Prosecutors to say Enterasys execs ‘cooked the books’

Federal prosecutors anticipate that they will spend three weeks presenting their case that former executives of Enterasys Networks “cooked the accounting books.”

The executives’ trial in U.S. District Court in Concord starts today.

According to trial brief submitted on Friday, the prosecution will try to show that the five defendants conspired in a “desperate” attempt to meet shareholder expectations by inflating revenue in the quarter after Enterasys was spun of by the Rochester-based Cabletron Systems – once the state’s largest employer — in August 2001. (Enterasys has since moved out of the state and been acquired by private investors.)

Specifically, U.S. Attorney Robert Morse will try to prove that the defendants “lied” to auditors, to regulators and shareholders by hiding secret arrangements involving five different companies, according to the brief.

Prosecutors say they will show how former chief financial officer Robert Gagalis – despite misgivings that he might be “crucified” because of the alleged deception and comparisons of the behavior to a cocaine habit — kept silent during an internal investigation about the accounting scandal.

Joining Gagalis as defendants are former chief operating officer Jerry Shanahan, finance vice president Bruce Kay, Robert Barber, a former executive in Enterasys’ Business Development Group, and David Boey, former director of sales and operations at the company’s Singapore office.

The prosecution’s brief mentioned a list of “uncharged coconspirators” that was submitted to the court under seal in order to allow certain hearsay evidence involving them to be entered into the record.

The government’s main witnesses will be those who have already pled guilty in connection with the alleged fraud – former CEO Enrique Fiallo, his executive assistant, Gayle Spence, Anthony Hurley, an assistant controller, and Gary Workman, who headed Enterasys’ Asia Pacific Sales.

The other two major witnesses are from Enterasys’ auditors KPMG, Jim Boyer and David Wilson.

According to the brief, the “pressure to meet or exceed the investing public’s expectations for the Second Quarter was immense and failure was simply not an option.”

The government plans to introduce alleged e-mails from Shanahan urging that others take responsibility for meeting the revenue target “no matter what” and to “not assume anything is sacred”

Of five transactions cited, two – with Tech Data (Canada) and Ariel — involved a secret side letter that would lead auditors to conclude that deal would not count as revenue given the accounting practices in force.

The Ariel transaction “screams out” that it would not qualify for revenue, Kay allegedly wrote in an e-mail, so prosecutors charged the contract was “doctored up” and backdated so it would be counted in that crucial second quarter.

The other three transactions – involving GEMMS, Paraprotect and Worldlink — were investment deals in which Enterasys would invest in a company if the company used the money to purchase Enterasys products through a particular distributor.

If auditors knew the nature of such “three-corner” transactions, they never would have counted them as revenue, prosecutors maintain.

The CFO of Paraprotect raised doubts about one of these transactions to Gagalis, the prosecution’s brief says, but he was assured that KPMG would review each one. In reality, Gagalis withheld the information from its auditors. according to prosecutors.

At NHBR Daily deadline, the defendants did not submit their own brief right before trial, but in previous motions they questioned evidence supplied by the auditors, who themselves may have once been targeted by federal prosecutors. — BOB SANDERS


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