The board has nominated eleven candidates to serve a one-year term
each. If elected, their terms would expire at the Company's 2007
annual meeting of shareholders.
Over the past year, the Company continued to take modest steps to
correct its accounting and financial reporting irregularities that
arose in 2000 and 2001. Despite its efforts to address these issues,
the Company's problems in its internal control over financial
reporting have persisted, resulting in several restatements. In
addition to the inadequate oversight over financial reporting, the
Company stock performance has declined by approximately 27.8% since
chairman of the board Lewis Ranieri became a member of the board in
late June 2001, as shown in the graph below. The precipitous decline
in the Company's stock since the beginning of this year, under the
leadership of Mr. Swainson, who became CEO under chairman Ranieri's
guidance, supports our view that the current board has not performed
effectively. Furthermore, while several executives who were hired
under his direction left the Company, chairman Ranieri continues to
oversee management.
In our view, the Company faces significant challenges in
maintaining and growing its revenue basis and increasing its net
income to improve its bottom line performance. The Company's
revenue growth has suffered significantly over the course of the
restatement periods. As shown in the chart below, it has declined to
such an extent that the Company's fiscal year 2006 revenue was nearly
38% lower than the Company's fiscal year 2000 revenue. We question
what shareholders have received in return for their investment in this
board, in terms of its strategic decisions, in light of the Company's
declining performance while the incumbent board has been in place.
|
Year (fiscal year ending March
of) |
2006 |
2005 |
2004 |
2003 |
2002 |
2001 |
2000 |
|
Revenue (in millions) |
$3,796 |
$3,603 |
$3,332 |
$3,057 |
$2,886 |
$4,190 |
$6,094 |
|
Year over Year Growth |
5.40% |
8.10% |
9% |
5.90% |
-31.10% |
-31.20% |
|
Recent Restatements
During the most recent fiscal year, and after restatements arising
from prior investigations, the Company once again announced a number
of restatements. This ongoing saga of continually changing numbers
challenges the integrity and confidence in the numbers reported to
investors by the company. It also raises serious questions about the
competence of those responsible for the misleading financial reports
issued by the Company, the Company’s internal controls that have not
detected such errors in a timely fashion before they are published,
and the level of oversight that has permitted such inadequacies to not
only exist, but continue to affect the financial statements.
In the current year, the Company once again announced yet another
restatement for improperly recorded revenues. After serious SEC and
Justice department investigations and charges, one would think the
company would ensure its revenue was properly reported. Yet “the
Company determined that, beginning in fiscal year 2004, it had been
systematically understating revenue for certain license agreements
which have been cancelled and renewed…This restatement resulted in an
increase in subscription revenue of approximately $43 million and $12
million in fiscal years 2005 and 2004, respectively, and approximately
$19 million in the first three quarters of fiscal year 2006.”
In the Company’s most recent Form 10-K, it also disclosed the
Company had restated the results for the third quarter of the 2006
fiscal year, for an error of approximately $31 million of commission
expense that had been missed and should have been reported in that
quarter. The Form 10-K goes on to say “…the Company also identified
approximately $14 million in income taxes recorded in the third
quarter of fiscal year 2006 associated with foreign taxable income
from prior years. Since we are restating the results for the third
quarter of fiscal year 2006, as well as prior fiscal periods, we have
determined that this charge should properly be reflected in the
periods to which it is related.”
As if accounting errors in reporting of revenues, sales commissions
and taxes were not enough, the Company also announced it was caught up
in the stock option backdating scandal. While we applaud the audit
committee for undertaking an investigation of this matter in light of
ongoing revelations of option backdating, we wonder why this wasn’t
looked at in connection with the original internal investigations the
Company undertook, and which cost the Company (and its shareholders)
dearly. The outcome of this latest investigation again has uncovered
improprieties during periods in which some current members of the
board were responsible for the oversight of prior management. However,
that oversight of prior management, which appears to have been
non-existent, has once again contributed to errors that resulted in
additional pre-tax compensation expense of $342 million dollars. The
Company has disclosed that, in fiscal years 1996 through 2001, it has
had delays of up to approximately two years from the date that
employee stock options were approved by the board committee to the
date such option grants were communicated to individual employees. The
terms of these options were generally set on the date the committee
acted. In almost all cases, the earlier date had an exercise price
that was lower than the market price of the Company’s common stock on
the date the award was formerly communicated to employees.
