Pro-business forces confident after Supreme Court argument
[UPDATE: I originally wrote this post on October 8, but am now updating it on October 9 after attending the oral arguments in the case. The updated portions are indicated below in italics.]
On Tuesday morning the U.S. Supreme Court heard oral arguments in what has been widely described as both the most important business case of the term and the most important securities case of the decade.
Though everyone advises against making predictions based on justices’ questions at oral arguments, everyone does so anyway. For what it’s worth, it seemed to me the Court was tending in the pro-business direction by about a 5-3 margin. (Justice Stephen Breyer did not participate.)
Chief Justice John Roberts stressed that in recent years Congress has been active in defining precisely which sorts of securities fraud actions private parties – as opposed to the Securities and Exchange Commission – should be allowed to bring, and that he felt the plaintiffs were asking the Court to “expand” upon those remedies. “We did that sort of thing in 1971,” the Chief Justice said, “But we haven’t now for some time.”
The case, known as Stoneridge Investment Partners v. Scientific-Atlanta, will determine how easy or difficult it will be for plaintiffs lawyers bringing class actions for alleged securities fraud to sue third-parties in addition to the corporation that issued the stock in question. The third parties most frequently targeted are accounting firms, law firms, investment banks, and vendors who did business with the issuer.
Today, if third parties formally sign documents that are included in an issuer’s SEC filings — the way auditors do when companies file their annual reports — there is no question that they can be held liable as “primary violators” if they make false statements. But if their role is anything less direct than that, they can currently be sued, if at all, only under a controversial theory known as “scheme liability”: I.e., they are accused of having committed acts with the “purpose and effect” of furthering the issuer’s allegedly fraudulent scheme. In the Stoneridge case, the Court will either accept or reject “scheme liability” as a legitimate basis for suing third parties in private class-action suits. (The Court is not expected to rule until several weeks after the oral argument, at a minimum.)
In today’s arguments, Chief Justice Roberts and Justices Anthony Kennedy, Samuel Alito, and Antonin Scalia all asked tough questions of Stanley Grossman of Pomerantz Haudek Block Grossman & Gross, who was representing plaintiff Stoneridge, while generally letting Stephen Shapiro of Mayer Brown Rowe & Maw, who argued for the defendants, off more easily. If Justice Clarence Thomas (who, as is his custom, asked no questions) votes with the other conservatives, that would make a majority. (Deputy Solicitor General Thomas Hungar also argued for the United States, supporting the defendant.) On the steps of the courthouse afterwards, former SEC commissioner Joseph Grundfest, the co-director of Stanford University’s Rock Center on Corporate Governance, said – after stressing the usual provisos about the futility and inadvisability of making such predictions – that his count was at least 5-3, and possibly 8-0. (Grundfest had joined a friend-of-the-court brief opposing the concept of scheme liability.)At a stand-up interview being televised elsewhere on the plaza, Nina Totenberg told Stoneridge’s counsel Grossman that, after watching the argument, she couldn’t see how he could get five votes. Grossman replied, “I wasn’t counting.”
The recurring theme of the conservative justices’ questions was that they could not see a practical difference between “scheme liability” and the older, more familiar theory known as “aiding and abetting” liability, which the U.S. Supreme Court barred private plaintiffs from invoking in securities fraud cases in the 1994 case known as Central Bank v. First Interstate Bank. Even Justice David Souter asked plaintiffs counsel Grossman at one point, “are you making a distinction that in the real world is not a distinction?”
On the other hand, questions from Justices Ruth Bader Ginsburg, John Paul Stevens, and, at times, Souter, too, suggested that they might still see room for a meaningful distinction to be drawn between the two concepts.
Six of the nine justices on the Central Bank court are still sitting. Three were in the majority that disallowed the aiding and abetting theory in that case – Justices Kennedy, Scalia, and Thomas – while three were among the dissenters: Justices Ginsburg, Souter, and Stevens. Justice Kennedy, who is often now seen as the Court’s swing vote – because he is the most moderate member of the five-justice conservative faction – wrote the pro-business majority opinion in Central Bank.
More than 30 interested outside groups have submitted “friend-of-the-court” briefs. Briefs in support of the scheme liability concept have been submitted by several of the nation’s largest pension funds, attorneys general for more than 30 states, major labor unions, AARP, the Consumers Federation of America, and the trial lawyers trade group, now known as the American Association for Justice. Briefs opposing the concept have been filed by the U.S. Chamber of Commerce, the major securities exchanges, the securities industry, accounting industry, banking industry, insurance industry, law firms, and law firm insurers. The Solicitor General of the United States has weighed in on the side of the business community – i.e., opposing the scheme liability concept – though it did so over the objections of the Securities and Exchange Commission, which voted, 3-2, to support the concept. (All key briefs are available here.)
