Four of five guilty in Enterasys trial
After a complicated month-long trial and seven days of deliberations, a jury with virtually no accounting experience convicted four former Enterasys Networks executives of conspiring to commit securities fraud Dec. 19 in U.S. District Court in Concord.
But the jury was never able to come to agreement on the charges facing Jerry Shanahan. The former chief operating officer of the company — an Irish national – was acquitted outright on one count and the jurors failed to agree on a verdict on five others, forcing the court to declare a mistrial. Shanahan was the only defendant who was never a CPA.
“At the end of the day, a lot of it boiled down to accounting,” said juror Peter Tengstrand shortly after the verdict.
Tengstrand and his fellow jurors found Enterasys’ top accountants – former chief financial officer Robert Gagalis and Bruce Kay, vice president of finance, guilty of eight counts of fraud, all relating to the 2001 spinoff of Enterasys from the former Rochester-based Cabletron Systems, once New Hampshire’s largest employer.
Robert Barber – a Cabletron official who was part of the Enterasys investment team — was convicted on four counts and David Boey of Atlanta, Ga., who headed Enterasys’ Asia Pacific sales division, was convicted on seven.
“Overall, we are very pleased,” said Deputy U.S. Attorney William Morse, who led the prosecution. “Investors in public companies are entitled to complete and accurate information. This sends a very strong message for other corporate executives not to mess with the books.”
Morse said he has not ruled out further prosecutions related to Enterasys. “We can’t comment on ongoing investigation, or even confirm that there is an ongoing investigation,” he told New Hampshire Business Review.
The three-attorney prosecution team alleged that the defendants inflated revenue to meet a $240 million target by using two accounting gimmicks – entering into secret side agreements to hide terms that would prevent revenue recognition and hiding from auditors the fact that investment cash to third party companies was recycled to purchase products through distributors, known as “three-corner deals.”
Much of the prosecution’s key testimony came from four former Enterasys officials, including former CEO Enrique “Henry” Fiallo, who had pleaded guilty to a securities fraud charge, as well as two auditors and officials from three companies that participated in the three-corner deals.
Gagalis and Kay were said to have a hand in multiple transactions as well as in filing the false information with the auditors. The other defendants’ alleged roles were mainly limited to specific transactions. Barber was primarily involved in three-corner deals, while Boey and Shanahan were primarily involved in separate deals involving side letters. But all, said the prosecution, were part of a conspiracy to defraud stockholders.
The nine defense attorneys, without calling a witness to the stand, said that such a disparate group of defendants not only didn’t conspire, but many of them didn’t even like each other. Making their case only through cross-examination and closing statements, they argued that the charges stemmed from the actions of overzealous auditors and regulators or the defendants themselves simply misunderstood complex accounting rules.
They did this after – through the jury selection process – they weeded out more savvy jurors with an accounting background or those who followed, or cared about, corporate fraud.
‘No smoking gun’
Still, the jury — which Judge Paul Barbadoro called a “model” — sifted through and cross-referenced thousands of e-mails and business records, applying obscure accounting rules that they had never heard of before.
Among them were e-mails from Gagalis who said “no documentation” of certain purchases should go to auditors, and one by Kay to change documents because they “screamed out” to the auditors.
But, said juror Tengstrand, “there was no smoking gun. It was an accumulation of evidence. That is what took so long.”
Tengstrand, an engineer, said he was more comfortable with numbers than most of the jury. Yet even he thought accounting was just a matter of bookkeeping before he was treated to a crash course in revenue recognition. It was this documentary evidence, more than the testimony, that convinced the jury.
Early on, the jurors realized that they couldn’t agree on Shanahan’s fate, so they put him aside, said Tengstrand. After reaching decisions on the fate of all of the other defendants, they argued about Shanahan’s role for three days.
At first – according to one juror’s account – all but one of the jurors wanted to acquit him on all charges. But after they reported to the judge that they were deadlocked on one count, his attorney, Andrew Good – not knowing what they were deadlocked on — argued for a mistrial on that count. As the jury went back, more of jurors became convinced of Shanahan’s guilt until – in Tengstrand’s words – it was nearly split down the middle.
The number of counts that they were deadlocked on grew from one to five.
Still, Shanahan’s lack of accounting experience prevented a guilty verdict, and in the end he was able to go free, accompanied by his wife, his two small children and a host of supporters who flew in from Ireland to watch the trial.
“I’m glad to be able to walk out of the courtroom,” Shanahan said. “It was a relief, but I was hopeful that I would be totally clear.”
Shanahan could be charged again and Morse told the court that he would be making such a decision “very soon.”
The other four defendants could face as many as 40 years in prison when they are sentenced in March.
For the time being, Barber and Boey, despite playing a lower-level role at Enterasys and in the alleged conspiracy and perhaps facing less time will be confined with ankle bracelets in their home. Gagalis was able to put some $1.5 million in equity from his Rye home and Kay offered two homes in Maine with equity of more than $600,000 as bond. They were judged less likely to flee and were allowed to travel domestically, as long as they obtained advance permission from their probation officer.
Barber was only able to pledge some $170,000 of equity in his Durham home and Boey – a Malaysian national – only had $60,000 at risk in his Atlantic house. Morse argued that Boey should be confined in jail because he might be deported after prison anyway, thereby increasing the likelihood that he would leave the country even while being electronically monitored. But his attorney, William Cintolo, argued that because he had the smallest role in the conspiracy he would likely be facing less than five years in jail – an assessment that Barbadoro said he tended to agree with.
So Barbadoro instead ordered that Boey be confined at home.
“He was taking orders, rather than ordering,” Cintolo had earlier said to NHBR Daily.
Cintolo said he didn’t regret his decision not to put his client on the stand, saying that the language barrier would prevent him being clearly understood by the juror.
Good also said he didn’t regret the decision. The other defense attorneys declined comment.
Sentencing of the convicted defendants is set for March 21 and 22. Sentencing of the four cooperating witnesses who had previously pleaded guilty to securities fraud charges is scheduled for April.