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IBM top brass accused again of using mainframes to prop up Watson, cloud sales

Securities fraud lawsuit reloaded

Special report IBM, along with 13 of its current and former executives, has been sued by investors who claim the IT giant used mainframe sales to fraudulently prop up newer, more trendy parts of its business.

In effect, IBM deceived the market about its progress in developing Watson, cloud technologies, and other new sources of revenue, by deliberately misclassifying the money it was making from mainframe deals, assigning that money instead to other products, it is alleged.

The accusations emerged in a lawsuit [PDF] filed late last week against IBM in New York on behalf of the June E Adams Irrevocable Trust. It alleged Big Blue shifted sales by its "near-monopoly" mainframe business to its newer and less popular cloud, analytics, mobile, social, and security products (CAMSS), which bosses promoted as growth opportunities and designated "Strategic Imperatives."

IBM is said to have created the appearance of demand for these Strategic Imperative products by bundling them into three- to five-year mainframe Enterprise License Agreements (ELA) with large banking, healthcare, and insurance company customers. In other words, it is claimed, mainframe sales agreements had Strategic Imperative products tacked on to help boost the sales performance of those newer offerings and give investors the impression customers were clamoring for those technologies from IBM.

"Defendants used steep discounting on the mainframe part of the ELA in return for the customer purchasing catalog software (i.e. Strategic Imperative Revenue), unneeded and unused by the customer," the lawsuit stated.

IBM is also alleged to have shifted revenue from its non-strategic Global Business Services (GBS) segment to Watson, a Strategic Imperative in the CAMSS product set, to convince investors that the company was successfully expanding beyond its legacy business.

Last April the plaintiff Trust filed a similar case, which was joined by at least five other law firms representing other IBM shareholders.

A month prior, the IBM board had been presented with a demand letter from shareholders to investigate the above allegations. Asked whether any action has been taken as a result of that letter, IBM has yet to respond.

Due to the way complex securities litigation works, the firm representing the largest group of investors – Ironworkers Local 580 Joint Fund – took over the handling of the case, then in September, 2022, moved to have the case voluntarily dismissed without prejudice [PDF], meaning the charges could be refiled. The Register understands this was a result of disagreements with the initiating law firm about how the case should be handled.

The new complaint expands upon the one filed last year while also omitting previous allegations that the supposed securities fraud allocated revenue for the purpose of maximizing executive bonus compensation.

It names as defendants four previously accused corporate leaders – former CEO Ginni Rometty, former CFO Martin J Schroeter (now CEO of IBM spin-off Kyndryl), current IBM CFO James J Kavanaugh, and current CEO Arvind Krishna – as well as nine additional current and past executives.

These include: Bridgette Van Kralingen (former SVP of IBM global markets; Shanker Ramamurthy (current IBM global managing partner banking); Pablo Suarez (VP & global leader, financial services sector centers of competence and digital banking at IBM); Sarah Diamond (former IBM global managing director, financial services sector), Alistair Rennie (former IBM general manager, blockchain); Mark Andrews (former VP of IBM Watson financial services solutions); Don India (former VP of IBM Watson financial services solutions); Chris Johnston (former North American business unit executive for Watson financial services); and Mark Foster (current global chairman IBM consulting).

Two members of this expanded cast of defendants, Shanker Ramamurthy and Pablo Suarez, were also named in an intellectual property theft case filed by former GBS consultant Gerald Hayden against IBM in March 2021. That case, still being litigated, focuses on events that occurred principally during the period from 2018 to 2020, around the time Rometty stepped down as chief exec. It describes IBM's alleged efforts to co-opt a proprietary business method for accelerating the lengthy enterprise sales process and to transfer GBS revenue to Watson.

How we got to this point: Let's go back a few years

In 2018, things were starting to look up for IBM. In April that year, the one-time corporate colossus reported revenue growth for the second quarter in a row after 22 consecutive quarters of revenue retreat.

But Big Blue had a problem. Mizuho Bank, part of the third largest financial group in Japan, was looking for an IT supplier. Mizuho's Request for Proposal (RFP) detailed the bank's need for KYC (Know Your Customer) solutions – because banks are obligated to identify and verify their clients to mitigate fraud – and an interest in the provider's platform strategy.

IBM at the time allegedly didn't have either a KYC-AML (anti-money laundering) offering nor a platform strategy.

But AML Partners (AMLP), a New Hampshire-based risk mitigation firm, did. And it submitted its technology in a response to Mizuho's RFP and agreed to cooperate with IBM to develop a suitable platform strategy that incorporated KYC capabilities.

Goodwill between the two companies would not last long.