Stoneridge specifically focuses on a fraud committed in 2000 by officials of cable operator Charter Communications (CHTR). (Several Charter officials ultimately pled guilty to criminal charges in connection with these acts.) To inflate its revenue, Charter asked two of its set-top box vendors, Scientific-Atlanta (a unit of Cisco (CSCO)) and Motorola (MOT), to bill it $17 million more than previously agreed upon, and then to use that extra money to buy advertising from Charter, which Charter then improperly booked as revenue. The vendors allegedly assisted in the scheme by backdating contracts and providing phony invoices and correspondence to help Charter deceive its accountants into approving the bogus revenue recognition. Neither vendor misrepresented its own finances to its own shareholders, and Charter’s shareholders never directly saw any of the misleading documents prepared by the vendors.
In April 2006 the U.S. Court of Appeals for the Eighth Circuit (in St. Louis) rejected the scheme liability concept and dismissed Stoneridge’s case against the vendors. Two months later, the U.S. Court of Appeals for the Ninth Circuit (in San Francisco) came out the other way in a case known as Simpson v. AOL Time Warner, approving the scheme liability concept. (Time Warner (TWX) is the parent of Fortune’s publisher.)
The most famous scheme liability case is one that is not directly before the Court, but whose presence will obviously loom large at the argument. After the Enron catastrophe, class-action impresario Bill Lerach filed a scheme liability case on behalf of holders of Enron securities against more than ten banks who had allegedly engaged in dubious transactions with Enron whose only apparent purpose was to help Enron draw up misleading financial statements. Lerach has already recovered $7.3 billion in settlements in the case from such banks as Citibank (C), J.P. Morgan Chase (JPM), and CIBC (CM). But in March 2007, the U.S. Court of Appeals for the Fifth Circuit (in Houston) ruled the same way the Eighth Circuit had, rejecting “scheme liability” and tossing out the case against the banks who had not yet settled, which included Merrill Lynch (MER), Credit Suisse (CS), and Barclays (BCS). (Lerach himself is scheduled to plead guilty on October 29 to conspiring to obstruct justice by bribing plaintiffs and deceiving judges in more than 150 shareholder class actions over more than two decades.)
The Stoneridge case is in one respect a very difficult case to decide but, in another, perhaps, quite easy. The difficult part is that, however the court rules, it will make a decision that works some real injustice to someone. If it rejects scheme liability, investors who have been hurt by mammoth frauds that have led to corporate bankruptcies will be unable to seek reimbursement from deep-pocketed third-parties who really do bear some responsibility for what happened to them. On the other hand, if the Court endorses the scheme liability theory, innocent third-parties will routinely and inevitably be joined as defendants in scores of frivolous cases and — having no way to get those cases dismissed at an early, inexpensive stage (i.e., on a “motion to dismiss”) — will be induced to pay extortionate settlement payments.
The potentially easy part of the case is that it may have already been effectively decided 13 years ago. “Scheme liability” sounds an awful lot like “aiding and abetting liability” — i.e., the notion that plaintiff shareholders should be able to sue third-parties who aided and abetted the issuer’s fraud. The U.S. Supreme Court rejected that theory, however, in its 1994 ruling in Central Bank v. First Interstate Bank. Though that 5-4 ruling was controversial at the time, Congress subsequently made its peace with that ruling — twice! In 1995, it restored by statute the right of federal prosecutors and the Securities and Exchange Commission to prosecute and sue aiders and abettors, but it specifically chose not to restore that right to private plaintiffs. Simply put, Congress decided that private securities actions were so subject to abuse that the costs to society of allowing private parties to sue alleged aiders and abettors were just not worth the benefits.
Congress then made exactly the same cost-benefit determination in 2002, when it passed the Sarbanes-Oxley legislation. Again it was asked to restore the right of private plaintiffs to sue aiders and abettors of securities fraud, and again it said no. Instead, it expanded the SEC’s power to impose fines and disgorgements on aiders and abettors – i.e., forcing them to cough up their profits – and then empowered the SEC to distribute those sums to defrauded investors in partial reimbursement for their losses. (These sums are not, however, as much as private plaintiffs could recover; so far the SEC in the Enron case has recovered about $400 million for shareholders, compared to the $7.3 billion collected by Lerach.)
