Unethical, Immoral, And Unconscionable

San Diego — 'The hogs are at the trough." On February 17, 2000, David Farley, chief financial officer of Peregrine Systems, e-mailed those words to the company's attorney, Richard T. Nelson. Farley (now deceased) was perturbed that company insiders were dumping shares during a period in which they had been instructed not to do so.

But bail out they did. Between February 15 and February 18, 2000, Peregrine's then-chairman John Moores and four other officials dumped a staggering $194 million worth of Peregrine stock. Moores, who sold $177 million of the stock, eventually dumped $487 million worth while the books were being cooked; he sold well over $600 million -- almost all he controlled -- during the course of the company's tainted history. In early 2000, the insiders got out before announcement of an acquisition sent the shares on a downward spiral, as several in the company had feared.

New information from Peregrine's own records now makes it clear that Padres majority owner Moores and his fellow Peregrine boardmembers and officers were repeatedly told that the company was in deep trouble at the very time it was boasting of amazing success. Moores and other boardmembers approved press releases and signed official financial reports presenting information they knew -- or were reckless in not knowing -- was false, according to this new information detailed in investor lawsuits.

Moreover, Moores and his board colleagues had been informed that the company's accounting was highly suspect. Eventually, fraudulent accounting was the cancer that led to the company's collapse and bankruptcy. To date, three former executives have pleaded guilty to criminal charges. After the crash, the company admitted that sales had been overstated by a staggering 38 percent. Peregrine didn't just count chickens before they were hatched; it counted chickens before it had a fecund hen.

The Department of Justice and the Securities and Exchange Commission are still probing the fraud. As an outgrowth of Peregrine's bankruptcy, two groups of plaintiffs got access to documents that the company had submitted to the two federal agencies as well as a congressional committee.

One of those cases is in U.S. district court. The other suit was filed in superior court by the litigation trustee appointed by the bankruptcy court. That second suit was moved to federal court, but the litigation trustee, Robert C. Friese of San Francisco, wants it back in state court.

The lead lawyer on the first suit is Solomon B. Cera of San Francisco. On November 21 of last year, U.S. district court judge Napoleon A. Jones Jr. threw out most of the fraud charges but left room for the suit to be amended. The second time around, Cera and his fellow attorneys had Peregrine records at their disposal. "Before, we were painting on a blank slate. We did not have these records, which are critically important," says Cera. Friese also has the records.

But Peregrine managed to cover many of its tracks. It purchased software to make e-mail messages self-destruct. Minutes of board meetings were doctored or "cleansed of potentially damaging information," says the federal suit. "The formally approved minutes are bare bones and uniformly unenlightening as to what transpired at board meetings." Moores and his close associate and then-boardmember Charles E. Noell III communicated by wireless handheld devices that were "essentially impossible to trace or reproduce," although such security devices are common, insists John Quinn, Moores's lawyer.

"Peregrine represents one of the most egregious financial frauds ever committed," says the federal suit filed by Cera, noting that both senior management and all directors "were complicit in the company's accounting fraud." Both suits stress how insiders were unloading their shares massively, while knowing -- as internal documents reveal -- that the company was ailing, and its accounting was extremely questionable.

As both suits emphasize, the Peregrine board was told of the company's relentless woes through quarterly "review and outlook" reports from Stephen P. Gardner, former chief executive. In various reports, Gardner lamented that quarters were "tough," sales productivity was abysmal, North American business was a "disaster," and because of suspected management inadequacy, a crisis lurked.

Peregrine's auditor was the infamous Arthur Andersen, which later was effectively closed down by the federal government after helping to cook the books for Waste Management, Sunbeam, Enron, Qwest, and WorldCom, among others. Andersen, notorious for its lax standards, put Peregrine on the list of its 20 riskiest clients. Gardner warned the board that Andersen was "uncomfortable" with Peregrine's accounting.

Why was Andersen uncomfortable? In April of 1999, the company held a meeting at La Costa, attended by Moores and other directors. Farley told the board that, to meet Wall Street's expectations, the company was adopting the sell-in method of accounting, although it was not the "preferred" method. Peregrine would ring up a sale when it delivered software to a distributor -- even if the distributor had no commitment to sell the product to an end user. But shareholders and the public didn't know about this extremely dubious sell-in method.

Andersen said it would be uncomfortable if more than 25 percent of sales were to distributors, not end users. The figure hit 52 percent and normally floated close to 40 percent. Later, Andersen suggested the sell-in method be changed. Also, Peregrine management and boardmembers, including Moores, were warned that company accounting violated generally accepted accounting principles. Quinn, however, ripostes that Andersen approved quarterly statements.

In violation of sound-management precepts, the audit committee did not keep minutes (or said it didn't), and that was one factor that "permitted the pervasive accounting fraud to go forward," says the Cera suit.

Gardner warned the board that "a large amount of inventory" was piling up at distributors and had to be sold, particularly since direct sales to end users were at "a very low level." Indeed, one quarter he lamented that the "bread-and-butter business went to hell," and the productivity of salespeople selling directly to end users was "at a ridiculously low level."

Such red flags of phony accounting abounded. Gardner told the board that the company was "borrowing from the future to make the present happen" and granting "extraordinary terms" to buyers so the company could please Wall Street with supposedly billowing sales. Later, it turned out the company was keeping the books open long after quarters closed and even bribing a distributor with a sack of money to commit to buying software.

In October of 2001, a sales executive sent a stinging e-mail to Gardner, saying the company was booking revenue from noncontracts. "Where's the commercial substance to these so-called 'contracts?' " he demanded to know. Gardner passed the memo to Moores, who gave a curious, disjointed response: "I can't figure out why [sic] the hell is complaining about." It was deliberately reckless conduct, according to the suit, but Quinn says the statement shows Moores did not understand what was going on. The whistle-blower was fired and then e-mailed Moores and others, saying that the booking of phantom sales was "unethical, immoral, and unconscionable."

At the same time, Moores knew the company was critically short of cash, according to the Cera suit, and even remarked, "We're the largest company in the world that lives hand-to-mouth."

But both suits emphasize that the company did not publicly disclose such accounting irregularities and financial woes, and insiders went on merrily dumping their shares. Quinn, however, says the charges won't stick, partly because the plaintiffs are "selectively quoting" from the Gardner reports.

The defense claims that Moores was an outside director. But Peregrine records show that an office of the chairman, including Moores, called corporate signals, and one of the company's own presentations identified Moores as a member of the senior management team. Moores absolutely controlled the company, says the federal suit -- a charge denied by Quinn.

When Judge Jones rejected most of the charges in the federal suit last November, he wanted more specificity and claimed the evidence did not show conclusively that the defendants knew that revenue was improperly recognized. I have read 400 pages of these complaints, and I can't see how any judge could reach either of those conclusions this time around. A jury must pass judgment on these very detailed charges. Says Cera, "There is a very, very stringent standard, and our complaint is now sufficient to meet it."