Litigation Release No. 18205 / June 30, 2003
Accounting and Auditing Enforcement Release No. 1808 / June 30, 2003
Securities and Exchange Commission v. Peregrine Systems, Inc., Civil Action No. 03 CV 1276 K (LAB) (S.D. Cal.) (June 30, 2003)
SEC Charges Peregrine Systems, Inc. With Financial Fraud And Agrees To Partial Settlement
The Securities and Exchange Commission today sued San Diego-based software company Peregrine Systems, Inc., in the United States District Court for the Southern District of California, for a massive financial fraud at the company that spanned 11 fiscal quarters. Simultaneously with the filing of the complaint, the Commission submitted to the Court, for its approval, a partial settlement with Peregrine.
According to the Commission's complaint, the purpose of the fraudulent scheme was to inflate the company's revenue and stock price. To achieve that end, Peregrine filed materially incorrect financial statements with the Commission concerning the quarter ended June 30, 1999, through the quarter ended December 31, 2001. In 2003 Peregrine restated its financial results for those quarters. In its restatement, Peregrine reduced previously reported revenue of $1.34 billion by $509 million, of which at least $259 million was reversed because the underlying transactions lacked substance.
The complaint alleges that Peregrine improperly booked millions of dollars of revenue for purported software license sales to resellers. These transactions were non-binding sales of Peregrine software with the understanding-reflected in secret side agreements-that the resellers were not obligated to pay Peregrine. Those involved in the scheme called this "parking" the transaction. Peregrine personnel parked transactions when Peregrine was unable to complete direct sales it was negotiating (or hoping to negotiate) with end-users, but needed revenue to achieve its forecasts. Peregrine engaged in other deceptive practices to inflate the company's revenue, including entering into reciprocal transactions in which Peregrine essentially paid for its customers' purchases of Peregrine software. Peregrine routinely kept its books open after fiscal quarters ended, and improperly recorded as revenue, for the prior quarter, software transactions that were not consummated until after quarter end. Certain Peregrine officers characterized these transactions as having been completed on "the 37th of December." Peregrine senior officers, and sales and finance personnel knew, or were reckless in not knowing, that the applicable accounting rules prohibited revenue recognition on these and other transactions for which Peregrine booked revenue.
The complaint alleges that, by various means, certain Peregrine officers and employees fraudulently concealed the revenue inflation scheme. When Peregrine booked revenue for the non-binding reseller contracts, and the customers predictably did not pay, receivables-some of them bogus-ballooned on Peregrine's balance sheet. Large aged accounts receivable were not being paid, an indication that Peregrine's financial health was deteriorating. To make it appear to investors that Peregrine was collecting its receivables more quickly than it was, a senior officer entered into financing arrangements with banks to exchange receivables for cash. Peregrine improperly accounted for these financing arrangements as sales of the receivables and removed them from the company's balance sheet. There were several problems with this. First, because Peregrine had given the banks recourse, and frequently paid or repurchased unpaid receivables from them, Peregrine should have accounted for the financing arrangements as loans and left the receivables on its balance sheet. Second, some of the "sold" receivables were not valid because the customers were not obligated to pay Peregrine. Third, several of the "sold" invoices were fake. For example, in June 2001, Peregrine's senior treasury manager, with senior management's approval and encouragement, created a false $19.59 million invoice and sold it to a bank. As a result, Peregrine's financial statements and books and records overstated Peregrine's cash flow from operations, and understated its accounts receivable.
The complaint also alleges that, as part of the cover up, Peregrine personnel wrote off millions of dollars in uncollectible-primarily sham-receivables, to acquisition-related accounts in Peregrine's financial statements and books and records. These write-offs were improper because they had nothing to do with acquisitions, and because the Peregrine personnel who directed the write-offs knew, or were reckless in not knowing, that certain written-off receivables should not have been recorded as revenue in the first place. Peregrine misled investors by not including the write-offs in its pro forma operating results, and by making the write-offs appear on Peregrine's income statement as one-time charges rather than expenses from operations. Through its officers and employees, Peregrine knew that (a) a substantial portion of these receivables should not have been recorded as revenue in the first place, (b) the receivables were not impaired by acquisitions, and (c) it was inappropriate to make it appear to the investing public that the write-offs related to non-recurring events.
The Commission's complaint seeks to permanently enjoin Peregrine from violating certain antifraud provisions of the federal securities laws (Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Exchange Act Rule 10b-5), and from violating certain reporting, books and records, and internal controls provisions (Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13). The complaint also seeks disgorgement of ill-gotten gains, prejudgment interest, and civil monetary penalties.
Peregrine, without admitting or denying the allegations of the Commission's complaint, has agreed (1) to be enjoined from violating the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws, (2) to disclose the current condition of its internal controls and financial reporting procedure, when a reorganization plan under Chapter 11 of the Bankruptcy Code becomes effective, (3) to comply, on an accelerated basis, with the rules regarding management's report on internal controls, implementing Section 303 of the Sarbanes-Oxley Act of 2002, (4) to retain an Internal Auditor to ensure that Peregrine's financial results are accurately reported in Peregrine's public financial statements, (5) to appoint a Corporate Compliance Officer to perform an ongoing review of Peregrine's corporate governance policies and practices, and (6) to commence a training and education program for its officers and employees, to prevent violations of the federal securities laws. The partial settlement provides that the amount of disgorgement and/or civil penalty to be paid by Peregrine, if any, shall be determined at a later date. In determining to accept Peregrine's offer of partial settlement, the Commission considered remedial acts promptly undertaken by Peregrine and cooperation afforded the Commission staff.
This is the fourth civil fraud action the Commission has filed in this investigation. In November 2002, the Commission filed a civil injunctive action against Ilse Cappel, the former senior treasury manager at Peregrine (Litigation Release No. 17859A). In April 2003, the Commission filed a civil injunctive action against Matthew C. Gless, Peregrine's former chief financial officer (Litigation Release No. 18093). In June 2003, the Commission filed a civil injunctive action against Steven S. Spitzer, a former vice president of sales at Peregrine (Litigation Release No. 18191).
The Commission's investigation of participants in the financial fraud at Peregrine is continuing.
The Commission thanks the U.S. Attorney's Office for the Southern District of California and the Federal Bureau of Investigation for their cooperation in this matter.