Obviously, the plaintiffs in Stoneridge (and Enron) claim that scheme liability is distinguishable from aiding and abetting liability; they claim that with scheme liability the third-party has to be shown to have played a slightly more active role in the fraud than had been required to establish aiding and abetting liability, although the precise definition of that magic extra oomph has varied depending on the court and the facts of the case. The defendants and their amici argue, on the other hand, that scheme liability is just a semantic ploy; it’s old wine in new bottles. For what it’s worth, to me scheme liability and aiding and abetting liability sound like one and the same thing.
In an earlier post on these issues, see here, I came down on the liberal side of this dispute, because of the unfairness of depriving shareholders of the right to sue parties who aided and abetted in the frauds that injured them. (There are very few other areas of the law where aiders and abettors are not liable to the same degree as principals.) But after reading many of the briefs from both sides in Stoneridge, I’ve changed my mind. These issues were decided in 1994, and Congress has twice consciously chosen not to overrule the part of that Court decision that barred private suits against aiders and abettors, which is what Scientific-Atlanta and Motorola really were (if anything) here. Congress decided — reasonably — that shareholder litigation is so fraught with abuse, and is such a grotesquely inefficient and ineffective way of reimbursing fraud victims, that it was wiser to leave the deterrence and punishment of aiders and abettors to the SEC and federal prosecutors.
Respondents’ (Vendors’) brief in the Supreme Court says: “The Vendors appropriately booked the sales proceeds as revenue and the advertising payments as an offset to revenue—which had no net impact on their financial statements” (page 7). The appellants (Stoneridge Investments) did not dispute that point.
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I found this discussion very interesting. And both author and commentators make some compelling points. However, I would take issue with Mr. Parloff’s suggestion that there “was no dispute” that Scientific-Atlanta and Motorola accounted for the transactions in an appropriate manner. We simply do not know one way or the other whether they did or did not. We only know that no allegations have been made against these parties with respect to how they accounted for the transactions. Has any independent accounting expert examined how Scientific-Atlanta and Motorolla accounted for and reported the transactions in question? I don’t think so. Has the SEC looked into the matter? Again, I don’t think so. Whether or not the auditors for these parties have looked into the transactions is irrelevant, as they would be unlikely to say that the transactions were improper when they have already given clean opinions regarding their financial statements. If Mr. Parloff can present specific evidence that some recognized expert looked into the transactions as reported by Scientific-Atlanta and Motorolla, then I would withdraw my conclusion. But if all Mr. Parloff can offer is that there have been no allegations regarding their financial reporting of the transactions, then I stand by my conclusion.
Ralph–
Tron should have said that the $30 million transaction and the $10 million were related transactions, because they occurred less than one month apart and were, in fact related. i don’t know the technical term, but in essence the accountants would say that the $10 million of the $30 million was a wash for that reason, and can’t be booked as revenue. (indeed, that’s what they initially did say.) the accountants aren’t deterministically bound by formalistic incantations that they know (or even suspect) are inaccurate. indeed, stoneridge sued charter’s accountants also and alleged that they had NOT been fooled by the vendors’ false statements. Scientific-Atlanta and Motorola’s accountants, on the other hand, in fact accounted for the transactions properly to their own shareholders, notwithstanding their own misleading documents. there was no dispute about that.
Roger, you claim that in my second example, i.e. the one that uses a fraudulent circular flow of funds, that Tron Corp. could still have reported the transaction as a legitimate one. But you don’t suggest how Tron might do this. What did you have in mind?
Let me see if I can help you. Tron records its purchase at $30 million instead of $20 million because it simply agrees to pay more. Okay, I guess that’s okay. If a company wants to overpay for something, they have the right to do that.
But Galaxay just signed a contract with Tron to buy $10 million of goods from Tron. If Tron now ones to record the deal correctly, it can’t book it as revenue. Can Tron record it below the line as “other income”? No, they can’t do that either.
It looks like the only thing Tron can do when it gets the $10 million from Galaxy is to reduce the purchase price on its books. But where is the support for that transaction? How could Tron reduce the purchase price to $20 million when it signed a deal with Gallaxy to buy stuff at $30 million?
Can you offer a solution to Tron’s problem of trying to go “legit”? You see, Roger, there is no reasonable, innocent explanation for what Tron and Galaxy did. And that, my friend, is scheme liability.
