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Computer Associates, INC Fraud – An Analysis

Introduction

Computer Associates International, Inc (CAII) is one of the globe’s largest providers of information technology management software. CAII specialty is that they are in the manufacture, market, develop, license software end products that permit their clients to administer systems, maintain security, and manage networks, applications, and storage of databases both dynamically and securely. CAII’s core aim is to assist individuals and companies to seize the full advantages of IT to increase their business by simplifying and unifying the management of their systems.

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Customer base of CAII includes almost 100% of the world’s top 1000 fortune companies, educational institutions, government agencies and plentiful companies that operate in the U.S.A and other parts of the world. CAII was established in 1976 and is having operations in more than 45 nations around the world and is a global leader in its line of business.

CAII has listed in the New York stock exchange and its market capitalization is around $8.58 billion as of March 18, 2009. After the infamous accounting scandal, the name of the company has been changed to CA, Inc in February 2006 from CAII. (Yahoo Finance 2009)

CA, Inc assists corporate around the world to administer IT to innovate, compete, control and manage their business. CA’s EITM (Enterprise IT Management) technology and vision assists its clients to amalgamate IT and simplify the administration of intricate computing atmosphere, whether marketed or supplied as mainframe, across the company. CA’s software assists the customers to control risk and costs, enhancing their services and making sure that IT is backing the business. The specialized software package of CA i.e. EITM facilitates the companies to efficiently administer, secure and manage the services. CA assists companies to make decisions by offering them a unique perspective on their IT risks and investments. CA also makes sure that its customers have secure access to the services and information they require to administer their business. (Yahoo Finance 2009)

In September 2004, Computer Associates International, Inc (CAII) was indicted with fraud charges by the Security Exchange Commission (SEC) of the USA. According to SEC , from the year 1998 to 2000 , Computer Associates Inc perused the accounting tactics of recording revenue from the contracts entered after the lapse of that quarter mainly to stand up to the expectations of quarterly estimates of Wall Street. (SEC 2004).

This research analyses the great CAII’s accounting scandal in the annals of the USA in detail. It also analyses the modus operandi of the scandal, the investigation and how finally CAII came out from the black mark and restructured its business and turned it be a profit making business as of date.

Analysis

SEC alleged that in the financial year 2000 and 2001, CAII untimely recognized revenue of $2.2 billion and in the previous quarters, it prematurely accounted for about $1.1 billion. Further, SEC alleged that its former CEO and Chairman and two other top executives prevented SEC from carrying on the investigation into the fraudulent accounting practices of the company.

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The following were the main charges against CAII.

  • CAII had disregarded its financial reporting commitments and obligation under “generally accepted accounting principles” (GAPP) by manipulating its quarter ending financial results cutoff to match with market anticipations.
  • SEC alleged that between January 1998 and September 2000, CAII precipitately recognized more than $ 3.3 billion in revenue from more than 365 software contracts which in actual parlance was not executed by CAII during the relevant period which was in contravention of GAAP.
  • SEC alleged that CAII kept the books of accounts open for many days after the closure of each financial quarter to report revenues from the contracts that were realized at a future date. For instance, in all the quarters of FY2000, CAII had inflated its revenue by 28% on an average basis thereby including untimely reported revenues belonging to financial quarters of FY 2001.
  • In the year 2001, CAII ceased its practice of accounting revenue prior hand, CAII was unable to match its earnings estimates and as the result, its stock price dramatically declined over 45% in a single day (SEC 2004).
  • According to US Attorney Office, the defendants unleashed a giant accounting fraud that cost gullible investors billions of dollars if company became red due to it (Anonymous 2004).

How was the fraud committed?

Three top executives of CAII namely Sanjay Kumar who was its erstwhile CEO and Chairman, Stephenson Richards, erstwhile head of sales and Steven Woghin, erstwhile General Counsel of the company were major master brain behind this accounting fraud.

Sanjay Kumar managed and carried out the accounting of prior period revenues in the current quarter results with a sole aim to boost profits so that it would match estimates projected and filed with Wall Street mainly to defraud gullible investors. He obtained backdated contracts mainly to use the same for unacceptable revenue recognition in the accounting books of CAII.

Richards, being the sales head, directed and permitted his employees to pressurize and obtain sales contracts after the completion of the quarter ending wittingly ignoring the fact that the company would inappropriately inflate the revenue from those unfinished contracts. He designed the fraud in such a way that his sales personnel obtained contracts with earlier dated signatures after the completion of the relevant financial quarter.

