News analysis
Dell's SEC settlement
Taking away Dell's cookie jar
Jul 23rd 2010, 17:58 by The Economist online | SAN FRANCISCO
THE spell has been broken. For years, Dell’s seemingly magical power to squeeze efficiencies out of its supply chain and drive down costs made it a darling of the financial markets. Now it appears that the magic was at least partly the result of a huge financial illusion. On July 22nd Dell agreed to pay a $100m penalty to settle allegations by America’s Securities and Exchange Commission (SEC) that, in the SEC’s words, the company had “manipulated its accounting over an extended period to project financial results that the company wished it had achieved.” The company neither admitted nor denied guilt as part of the settlement—a common phraseology in such deals.
The penalty seems rather light given the gravity of the SEC’s accusations. According to the commission, Dell would have missed analysts’ earnings expectations in every quarter between 2002 and 2006 were it not for accounting shenanigans. This involved a deal with Intel, a big microchip-maker, under which Dell agreed to use Intel's central processing unit chips exclusively in its computers in return for a series of undisclosed payments, locking out Advanced Micro Devices, a big rival. (Intel is expected to settle a long-running anti-trust case that has highlighted these payments in the next couple of weeks.) The SEC's complaint said Dell had maintained “cookie-jar reserves” using Intel’s money that it could dip into to cover any shortfalls in its operating results.
The SEC says that the company should have disclosed to investors that it was drawing on these reserves, but did not. And it claims that, at their peak, the exclusivity payments from Intel represented 76% of Dell’s quarterly operating income, which is a breathtaking figure. Small wonder, then, that Dell found itself in a pickle when its quarterly earnings fell sharply in 2007 after it ended the arrangement with Intel. The SEC alleges that Dell attributed the drop to an aggressive product-pricing strategy and higher than expected component prices, when the real reason was that the payments from Intel had dried up.
A tarnished reputation
As well as a blow to Dell’s hitherto sparkling reputation, the settlement is also a severe embarrassment for Michael Dell, the firm’s eponymous founder and current chief executive. He and Kevin Rollins, a former boss of the company, agreed to each pay a $4m penalty without admitting or denying the SEC’s allegations. Several senior financial executives at Dell also incurred penalties. “Accuracy and completeness are the touchstones of public company disclosure under the federal securities laws,” said Robert Khuzami of the SEC’s enforcement division when announcing the settlement deal. “Michael Dell and other senior Dell executives fell short of that standard repeatedly over many years.”
Mr Dell nevertheless looks set to keep his job. Sam Nunn, one of the directors on Dell’s board, said that it had reaffirmed its unanimous support for Mr Dell’s continued leadership and welcomed the settlement which, it said, “is in the best interest of the company, its customers and its shareholders.”In its statement on the SEC settlement the company played down Mr Dell's personal involvement, saying that his $4m penalty was not in connection with the accounting-fraud charges being settled by the company, but was "limited to claims in which only negligence, and not fraudulent intent, is required to establish liability, as well as secondary liability claims for other non-fraud charges."
Welcome though the sanctions are, the episode will do little to convince investors that the authorities can effectively deter managers from manipulating companies’ figures to their benefit. The complexity of corporate accounting offers plenty of possibilities for manipulation that even eagle-eyed accounting firms can find tricky to uncover. Dipping into the cookie jar is a bad habit that is unlikely to be cured any time soon.
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Everyone's settlement with the SEC is relatively light compared to the damage done. It is always a win for the violator and a loss for the victim. Only in America!!
I would like to see the detail of how Dell hid this in their accounts. Give us the entries so we can understand what happened. Then we can decide if it was fraud. If it was then I want to know why the Surbanes Oxley penalties of jail time were not impossed.
I would like to see the detail of how Dell hid this in their accounts. Give us the entries so we can understand what happened. Then we can decide if it was fraud. If it was then I want to know why the Surbanes Oxley penalties of jail time were not impossed.
..."at their peak, the exclusivity payments from Intel represented 76% of Dell’s quarterly operating income..."
It is astounding that these payments which went all the way back to 2003 at around 10% of operating income and increased over time were never picked up until the payments ceased.
Indeed Intel only stopped the payments as Dell began using their rivals AMD CPU's. The external auditors should also be quizzed about their responsibility in this failure.
Heart breaking!!! In India i remember INTEL laying off employees just because they showed fake medical bill for medical reimbursement. INTEL by itself violates the norms???
A $100 million fine for deceiving stockholders to be paid by - stockholders. Dell’s accounting shenanigans hurt only Dell’s own shareholders. It’s ridiculous that the injured party is also footing the vast majority of the bill. Dell and Rollins’ personal $4 million fines are almost certainly a fraction of the personal enrichment they derived from their deception. The only way justice is served is if you willfully ignore the fact that the victim is the one bearing the consequences.
