More than three years after MicroStrategy Inc. disclosed that its reported profits were an accounting mirage, an announcement that was quickly followed by the bursting of the speculative bubble in dot-com stocks, the Securities and Exchange Commission has ended its investigation of PricewaterhouseCoopers LLC with no enforcement action against the audit firm that vouched for the misleading financial statements.
"This closes the book on MicroStrategy," PricewaterhouseCoopers spokesman Steven G. Silber said.
The SEC did, however, take action against the former lead PwC auditor at MicroStrategy. The agency said that Warren Martin, the partner who led the audits of the software company, failed "to act with due professional care" or to "maintain an attitude of professional skepticism."
Under an Aug. 8 settlement, without admitting or denying those findings, Martin agreed to be barred from auditing publicly traded companies. Martin, now at the McLean-based investment bank Claris Capital LLC, according to that firm's Web site, can apply for reinstatement with the SEC after two years.
The SEC alleged that Martin allowed MicroStrategy to book revenue before the company had earned it. On some major deals, MicroStrategy counted the revenue before it had signed contracts, the SEC said.
One aspect of the SEC's case contained echoes of the accounting scandal at Enron Corp., where Arthur Andersen's audit team went against the advice of Andersen's own technical experts. Martin failed to properly consider "concerns raised by PwC personnel that should have alerted him to the audit failures," the SEC said.
Martin did not return calls seeking comment. A PwC spokesman who declined to be identified said Martin voluntarily resigned from the accounting firm, adding that no PwC personnel were disciplined by the firm in connection with the MicroStrategy audits.
In a 1996 proposal to MicroStrategy, PwC identified Martin as its software practice leader in the mid-Atlantic, according to a document filed in private litigation over the audits.
Last week, the SEC barred another PwC partner from auditing public companies based on his audits of Tyco International Ltd.
MicroStrategy's stock was one of the stars of the dot-com era, but it plummeted in March 2000 when the company disclosed that its revenues had been overstated and, contrary to financial reports showing profits, it had been losing money. In one day, the company's stock lost more than 60 percent of its value, and chief executive Michael J. Saylor's holdings, once valued on paper at $14.5 billion, sank by $6.1 billion.
The disclosure helped shake investors' confidence in highflying stocks of upstart Internet companies. "This one popped the bubble," financial commentator James J. Cramer wrote. "MicroStrategy forever changed the Internet mania."
Two years later, accounting scandals at companies such as Enron, WorldCom Inc., Adelphia Communications Corp. and Tyco spurred Congress to impose new restrictions and a new disciplinary system on corporate auditors.
The SEC's action against Martin this month showed how long it can take the agency to resolve investigations, especially when big audit firms are involved. Saylor and two other MicroStrategy executives settled SEC fraud charges in December 2000. In May 2001, PwC agreed to pay more than $50 million to settle a suit by MicroStrategy investors who alleged that the firm defrauded them when it approved MicroStrategy's financial reports.
At the time, PwC denied the investors' allegations, saying the firm had "strong and compelling" defenses.
The SEC's administrative action against Martin this month covered some of the same ground as the earlier action against the executives and the investors' lawsuit, such as the accounting for deals with NCR Corp. and Primark.
The SEC alleged that Martin took MicroStrategy's word on key matters, such as the terms of contracts, instead of independently verifying them.
"Besides the fact that the details of even MicroStrategy's largest transactions were either inadequately confirmed or not confirmed at all with its customers, management representations were apparently believed even when they contradicted other available information, including contract language, PwC staff, and the press," the SEC order said.
Martin failed to follow a PwC manual, "The User-Friendly Guide to Understanding Software Revenue Recognition," the SEC order said.
One of the main issues was whether MicroStrategy could immediately book all of the expected revenue from contracts that called for the company to deliver software and services over time. Under accounting rules, companies can't book the revenue from any component of a software deal until that component has been delivered. What's more, to book revenue from any element of the deal up front, the company must be able to show that it has a track record of selling that particular element that supports the revenue attributed to it.
The order noted in a footnote that the co-leader of an in-house advisory unit at PwC warned that some of the accounting at issue was problematic.
A document filed by the shareholders in their suit against PwC provided more detail.
In March 1999, a year before MicroStrategy disclosed its accounting problems, PwC technical consulting partner John Dirks reviewed a template for MicroStrategy's accounting method, the report filed by the shareholders said. Dirks described MicroStrategy's approach as "we may be tilting at windmills trying to find a hole . . . to overcome the substance of the business," the report said.
The shareholders' report by consultant Andy Mintzer, based on e-mails, depositions and other documents, raised other issues not addressed in the SEC enforcement action. The report cited internal MicroStrategy and PwC communications indicating that the two were discussing joint business activities while PwC was auditing MicroStrategy's books.
"If at the same time that PwC is performing the audit . . . they're negotiating with the audit client to become a partner in a business transaction, that would impair the auditor's independence," said Lynn E. Turner, former chief accountant at the SEC.
"All of the allegations made by the plaintiffs' hired witness have been litigated, investigated by regulators and resolved," PwC's Silber said. "Most recently, the SEC entered into a widely reported settlement with Warren Martin without bringing any charges against PwC or any individuals at the firm."
In early 2000, Forbes magazine published an article questioning the way MicroStrategy accounted for deals that helped it show rising revenue. After the article appeared, PwC personnel reexamined MicroStrategy's accounting and pushed the company to correct past financial statements. The correction showed that the company had been losing money since before it first sold stock to the public.
MicroStrategy's stock, which traded as high as $333 per share 10 days before its accounting problems came to light, was trading at 48 cents last year when the company performed a reverse split, giving investors one share for every 10 they held. The stock closed Friday at $36.90.