When it came time for IBM to present the financial solution to Mizuho, company executives cut AMLP out of the deal by claiming AMLP's technology as their own, according to Frank Cummings, CEO of AMLP, and former IBM employees who worked on the RFP.

Cummings raised concerns about the handling of the deal on April 15, 2018, in an email to Michael Henry, who at the time was the IBM Global Business Services executive overseeing the engagement.

Henry replied promptly and said he would investigate. But that probe evidently was not satisfactory.

On May 1, 2018, Cummings escalated the issue, hoping to discuss "grave matters of business" related to potential fraud. He wrote to Mark Foster, IBM's SVP of Global Business Services at the time, and copied in then-CEO Ginni Rometty, her assistant, and AMLP co-founder Jonathan Almeida.

"First and foremost, IBM involved my firm and our software in IBM's efforts to resolve its problems at Mizuho, but in a final draft of the Mizuho proposal not shared with me. Mr Henry apparently altered the proposal purposely to misidentify AML partners' software as 'Watson Financial Crimes' products," Cummings wrote in an email now seen by The Register.

"This misrepresentation of our software – and misrepresentation to the client Mizuho – was done without our permission or formal agreement."

"By adding Watson Insights to the Mizuho proposal, this deal is now at great risk; a viable alternative would have been to do an up-sale after implementation," the letter continues.

"To be clear, IBM does not possess an operational AML (anti-money laundering)/KYC system, and it is misrepresenting that claim to Mizuho in a way that harms my company."

More troubling still, Cummings said he had since learned Henry wanted to bring in replacement technology from Ireland-based competitor Fenergo, adding that sources at IBM had informed him IBM personnel involved in the deal had ties with Fenergo prior to being recruited to join IBM's Watson team.

As detailed in one of several OSHA complaints against IBM filed by whistleblowers and seen by The Register, Henry allegedly had received compensation at one point from Fenergo for helping the bank tech firm obtain millions of dollars in investment funds.

Michael Henry, no longer with IBM, has not replied to inquiries seeking comment. The aforementioned Hayden-filed lawsuit [PDF] also detailed Henry's alleged interference in the AMLP deal.

Cummings offered IBM's leadership an opportunity to save face by saying "this cannot be a corporate strategy, not at IBM," and went on to tease the possibility of a mutually remunerative relationship – if the Mizuho situation could just be resolved.

When The Register spoke with Cummings on the phone to confirm the authenticity of the email messages, he no longer lauded the company's leadership.

"Literally, a cabal of the worst of the worst got in charge of IBM and destroyed its reputation," Cummings said.

Big Blue defends itself

On May 2, 2018, Sarah Diamond, then Global Managing Director of Banking and Financial Markets and among those named in the new securities lawsuit, responded to Cummings's message on behalf of Foster to say, "IBM takes these matters seriously, and is looking into them in detail."

Three weeks later, Diamond denied Cummings's allegations – that IBM was committing fraud, negotiating in bad faith, misrepresenting AML Partners' software as its own, breaching its NDA with AML Partners, and stealing AML's intellectual property.

"While I will not walk through each of your allegations separately, I want to assure you that, with respect to the Mizuho RFP in particular, IBM has not changed (and does not intend to change) its written RFP response to replace ALP's RegTech Surety Suite solution with a Fenergo solution," Diamond wrote in an email.

"Moreover, the alleged conflict-of-interest with Fenergo identified in your correspondence does not exist. To the extent Mizuho decides to choose a solution other than one from AMLP, it would not be the result of any 'bait- and-switch.' It is our understanding that Mizuho is still in the process of evaluating the bid submissions and determining whether it wants to separate the on-boarding component from the due diligence component or what specific solution components it desires. If the client selects IBM's RFP response that includes AMLP, IBM has full intention to move forward with AMLP."

She insisted that IBM had not changed its written RFP to replace AML's technology and did not intend to do so.

According to the Hayden complaint from 2021, "Michael Henry was under pressure from more senior IBM executives to sell Watson. On information and belief, this pressure came from, among others, Sarah Diamond."

IBM in its answer to the Hayden lawsuit denies this [PDF] and other allegations.

That lawsuit describes the outcome of IBM's engagement with Mizuho. AML Partners was allegedly dropped from the Mizuho engagement after Sam Kalyanam, Global Business Head of Watson Financial Crimes and Compliance Group, wrote an email proposing Fenergo's technology instead of AML Partners.

IBM denies this in its answer filing. The Register inquired to Fenergo about these allegations, and the company did not respond. Mizuho Bank declined to comment.

A source familiar with the 2018 RFP told The Register that IBM associates in Japan and elsewhere would not confirm who won the deal nor its terms, despite internal announcements about a Mizuho success.

