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HP's $5 Billion Fraud Lawsuit Against Former Autonomy Executives Is Now Public

Allegations of "contrived transactions," some rewarded with a Porsche.

Re/code

A British court today disclosed documents in the $5 billion accounting fraud lawsuit brought by computing giant Hewlett-Packard against the former executives of Autonomy, the British software firm it acquired in 2011.

In the complaint, released today by the U.K.’s High Court of London, HP accuses Mike Lynch, Autonomy’s former CEO, and Sushovan Hussain, its former CFO, of engaging in “improper transactions and accounting practices that artificially inflated and accelerated Autonomy’s reported revenues, understated its costs of goods sold,” and had the effect of making Autonomy appear to be more profitable and growing faster than it actually was.

“The reality was that the group was experiencing little or no growth, it was losing market share, and its true financial performance consistently fell far short of market expectations,” HP said in a statement.

Lynch and Hussain, in statements made on their website Autonomy Accounts, denied any wrongdoing.

HP’s complaint is laid out in a 134-page document filed last month. Included in the allegations are details concerning what HP describes as “pure hardware sales” of computers between Autonomy and its customers that amounted to about 11 percent of Autonomy’s revenue during a period spanning mid-2009 to mid-2011.

HP says that during a 2009 executive off-site meeting, Lynch and Hussain asked the executive responsible for hardware sales, identified as Michael Sullivan, to sell $10 million worth of hardware that quarter. “Lynch told Sullivan that if he achieved this goal Lynch would buy him a Porsche,” HP’s complaint says.

In these hardware deals, no Autonomy software was installed on the computers, but the sales were accounted for as software. Autonomy lost money on the deals, HP says, but didn’t disclose the losses in financial reports. “This nondisclosure contributed significantly to the false appearance of a rapidly growing software business,” HP’s complaint reads. “The fact that these substantial pure hardware sales were consistently made at a significant loss was also concealed in Autonomy’s published information. [Cost of Goods Sold] was artificially reduced, thereby inflating Autonomy’s reported gross margins.”

HP also alleged that Autonomy engaged in numerous instances of what it calls “contrived transactions” that were devised in order to book revenue improperly or were entirely fabricated. In some cases, HP says, Autonomy used third parties known as Value Added Resellers or VARs to “fabricate or accelerate” sales that were reported as revenue by Autonomy.

In one case that has been previously described, a VAR company agreed to accept an Autonomy software license for which it wouldn’t have to pay, on behalf of a prospective customer to which Autonomy had tried and failed to sell to directly.

Details of one such 2009 transaction were disclosed last year. Autonomy had failed to close a deal with investment bank Morgan Stanley before the end of the fiscal quarter. It went on to book $4.8 million in sales of hardware to a U.S.-based reseller, MicroTech, with Morgan Stanley as the intended end customer.

In this instance no money changed hands, but as HP puts it, “the arrangement was purely a pretext for the recognition of revenue,” which showed up on Autonomy’s financial statements for that quarter. “No revenue should ever have been recognized or reported at any time, because neither the VAR nor the Autonomy group company ever sold a license to the end-user,” HP’s complaint says. VARs who participated in these arrangements were sometimes paid “marketing assistance fees” by Autonomy, HP says.

In a post on their blog devoted to the case, Lynch and Hussain disputed the allegations: “HP has waged a three-year smear campaign riddled with half-truths and obfuscation. They have intentionally made the claims as complex and convoluted as possible,” they wrote. They say that during the years they ran Autonomy, their practices were in full compliance with the laws of the U.K. and with the accepted accounting standards in that country.

“[I]t should not be surprising that there is not one shred of actual evidence establishing any pre-acquisition misconduct by anyone at Autonomy, let alone evidence of fraud,” Lynch’s lawyer Christopher Morvillo writes in a 42-page letter responding to the complaint. “There are no documents or witnesses — and HP has pointed to none — that demonstrate that any former member of Autonomy’s management acted with anything but honest intentions, [and] good faith.”

Regarding the Microtech transactions, Morvillo said that Autonomy’s auditor, Deloitte, was aware of some of the practices described by HP and “carefully tracked reseller sales across quarters and clearly understood the fate of these deals.” It goes on to describe arrangements like the one with Microtech as “unremarkable commercial tactics” that “did not affect a reseller’s obligation to pay or the propriety of Autonomy’s recognition of revenue.”

Much will depend on how these accounting differences between the U.S. and the U.K. are interpreted and applied in court. U.S. companies follow an accounting system known as Generally Accepted Accounting Practices, while U.K. companies adhere to a system known as International Financial Reporting Standards. The difference between them is important because GAAP rules establish clear practices for how revenue for software sales can be recognized, while IFRS rules treat software differently. Lynch has previously argued that at least some of HP’s allegations can be explained by the differences in accounting standards.

HP acquired Autonomy in 2011, paying more than $10 billion. The transaction was one of several missteps by former CEO Léo Apotheker, who was later fired by HP’s board of directors after only 11 months on the job. In 2012 HP essentially admitted that Apotheker had overpaid for Autonomy and recorded an $8.8 billion writedown, of which more than $5 billion was attributed to a reduction in the value of Autonomy. The company took a lot of flak from critics for the deal, who said the problems with Autonomy’s accounting practices should have been detected before the deal was approved.

The case is also a pending criminal matter. While the U.K.’s Serious Fraud Office closed its investigation in January without bringing charges, it also ceded its jurisdiction in the matter to the U.S. Department of Justice, which is still actively investigating.

So here for your reading enjoyment is the full 134-page complaint, followed by the response to it by Lynch’s lawyers.

Particulars of Claim HP Vs Lynch et al.

And here’s the 42-page response from Lynch’s legal team.

Clifford Chance Letter in Response to HP’s Claim 050515sig

This article originally appeared on Recode.net.

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