In-depth: Deloitte and accounts expert both cleared what HPE described as 'contrived' Autonomy sales

Lynch's man backed auditor but how much did it truly know?


Autonomy trial Mike Lynch's expert accounting witness told the High Court that because Deloitte signed off Autonomy's accounts, everything must have been legal and above board.

Summarising disputed transactions between former British software business Autonomy and various resellers and customers, Gervase MacGregor cited auditor Deloitte's working papers as he concluded that everything Autonomy did was, broadly, A-OK and within the British accounting rules of the day.

A one-time investigator for UK watchdog the Financial Reporting Council, MacGregor was also the accounting expert for Sushovan Hussain during the latter's 2018 criminal trial in America. Lynch retained MacGregor as his accounting expert for the High Court trial that ended in January.

Like his counterpart, Peter Holgate, HPE's expert witness, MacGregor was told to pore over Autonomy's financial records and decision-making and express his expert opinion on whether each of the deals highlighted by HPE as evidence of deliberate malpractice were dodgy or not.

Unsurprisingly, he concluded all was broadly well – because Deloitte signed all the deals off at the time. Unlike Holgate in the latter's first expert report, MacGregor had access to Deloitte's detailed working papers, which helped him understand "the thinking of each of Deloitte and Autonomy on relevant issues at the time."

"Deloitte's 2009 and 2010 year-end audit working papers show that Autonomy's hardware sales were carefully considered" against accounting rules of the time, said MacGregor in his first expert report.

Quarter-start buybacks recorded as 'sales and marketing'

In one deal Lynch's expert examined closely, Autonomy was trying to close a sale of its Digital Safe product plus a support contract to American groceries megacorp Kraft in Q3 2009. Autonomy's fiscal year tracked the calendar year.

With the end of Q3 fast approaching and Kraft unwilling to sign off the sale before a scheduled October board meeting – well past the start of Q4 – Autonomy's salespeople reached an agreement with a friendly reseller called Capax Discovery: the Digital Safe licence would be transferred to Capax instead of sold to Kraft. Revenue for Autonomy would be recognised at that point as an upfront sale and counted as Q3's takings. Capax would then transfer the licence to Kraft once the deal was sealed between Autonomy and its true customer in Q4. Money would then be moved around so Capax was made whole.

Sure enough, in Q4 2009 Autonomy bought the Digital Safe licence back from Capax, threw in "$0.4 million" for the reseller's troubles and waived Capax's "contractual obligations to Autonomy under the original contract." The $400k was recorded as "third-party commission cost" under Autonomy's "sales and marketing" budget.

Discussing how the accountants and auditors handled this, MacGregor wrote: "At no point, however, did it appear that Deloitte challenged the upfront revenue recognised from the licensing of the Digital Safe software, or indicate to the contrary that it should be rateably recognised over the term of the licence."

Instead, he said: "Licence revenue recognised on the direct licence sale to Kraft by Autonomy in Q4 2009 was offset by [a] credit note (raised in Q4 2009) against the sale to Capax Discovery, i.e. the net effect on revenue in Q4 2009 was nil."

So that everything was netted off properly, wrote MacGregor, "as a matter of accounting books and records the revenue recognised in Q3 2009 remained, but revenue was not double-counted on the direct sale to Kraft."

The sale was recorded in Q3 2009 as having been made to Capax and counted as revenue; in Q4 a credit note was issued to Capax that zeroed the value of the sale; then Kraft paid up, making the books whole again. HPE accused Lynch and co-defendant Sushovan Hussain of creating "a contrived means of accelerating the recognition of revenue from the hoped-for transaction with Kraft."

Auditors signed it off as A-OK

What did Deloitte make of this rather complex arrangement? MacGregor dug out its audit review paper, which was presented to Autonomy's internal Audit Committee when it was pondering that year's accounts. This said:

The end user is Kraft and the VAR involved is Capax Discovery LLC. PDW [per discussions with] Autonomy it is apparent that in depth discussions were held between Kraft and Autonomy prior to quarter end. Kraft were unable to finalise the deal until their board meeting on 15 October; hence Autonomy decided to sign a deal with Capax whereby Capax complete the deal with Kraft after the 15 October but take on all the risk. Deloitte have reviewed correspondence with all parties involved that supports this sequence of events…

Having satisfied himself that the auditors examined the deal at the time, MacGregor then wrote in his report that HPE was wrong to allege the deal broke accounting rules. After all, Deloitte said it was OK and it had access to all the contemporaneous documents proving so, he said.

The expert wrote: "In respect of the overall allegation that this was a 'contrived' transaction made in order to accelerate the recognition of revenue on a transaction with Kraft, in my opinion the claims made that Autonomy did not comply with IAS 18.14(a), (b) and (d) [British accounting rules in force at the time] appear to the contrary to have been considered at the time of original revenue recognition."

"Deloitte said it was OK," is the main plank of Lynch's defence against the accounting allegations made by HPE. The auditor – one of the "Big Four" – reached an out-of-court settlement with HPE prior to the start of the Autonomy trial.

But there was a critical question still lurking over this deal, as well as others held up by HPE as proof of deliberate fraud. Did Autonomy make a secret side agreement with Capax saying that no matter if Kraft pulled out, Capax would never have to pay Autonomy for the software licence? Here MacGregor went from confidently striding ahead to tap-dancing on the head of a pin.

Such a thing, he reluctantly conceded, "could be a factor in determining whether or not the risks and rewards of ownership were transferred and/or it was probable that there would be a transfer of economic benefit and therefore whether or not the criteria for revenue recognition under IAS 18.14 had been met at the time that revenue was recognised by Autonomy".

In plain English, yes, the existence of a side agreement that wasn't disclosed to Deloitte could see its audit judgment cast aside.

Sidling along

Side agreements were, as Autonomy's US CEO Stouffer Egan testified, not uncommon – though Lynch and co-defendant Sushovan Hussain both claim Egan only testified to save his own skin from American prosecutors.

John Baiocco, Capax Discovery's CEO, was questioned thoroughly about side agreements during his time in the witness box last year. When Lynch's lawyer, Robert Miles QC, suggested that by doing this Autonomy was in effect lending Capax Discovery cash to get it up and running (the reseller was an offshoot of the main Capax company, set up specifically for Autonomy business), Baiocco strongly disagreed.

"That would be false," the reseller boss told the High Court. "I knew flat out when I signed [the licence agreement] that we were going to get the money on the handshake deal." He later added: "To me it was – he [Christopher Egan, Autonomy's US sales chief] was going to give me the money all the way through."

On the flip side, as recounted at the link above, Baiocco told the High Court that his HPE-funded lawyer wrote his witness statement, a document he appeared not to recognise when shown a copy in court.


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