Ralph–
in both cases Tron is capable of reporting its finances correctly, but doesn’t; in both cases Galaxy could (disingenuously) say it did not know Galaxy was misreporting its finances. (Your hypo differs from actual facts in that you have Galaxy reporting extra revenue, too. neither Scientific Atlanta nor Motorola did.)
Stoneridge claimed the crucial extra factor here was that the vendors backdated contracts and issued false correspondence. But investors never saw those. The false statements were made to assist (i.e., aid and abet) Stoneridge in falsifying its financial statements, which is what the investors saw.
in central bank, a land authority was issuing bonds to the public. the bond covenants required the land authority to give the bank proof that the land was worth 160% of the value of the bonds. the bank noticed that the land underlying the bonds did not seem to have sufficient value and demanded that a new appraisal be done to make sure the collateral was sufficient. the land authority talked the bank into postponing the new appraisal until after the bond issue was complete. it then defaulted. if the bank had done it’s job, the bonds would never have been issued and the fraud could not have occurred. nevertheless, the court held that the bank was just an ‘aider and abetter,’ and couldn’t be sued under 10(b).
Roger, I did not mean to imply that aiding and abetting does not require knowledge that fraud is being committed, as knowledge is essential by definition. However, scheme liability requires much more. It requires collusion, conspiracy, and direct participation in the execution of the fraud. Scheme liability requires that the third party intentionally act in the execution of the fraud itself.
Let’s take a practical example germane to the case. Tron Corp is near the end of the quarter and it knows that it is not going to meet analysts’ numbers and its stock will get hammered when that news hits. Tron approaches Galaxy Inc. two weeks before the end of the quarter and says, “Look, we’ve got to make our numbers…..Give us a $10 million order, and the contract will make the goods on approval, so you can return the goods and get your money back if you do so within six months.” Galaxy agrees and signs the contract. At the end of the quarter, Tron reports the $10 million of revenue and beats the analysts’ numbers, giving the stock a boost instead of a hammer.
Now the accounting rules preclude Tron from reporting the $10 million as revenue because Galaxy could cancel the sale within 6 months if it wants to. Tron has knowingly violated the accounting rules to deceive investors and to artificially prop up the stock.
But what about Galaxy? Galaxy knew what Tron was up to. Didn’t they have knowledge that Tron was going to use the transaction so that Tron could issue fraudulent financial statements? Yes they did, and they might be said to have aided and abetted Tron. But despite what Tron told Galaxy, Tron could just as well have decided against committing fraud and correctly booked the sale as unearned revenue, rather than fraudulent (earned) revenue. Thus Galaxy could present a reasonable, innocent explanation if the contract terms come to light.
Okay, let’s change the situation. To meet its numbers Tron comes up with a different scheme. Tron already signed a contract to purchase $20 million of Galaxy’s products. Tron tells Galaxy to change the order to $30 million. That way, Galaxy will have an extra $10 million to buy Tron’s goods so Tron can meet its numbers. Galaxy agrees and creates paperwork that backdates the new $30 million contract so it looks like it was negotiated over a month earlier. At the same time, Galaxy signs a new contract to buy $10 million of goods from Tron. The deal puts Tron over the top, trumping analysts’ expectations. Galaxy also gets to report an extra $10 million in revenue.
This transaction also violates the accounting rules. But here, Galaxy has not merely aided and abetted Tron. Galaxy has colluded, conspired, and directly participated in the execution of the fraud. There is intent to make the fraud happen in a very direct and unmistakable manner. There is no reasonable, innocent explanation for Galaxy to use if the facts come to light. That’s scheme liability.
Reply to Ralph Amato:
you write, “The former would require that plaintiffs establish KNOWLEDGE and INTENT on the part of the third party colluding in the fraud. In the latter, there could be reasonable, innocent explanations for the third party’s participation.”
But that’s mistaken. Aiding and abetting DID and DOES require knowledge and intent. (aiding and abetting is unambiguously illegal and could and still can get you jail time; it just can’t, since 1994, get you sued by a private lawyer.) that’s why it’s so hard to figure out any important way in which scheme liability differs from aiding and abetting.
I have to agree with Mr. Amato’s analysis in your comments section. But I would take it a step further. People seem to forget that the Central case, which gave the green light to companies that “aid and abet fraud” was decided by the Supreme Court in 1994. The next year, Congree enacted the Private Securities Litigation Reform Act of 1995, which again put limitations on lawsuits against companies committing fraud on the market. That was green light #2 for the fraudsters. Thus, there is an ineluctible connection between these green lights and the massive frauds that immediately followed them: Enron, WorldCom, HealthSouth, and the dozens and dozens of other fraud cases.
