People Have Been Thrown in Prison for the Kinds of Stuff Carly Fiorina Engaged in as Lucent’s CEO

While Carly Fiorina has unquestionable debate skills, the more I research her background, the more troubled I become. While it's clear that she is -- politically speaking -- somewhere to the left of Jeb Bush on policy, it is her business record that is most alarming.

Let me start with a little history lesson and a company called Lernout & Houspie. Founded in 1987 by two Belgians, L&H went public in 1995 on NASDAQ and operated from U.S. headquarters in Burlington, MA. Specializing in voice recognition software, L&H rode the tech boom to a peak market valuation of $10 billion.

L&H, despite its rise, was dogged by rumors of financial fraud. By early 1999, The Wall Street Journal reported that its earnings had been inflated. A subsequent WSJ investigation led to revelations in August of 2000 that much of the company's value had been achieved by booking imaginary sales through a wide range of accounting gimmicks.

In April 2001, the founders -- Jo Lernout and Pol Hauspie, as well as former CEO Gaston Bastiaens -- were arrested in what was then one of the largest accounting scandals in history.

What were the accounting gimmicks that L&H used? Among them, "investing" in companies that were then required to turn those investments around to "purchase" L&H products and services. As the WSJ reported:

The company ... appears to have improperly reported revenue from barter deals with other software firms in which no cash changed hands; immediately recognized revenue for sales that were contingent on L&H later performing development work for the customer; and sometimes reported sales before contracts were signed, when it was unclear the customer had the ability to pay or when the customer's ability to pay depended on investment from L&H... In all, tens of millions of dollars in revenue over the past several years may have been improperly recorded...

Thousands of individual shareholders have lost a collective fortune in the fall of a company whose market value was nearly $10 billion nine months ago...

...Michael Faherty, a former L&H salesman in the U.S., says he and others were encouraged to refer potential but cash-poor customers to FLV Fund. "If FLV invests $1 million" in the customer, he says, "it was understood that we'd get about $300,000" in the form of license fees paid by that customer to L&H...

... In 1995, for example, FLV took a 49% stake in the Belgian unit of Quarterdeck Corp., a highflying California software company headed by another Belgian, Gaston Bastiaens. This Belgian unit became L&H's largest customer, accounting for 30% of revenue that year, and Quarterdeck itself chipped in 6.5% of L&H's sales...

In simple terms, L&H laundered loans and investments to other companies, which it then booked as phony sales.

And what happened to the founders, Lernout and Houspie? In 2010, they "were found guilty by a Belgian court of fraud violations in the accounting scandal [and] each given sentences of five years..."

Well, Fiorina ran the telecom giant Lucent as it was imploding, a fact that she was able to conceal until after she'd jumped ship to HP with over $60 million in performance-based pay.

A series of major orders were announced under Fiorina that subsequently turned out to be completely fraudulent. In 1999, for example, Fiorina trumpeted a huge sale of up to $2.1 billion of equipment to a company called PathNet. Problem was, however, that PathNet's annual revenue was $1.6 million and it could ill afford such a massive purchase. In other words, Fiorina's PathNet deal was as crooked as a corkscrew:

In the giant PathNet deal that Fiorina oversaw, Lucent agreed to fund more than 100% of the company’s equipment purchases, meaning the small company would get both Lucent gear at no money down and extra cash to boot. Yet how could such a loan to PathNet make sense for Lucent, even based on the world as it appeared in the heady days of 1999?

It didn't make any financial sense. Just after Fiorina's departure, Lucent revealed that it had written $7 billion of loan deals to customers, many of them unviable startups like PathNet, which itself went bankrupt in 2001. Post-Fiorina, Lucent also collapsed as the nature of her vendor-financing deals became obvious; but she walked away with upwards of $60 million.

In short, Fiorina used the same fraudulent tactics that L&H employed, investing in companies in order to massively inflate sales numbers.

Unlike Lernout and Houspie, though, Fiorina jumped ship before the implosion and walked away with tens of millions of dollars.

Fiorina, based upon these reports, has a distinctly unsavory background and has as much business running for president as Hillary Clinton does. Which is to say, none.

According to Wikipedia,
“In 1995, Fiorina led corporate operations for Lucent Technologies, Inc., a spin-off from AT&T of its Western Electric and Bell Labs divisions into a new company.[39] In that capacity, she reported to Lucent chief executive Henry B. Schacht.[40] She played a key role in planning and implementing the 1996 initial public offering of a successful stock and company launch strategy.[37][41][42] The spin-off became one of the most successful IPOs in U.S. history, raising US$3 billion.[36][39]

Later in 1996, Fiorina was appointed president of Lucent’s consumer products sector.[41] In 1997, she was named group president for Lucent’s US$19 billion global service-provider business, overseeing marketing and sales for the company’s largest customer segment.[37][43] That year, Fiorina chaired a US$2.5 billion joint venture between Lucent’s consumer communications and Royal Philips Electronics, under the name Philips Consumer Communications (PCC).[44][45] In the edition of October 12, 1998 of Fortune magazine Fiorina was named “The Most Powerful Woman in American Business”.[36]