Woghin as the General Counsel of the company ordered to approve the earlier dated contracts to the legal department of the company knowing the fact that contracts so obtained included misleading and false signature dates and thus revenue of the company would be artificially inflated by indulging in such activities. Woghin was latter dismissed from the role of General Counsel of the company. (Long Island Business News, 2004).

It was alleged that the CFO of the company just after the fiscal quarter end appraised contracts for revenue recording purposes manually and then listed out contracts by handwritten which had to be accounted for the purpose of revenue reorganization. (SEC 2004).

Pressures / Incentives

In CAII, under the leadership of erstwhile CEO Kumar, there was a complete breakdown of leadership. Thus, the top leadership fostered a “mania of fear” and threw the written policies and procedures in the dust bin. There was a “choice for elevating from within” the company and the outcome was the existence of an executive team that was immatured, too infantile, beginners and more reliant on top most executives for instructions. (Biegelman, 2008:2).

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The incentive for Sanjay Kumar to commit this kind of fraud was that he was paid in 1998 a stock bonus amounting to $331 million and this had been considered as the grand one-time payment ever made to a corporate executive in the annals of US history. (Berenson A 2004a).

It is to be observed that revenue will be the single largest thing in financial statements and revenue recognition has been considered to be a major head-ache for not only accountants and but also for standard-framers. Sanjay Kumar was actually a key architect in software designing and he was the main backbone for the CA’s business. Having not known the ramification of improper revenue recognition, he indulged in proponing certain sales contracts to the current quarter. (Jeffery 2004).

In addition to the above, there were many organizational disadvantages. CAII had a parallel organization structure where frank and open communications between various departments of the company were not encouraged. Middle managers of CAII were overshadowed by the senior leaders since they kept all decision making powers with them and there was no delegation of authorities to the lower levels. Communications through meetings between the top and middle managers were virtually absent. (Biegelman 2008:104).

Though, CAII is having a code of conduct in force, no training was imparted to any of its employees about its significance. In the absence of written procedures and policies in practice, employees were under compulsion to know about accounting and other significant policies merely through “word-of-mouth” only. (Biegelman 2008:95).

Though, CAII had an internal audit department, but it remained only as a mouth piece of management. It was structured in an unsystematic style, not adequately staffed and incompetent to carry out critical audits. Further, the head of the internal audit department or the CFO of the company was not a CPA. (Certified Public Accountant). (Biegelman 2008:264). Further, CFO of CA Ira H.Zar for his role in the scam was to be awarded 20 years imprisonment and since he had opted to cooperate with a government investigation, he may be awarded lesser punishment (Berenson A 2004b).

When the accounting fraud was made public, the top executives who were sided with the then management with out knowing what is happening started to plead guilty for their criminal actions. The utmost joke was that the Board of Directors declared that they were unaware of these fraudulent accounting practices in their company. One of the main reasons for occurrence of such accounting fraud in CAII is the non-existence of a compliance department.

The positive reforms that CA subsequently undertook offer learning points and best practices for other corporate around the world. (Biegelman 2008:.87).

Opportunities

Learning from mistakes is not only the unique characteristic of man kind alone but also is applicable to corporate now. Usually, an individual or an organization encounters a second opportunity to right an unpleasant wrong. However, resurrection and reincarnation can happen, even from the rubbles of corporate scandal and fraud. Though CAII suffered through many years of an investigation by the government, continuous splashing of accounting scandal by CAII by media, due to outcome of inquiry, SEC prosecuted many of its erstwhile top executives, despite of negative effect on their shareholders value and standing, CAII is able to resurrect and remain as a profitable business now like phoenix resurrects from its ashes. This is the success story and CA has fully seized the opportunity by daringly surpassing its bad time. (Biegelman, 2008:87).

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In CAII, any dissenting opinion was suppressed due to the existence of “culture of intimidation.” Any individual who wish to raise his voice against accounting fraud was immediately brought to the knowledge of General Counsel who admonished such employee for such conduct. (Biegelman, 2008:264).

The accounting fraud offered an insight to CAII how to run a business on not only ethical grounds but also with compliance of statutory rules and regulations. Thus, Computer Associate resurrected from intentionally contemptuous behavior to compliance and egressed as the new CA, Inc with more far compliant and stronger company later. Thus, CAII learned from its past mistakes.