Now, the U.S. Supreme Court appears poised to give fraud green light #3 in the current Stoneridge decision. The inevitable result of this is not difficult to predict. Not only will the Court give an unending path of green lights to commit fraud on the market, but they have effectively raised the speed limit to a dangerous level.
The next logical step is that third parties such as banks, investment banks, lawyers, and accountants will develop schemes to commit frauds on the market on a size and scale that will dwarf the Enrons, WorldComs with which we are familiar with today.
Of course, when the next wave of corporate frauds occur, and the banks, investment banks, and the lawyers which created them get off the hook easy with a few puny fines, thanks to green light #3, there will be a public outcry to make the securities laws tougher on third party corporate fraudsters. The plaintiffs bar will be saying “I told you so.” And the defendant attorneys will be saying “tougher laws can’t stop such frauds, and will impede our free market system.”
But by then, the massive damage will already have been done. Who says crime doesn’t pay?
Roger, you are completely wrong. There is a HUGE difference between scheme liability and aiding/abetting. The former would require that plaintiffs establish KNOWLEDGE and INTENT on the part of the third party colluding in the fraud. In the latter, there could be reasonable, innocent explanations for the third party’s participation.
This particular Supreme Court, in my opinion, is completely dishonest. I will not even use the the legal phrase, “intellectually dishonest,” as I don’t believe that their work merits the use of the adverb “intellectually.” The Stoneridge case is really about what the Securities & Exchange Commission rules say. And you don’t have to be a legal scholar to appreciate what Rule 10b-5 says. However, you do have to understand the English language. And with respect to Stoneridge and the Enron case, it effectively says:
It shall be unlawful for any person, directly or indirectly to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security.
Note that Rule 10b-5 refers to “any person,” which would include third parties, and not just the issuers. Rule 10b-5 also does not require that the third party in the deception make a PUBLIC statement to deceive investors in the issuer’s stock, nor does it require that the public RELY specifically on what the third party has done. However, it DOES require that the person (third party) engage in a course of business that would operate as a fraud or deceit upon the purchasers of the issuer’s stock. And that is exactly what happened in the Stoneridge and Enron cases. Had Congress intended the rule to exclude third parties, they would have specifically referred to deception by the “issuer,” using that term. Their use of general terms provides for inclusion of third parties.
Nonetheless, in the oral arguments, the Supreme Court has totally ignored Rule 10b-5 and, in fact, they don’t even refer to it, although the interpretation of this law is what they are supposed to be deciding about. They behave like banal, pedestrian politicians, but without the style or rhetoric of such politicians.
The “correct” decision would be to rule that third parties can indeed be held liable in fraud cases, but the burden is on the plaintiffs to establish that those third parties acted with scienter in the fraud. That is an extremely HEAVY burden to satisfy and would clearly curb any potential “abuses” by plaintiffs seeking to recover for their damages. If there are reasonable, innocent explanations for the third party’s involvement in the primary party’s fraud, then we are talking about aiding and abetting, and the third party’s transgression would not rise to the level of scheme liability. HOWEVER, in the case of Stoneridge (i.e. Charter Communications) and Enron, there is absolutely no question whatsover, that the SOLE purpose of the transactions in question was to enable the primary party to commit fraud. It’s as though a person sold guns to the primary party, showed them the procedure about how to rob the bank, and then after they executed the bank robbery, drove them away in the getaway car. According to this Supreme Court, such a person has “merely” aided and abetted the crime, and therefore should not be held liable. In reality, of course, such a person was not merely an “aider,” but played a critical role in helping the primary party to commit the crime, and, in fact, the crime could not have been commited without their active participation, direct involvement and knowledge, collusion, and intent. That was the role of the vendors in the Charter case and the banks in the the Enron case.
But let’s face facts. This Supreme Court is not interested in correctly interpreting the law. It serves to protect the big business interests, particularly in cases like these where the public might recover damages for the deceptions perpetrated by the same interests.