It appears when it comes to financial reporting, investors have
failed to get an adequate return on their investment in this and prior
boards. One can only wonder what it will take to get high quality,
transparent numbers and disclosures from this Company that don’t
change.
Prior Restatements
As discussed in our Proxy Papers for the previous three years, in
2002, the United States Attorney's Office for the East District of New
York ("USAO") and the staff of the SEC commenced an investigation into
the Company's past accounting practices, including the premature
recognition of revenue from software licenses in fiscal year 2000. In
response, the board determined that the audit committee (now the audit
and compliance committee) should conduct an investigation into the
timing of revenue recognition. In April 2004, the Company restated its
financial statements for fiscal years 2000 and 2001 due to errors in
its revenue recognition reflected in those statements. In addition, in
the process of reviewing its revenue recognition for past periods in
2005, the Company identified additional transactions that it entered
into during fiscal years 1998 through 2001 that had been accounted for
improperly. As a result, the Company made further adjustments to its
financial statements for fiscal years 2000 and 2001, restated its
financial statements for fiscal years 2002 through 2004, and made
certain adjustments in its financial statements for fiscal year 2005.
Regulatory Investigations and Criminal Proceedings
On September 22, 2004, the Company entered a deferred prosecution
agreement ("DPA") with the USAO and a final consent judgment with the
SEC. These agreement effectively resolved the agency investigations
into Company past accounting practices and the actions of former
employees to impede the USAO and SEC investigations.
Under the DPA, the Company is required to cooperate fully with the
USAO, the FBI and the SEC in their on-going investigations into the
misconduct of any present or former employees and to support their
efforts to obtain disgorgement of ill-gotten gains. In September 2004,
Steven Woghin, the Company's former general counsel, plead guilty to
conspiracy to commit securities fraud and obstruction of justice.
Additionally, in April 2006, Sanjay Kumar, the Company's former
chairman and CEO, and Stephen Richards, the Company's former executive
vice president of world sales, plead guilty to all counts of a nine
count indictment, which included charges of securities fraud and
obstruction of justice. Sentencing of Messrs Kumar and Richards is
expected to take place in October 2006. Litigation with respect to the
SEC's claims for disgorgement and civil penalties against each these
former employees is pending.
Civil Litigation
In addition to the government enforcement proceedings, several
civil lawsuits have been filed by shareholders against the Company and
certain of its former and current directors and employees. In August
2003, the Company agreed to the settlement of a class action and
several derivative actions, claiming breach of fiduciary duties on the
part of all individual defendants. As part of the class action
settlement, the Company agreed to issue a total of up to 5.7 million
shares of common stock to the shareholders representing in the
lawsuits, and pay plaintiff's attorney's fees. In October and December
2004, four shareholders filed motions to vacate the order of final
judgment and dismissal entered by the federal court in connection with
the settlement of the derivative action and reopen the settlement to
permit the moving party to pursue individual claims against certain
present and former officer of the Company (the "60(b) motions").
Furthermore, in January 2005, a consolidated derivative action was
filed against the Company, as a nominal defendant, and certain of its
former and current directors and officers, seeking contribution toward
the consideration the Company had previously agreed to settle the
aforementioned class action. The consolidated derivative action has
been stayed pending a ruling on the 60(b) motions.
In addition, in September 2004, two civil actions were brought in
Delaware Chancery Court seeking to compel production of the Company's
books and record to determine whether the Company has been involved in
obstructing the USAO and SEC investigations and whether certain
Company directors and/or employees breached their fiduciary duties to
the Company and wasted corporate assets. A second complaint, filed in
September 2004, concerns the inspection of documents related to Mr.
Kumar's compensation, the independence of the board and the ability of
the board to sue for return of that compensation.
On August 14, 2006, the Company disclosed in a Form 10-Q that a
derivative action was filed in federal court against certain current
and former directors of the Company. The complaint alleges claims
against the individual defendants for breach of fiduciary duty, abuse
of control, gross mismanagement, corporate waste, and violations of
federal securities laws arising from alleged false and material
misstatements made in its proxy statements issued in 2002, 2004, and
2005. The premise for these claims are the disclosures made by the
Company in its 2006 annual report concerning the aforementioned
restatements. The complaint seeks, among other things, an
order setting aside the election of nine of the Company's directors at
this year's annual meeting and unspecified compensatory damages.
Obligations under the DPA
Under the DPA, the Company has also agreed to (i) establish a
restitution fund of $225 million to compensation present and former
shareholders for losses incurred as a result of the misconduct of
certain former executives; and (ii) take numerous steps to strengthen
the Company's management, corporate governance, financial reporting
compliance and adherence to federal securities laws.
