18 Feb 2013 03:45pm

Autonomy, HP and the FRC: who has the most to lose?

Although the FRC has now formally identified Autonomy as the target of an investigation related to pervasive accounting improprieties, it may be HP that has the most to lose, writes Michael Stocker, partner at Labaton Sucharow

On February 11, the FRC announced that it had commenced a probe, in consultation with ICAEW, into Autonomy’s accounts between 1 January 2009 and 1 June 2011—the period preceding Autonomy’s highly publicised acquisition by Hewlett Packard in October 2011.

While the FRC has provided little detail about the scope of its investigation, revelations on both sides of the Atlantic make it clear that the probe could potentially be explosive. The acquisition soured only a year after the deal was complete, when HP stunned the markets with the announcement that it would take an $8.8bn non-cash impairment charge related to Autonomy.

HP left Autonomy little room to claim that any accounting discrepancies had arisen from good faith

HP’s CFO asserted that Autonomy management was responsible for the disaster, claiming that some $5bn of the write-down was attributable to accounting improprieties, disclosure failures, and other misrepresentations made by Autonomy before the acquisition was complete.

The accounting chicanery identified by HP was startling: revenue recognition issues relating to value added resellers (VARs), improper acceleration of revenues, and overstatements of product margins. In particular, it suggested that Autonomy improperly recognised revenue from VARs when the appropriate revenue recognition criteria had not been met.

While the company provided little detail for these claims, there has been some suggestion that Autonomy accelerated revenues by persuading its customers to purchase products sooner, at the cost of future profits.

Given the broad scope and egregious nature of the alleged misconduct, HP left Autonomy little room to claim that any accounting discrepancies had arisen from good faith efforts to interpret ambiguous rules.

Indeed, HP itself has indicated that it believes the misconduct to be very serious - so much so that when HP identified an Autonomy whistleblower last May, it immediately launched an internal investigation spearheaded by the company’s General Counsel and by PwC, which acted as its outside forensic consultant.

HP also referred the matter to the US securities regulators.

And this is where HP’s own conduct may gives rise to serious concerns among investors and regulators alike.

First, if the accounting improprieties are as glaring as HP claims, what are the markets to make of the Company's claims at the time of the Autonomy acquisition was announced that its due diligence was rigorous and very conservative? Given that analysts had raised grave concerns about the prudence of the transaction even before it was finalized, it seems surprising that the Company and its experienced auditors missed red flags of accounting manipulation.

HP may face even more serious concerns, however. If it was so concerned about Autonomy's accounting that it referred the matter to US regulators no later than early June of last year, why did it wait until November to warn investors of the problem?

These questions suggest that there is really little upside for HP in the announcement of the FRC's investigation. If Mike Lynch is right, then there were no accounting improprieties, and investors will be left questioning the real reason for the gigantic write-down HP took last November. If HP is right and there was pervasive misconduct, HP itself looks reckless in the statements it has made about due diligence for the acquisition, and even more suspicious for failing to give a timely warning to investors.

While the FRC’s probe and parallel investigations across the Atlantic may take some time to produce results, it is likely that investors may find faster answers in the courts, where shareholder litigation is already well underway.

Michael Stocker is partner at Labaton Sucharow, a member of the Association of the Bar of the City of New York, the National Association of Public Pension Plan Attorneys and the New York State Bar Association

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