SEC fills in details of Riverstone charges

Riverstone Networks officials routinely cleaned up and booked “dirty” deals, by hiding verbal side agreements and e-mails that would have prevented them from being recognized as revenue, according to a revised civil complaint filed last week by the Securities and Exchange Commission last week.

The actions were taken shortly after the company was spun off in 2001 from Rochester, N.H.-based Cabletron Systems, the SEC alleges.

Six executives, including former Chief Executive Officer Romulus Pereira and Chief Financial Officer Robert Stanton, conspired to falsely report some $19.1 million in revenue, according to the 82-page amended complaint — four times the size of the original one filed last October in U.S. District Court in California, where Riverstone relocated shortly after the spinoff.

Other former Riverstone executives charged are L. John Kern, vice president of sales, Andrew Feldman, vice president of marketing, William McFarland, vice president of finance, and Lori Cornmesser, director of sales operations.

The amount of fraudulently recorded revenue is about $10 million less then originally charged, and the new complaint quietly drops some deals previously mentioned, but the deals that are included are much more detailed.

The amended complaint attempts to paint a picture of concealment and deceit, quoting from e-mails that are particularly damaging to Kern, who reported to Pereira.

In one $2 million deal with the Chinese reseller Everbright Innovation Technologies Co. Ltd., Kern allegedly granted the company rights to return half of the product it would purchase, even though it would all be recorded as a sale.

But these “rotation rights,” Kern wrote to Cornmesser in an e-mail, “cannot be in writing. Needs to be verbal only.”

A month later, however, Kern had to explain to a salesperson that the Everbright transaction “had nothing to do with sales, just throwing money to waste to get revenue.”

Everbright’s revenues were included in a quarterly report, without which the company wouldn’t have made a profit. The Chinese firm eventually returned half of the order.

‘Pull deals forward’

In another deal with a reseller called Smartnet, Kern allegedly said in an e-mail to allow return rights, but “this cannot be in writing for revenue. If included, we might as well not bother with the order. I need you to agree to this verbally with Smartnet based on your word.”

Another time, Kern suggested to “let’s talk live” when asked if he agreed to a side agreement and he allegedly asked to “please delete these e-mails” concerning another side agreement.

When many of these companies insisted on their return rights, Kern had to let the bookkeepers know about them, causing some confusion. To straighten all this out, Kern allegedly wrote Cornmesser, “Lori, we should sit down and go through all of the ‘deals’ we have done in the last few quarters, so you can get a list of exceptions …. So in other words, a list of official legal agreements and a list of the ‘unofficial’ verbals.”

While Pereira and Stanton were not directly involved in these side agreements and contingencies, they set the revenue goals even before Riverstone was spun off from Cabletron in February 2001, urging executives to “close the gap” and “pull deals forward” to meet them by the end of the quarter.

And they were informed (if they didn’t already know) about the allegedly fraudulent means that this was done, when the companies began to exercise return rights, according to the complaint.

This was first detailed in a side agreement with World Wide Technology, a Missouri-based firm, concerning a $2.8 million purchase.

This company was originally recommended by Piyush Patel, CEO of Cabletron at the time of the spin off and then chairman of Riverstone’s board to Feldman.

(Patel is not a defendant in the SEC complaint against involving Riverstone, but he is one of the defendants in a SEC civil complaint against 10 former executives formerly Cabletron’s major spin off, Enterasys Networks, involving similar allegations during the same time period. Most of the former Enterasys executives, but not Patel, either pleaded guilty to or were convicted of criminal charges of securities fraud and are awaiting sentencing,

Feldman told Pereira and Stanton that World Wide Technology would not take such an order without assurances that it could be sold through to an end-user. In other words, that it would have a right to return the product if it wasn’t sold. Feldman allegedly told this to Pereira and Stanton, and WWT put it in its order, but it was booked, via Cornmesser, without it.

The firm’s director of credit and collections, however, e-mailed all of the defendants (save Cornmesser) about the agreement. The revenue, which made WWT the company’s fifth-largest customer, was included as a done deal in the quarterly statement, putting the company in the black.

After that deal, company officials should have closely examined other such transactions, but they didn’t, the SEC charges, and they also ignored other warning signs.

At one point, that same credit director e-mailed McFarland and Kern saying, “there is a reluctance from you [the sales department] to come back to Credit with any deals made outside of normal credit terms. This is just one of the many deals of this nature.”

When Riverstone finally revealed its revenue recognition problems and subsequent SEC investigation, the stock plummeted and never recovered. Lucent Technologies picked up the company’s assets at a bankruptcy sale, leaving investors with only a fraction of the amount they paid for the company’s stock at the time of the spinoff.

According to the bankruptcy papers, some of the executives charged civilly were recently targets of a criminal grand jury investigation, but thus far no criminal charges have been filed. – BOB SANDERS