We believe that the Company has continued to take steps to restore
confidence in its corporate governance practices. In 2005, the Company
added three new independent directors to its board: William McCracken
in February; Rob Zambonini in April; and Christopher Lofgren in
November. As required by the DPA, more than two-thirds of the current
board members are independent. In addition, as discussed in our 2005
Proxy Paper, with the departure of Russell Artzt as a board member,
none of the current board members served as a executives during the
time period in which the Company acknowledged improper accounting.
Ongoing Accounting and Financial Reporting Deficiencies
While we commend the board for making these reforms, we remain
particularly concerned that the Company continues to identify new
accounting problems arising from the same period in which the audit
committee conducted its initial investigation into the Company's
accounting irregularities. As a consequence, the Company decided to
restate its financial statements on several occasions, including an
increase in its non-cash stock option compensation, over these prior
periods. In addition, the Company disclosed in its 2006 DEF 14A that,
due to material weaknesses in its internal controls, the term of Lee
S. Richards, III, as the independent examiner appointed under the DPA,
may be extended beyond September 30, 2006.
In its most recent annual report, the Company also disclosed that
it had identified several material weaknesses in its internal control
over financial reporting. Specifically, the Company identified the
following control deficiencies: (i) the Company failed to maintain an
effective control environment due to a lack of effective communication
policies and procedures; (ii) its policies and procedures relating to
controls over the accounting for sales commissions were not effective;
(iii) its policies and procedures relating to identification, analysis
and documentation of non-routine tax matters were not effective; (iv)
its policies and procedures relating to accounting for and disclosure
of stock-based compensation were not effective; and (v) its polices
and procedures were not effectively designed to identify, quantify and
record the impact on subscription revenue when license agreements have
been cancelled and renewed more than once prior to the expiration date
of each successive license agreement.
Due to the restatements, the Company failed to timely file its
2006 annual report and its quarterly report for the second quarter of
fiscal year 2006. We note that this is the second consecutive year
that the Company has failed to timely file its annual report. We
believe the members of the audit committee bear the responsibility for
the Company's consistent failure to ensure accurate, reliable and
timely disclosure to investors over the past several years. In this
case, we believe that members of the audit committee have not
satisfactorily performed their duties in this regard.
Departure of Several Officers Hired Since 2004
In the last year, the Company has ousted several of its officers
who were appointed since chairman Ranieri took direction of the board
in April 2004. The Company appointed Jeff Clarke and Greg Corgan to
serve as chief operating officer and senior vice president for
worldwide sales in April 2004. In April 2006, the Company announced
that Mr. Clarke was leaving to assume the position of president and
CEO of a division of Cendant Corp. In July 2006, the Company entered a
separation agreement with Mr. Corgan, after ending his employment the
previous month. In February 2005, the board named Robert W. Davis as
executive vice president and CFO; in May 2006, the Company announced
that Mr. Davis would leave the Company under mutual agreement. In our
view, the departure of these officers reflects the board's failure to
assume accountability for the initial selection of these individuals,
the Company's poor performance and persistent accounting and financial
reporting since Mr. Ranieri became chairman.
In April 2006, the Company also announced that Robert Cirabisi had
assumed the responsibility as interim CFO. Mr. Cirabisi served as the
Company's U.S. Controller in 2000, during the period in which
accounting and financial problems took place. In July 2006, the board
appointed Nancy Cooper executive vice president and CFO. Once Ms.
Cooper's appointment becomes effective, Mr. Cirabisi will return to
his position as the Company's corporate controller and principal
accounting officer. We believe that the Company should untie its
relationship with those executives that served in its accounting and
finance departments during the time period in which the Company
acknowledged improper accounting.
We recommend withholding votes from the following nominees up for
election this year based on the following issues:
Nominee RANIERI has served as a board member since 2001 and
as chairman of the board since April 2004, during which time the
Company has experienced declining stock performance and considerable
management turnover. In our view, Mr. Ranieri, as chairman of the
board, should be held accountable for failing to put in place an
effective management team to improve the Company's financial
performance. While Mr. Ranieri has served as chairman:
- the Company's stock has declined by approximately 27.8% since he
became a member of the board in 2001;
- the Company's stock has declined by approximately 13.6% since
Mr. Swainson became CEO in February 2005; and
- the Company has forced the departure of several executive
officers in 2006, who were hired during his tenure as chairman of
the board, including Messrs. Clarke, Corgan, and Davis, former
executive vice president of worldwide sales, COO, and CFO of the
Company, respectively.
