‘To sell’ parsed at Enterasys trial
What does “primary responsibilities to sell” mean?
A chunk of the government’s case against some of the five former Enterasys Networks executives charged with securities fraud during the company’s 2001 spinoff from Cabletron Systems could hinge on the answer.
It was the question raised Thursday by William Cintolo, an attorney for David Boey — a defendant and former sales head of Enterasys’ Asia Pacific division — to James Boyer, a partner of KPMG, the auditor that the conspiring defendants allegedly lied to in order to inflate the company’s revenue.
Boyer, testifying in U.S. District Court in Concord, said that the then Rochester-based Enterasys improperly reported some $11 million in revenue that quarter, enabling it to meet Wall Street expectations of $240 million for the crucial quarter that ended Sept. 1, 2001, less than a month after the company went public.
KPMG approved those figures, Boyer said, because “we were looking at it incorrectly because we didn’t have all the facts.”
The first crucial new fact that came to Boyer’s attention was on Jan. 31, 2002: two versions of a $3.9 million contract between Enterasys and Ariel International, a distributor in the Asia Pacific region. One contract, signed Aug. 31, had two terms that were problematic in recognizing the revenue, he said. In the other version, negotiated after the quarter ended, but also dated Aug. 31, the language was removed — only to be included later in a secret side letter.
Earlier testimony and evidence indicates that defendant Bruce Kay, Enterasys’ former vice president of finance, ordered the deal be renegotiated and that it was Boey who made the actual changes at the bequest of his superior, Gary Workman, president of Enterasys’ Asia Pacific region, who signed the contract. Workman has pleaded guilty to one count of wire fraud.
After a “quick read,” Boyer became concerned not only about the impact on revenue recognition, but that there was “something fundamentally wrong” that could include an attempt to keep information from auditors. It was such a serious matter that he recommended an immediate meeting with the audit committee of Enterasys’ board of directors, headed Cabletron co-founder Craig Benson, who later went on to serve a term as the state’s governor.
Boyer was not asked what Benson – who has not been implicated in the conspiracy in any way – said at the meeting the following day, but the result was an intensified audit during which other dubious transactions came to light. Four of them are included in the indictment against the defendants.
Boyer focused on what he said was the “key” clause in the Ariel contract that was removed and then put in back in the side letter: “Enterasys will have the primary responsibilities for selling these products.”
The clause originally came after Enterasys would sell $4 million of the products to Ariel.
“That doesn’t make sense,” said Boyer. “You sell something once and that’s it. How can you sell it a second time?”
The conclusion, said Boyer, is that if Enterasys was still responsible to sell the products, as indicated in the side letter, it wasn’t a sale at all.
Despite this, several executives – including defendant Robert Gagalis, chief financial officer at the time – signed a management letter with the quarterly filing with the Securities and Exchange Commission that said that there were “no side agreements with customers, or other terms in effect, which allow for the returns of merchandise.”
But Cintolo, representing Boey, challenged Boyer’s interpretation of the word “sell.” Sell, he said has two meanings. That’s how, he offered in questioning Boyer, it was possible to sell the product twice. Enterasys sells, or transfers ownership, to Ariel, but it remains the responsibility of Enterasys to sell, or market, it.
Looking at it this way, he asked Boyer, “Does that phrase create a right of return?”
“I’m not sure,” said Boyer.
Because of the confusion in the language, augmented by the fact that the agreement was negotiated in Chinese, the parties removed the offending terms from the main agreement to placate the auditors. Such a change, argued Cintolo, is a clarification, and that’s “not a bad thing, if it helps two parties understand” the original “meeting of the minds” in hammering out the agreement.
Judge Paul Barbadoro was so intrigued by this line of defense that he said he would considering it when ruling on Cintolo’s expected motion to dismiss the case against Boey. But, he asked the attorney when the jury was out of the room, “if it were just a clarification, why would they put in a side agreement?” – BOB SANDERS