In a case his attorney says could have had a “chilling effect” on senior financial executives’ communications with analysts if it had gone the wrong way, Frederick Schiff, a former CFO of Bristol-Myers Squibb, won a deferred prosecution agreement from a New Jersey federal court last week. Schiff had been charged in 2005 with conspiracy and securities fraud for an alleged earnings-management scheme.
Under the DPA, Schiff, a 20-year veteran of the company who left in 2002 after only 1 year as CFO, must pay $225,000 to a BMS shareholder fund administered by the U.S. Department of Justice. Also, he cannot be CFO or chief executive of a public company for two years. If he stays out of trouble, the criminal charges against him will be dropped in a year, according to his lawyer, David Zornow. Schiff has admitted no wrongdoing.
Along with Richard Lane, a former executive vice president at BMS who also won a DPA, Schiff was charged with planning and hiding a channel-stuffing scheme aimed at meeting sales and earnings targets and Wall Street consensus earnings estimates. But in March 2008, five days before the defendants were set to go to trial, U.S. District Judge Faith Hochberg narrowed the liability under which they could be charged in a way that “eviscerated the government’s case,” Zornow tells CFO.
Most significant for CFOs, Judge Hochberg threw out the government’s argument that Schiff and Lane had a duty to disclose certain information in analyst calls and in financial filings. The government had charged that the two men failed to reveal the company’s practice of using financial incentives to boost wholesaler purchasing. “If this case had been pursued, it could well have had a chilling effect on the conduct of corporate executives on analysts’ calls, in a way that would have been very harmful,” says Zornow, an attorney with Skadden, Arps, Slate, Meagher & Flom.
The government then appealed Hochberg’s ruling in the Third Circuit U.S. Court of Appeals, which unanimously upheld her decision in April. “In light of the Third Circuit’s ruling on various legal issues in this case, we determined that the interest of justice would be best served by deferring prosecution,” Rebekah Carmichael, public affairs officer with the U.S. Attorney’s Office in New Jersey, said after the announcement of the DPAs.
In the indictment, prosecutors had argued that during conference calls, Schiff and Lane misled investors about the amounts of BMS inventories stocked by wholesalers. They also allegedly ignored concerns expressed by company employees about the use of financial incentives to spur the wholesalers to take the goods.
In October 2001, prosecutors noted that Schiff and Lane approved a package of $47 million in sales incentives to wholesalers allegedly to enable BMS to hit its earnings numbers for the third quarter. A month later, Lane approved a package of $85 million in sales incentives for the fourth quarter of 2001, according to the indictment.
The rulings against the government were also significant “because the government typically gets its way in these cases,” says Zornow. The difference between this case and earlier, successful prosecutions such as Enron and WorldCom is that “those were blatant accounting frauds where there were phony revenues,” he says.
Further, traditional channel-stuffing cases involve suppliers asking wholesalers near the end of a quarter to accept a shipment of goods. Typically, the supplier then books the “sales” as revenue in order to meet company earnings targets. After the end of quarter, the wholesaler ships the goods back to the supplier. The case against Schiff and Lane, on the other hand, involved “real sales [to wholesalers] for real dollars,” says Zornow.