This case involves a company that included business segments focused on electrical and electronic components, healthcare and specialty products, and security services, using Quickbooks software services. The company generated $30 million in sales and a net worth of $20 million. Much of the company’s rapid growth derived from numerous small acquisitions. This strategy helped fuel a massive revenue growth rate and propelled the company’s stock price upward. Despite having made 20 acquisitions in a 2-year time period, the company never disclosed the acquisitions to the public. The CEO and CFO were fully aware of the lack of disclosure. The accounting department, comprised mostly of CPA backgrounds, underreported the pre-acquisition earnings of newly acquired companies in order to give the company an earnings boost after acquisitions. The CEO and CFO were indicted for accounting fraud.

In this case, the CEO appears to have been heavily focused on making sure the company’s accounting tactics provided the best possible results. It also appears that there was most likely a lot of pressure to achieve higher earnings, which influenced the CFO’s choice of accounting practices. Financial reports are usually made up of management decisions and estimates that can greatly transform a company's financial picture, depending on how aggressive a company’s CEO is and how the company’s accounting department wants to apply Generally Accepted Accounting Principles (GAAP). The financial statements of companies involved in complex mergers and acquisitions can be prepared following GAAP standards and these standards allow accountants at a company to interpret the rules in both conservative and aggressive ways. In this case, the company’s accountants chose to implement accounting practices that bordered on compliance, but were not used to defraud investors.

1. Did the CEO and CFO implement deceptive accounting practices to defraud investors?

Company Uses Aggressive Accounting Practices to Show Profit Boosts

This case involves the CEO of an e-commerce business specializing in digital payment processing. The CEO started the company with almost no money in a one-room office that only had one telephone. He grew the business to eventually become one of the largest providers of digital payment services in the United States. When the company went public, it expanded its operations overseas, employed approximately 15,000 people, and generated $900 million in revenue. The CEO regularly instructed his accounting teams to implement aggressive accounting practices to boost earnings reports if they fell short of Wall Street expectations. The lead accountant pushed the team to implement complex and sometimes experimental techniques to meet goals. The CEO was indicted for accounting fraud/forgery.

The CEO in this case clearly relied on new marketplace trends to create a very successful business model for the company. Strong leaders like this CEO are often known for using strong hand tactics with their accounting staff. In many companies similar to this one, the accounting decisions are most likely made by the accountants themselves (not at the executive level), with many checks and balances along the way. If the CEO in this case was not the mastermind behind the financial decisions, he did not commit fraud. In many cases like this one, the CFO and other accountants may take measures to keep profits high and may conceal these tactics from the CEO. In this case, the main responsibility for finding the accounting errors would have rested with the auditors who failed to find the overstated earnings. This means that the CEO is not guilty of fraud in this case. Becoming a successful entrepreneur requires that a CEO take many risks—and often huge risks. The CEO in this case, may have been driven by his ego to control the company by taking risks with the company’s financial reports.

1. Can a CEO defend himself against fraud charges if he requested his accountants to use aggressive accounting practices to boost the company’s financial position?

Expert Witness Defends E-Commerce CEO Against Accounting Fraud Charges

This case involves the CEO of a company that had a projected total revenue for the year of $nearly $20 billion. The CEO set the company’s internal targets $500 million higher than the public prediction to encourage company employees to surpass public targets. Several employees expressed concern that the public and internal targets were too high and believed the company could only make $18.4 billion. The CEO received a “risk estimate” forecasting a potential shortfall in the yearly earnings. The estimate stated that earnings could end up nearly $900 million below the public projections. The CEO received a substantial portion of his salary in stock options. The CEO exercised his stock options at the same time that he received information that the company’s earnings were in danger of falling nearly one billion dollars short of projected revenue estimates. The CEO sold more than a million shares of his stock in the company during trading windows each quarter directly after the company announced its quarterly earnings. The CEO was indicted for insider trading and tried to defend himself by showing that he had committed in advance to a Rule 10b501 stock sale plan.

A corporate CEO engages in illegal insider trading if he has material, nonpublic information upon which he trades his securities. Under Rule10b5-1, a corporate executive can have a written plan for trading securities if the plan was established in good faith at a time when the executive was unaware of material non-public information. This plan is an affirmative defense against charges of insider trading, even if actual trades made pursuant to the plan were executed at a time when the executive was aware of material, non-public information that would otherwise subject them to liability for insider trading. A corporate executive who receives a significant portion of his compensation in stock options may set up a Rule 10b5-1 plan to diversify his holdings. A Rule10b5-1 Plan can be used for the exercise of options and the subsequent sale of the shares received. A corporate executive can use a Rule 10b5-1 Plan shortly after the company announces its financial results because previously material non-public information about the company’s financial situation should have already been publicly disclosed. Usually, a corporate executive will submit a 105b-1 plan to their company’s compliance department for review prior to the plan being adopted. Rule 10b5-1 plans have certain safety measures that can be followed so that the plans don’t run afoul of SEC rules. If a corporate insider wants to use a Rule10b5-1 Plan they should: (1) make a decision to terminate the plan far in advance of news events; (2) not allow plan sales of securities to happen at the same time as certain pre-or post-earnings release dates; (3) not use the plan for large isolated trades and (4) make sure to space out the sales over several quarters so that there are no “good faith” issues to deal with later.