Since March 2000, Saylor has sold 1.2 million shares for $37.8 million, according to Thomson Financial.
PwC remains MicroStrategy's auditor.
"This closes the book on MicroStrategy," PricewaterhouseCoopers spokesman Steven G. Silber said.
The SEC did, however, take action against the former lead PwC auditor at MicroStrategy. The agency said that Warren Martin, the partner who led the audits of the software company, failed "to act with due professional care" or to "maintain an attitude of professional skepticism."
Under an Aug. 8 settlement, without admitting or denying those findings, Martin agreed to be barred from auditing publicly traded companies. Martin, now at the McLean-based investment bank Claris Capital LLC, according to that firm's Web site, can apply for reinstatement with the SEC after two years.
The SEC alleged that Martin allowed MicroStrategy to book revenue before the company had earned it. On some major deals, MicroStrategy counted the revenue before it had signed contracts, the SEC said.
One aspect of the SEC's case contained echoes of the accounting scandal at Enron Corp., where Arthur Andersen's audit team went against the advice of Andersen's own technical experts. Martin failed to properly consider "concerns raised by PwC personnel that should have alerted him to the audit failures," the SEC said.
Martin did not return calls seeking comment. A PwC spokesman who declined to be identified said Martin voluntarily resigned from the accounting firm, adding that no PwC personnel were disciplined by the firm in connection with the MicroStrategy audits.
In a 1996 proposal to MicroStrategy, PwC identified Martin as its software practice leader in the mid-Atlantic, according to a document filed in private litigation over the audits.
Last week, the SEC barred another PwC partner from auditing public companies based on his audits of Tyco International Ltd.
MicroStrategy's stock was one of the stars of the dot-com era, but it plummeted in March 2000 when the company disclosed that its revenues had been overstated and, contrary to financial reports showing profits, it had been losing money. In one day, the company's stock lost more than 60 percent of its value, and chief executive Michael J. Saylor's holdings, once valued on paper at $14.5 billion, sank by $6.1 billion.
The disclosure helped shake investors' confidence in highflying stocks of upstart Internet companies. "This one popped the bubble," financial commentator James J. Cramer wrote. "MicroStrategy forever changed the Internet mania."
Two years later, accounting scandals at companies such as Enron, WorldCom Inc., Adelphia Communications Corp. and Tyco spurred Congress to impose new restrictions and a new disciplinary system on corporate auditors.
The SEC's action against Martin this month showed how long it can take the agency to resolve investigations, especially when big audit firms are involved. Saylor and two other MicroStrategy executives settled SEC fraud charges in December 2000. In May 2001, PwC agreed to pay more than $50 million to settle a suit by MicroStrategy investors who alleged that the firm defrauded them when it approved MicroStrategy's financial reports.
At the time, PwC denied the investors' allegations, saying the firm had "strong and compelling" defenses.
The SEC's administrative action against Martin this month covered some of the same ground as the earlier action against the executives and the investors' lawsuit, such as the accounting for deals with NCR Corp. and Primark.
The SEC alleged that Martin took MicroStrategy's word on key matters, such as the terms of contracts, instead of independently verifying them.
"Besides the fact that the details of even MicroStrategy's largest transactions were either inadequately confirmed or not confirmed at all with its customers, management representations were apparently believed even when they contradicted other available information, including contract language, PwC staff, and the press," the SEC order said.
Martin failed to follow a PwC manual, "The User-Friendly Guide to Understanding Software Revenue Recognition," the SEC order said.
One of the main issues was whether MicroStrategy could immediately book all of the expected revenue from contracts that called for the company to deliver software and services over time. Under accounting rules, companies can't book the revenue from any component of a software deal until that component has been delivered. What's more, to book revenue from any element of the deal up front, the company must be able to show that it has a track record of selling that particular element that supports the revenue attributed to it.
The order noted in a footnote that the co-leader of an in-house advisory unit at PwC warned that some of the accounting at issue was problematic.
A document filed by the shareholders in their suit against PwC provided more detail.
In March 1999, a year before MicroStrategy disclosed its accounting problems, PwC technical consulting partner John Dirks reviewed a template for MicroStrategy's accounting method, the report filed by the shareholders said. Dirks described MicroStrategy's approach as "we may be tilting at windmills trying to find a hole . . . to overcome the substance of the business," the report said.
The shareholders' report by consultant Andy Mintzer, based on e-mails, depositions and other documents, raised other issues not addressed in the SEC enforcement action. The report cited internal MicroStrategy and PwC communications indicating that the two were discussing joint business activities while PwC was auditing MicroStrategy's books.
"If at the same time that PwC is performing the audit . . . they're negotiating with the audit client to become a partner in a business transaction, that would impair the auditor's independence," said Lynn E. Turner, former chief accountant at the SEC.
"All of the allegations made by the plaintiffs' hired witness have been litigated, investigated by regulators and resolved," PwC's Silber said. "Most recently, the SEC entered into a widely reported settlement with Warren Martin without bringing any charges against PwC or any individuals at the firm."
In early 2000, Forbes magazine published an article questioning the way MicroStrategy accounted for deals that helped it show rising revenue. After the article appeared, PwC personnel reexamined MicroStrategy's accounting and pushed the company to correct past financial statements. The correction showed that the company had been losing money since before it first sold stock to the public.
MicroStrategy's stock, which traded as high as $333 per share 10 days before its accounting problems came to light, was trading at 48 cents last year when the company performed a reverse split, giving investors one share for every 10 they held. The stock closed Friday at $36.90.
Since March 2000, Saylor has sold 1.2 million shares for $37.8 million, according to Thomson Financial.
PwC remains MicroStrategy's auditor.
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