I rest my case……………………
I feel for the people who really lose in these situations (see Enron and 99% of workforce). However, if there was a ruling for the plaintiffs, what is to stop them from suing anyone who has any sort of business connection to that company? If you sue your tax firm for fraud, are you also going to sue the private company that handled their waste? Allowing you to sue one third company will allow you to sue all third companies. I would like this to see this done on a case by case basis. For example, if we examine the corporate ties between Scientific Atlanta and Charter we find some interesting connections http://www.newsvisual.com/newsvisual/2007/10/scientific-atla.html that could have possibly played a role in this. Some further investigation and if we find that it was deliberate fraud, then yes you can sue the third company. Unfortunately, this is not legally possible, but it is the only fair thing to do in my opinion.
greatest respect for your writings. But you are right on this one as to the conclusions, but for the wrong reasons. Take a look at Ultramares v. Touche. The vendor (third party here) did nothing wrong. They did not lie to their shareholders and THEY BOUGHT ADVERTISING. They did not falsify one document.
Contrast this with Enron where the banks and the accountants dreamed up a scheme to lend without the loan showing up on the balance sheet. They participated in a scheme who’s main purpose was to hurt the stockholders of Enron.
I could go on and on about how Harvey Pitt, the general counsel for the AICPA and chairman of the SEC cooked up Sarbanes Ox to AVOID liability for the Certified PUBLIC Accountants and how Glass Stegall was eviscerated so that the banks could use brokerage companies to defraud the public, but this is not the place.
I say this with the requisite legal background to know of which I speak.
The issue is not a schema or other “conspiracy” type theory. The issue is stock manipulation. Period.
Keep up the very good work.
Always a fan.
Duke.
It certainly would be nice if this new court will actually ever do the right thing versus the easy thing. First Abortion rights, then enabling this obviously corrupt and inept administration from being held accountable for their missteps… Now put the big finger up at all the folks that got hosed by scams which they could not possibly have insight into…
The 8/9 Oct 2007 Legal Pad just shows how the legal system has been structured to protect the wealthy and powerful. The law should allow, no require, that every corporate officer at Charter Communications, Scientific-Atlanta, and Motorola who was involved should be tried for fraud and if convicted, should be held jointly and individually responsible for all investor losses to the full extent of their personal wealth. Put a few of these thieves in jail and take every penny they have in restitution and we will see a lot less criminal activiy in the executive suite!
Get used to the future. Just give your bank accounts to the Corporations and get it over with, whatever the gov. doesn’t steal from you in unnecessary taxes, will be stolen from you in your investments.
Don’t invest in American Corporations, you will lose. Invest your money in other foreign markets. Screw the U.S. let these idiots policies destroy it sooner than later so the rebuilding can begin.
“Though that 5-4 [Central Bank] ruling was controversial at the time, Congress subsequently made its peace with that ruling — twice!”
Moreover, Congress since then also has significantly limited the reach of RICO to securities actions. “Scheme liability” sounds like a backdoor attempt to impose RICO liability concepts onto the federal securities laws which has been squarely rejected.
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This blog is about legal issues that matter to business people, and it's geared for nonlawyers and lawyers alike. Roger Parloff is Fortune magazine's senior editor (legal affairs). He practiced law for five years in Manhattan before becoming a full-time journalist.
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My conclusion stands. There is no way to know whether or not Scientific-Atlanta and Motorola booked the transactions in accordance with GAAP because there has been no reference to independent forensic accounting experts that have looked at the respondents’ respective accounting treatments. The fact that Stoneridge did not say that Scientific-Atlanta and Motorola accounted for transactions improperly does not mean that they were booked properly. Although you might presume that somewhere during discovery, this matter would have been investigated, we have no way of knowing whether or nor such a forensic examination took place.
In fact, it appears more likely that there was not such an investigation. The vendors’ claims are suspicious on the face of it. Using the excellent examples provided by Mr. Adamo, it does look like there is a problem with the respondents’ accounting. If, for example, Motorola originally agreed to sell goods for $20 million, but as part of the mutual round tripping scheme backdated the documents to artifically boost the deal the sale to Charter to $30 million just so Charter could make a phony sale to Motorola for the difference, or $10 million, all of the $30 million proceeds that Motorola received cannot be booked as revenue according to generally accepted accounting principles. Yet, that is exactly what the vendors say that they did in Mr. Parloff’s excerpt. And, continuing with this example, the fact that Motorola recorded the $10 million payment to Charter as an offsetting cost on Motorola’s books–making the transaction neutral from a net income standpoint–does not at all mean that the transaction was appropriately recorded. Using the vendors’ own statements, on the fact of it, they violated GAAP because they recorded ALL of the proceeds–including the funds that were used for the fraudulent round tripping scheme–as revenue on their books.
Given these facts, there SHOULD have been an investigation into Scientific-Atlanta’s and Motorola’s accounting for these transactions.