San Diego After pleading guilty to conspiracy, fraud, and obstruction of justice in the Peregrine Systems swindle -- the biggest and most blatant in San Diego history -- former chief executive Stephen Gardner last month got on the stand to confess his sins. He may have to own up to even more transgressions. He claimed that he had given the same false information to the board of directors that he had given to the public.
That is simply not so. Between 1999 and 2001, Peregrine falsely inflated its revenue by 40 percent. Throughout that entire period, Gardner told the public that the company was doing wonderfully. But during that fraud period, Gardner was telling the board that Peregrine was doing poorly and, worse, breaking the rules: the auditors were unhappy with the phony accounting, regulators were cracking down and the company couldn't get away with past shenanigans, and the software firm was borrowing from the future to meet Wall Street's quarterly expectations, among many putrid things.
Various civil suits, using official company records, outline in detail how the board was informed by Gardner, by the company's accounting firm, and by others that the books were being cooked. The board members as well as the top executives massively unloaded their stock to public investors who, until the very end, were blissfully unaware of the rot that was being covered up by fraudulent accounting. John Moores, longtime chairman, unloaded almost $500 million worth of stock during the fraud period and $650 million while Peregrine was a public company.
There is a criminal trial of four ex-executives going on right now, and some other former executives will go on trial later. Defense lawyers in the current trial, along with plaintiff lawyers in civil suits against former Peregrine officials, rightly suspect that the U.S. Attorney's Office based much of its case upon a self-serving study that Moores's personal lawyer, Charles La Bella, hired law firm Latham & Watkins to concoct. The idea was to try to save Moores's hide in 2002, after the scandal had broken and the company had plunged into bankruptcy.
At a hearing in February in the ongoing criminal case, one of Gardner's attorneys, Reid Figel, said, "One of the issues that has not really been discussed much in the motions, generally, is the involvement of Mr. Moores and his counsel in the government's investigation.... We would want to make sure that we were permitted to inquire as to whether government agents have attempted to prepare the case, and to make charging decisions, and make inferences and things like that consistent with what we believe happened here, which is that John Moores, who is the person who sold nearly $700 million worth of stock and whose personal counsel [La Bella] was involved in representing Peregrine in the internal investigation, had an influence in the way this case was brought and the way the witnesses have been prepared."
In a column that appeared in the Reader March 22, Eugene Iredale, attorney for one of the criminal defendants, said that the government's case was based on the Latham & Watkins attempted whitewash. Matthew Gless, former Peregrine chief financial officer who has pleaded guilty in the case, even said the report was an attempt to get the board off the hook. Gless, like most board members and top executives, was close to Moores.
In the early stages of the case, Iredale did what he said he would do: he began asking witnesses about Moores's involvement. (Moores was on the Peregrine premises; the company boasted that it was run by the "office of the chairman" -- Moores and colleagues. Civil suits charge that Moores essentially ran the company.)
On April 19, the U.S. Attorney's Office requested that the court ban any cross-examination of witnesses on "investment decisions and actions taken by members of the Board of Directors, and specifically John Moores, without first making an offer of proof of how much evidence is inconsistent with the guilt of the defendant." The government argued that Iredale in his opening statement "referred to John Moores and other members of the board of directors several times." Then Iredale asked the first witness about Moores. The government complained about Iredale's "references to John Moores in the press" and attached the Reader article to its complaint. U.S. District Court Judge Thomas Whelan granted the government's request.
Iredale did not return multiple telephone calls to inquire about the matter.
Robert Grimes, local criminal defense attorney, has published a regular blog on the case, accessible at www.grimesandwarwick.com. Five witnesses were barred from testifying after it was learned they had looked at the blog. One was Gless. One of the jurors, who seemed most receptive to the defense case, was dropped because he had allegedly read the blog.
The blog did not report anything on the judge's decision to bar discussion of board actions and Moores during cross-examinations. I called and e-mailed Grimes for an explanation but got no response. Grimes has admitted he is being paid by a law firm involved in the civil litigation but won't say which one it is.
What, then, was the board told throughout the Peregrine hoax? On April 14, 1999, it was informed that the company was adopting a hyperaggressive accounting method by which a sale would be rung up when software was sold to a reseller, even if that reseller had no commitment from a buyer. Legitimately, a sale should only be recorded when the product is actually purchased by an end user. But the board was told it had to use the unchaste method if it wanted to match Wall Street quarterly sales expectations. On January 18 of 2000, Gardner told the board that the amount of such reseller transactions -- instead of actual sales -- "makes our auditors uncomfortable."
At the same meeting, Gardner told the board, "Due to several highly publicized incidents at other companies (Informix, Network Associates, HBOC), the rules are tightening and practices are being re-examined." All three of those companies had gotten into trouble with the Securities and Exchange Commission for doing what Peregrine got caught doing: making side agreements and secret payments to distributors and backdating contracts to be able to record fictitious sales. Could anything have been clearer to the Peregrine board, especially since its members were sophisticated in software accounting?
In October of 2001, a Peregrine salesman sent an e-mail to Gardner and Moores, complaining that there was "no justification to book revenue when no product has been ordered" and "there is little likelihood of payment." Peregrine's revenue recognition policy was "unethical, immoral, and unconscionable," he complained. The salesman was fired.
Gardner told the board that the company had to grant "extraordinary terms" to record sales in a previous quarter, thus was "borrowing from the future" to match Wall Street's expectations. And no one on the board suspected that the company was backdating contracts and making side deals to record revenue fraudulently? Come now. The board's audit committee was repeatedly told about suspicious deals to hype sales, as well as the accounting firm's ongoing unhappiness.
But the public only heard how the company was growing fantastically -- until the end, and by then, the insiders had dumped shares massively.
All this evidence should make a slam dunk in civil suits. Not in San Diego. Judges can keep such cases from ever getting to the jury. Superior Court Judge Joan Lewis in 2005 ruled that one suit against Peregrine insiders had to be heard in fraud-friendly Delaware. That was overturned by the appellate court; then Lewis lost all the way to the U.S. Supreme Court. Just recently, she found another pretext to throw out the case: ignoring decades of bankruptcy court precedents, she decided that state courts couldn't hear cases with more than 50 shareholders seeking redress. "We believe the ruling is in error," says San Francisco attorney Robert Friese, who was appointed to press the case by the bankruptcy court. "We are hopeful the appellate court will give us the kind of ruling it did last time."
Another egregious case is in U.S. District Court. Judge Roger Benitez gutted it, despite the overwhelming evidence. That is on appeal, too.