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Did Fake Purchase Orders Lead to CFO's Ouster?

International Rectifier gives more details on its accounting woes, but won't say specifically why its CFO was fired.
Sarah Johnson, CFO.com | US
September 4, 2007

What's in a name? Irony, in the case of International Rectifier. The company, which has been struggling with a series of accounting problems, announced just before the Labor Day weekend that most of the problems it needs to rectify are, in fact, international, and at least partly the result of fake purchase orders created by a Japanese subsidiary.

An audit investigation that began at least five months ago had already prompted the company to say at least six quarters' worth of financial statements should not be relied upon and to put its CEO on a leave of absence with pay. In addition, according to analysts who follow IR, the accounting problems, which were not described until the August 31 filing, may have something to do with why Michael McGee, its CFO of 14 years, was fired earlier this summer.

On Friday, IR revealed that a Japanese subsidiary apparently created fake purchase orders and phony warehouses. The company said it has also found issues with how it classified charges from its restructuring efforts over the past four years, and it noted problems with its transfer-pricing methodology dating back to its fiscal year 2002. The company now says the bulk of its financial statements over the past five years cannot be trusted.

In the meantime, the company has implemented new internal controls at the subsidiary and placed some of the Japanese unit's managers on leave.

IR made the revelations in a filing explaining why it is so late with its 10-K for fiscal year ended June 30. However, the company won't predict when it will bring its financials up to date. IR will do so "as promptly as practicable" as it continues its investigation, it said. The company also wouldn't rule out the possibility that an investigation by an independent accounting firm would turn up more problems. So far, the work related to this probe has cost the company approximately $13.1 million.

The El Segundo, California-based company realizes 11 percent of its $1.17 billion in revenue from Japanese customers. In addition to its Japanese subsidiary, International Rectifier Japan Co. in Tokyo, IR owns a stake in two other Japanese entities, including Japanese listed Nihon Inter Electronics Inc., of which it holds 9.7 percent interest. While CFO, McGee was chairman of Nihon from 2000 to 2005 and co-CEO for three of those years. He was terminated in early July; however the company has refused to explain why. Attempts to locate McGee have been unsuccessful.

Still, as a "worldwide chief financial officer," McGee's responsibilities included "all worldwide facilities," spokesman Graham Robertson told CFO.com. Robertson emphasized that IR has not blamed any one executive for the accounting issues as the investigation continues.

McGee is not the only executive who left IR in the middle of the investigation. One day before releasing its most recent regulatory filing, IR announced that it had asked CEO Alex Lidow to leave the company while its investigation continues. General counsel Donald Dancer has taken over as acting CEO and vice president of corporate finance Linda Pahl is the new acting CFO.

Both of Dancer's and Pahl's names were on the August 31 filing outlining the Japanese subsidiary's problems and the effect it has on IR's financials. The subsidiary "circumvented established controls and processes to record false or premature sales by creating fictitious customer purchase orders in the existing control system," the filing noted. These orders and subsequent shipments were not reflected in the company's books until a real order was placed.

When the subsidiary received "an actual" customer purchase order, the company filled the request from the inventory in the so-called off-books warehouses. The customer service department used a separate database to keep track of the orders. If a real order could not be filled, then the subsidiary would place the order though the company's "normal" purchase system. IR further admitted that part of the cash received from customer for actual accounts receivable was applied to fictitious accounts receivable.

To fix the acknowledged material weakness in Japanese subsidiary's internal controls, IR has made several changes, such as implementing new controls for inventory, order processing, and accounting. IR has also placed some Japanese managers on administrative leave and conducted a physical count of its inventory in the off-books warehouses, valued at $16 million as of April. The company has also assigned an interim controller to the subsidiary.

The company also acknowledged that it found issues with transfer pricing and other tax issues during fiscal years 2002-2007 while getting ready to adopt FIN 48, the Financial Accounting Standards Board's rules for accounting for uncertain tax positions. The company is reviewing its potential tax liabilities, credits, and other related matters and says it may have to restate its recorded tax liabilities and tax provisions for the previous years, including the first two quarters of fiscal year 2007.

IR has also decided to reclassify charges taken for restructuring initiatives it undertook in December 2002. The company had been recording some of the related amounts as "impairments of assets, restructuring, severance, and other changes" when it should have put then in other line items of its income statements or disclosed them in footnotes. The company's impending restatement will reflect this change, but the company does not expect it to materially affect its past results.




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