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Probe Of Lucent Is Broader

SEC Probe Covers Issues Back to 1995, Some Involving Board Member O'Neill

Nov 1, 2002

The Securities and Exchange Commission's formal investigation into Lucent Technologies Inc.'s accounting and financial-reporting practices is far broader than the company has disclosed, according to people familiar with the probe, covering possible earnings manipulations dating as far back as the mid-1990s.

SEC investigators also are seeking to determine whether any current or former Lucent board members, including Treasury Secretary Paul O'Neill, may have been aware of any accounting violations at the company as they were occurring, the people said. Of particular interest to SEC investigators: the role of Lucent's audit committee, the group directly responsible for overseeing the integrity of Lucent's internal controls, as well as its financial-reporting and accounting practices.

Mr. O'Neill joined Lucent's board and audit committee in October 1996, six months after Lucent's initial public stock offering as part of its spinoff from AT&T Corp., and resigned to join President Bush's cabinet in December 2000, the same month Lucent announced it would revise the previous quarter's financial results. The revisions reduced revenue by $679 million for the three months ended Sept. 30, 2000, and widened its losses by $259 million.

There isn't any indication that Mr. O'Neill's role in the Bush administration has influenced the SEC's Lucent probe. Nor does anything indicate that Mr. O'Neill or other outside board members during their tenures were aware of any improper accounting practices at Lucent as they were continuing. Historically, the SEC seldom has brought disciplinary actions against outside corporate directors in cases involving accounting irregularities. However, according to a person familiar with the inquiry, the role of directors has become a more standard feature in SEC accounting probes since Enron Corp.'s collapse last year.

A Lucent spokeswoman, Kathleen Fitzgerald, said Lucent has "no reason to believe the SEC has expanded their investigation" beyond the $679 million revenue revision. She said Lucent believes that, with the exception of a $125 million portion of the revenue revision, the company's financial-reporting practices at all times were proper. Ms. Fitzgerald said Lucent contacted the SEC Thursday, and "they have told us they are close to completing their two-year investigation." She declined to elaborate about the conversation with the SEC.

Mr. O'Neill declined to answer written questions about his tenure at Lucent. In a statement, Michele Davis, a spokeswoman for Mr. O'Neill, said: "Corporate misdeeds revealed during the last year led the secretary to be very vocal in calling for increased corporate disclosure and greater accountability for CEOs. The secretary is not aware of any SEC inquiry into the audit committee, but he is confident that the audit committee acted appropriately during his tenure." An SEC spokesman declined to comment.

Lucent's audit-committee chairman is Paul A. Allaire, former chairman and chief executive officer of Xerox Corp., which earlier this year paid a $10 million fine without admitting wrongdoing as part of a settled civil fraud complaint by the SEC that accused the office-products maker of committing accounting fraud during his tenure. A member of the audit committee since October 1996, he has been chairman of it since February 1999, succeeding Donald S. Perkins, retired chairman of retailer Jewel Cos., who was the committee's chairman since 1996.

The other members of Lucent's audit committee at the time of the 2000 revenue revision were Franklin A. Thomas and Betsy S. Atkins. Ms. Atkins served on the committee from April 2000 until she resigned from the board in May 2002; she co-founded Ascend Communications Inc., a company Lucent acquired in 1999. Mr. Thomas, a Lucent director since 1996 and a retired president of the Ford Foundation, is on boards of six other companies, including Alcoa Inc., where Mr. O'Neill was chairman before becoming Treasury secretary. Messrs. Allaire and Thomas didn't return phone calls, while Mr. Perkins was unavailable to comment. Ms. Atkins declined to comment Thursday.

In an interview several weeks ago, Ms. Atkins said Lucent's board didn't become aware of any financial-reporting problems at the company until sometime after Lucent changed its CEO in October 2000. She said the audit committee had placed "quite a bit of focus and vigor into making the financial controls stronger" at Lucent. Mr. O'Neill was "a very engaged board member" who asked tough questions of executives, she said. "Of all the directors, he far and away shined."

To date, Lucent has disclosed only that the SEC probe pertains to the telecom-equipment manufacturer's announcement nearly two years ago that it had overstated the revenue and earnings it originally announced for its fiscal 2000 fourth quarter. In the announcement, Lucent said it had improperly recorded $125 million in revenue during the quarter. Among other revisions, it said it had chosen to reduce its revenue by a further $452 million to reflect a decision to allow two distributors to return products. Lucent said that the actions resulted from an internal probe that began in November 2000, that its board members weren't aware of the problems until then, and that the company had reported its findings to the SEC and investors promptly.

The people familiar with the SEC's investigation said the commission's staff is examining whether Lucent overstated its profitability as far back as 1996. (Thursday, USA Today reported that the SEC is looking into revenue-recognition issues from 1999 and 2000.) Moreover, the staff is probing whether Lucent executives in 1999 and 2000 provided revenue forecasts to investors and securities analysts that they knew or should have known to be unattainable, the people said.

And the SEC is seeking to determine if Lucent intentionally overstated the size of a $2.6 billion pretax restructuring charge recorded in 1995, just before its spinoff from AT&T, setting up so-called cookie-jar reserves that could be dipped into later to help the company's bottom line, the people said.

SEC investigators' concern is that Lucent may have improperly timed reversals of its restructuring reserves into income in order to help the company beat Wall Street analysts' quarterly earnings estimates, the people said. As early as 1996, Lucent said in its financial statements that actual costs under the restructuring plan were lower than originally forecast.

From 1996 through 1999, the company reversed $540 million of the $1.9 billion in reserves it had set up with the restructuring charge, a longstanding point of criticism among some analysts. During that time, Lucent reported 14 consecutive quarters during which it beat Wall Street analysts' earnings expectations, according to Thomson First Call. But were it not for its reversals of the $540 million, the company would have disappointed expectations for at least three quarters, according to an analysis of Lucent's financial statements by Charles Mulford, accounting professor at Georgia Institute of Technology in Atlanta.

Mr. Mulford said Lucent's reserve reversals "appear to have served as an earnings support mechanism from which the company metered out profits to boost corporate performance over a four-year time frame." He said the pattern looks strikingly similar to that of other companies already disciplined by the SEC for dipping into cookie-jar reserves, including Xerox.

One key distinction in the Xerox instance is that the SEC accused the company of not adequately disclosing its reversals. Lucent's disclosure of its reserve reversals weighs in its favor, but, by itself, doesn't mean that the maneuvers complied with prevailing accounting standards, according to one person familiar with the Lucent probe.

Lucent denies that it manipulated earnings through its restructuring charge. The fact that "we disclosed the existence of the reserve, and any adjustments we made to them over time, disproves claims that there was some type of cookie-jar reserve to discreetly boost our earnings," Ms. Fitzgerald said. Many of Lucent's restructuring projects were complex, and some couldn't be completed as expected, she said, adding that Lucent reviewed the reserves each quarter and made appropriate adjustments.

In connection with the closing of Lucent's acquisition of Ascend Communications, the SEC's Division of Corporation Finance in 1999 queried Lucent about its restructuring-related accounting practices.

Ms. Fitzgerald noted that the division didn't require the company to make any financial restatements. Further, Lucent denies that its executives misled investors in 1999 and 2000 about its financial targets, as some shareholders alleged in a class-action complaint pending in a federal district court in Newark, N.J.

The broader nature of the investigation could weigh on Lucent as it tries to emerge from two years of financial straits.

In absorbing $28 billion in net losses, it has cut its work force by about two-thirds and slowed development of new products.

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