By 2020, IBM announced it had joined forces with Fenergo to fight financial crime. "The agreement enables IBM and Fenergo to create solutions that combine Fenergo's [client lifecycle management] offering with IBM's RegTech portfolio of anti-money laundering (AML) and know-your-client (KYC) solutions, all built with Watson," the press release declared.

This from an enterprise that, according to Cummings, did not possess an operational AML/KYC system two years earlier.

One of the OSHA complaints against IBM we've seen recounts a conversation in which Henry allegedly said that Mark Foster, SVP of IBM's GBS division, was a friend of Rometty and served as a figurehead who allowed Rometty and Diamond to do whatever they had to in order to keep Watson afloat.

"Henry was acknowledging that IBM senior management was illegally 'revenue shifting,' giving GBS deal earnings to Watson to mislead investors about Watson," the OSHA complaint stated.

The 2021 intellectual property complaint focuses on allegations that IBM stole protected business methods – "Awareness to Execution" (A2E) and "Efficiency, Effectiveness, Real Time" (EERT) – developed by the plaintiff to accelerate enterprise deals and to support real-time management of financial data.

And it describes other IBM engagements where GBS revenue was allegedly shifted to the Watson division – thereby depriving the consultants involved of commissions.

For example, IBM GBS closed a deal with Ocean Bank, the second largest retail bank in Florida. But according to Hayden's complaint, "IBM denied credit for the Ocean Bank deal to GBS and instead awarded it to the Watson Group," supposedly at the direction of Diamond, a former Watson general manager.

Why Watson?

Watson was part of CEO Ginny Rometty's transformation plan. Rometty took over from Sam Palmisano in 2012, and initially followed his "Roadmap 2015" until late 2014. She then set about deemphasizing the company's legacy hardware, software, and IT services businesses while trying to boost "Strategic Initiatives" – cloud, analytics, mobile, social, and security, or CAMSS.

The Watson platform, introduced in 2014, was the A in CAMSS. IBM created a separate business unit called Watson Health in 2015.

There was zero – I mean zero – AI in that product suite. I know because I worked directly with the engineering development manager

Rometty described the spinoff as a moonshot, in the tradition of IBM's work for NASA. "Our moonshot will be the impact we will have on healthcare," she said in a 2015 interview with Charlie Rose.

A source familiar with IBM, citing claimed correspondence between Rometty and a Trump family member, told The Register that Rometty was eager to make Watson Health a high profile success in the hope it could help her obtain a political appointment.

Coincidentally, IBM's law firm, Jones Day, had close ties to the Trump administration through partner Donald McGahn, Trump's first White House counsel. In January 2021 IBM hired Garry Cohn, who had been part of the Trump administration, and he is now Big Blue's vice chairman.

By 2016, Watson Health looked frail. A University of Texas System audit [PDF] found the $62 million IBM Watson engagement with the school's MD Anderson Cancer Center, which began in 2013, ducked university procurement rules. By September 2016, the MD Anderson Watson project, Oncology Expert Advisor, was abandoned.

A former IBM employee who spent decades with the company told The Register that he had worked for several years on Watson Health, which he said was cobbled together from a handful of different healthcare company products.

"I worked in a group where we acquired Truven Health Analytics," he explained. "There was zero – I mean zero – AI in that product suite. I know because I worked directly with the engineering development manager. He even brought this to Ginni's attention. He said, in some executive meeting, 'Hey, Ginni, you know, just to make it clear, I'm the VP of development for Truven, and I'm telling you, there's no AI in here. And that, he said, that was not received well.

"Just because you slap Watson on there doesn't make it AI. They call it AI and analytics, and pretty soon it gets all cobbled together. 'Oh, this is our AI division,' or 'analytics group' and 'this is what the revenue is.' Everything gets sliced and diced and repackaged up to be whatever they want it to be."

But IBM was determined to make the most of the Watson brand. In September 2016, the tech goliath purchased financial consultancy Promontory Financial Group, which became Watson Financial Services in 2017. Around that time, financial analysts were questioning why Watson wasn't contributing to revenue.

It was Watson Financial Services, along with IBM's GBS consulting arm, that worked on the Mizuho Bank deal.

Just because you slap Watson on there doesn't make it AI. They call it AI and analytics, and pretty soon it gets all cobbled together

But there was another reason Rometty and other IBM leaders wanted Watson to do well: bonuses. From 2015 through the end of 2018, Big Blue tied executive bonuses and employee commissions in part to revenue for its Strategic Imperatives – CAMSS products.

This was noted in the press at the time. For example, on February 6, 2017, Bloomberg reported that Rometty "got her biggest bonus as head of the company last year after the shares rose about 21 percent, the first annual gain in four years. … The [$4.95 million] bonus was tied to goals for operating net income, operating cash flow and revenue from the company’s 'strategic imperatives,' according to a March proxy statement."

