06 a share, compared to the $14 that it sold for during the spinoff. Few investors expect more than a half-dollar more per share to be paid off in any future distribution.

One of the holdups of any subsequent distribution is the claim of all of the defendants — except Cornmesser — on the bankrupt estate (renamed RNI Wind Down Corp.). With Riverstone’s insurance policy exhausted, the defendants are demanding that RNI pay their legal fees.

Kern and McFarland have settled with the estate for $1.5 million, but Pereira, Stanton and Feldman are asking for a total of $12 million, or $4 million each, according to Bill Baldiga, an attorney who represents the shareholders in bankruptcy court. RNI maintains it doesn’t have to pay the officials anything.

In early pleadings on the matter, Pereira said he might need the money to defend himself against a criminal investigation.

The SEC can’t file criminal charges, only the U.S. attorney’s office can. The civil charges don’t preclude criminal charges.

A hearing on the legal reimbursement is scheduled for Nov. 8 in Delaware bankruptcy court, the day after the criminal trial is scheduled to begin in U.S. District Court in Concord for the former Enterasys officials.

As for the civil trial of the six Riverstone defendants, that could be at least a year away, if it is not settled beforehand, said Leslie Hughes, an attorney for the SEC. Hughes declined to comment further on the case.

Attorneys for Pereira and Stanton could not be reached by NHBR Daily deadline. – BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW

Categories: News