In new CA, Inc, a corporate culture has been developed where employees are not scared to make complaints about potential violations and other wrong doings of business conduct. Successful companies do always encourage whistle blowing and offer safeguard those who blow the whistle. In their landmark study perused by the “Compliance and Ethics Leadership Council of the Corporate Executive board” made in 2007 found that primary signs of probable fraud and misconduct were due to fear of reprisal which was the sole utmost concern for whistle blowers (Biegelman 2008:202).

Rationalization

One may ask why the fraud was not detected at the initial stage. This is mainly due to fear psycho that had been inflicted by the top management of CAII. It is the whistle blowers who gave tips of about some of the famous corporate scandals like Enron, WorldCom, Xerox and invited notice to the fraud unleashed on them. To be a whistleblower, it requires a great extent of conviction and courage. Sometimes, the whistleblower may have to loose his job or even meet dangers to his life for acting according to their conscience and by executing their ethical duty. It is to be recalled about the courageousness of Cynthia Cooper who was the head of the internal audit of WorldCom who exposed the fraud to the audit committee despite she was threatened with dire consequences by the perpetrators of fraud at WorldCom. Thus, the role of whistleblowers in ditching out the compliance failures and frauds on shareholders is to be lauded. (Biegelman 2008:202).

Further, the audit committee of any company should be more vigilant not to award liberal incentives to top executives mainly to cook the books to show substantial results. (Knowledge @Wharton, 2004).

It is to be remembered that bad things happen if good people remain as silent. In CAII, there existed culture of silence where employees were afraid to come out and speak about frauds.

As a revamping measure, CA inducted John Swainson, the erstwhile IBM top executive as CEO of CA in February 2005. (LaMonica, 2005)

Conclusion

Finally, CAII brokered a deal with SEC. The following relief measures were ordered by the SEC. CAII was ordered to pay $ 225 million to its financially suffered shareholders by USAO and analogous remedy in the SEC consent judgment also. It was asked to appoint a compliance officer to prevent such frauds in the future. Woghin, erstwhile General Counsel of the CAII was barred from acting as either director or an officer of a public company. Woghin was given a permanent injunction barring him from flouting the reporting of anti-fraud and various offenses under federal securities laws. (SEC 2004)

Its erstwhile CEO Sanjay Kumar was charged on securities fraud and impediments of justice charges as he lied and concealed evidence of this massive accounting fraud. All penalty payments have now been paid by CA.

As a cleansing process, CA has been asked to revamp its management, appoint more independent directors in the Board and appoint a compliance officer to prevent such frauds in the future.

CA fraud offers an insight to accountants (CPA’s) that they should work hard to prevent it otherwise they may face criminal charges. Executives are now aware that any fraud may not only land them in prison but also have to pay out heavy sums as damages. Due to recent tough regulations like the Sarbanes-Oxley Act and vigilance of accounting profession in USA, the chances for occurrence of corporate frauds in USA seems to be dim in the future.

The case study of CA, Inc will be the best practice for the other corporate and they can now learn from mistakes and frauds committed by CAII which would definitely cost them a major consequence if they peruse the footprints of CA.

Learning from past mistakes, now CA, Inc is still the global leader in the IT corporate software sector and is one of the blue chip companies of Wall Street currently also.

References

  1. Berenson, A. (2004) “Ex-Chief of Computer Associates is Indicted on Fraud Charges” The New York Times. Web.
  2. Berenson, A. (2004) “3 Plead Guilty in Computer Associates Case” The New York Times.
  3. Biegelman, Martin T. (2008). Building a World-Class Compliance Program. New York: John Wiley & sons
  4. Jeffery, Marshall. (2004). The Perils of revenue recognition: there are few more troublesome areas in accounting. Financial Executive.
  5. Knowledge @Wharton (2004) “How Serious was the Fraud at Computer Associates.” Knowledge Wharton. Web.
  6. LaMonica, Martin. (2005). Computer Associates reorg spotlights security. New. Net. Web.
  7. Long Island Business News. (2004). After arrests, Computer Associates nears end of audit. All Business.com.
  8. SEC (Securities and Exchange Commission). (2004). “SEC files Securities Fraud Charges against Computer Associates International, Inc.”; Web.
  9. Yahoo! Finance. (2009) “CA, Inc. Profile. “ Web.

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