The April 2022 securities fraud lawsuit filed against IBM claimed the company's decision to tie CAMSS revenue to bonuses led executives and similarly incentivized employees to misclassify revenue from various products as CAMSS sales, fraudulently, in an effort to enhance their compensation.

Executive interest in inflating bonuses may also explain IBM's $58 billion in stock buybacks, partially paid for with borrowed funds, between 2012 and 2019 under Rometty. Buybacks boost earnings per share – net income gets divided by fewer shares – and can increase performance-based compensation if they help financial results meet performance targets set for executives.

IBM's layoffs during this period – the subject of numerous age discrimination lawsuits, many of which have quietly settled – can also be viewed through the lens of financial engineering to maximize executive compensation awards. So too can numerous allegations that Big Blue capped commissions, withholding payments promised to enterprise sales staff for the sake of the company's balance sheet.

While the latest securities fraud lawsuit omitted allegations related to motive – financial engineering to maximize bonuses – The Register understands such claims may resurface as what's expected to be a lengthy legal process plays out.

Confirmation from former IBMers

After The Register reported on last year's securities fraud claim involving the stuffing of enterprise contracts, the former IBM employee cited above wrote to say, "I can affirm and attest that the practices you describe in your article occurred, and your facts are accurate.

"As I'm sure you heard from other IBMers, yes, IBM employed a carrot and stick approach to encourage sales professionals to engage in this behavior: if you played the game, you were rewarded by increased commissions, higher performance ratings, and management approval; if you did not play the game, you were penalized with lower commission checks, lowered performance ratings, and likely either a 'Performance Improvement Plan' (PIP), or a 'Resource Action' package (i.e, layoff).

"This is a decades-long, Enron-level grift perpetrated by upper management."

If you played the game, you were rewarded by increased commissions

Peter E Greulich, who retired from IBM in 2011 after 30 years at the company and now writes about IBM and corporate management, told The Register in a phone interview that ELAs started out being helpful for customers.

"In the Software Group, we used to have something called an Enterprise License Agreement," he explained. "And fundamentally, it was a great concept. We would walk in and a customer maybe had significant investment in a set of Tivoli products, right? And a client executive would say, 'Look, you got all these Tivoli products. Let's take a look at some other products. Let's get the amount that you buy up, let's get the discount down.'"

Greulich explained how that worked at a very large customer account where he and his colleagues had to make multiple visits to close the deal.

"We had to sell individual organizations [within the company] on our products, and then a reputable client exec – the person that owns the account and who would suffer if anything bad happened – would would put together an Enterprise License Agreement with all the products that a customer might have need for over an extended period of time. They might not need it today. But they would believe that they may need it a year or two or three years down the road."

Initially that worked out well, said Greulich, because client execs make salespeople prove to the customer that what was being sold might be used someday.

"It evolved, though, to the point where executives started telling organizations, 'hey, this product needs to be in the ELA deal.' Like 'I don't care how you get it in there, but it has to be in there.' And the fundamental unsaid statement was, 'whether the customer needs it or not.'"

When Gartner did their analysis, they said, 'hey, we can't find one customer using this product'

He cited Tivoli Provisioning Manager as a product that IBM salespeople tried to sell, though no one wanted it. "When Gartner did their analysis, they said, 'hey, we can't find one customer using this product.' We'd been selling the heck out of it because of the Enterprise License Agreements. Executives had issued an order down to the client teams that if they didn't move that product, then they're in trouble."

The allegations of security fraud were brought to the IBM board of directors last year, as the company acknowledged in a June 30, 2022 financial filing:

On April 5, 2022, a putative securities law class action was commenced in the United States District Court for the Southern District of New York alleging that during the period from April 4, 2017 through October 20, 2021, certain strategic imperatives revenues were misclassified. The company, two current IBM senior executives, and two former IBM senior executives are named as defendants. … On March 25, 2022, the Board of Directors received a shareholder demand letter making similar allegations and demanding that the company’s Board of Directors take action to assert the company’s rights. A special committee of independent directors has been formed to investigate the issues raised in the letter.

IBM, according to an OSHA whistleblower document, was made aware of allegations of securities fraud and intellectual property theft back in March 2018 when an internal complaint was allegedly filed with the head of human resources and the company's ethics committee. IBM's response, it's claimed, was to retaliate against the employees who raised the issue through corporate channels.

The Register twice asked IBM whether its board of directors has taken any action in response to the allegations in the demand letter and we asked the company to comment on the latest lawsuit. We've not heard back. ®

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