Riverstone admits revenue inflation in SEC filings

Riverstone Networks, one of the troubled spin-offs of the former Cabletron Systems, admitted in recent filings to the U.S. Securities and Exchange Commission that former officials were engaging in revenue-inflating practices similar to those that have led to criminal indictments and three guilty pleas in the securities fraud investigation of fellow Cabletron spin-off Enterasys Networks.

Both companies engaged in the practices shortly after being spun off from Cabletron, a firm co-founded by Gov. Craig Benson and once the state’s largest employer. Both have since been drastically downsized and moved their headquarters out of New Hampshire. Enterasys is based in Massachusetts; Riverstone is in Santa Clara, Calif.

According to the long-delayed filings, which cover the period from March 2002 to November 2003, certain Riverstone employees agreed to unauthorized side agreements with liberal return rights that would cast doubt on transactions with resellers that were previously recorded on the company’s books as sure revenue. Similar practices led to the indictments at Enterasys in what appears to be a widening investigation.

As a result of this and other accounting irregularities, Riverstone restated its financial filings.

It now reports that it started fiscal year 2003 (beginning in March 2002) some $167.2 million in debt, $95 million more – or more than twice as much — as previously reported.

What happened in fiscal year 2002 — which began shortly after Riverstone split from Cabletron — may not be disclosed, because Riverstone announced that it may never file a restatement for its first full year. The company went on to lose $87.8 million in 2003, and $76 million in the first three quarters of 2004. The company said it plans to file its 2004 annual statement in mid September.

Despite the red ink, the company’s stock rebounded slightly after the SEC received the most recent filings, partly because the company had failed to meet its own filing forecast three times before.

The company still will have about $100 million in cash, even after taking into account bondholder debt.

Riverstone launched its own internal investigation into the practices after the SEC announced that it was examining the company — an action that caused Riverstone to attempt to restate all of its previous filings and hold off on submitting any more.

The yearlong delay led to the company’s stock being delisted by the Nasdaq exchange as well as a call by bondholders to call in its debt, something that is still being contested in court. In that time, the stock price plunged to less than 75 cents a share.

If the company fails to file for 2002, its stock probably will remain delisted until late 2005. The Nasdaq generally requires three years of filings, but Riverstone may ask for a waiver of that rule. It has announced a number of corporate governance reforms that might help it get relisted sooner.

Pipal Systems deal

In addition to the secret side agreements, the investigation — conducted by Ernst & Young — also found evidence indicating that “revenue was improperly recognized on sales to customers in which the company had an investment interest that had no business substance” as well as improper accounting for barter transactions.

Riverstone did not specify which investments or barter transactions it was referring to.

The filing also included for the first time terms of the merger with Pipal Systems. Riverstone bought Pipal — a firm of which Benson was a board member, a major stockholder and creditor — for $23 million in January 2003. Indeed, the deal includes as a fee the payoff of a $6.6 million loan to Softdraw LLC, Benson’s investment company.

Soft Draw was a major investor in the Golf Club of New England and recently took over the club after the Stratham golf club — co-founded by Benson — went bankrupt.

The filing also included an agreement to pay Richard Lowenthal, a former Pipal board member who joined Riverstone — and a contributor to Benson’s campaign — at least $100,000 for acting as a consultant to the merger.

It is unclear whether the Pipal deal had any impact on the restatement, or was part of the internal or SEC investigation.

It also is unclear how far investigators are planning to go back, both in the Riverstone or the Enterasys investigation, and determine whether the practices date back to Cabletron Systems. Cabletron (and Benson personally) was accused of similar practices in an active shareholder suit that is in the discovery phase.

The statute of limitations for criminal fraud charges goes back five years, which would date back to the fall of 1999. The limits can reach further back if a conspiracy is involved, as long as the last act of the conspiracy is within the statute of limitations.

Benson stepped down from the company in June 1999, when Piyush Patel, his hand-picked successor, took over with the intention of splitting up the company. Riverstone was spun off in February 2001 and Cabletron became Enterasys in August of that year. Patel later became chairman of Riverstone, but stepped down shortly after the SEC announced it was investigating the company.

Benson, who was Cabletron’s, and then Enterasys’, largest single stockholder, headed the Enterasys audit committee. He sold most of his Enterasys stock shortly after he became governor in January 2003. It is unclear whether Benson still has a major stake in Riverstone.