As if it wasn’t a big enough risk already, CFOs may have to brace themselves for more private litigation over accounting fraud if a court decision on April 21 involving failed telecom equipment maker REMEC serves as precedent. The good news is that plaintiffs will have to show evidence of the executives’ intent in such cases.
Most cases involving accounting are either dismissed because they involve judgment or are settled before they go to trial, Robert Brownlie, a partner in the law firm of DLA Piper who represented the defendants in the REMEC case, told CFOZone last Thursday. The Del Mar, Calif., company filed for bankruptcy in 2005.
One of the largest such cases involved former Lucent executives, whom shareholders charged had defrauded them through improper accounting for goodwill. In that case, shareholders agreed in 2003 to accept a $600 million settlement.
In contrast to the Lucent case, the one filed by shareholders against REMEC’s former CEO, Ronald Ragland, and former CFO, Winston Hickman, was dismissed, though it also rested on charges that they misled investors because they didn’t write off goodwill that was impaired.
But the dismissal was more difficult to achieve than it would otherwise have been, said Brownlie, because the plaintiffs submitted evidence of internal reports and testimony showing that the company was behind schedule on certain objectives and not meeting its internal forecasts. The court said that those reports created a factual issue that should be determined by a jury; the defendants had to show there was no evidence of intent to deceive on the part of management.
“Normally, with matters of opinion or judgment, you either can’t bring a suit or it’s very difficult to do so,” Brownlie said. But he warned that the decision could mean more cases against corporate executives over accounting fraud.
The court dismissed the charges even though the plaintiffs’ accounting experts testified that they would have reached different conclusions than the former executives did.
Brownlie added that his case was helped by evidence of good faith conduct by the defendants, including evidence of transparency between the company and its auditors, disclosures of disappointing results and write-offs of other accounting items during the period of the alleged fraud and the absence of stock sales.
Describing the outcome for CFOs as “both good and bad news,” Brownlie said the decision showed that the critical issue in such cases will be “a connection between claims and evidence.” And he cautioned that in other accounting cases, it’s likely to be harder to defend executives on the basis of intent, which is why he said “there’s a paradox” in the REMEC decision.