This is all reminiscent of the fine the SEC imposed on Bank of America for misleading its investors about the soundness of the Merril Lynch merger. It used to be under the impression that the SEC was there to protect investors from unscrupulous managers and other bad actors, not fine those investors and let management off the hook. If a homeowner were ripped off by their real estate agent, would justice be served by the state cutting a deal with the agent to drop the investigation in return for a fine on the homeowner's property (oh, but you're still punishing the agent since 3% of the fine will come out of his commission).
Indeed, the original SEC fine in the Bank of America was kicked back by the Judge. In his reasoning Judge Rakoff noted “It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims’ money should be used to make the case against the management go away”.
If a company injures a third party, BP for example, it is perfectly appropriate for the company to pay a fine and compensate those damaged. However, it is a travesty of justice that when management abuses their own, the very agency that should have protected shareholders from the original abuse sees fit to reward itself by allowing the abusers to escape in return for a fine on the abused.
@quaser66
Please read the article carefully. The article says; ONGOING antitrust case against Intel.... the penalty against Intel has not happened YET.
A few years ago Michael Dell and his company were Tom Friedman's, a New York Times OP-Ed pundit, shining example of the new "The World Is Flat" economy. That is par for the course as the NY Times Op-Ed economic pundit, Paul Krugman, was a consultant for and promoter of the Enron business model.Mr Krugman is a Nobel prize recipient.
coorperate american corruption...
Hmm…this does remind me that my first Dell cratered at less than one year usage, all data lost. While the SEC are obviously a bunch of wussies, the people whose opinions really matter are the investors. Why should they ever trust these bozos again?
I was heavily involved in Sarbanes Oxley implementation, and setting aside THAT debate (it cost too much, traumatically intrusive, lacked adult supervision, etc.), a hundred Sarbanes is better than investor confidence flat lining at zero. People forget how close we were to the edge.
In a broader sense, respect for the rule of law demands equal application, particularly for American sensibilities. Otherwise, bring on the night.
Where's the jail time? No wonder respect for American institutions is at an all time low! I will start looking into this Tea Party thingie. The insanity cannot continue.
By the way, this is being written on a Dell computer, the last I will ever buy.
Dell's auditors should be facing some scrutiny & a ruler to their knuckles too. This type of financial misstatement/ omission is why companies are audited- this should have been detected by the outside auditors.
Yes Michael Dell got off very lightly. When this happen to Informix the CEO Phil White ended up in jail.
To Walthnix
Ok Martha wasn't the best example...but my query still stands:
Who decides that when a Goldman Sachs or a Dell commit fraud that it is to be pursued as a Civil Law matter with a fine and no acceptance of responsibility whilst others must answer to Criminal Law charges and prison?
Is there a defined process? Is it arbitrary? Is it merely a subjective assessment by the SEC legal department? Is it political?
Civil lawsuits are settled with financial penalties, which to a company such as Goldman Sachs, in reality, imposes no financial, practical or moral restraint upon the company whatsoever.
However even a mere six months in federal prison for likes of Blankfein, Viniar, and Dell himself would put an end to these financial shenanigans quick smart...
LaContra, I agree that Dell executives and all others like them should go break rocks in prison for a few years when they commit fraud and this whole thing about not admitting guilt must go, but Martha Stewart was not convicted of financial manipulations, she was convicted of lying to and stonewalling Security and Exchange Commission investigators. she would have gotten off if she had just talked, whereas Dell & co knew they screwed up but did not obstruct when the investigation got under way.
FYI, another reason Dell lost money and had to manipulate is because their quality went down hill, they used cheap Taiwanese capacitors (critical electronic component) in their business products (Optiplex GX-270 I believe) as well as many other shortcuts, plus they trashed their technical support and customer service.
Where exactly is the divide where the SEC stops treating fraud as a 'civil' matter (allowing settlements with no acceptance of responsibility) and starts treating it as a 'criminal' matter (where company officers go to prison)?
It all seems rather arbitrary and opaque....why does Goldman Sachs and Dell get (relatively) piddling fines and no responsibility clauses when Enron, WorldCom, Health South, and even Martha Stewart get prison and restitution?
Who decides?
I agree it all seems very relaxed seeing they were effectively accused of fraud.
caesariaTulsa, what interesting comments you make.
To caesariaTulsa
On the TV news you say?
...well it must be true then.
Interestingly, why not a penalty on Intel as well? After all paying cash to your customers to keep competition away is probably equally illegal ?
I know that this sounds sarcastic, but during times of recession, its nice to look the other way and desperately protect jobs, etc. A Goldman like penalty on Dell on this occasion would definitely have destroyed Dell forever.
On the tv news, they said Obama ordered this witch hunt against Michael Dell due to the fact that Mr Michael Dell is a top drawer supporter of Gov. Rick Perry and sees Gov. Perry and the state of Texas as the best hope against the secular socialism that has done so much to destroy our high quality lifestyle and our right to bear arms so we can defend ourselves against the EPA wants to flush our oil companies down the toilet, all the time propagating the myth of global warming and telling us if we eat bacon we must pay an extry tax on it. The wife has a niece who operates one of those Dells and she swears by it!