1. Can a CEO who is accused of insider trading use evidence of selling stock under a Rule 10b5-1 Plan to defend himself?

Expert Witness Helps CEO Beat Insider Trading Charges by Using Rule 10b5-1 Plan

This case involves a publicly traded telecommunications company. The company went public when it acquired a publicly traded long distance telecom services company. Throughout the 2000s, the company continued to grow by acquiring various companies and expanding its operations across the United States, using multiple software programs like Quickbooks to expand and manage their portfolio. The company used an aggressive acquisition strategy. Analysts remarked that the company, which had a negative cash flow of over $7 million after 11 years in business, would be able to generate only $64 million in free cash flow in two years and $100 million in three years. Considering the situation, many company observers predicted that the company would soon declare itself bankrupt. The company’s accounting department used accounting practices that showed constantly increasing profits. The accounting department wrote down millions of assets the company acquired and included in this charge against the earnings the cost of company expenses expected in the future. This created a profit picture that was constantly improving. The accounting department classified $800 thousand in line costs as capital expenditures rather than current expenses to increase net income and assets.

One of the main things behind the troubles of a company like this is that telecommunications firms faced reduced demand as the dot-com boom ended and the economy entered a recession. The revenues of these companies fell short of expectations, while the debt they took on to finance expansion remained high. The first issue to look at in a case like this is auditing. Auditing is always important when a company’s financial situation is in trouble. There is always increasing pressure on a company to meet earnings goals and this means that the CEO and the CFO may be required to sign off on the fairness and accuracy of financial statements. In many cases like these, if company executives have carefully considered the possible consequences of manipulating numbers to meet earnings forecasts, there is less likelihood of fraud. In cases like this, Generally Accepted Accounting Principles (GAAP), are very difficult to interpret and apply because the standards are written in highly technical ways. The GAAP standards can be difficult for accountants to apply because they are rule-based and have to be applied in many types of transactions in varying business situations. In general, the quality of financial reporting within most large companies is very high. Most CFO’s are very concerned with fair and accurate reporting because of high pressure and penalties from the SEC. Also, more and more of these companies are trying to improve the transparency of their financial reporting by internal controls that focus on longer-run profit performance rather than focusing just on short-run profits.

1. Can a company use accounting practices that capitalize line costs to show positive revenue streams?

Telecommunications Company Undergoes Audit of Its Financial Statements

: United States District Court for the Western District of Virginia, Harrisonburg Division 

Keystone Transp. Sols., LLC v. Northwest Hardwoods, Inc.

After the plaintiff shipping and logistics company failed to sell its services to either the defendant company or another purchaser, it eventually ceased operations. In this lawsuit, the plaintiff alleged that the defendant company, along with the former president of shipping company who was now working for the defendant company, interfered with its business interests and improperly gained access to confidential trade secrets and proprietary Shippers Savings Model (SSM). The defendant challenged the testimony of the plaintiff’s logistics expert witness, who was a co-founder and CEO of the plaintiff shipping company.

The logistics experts co-founded the plaintiff shipping company and previously served as CEO. Along with his fellow founder, the expert had investigated transport inefficiencies in the market for forest products and developed the Shipper Savings Model (SSM). The expert explained that the high-level conclusions of SSM were not unique, but its specific savings findings were confidential, and, for this reason, the company took significant steps to ensure that the information, modeling, and data were kept secret.

There were six different opinions that the expert intended to present:

Research, information, review, and results arising from the development of the SSM are considered valuable and confidential in the transport logistics industry;

Use of non-disclosure agreements in these industries to protect information from unauthorized use and disclosure by a competitor;

The plaintiff had made commercially reasonable efforts to maintain the confidentiality of its trade secrets;

Data on the business model, strategies, and procedures of the plaintiff was confidential and not readily available from public information;

The defendant company had committed to the opening of a new business location within 10 weeks of receiving access to the plaintiff’s confidential information;

The current business operated by the defendant company was the same for all material aspects of the business proposal by the plaintiff.

The defendants filed this motion to exclude the expert’s testimony because he had a direct financial interest in the outcome of this lawsuit, had no experience or advanced technical knowledge in the subjects on which he wished to offer opinions, and his conclusions were inaccurate because they were based solely on informed speculation.

The defendants argued the expert’s testimony was not reliable because he had a direct financial stake in the outcome of the litigation. The court noted that the particular circumstances of this case, including his clear, substantial, and direct financial contribution to this dispute and the fact that his testimony was mostly subjective rather than based on reproducible scientific or other technical methods, led the court to the conclusion that he should not testify as an expert.

The plaintiff conceded that the expert did not have sufficient experience to qualify as an expert in forest products logistics, but argued that he was an expert in the more general field of transport logistics. The court noted the essential question was whether he had sufficient expertise to deliver all the opinions he gave. Many of his opinions did not fall within either of these fields.

The court found that many of his opinions were simply the plaintiff’s account of the facts in the form of expert testimony. Certain aspects of his opinions were also found to not helpful to the jury and were excluded. The expert’s report did not sufficiently link his expertise through his experience to his opinions. His opinions on trade secrets were also excluded because they were legal conclusions.

The defendants’ motion to exclude the testimony of the logistics expert witness was granted.

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CEO Expert Witness Case Studies

Company Uses Aggressive Accounting Practices to Show Profit Boosts

Expert Witness Defends E-Commerce CEO Against Accounting Fraud Charges

Expert Witness Helps CEO Beat Insider Trading Charges by Using Rule 10b5-1 Plan

Telecommunications Company Undergoes Audit of Its Financial Statements

Company CEO is Accused of Bias for Serving as an Expert Witness

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