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Whistleblower court case comes back to haunt company

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Microsoft admitted yesterday that it is being investigated by the US Securities and Exchange Commission over a possible breach of SEC rules. In a conference call, CFO Greg Maffei said that the SEC is investigating the way that Microsoft treats reserves. In a crafty move to detract from the significance of the SEC move, Microsoft also announced some unrelated changes in accounting practices. Maffei also said that he was "comfortable" with the estimates being made for Q4, which has just concluded: the results will be announced on 19 July. Microsoft was told of the SEC investigation some months ago. It began in January following disclosures related to a wrongful dismissal claim brought by Microsoft's former general auditor, Charles Pancerzewski. (Earlier story) He was offered a "resign or be fired" choice in 1996 after he drew attention to accounting practice irregularities. Mike Brown, the former CFO, wrote in an email to Gates that "I believe we should do all we can to smooth our earnings and keep a steady state model". Pancerzewski was appointed in February 1995 and complained that Microsoft used its reserves to pad its earnings in lean quarters. This would mean that Microsoft misreported its earnings, in breach of SEC rules, but its share price kept rising. For its part, Wall Street does not seem to mind. It is argued, in the WSJ in particular where undoubtedly there are vested interests in keeping Microsoft's share price up, that even if the accounts had to be restated, the result would be to show more income from the secret slush fund, so there was no deception. Pancerzewski had a negative review of his work from Brown in August 1995, after which he received the quit or be fired ultimatum. The result was that he quit, but filed suit under the Whistleblowers Protection Act in 1997. Microsoft's records were subpoenaed. Judge Carolyn Dimmick dismissed some charges, including age discrimination, but said there was enough evidence to go to trial on the whistleblower charges. In November, the case was quietly settled out of court, with Pancerzewski apparently accepting $4 million in compensation. One of the terms of the settlement was a gagging agreement, of course, and the court record being sealed. Both Brown and Pancerzewski were formerly with Deloitte & Touche, Microsoft's auditors. The circumstances in which Brown left Deloitte to become CFO while the firm was the auditor have not been satisfactorily explained, and could well be against even the elastic ethical rules about jumping ship from auditor to client. Brown however head-hunted Pancerzewski to Microsoft, prior to having his head. The SEC won't comment on the case, and Microsoft is naturally protesting its innocence in the matter. But from what has been seen in the Microsoft trial, such protests must now be tempered by disclosures of unethical business practices. The big difference between the present DoJ antitrust case and being found guilty of false accounting charges is that people can go to prison for the latter. There seems to be little doubt that any manipulation of earnings results would have been to prop up the share price. There are also other matters that will concern the SEC, including the exact way in which analyst expectations are always exceeded so far as Microsoft's results are concerned. There is enough flexibility in the rules of accounting practice to make it just possible for this to be done legally, but it would be very easy to step over this boundary, and a legal challenge by the SEC cannot be ruled out. Microsoft has also been very lax in making formal statements to the SEC about changes in share ownership by Microsoft executives. An SEC rule requires that it be notified no later than the tenth day of the month following the transaction. There was a noticeable improvement in this reporting when the trial started. In addition, statements during the trial by Microsoft's economics witness Richard Schmalensee showed that Microsoft told him it did not account for Windows revenue, and that IE development costs could not be separated. There was widespread incredulity about this. With Microsoft's shares rising $2.19 to $90.19 yesterday, it would be interesting to know if Microsoft was a major buyer of its own shares yesterday, so as to ensure that the share price did not dip on the news, and start a panic. ®

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