Vitesse's Mess

In one of the most sweeping mea culpas since the options backdating scandal broke, Vitesse Semiconductor said former members of its senior management team "backdated and manipulated" the grant dates of stock options issued over several years, used improper accounting practices—primarily related to revenue recognition and inventory, and prepared or altered financial records to conceal the questionable practices.

As a result, the chip maker dismissed KPMG as its independent auditor, citing its lack of independence. It added that the board is in contact with other public accounting firms and will work to engage a new independent public accounting firm as soon as practicable. The company also said it has taken a number of other remedial actions to address the issues.

The committee said it did not find evidence that any current member of the board—other than former chief executive officer Louis R. Tomasetta—the compensation committee, or current senior management was aware of improper practices with respect to stock options. Nor did the special committee find evidence that members of the board, other than Tomasetta, profited from the practices.

However, the special committee identified one option grant to members of the board in 1996, which appeared to be inadvertent, that had the effect of increasing the profit to some board members upon exercise by approximately $18,000 each. It added that current board members, other than Tomasetta, who profited from the 1996 grant volunteered to return to Vitesse the increased profit to them caused by the improper dating of their options.

The committee also estimated that the total additional expense to Vitesse resulting from the backdating and manipulation of stock options is roughly $120 million since 1995, including about $20 million to $25 million for fiscal years 2002 through 2006.

In May, Tomasetta, Yatin Mody, Vitesse's former chief financial officer, and Eugene F. Hovanec, former executive vice president, were immediately put on administrative leave at the outset of the review by the special committee and were eventually terminated as officers and employees of Vitesse.

The special committee also found evidence of a slew of other accounting failures. For example, Vitesse failed to record credits for merchandise returns and other customer credits in the appropriate accounting periods, and did not write-off related accounts receivable. It also failed to record inventory for returned merchandise in the appropriate accounting periods.

In addition, the company recorded false sales invoices that increased revenue, permitted merchandise returns significantly in excess of the customers' contractually permitted levels—which included the improper handling of those returns—and booked sales that did not meet the requirements for revenue recognition, including consignment sales, shipments prior to customers' requested shipment dates, and shipments to warehouses.

"The special committee found evidence that certain of these practices appear to have been used on certain occasions to manipulate revenues for accounting periods in consideration of Wall Street expectations," the company explained. The special committee also found evidence that certain officers and employees prepared or altered documents or Vitesse's financial records to conceal some of these practices from Vitesse's board of directors and its independent public accountants.

Vitesse announced that it would change its revenue recognition policy to use a "sell through" methodology, under which revenue is not recognized until a sale is made to the ultimate customer, rather than a "sell in" methodology, under which revenue is recognized when a sale is made to Vitesse's distributors. The company also said the board has requested the special committee analyze Vitesse's claims against Tomasetta, Mody, and Hovanec in connection with certain of the questionable activities and evaluate those persons' claims for advancement of legal expenses.

The committee has instructed management to develop a remediation plan to rectify the accounting matters, as well as implement corporate governance changes at the board, management, and employee levels to establish "best practices" aimed at preventing opportunities to manipulate revenues and other financial data.

Meanwhile, Vitesse appointed Edward Rogas, Jr. chairman of the board and chairman of the audit committee, and named Moshe Gavrielov chairman of the compensation committee. In addition, John C. Lewis said he will retire as a director, effective January 1. "The board is undertaking a further review of the composition of the board and its committees and will commence efforts to identify appropriate and qualified persons to become directors of Vitesse," said the company in a statement.