We believe that Mr. Ranieri, as chairman of the board, should be
held accountable for the Company's lackluster performance under his
direction, despite ample opportunities to bring on an effective
management team to implement the necessary operational changes.
Nominee D'AMATO has served as a member of the audit
committee for more than 6 years. He is the last holdout from the
members of the audit committee that approved certain financial data
that improperly timed recognition of the Company's license revenue in
fiscal years 2000 and 2001. The Company stated that it had prematurely
booked $1.8 billion in revenue in fiscal year 2000 and $445 million in
fiscal year 2001. We believe the audit committee is charged with the
responsibility of properly overseeing the Company's financial
reporting. As expressed in our 2005 Proxy Paper, we recommend
withholding votes from this nominee based on what we view as his lack
of oversight in what ultimately led to the prior restatements of the
Company's financials.
We are also concerned by the fact that Mr. D'Amato has continuously
been a member of the audit committee since the Company acknowledged
improper accounting, and that the Company still, as of July 31, 2006,
has ineffective internal controls in place that gave rise to the
recently identified accounting errors that required the Company to
restate its financials on several occasions in the past year. The
impact of these errors on subsequent periods and the lingering
problems with the Company's internal controls reinforce our view, as
we expressed in our previous two reports, that it would be best for
all directors who served during periods of accounting irregularities
be removed from the board.
Nominees LA BLANC and SCHUETZE have served on
the audit committee since 2002. Ms. Unger joined the audit committee
upon becoming a director in August 2004. During their tenure on the
audit committee, numerous accounting problems have arisen which
undermine the reliability of its financial reporting. In particular,
Messrs. La Blanc and Schuetze and Ms. Unger have served on the
Company's audit and compliance committee when the Company has also
faced:
- Several restatements over the past year to make adjustments in
subscription revenues, sales commissions, and income taxes for prior
periods in which these directors served as members of the audit
committee;
- Another restatement to increase its non-cash stock-based
compensation expense by $342 million for the ten year period from
fiscal year 1996 through 2006;
- Numerous material weaknesses in the Company's internal control
over financial reporting, including the five material weaknesses
discussed above which existed as of March 31, 2006, leading the
Company to conclude that its internal control over financial
reporting was not effective at the end of fiscal year 2006; and
- The inability to timely file the Company's annual report for the
second consecutive year.
Glass Lewis generally believes that restatements resulting from a
material weakness in a company's controls over revenue recognition
should be of serious concern to shareholders. Revenue is typically the
largest and most critical item on the income statement, therefore, we
believe companies are often tempted to overstate revenues by either
fraudulently misstating or by abusing existing generally accepted
accounting principles. In a 2003 study by the Huron Consulting Group,
revenue recognition was the single largest reason for corporate
restatements over the preceding five years. Furthermore, the 1999
Treadway Commission report on fraudulent financial reporting found
that more than half of the fraudulent financial reporting cases
involved overstated revenue. The complex nature of revenue recognition
and the heavy reliance on estimates, coupled with the poor
transparency in disclosures, should cause concern for shareholders due
to the corresponding increased risk of restatements as actual results
may vary significantly from the results initially estimated by a
company.
We believe this restatement signals a lack of competent internal
accounting expertise, poor internal controls and systems, and
aggressive financial reporting practices at the Company. We believe
that members of the audit committee bear the responsibility for
ensuring that the Company is pursuing careful application of GAAP and
reasonable accounting practices that ensure fair and reliable
disclosure to investors. In this case, we believe that members of the
audit committee during the relevant restatement periods have not
satisfactorily performed their duties in this regard.
We note that Messrs D'Amato and Ranieri also served as audit
committee members during periods subject to restatement. As such, we
recommend withholding votes from those nominees on this basis. We also
recommend withholding votes from Messrs. La Blanc and Schuetze, who
have served on the audit committee for the past four years. We believe
that four years is more than sufficient time to have established
credible and transparent financial reporting, without the constant
flow of restatements and lack of timely filings that continued in the
most recent fiscal year. However, at this time, we refrain from
recommending to withhold from Ms. Unger, as she has only served on the
audit committee for the past two years.
We do not believe there are substantial issues for shareholder
concern as to any other nominee.
Accordingly, we recommend that shareholders vote:
WITHHOLD: D'Amato; La Blanc; Ranieri; Schuetze
FOR: All other nominees