Lucent added 22,000 jobs and revenues grew from US$19 billion to US$38 billion and the company’s market share increased in every region for every product.[39][46] According to Fortune magazine, Lucent increased sales by lending money to their own customers, writing that “In a neat bit of accounting magic, money from the loans began to appear on Lucent’s income statement as new revenue while the dicey debt got stashed on its balance sheet as an allegedly solid asset”.[46] Lucent’s stock price grew 10-fold.[46]”

The problem with these silly hit articles and statements is that they are either written by economic / business idiots (including some in academia and the business press) or by people who know better but are purely politically biased and ideological (including some in academia and the business press) but realize that their intended audience doesn't really understand the issues and will believe anything that aligns with their [usually already formed or soft and pliable] views about a candidate or the subject of attack. Know thy audience!

Article is, on its face and on many levels, financially illiterate and incredibly stupid, and deliberately confuses apples with oranges.

Lernout and Hauspie have engaged in many fraudulent money-laundering operations with the "shell companies" and false booking of sales (U.S. SEC, Securities and Exchange Commission v. Lernout & Hauspie Speech Products, N.V. Civ. No. 1:02CV01992 (D.D.C.), October 10, 2002 ). L&H fraud had nothing in common with the bursting of the telecom / dotcom bubble.

What they are supposedly accusing Fiorina of doing is known as "vendor financing" which is a legitimate way of doing business, and has existed at Lucent before Fiorina, has existed before Bell Labs was spun off as Lucent from AT&T, has existed before AT&T, has existed before Nortel, Alcatel, Nokia, Ericsson, Siemens, Cisco, IBM, GE, Boeing and many other companies and private parties, and is being used today and will be used tomorrow. Some of these companies have failed, but Fiorina didn't kill / destroy any of them.

First, Fiorina was not the CEO or CFO of Lucent, just a president of one very successful $19B division (bigger than most S&P 500 companies and much bigger than any enterprise Donald Trump has ever ran) — see the chart of Lucent and its spinoffs under Fiorina: Lucent Technologies Inc. and spinoffs flowchart - FR, post #26, 2015 August 15, and Carly Fiorina as a boss: The disappointing truth - FR, post #28, 2015 August 16.

Second, she left Lucent for HP in 1999, at the height of Lucent's success, before dotcom bust, when Lucent and other telecom suppliers like Nortel (now bankrupt), Alcatel, Ericsson, Juniper Networks, Extreme Networks, Cisco et al (all shadows of their 1999 valuations, if still alive) were all participating in the buildout of physical infrastructure of the Internet and were all doing well, competing for the piece of the Internet pie. All have done vendor financing because it was beneficial for both parties — vendors and buyers. Fiorina didn't "destroy" Lucent anymore than she "destroyed" all these other companies (like Bell Canada's Nortel Networks which was competing with Lucent for every account and acquisition).

To understand why vendor financing is so popular — particularly in capital-intensive industries (such as technology or heavy industry or construction or medicine, media etc. etc.) — you have to understand what it actually is and how it works:

A profitable vendor has a growing pile of cash sitting in the bank at low interest rate because the copany can finance its operations and capital expenses from free cash flow. At the same time the fast growing but capital-intensive industry has many entrants that are either too young and doesn't have the best credit terms at the bank, or doesn't have the bank that understands their business well, or some stable profitable companies with a lot of debt which they can service fine, but can't tap more debt at the bank on favourable terms to expand into areas of growing business opportunity. Who'd be better to finance the purchase of the equipment than the equipment supplier who understands the business and can evaluate the opportunity risk of financing a purchase versus having this money sitting in the bank and potentially losing business to another equipment manufacturer (OEM)?

If all goes well, OEM / vendor not only makes the sale, beating the competitors, but also collects a substantial interest in excess of bank interest rates. Acting as a "banker" has additional benefits of repeat sales ("locking" the customer) because it may be difficult to switch from one manufacturer / "platform" to another. If not, the rights to equipment / collateral go back to vendor.

In simplified accounting terms it works something like this — sales are recorded, [loaned] cash and expected interest goes from the asset side of the ledger to receivables and collateral is recorded as a depreciated liability (depreciation and acceleration are different for different types of merchandise / product / equipment).

Most of you have been the "victims", er, beneficiaries of vendor financing. Examples?

Ever bought a car on credit from the dealer? You have just experienced a "vendor financing" transaction. The dealer you bought it from may also have had financing from the auto manufacturer, to fill the lot with cars to sell.

How about refrigerator or a washing maching or furniture from Sears or a specialty store, with a store credit / loan? Another "vendor financing" or maybe double, if the store had the merchandise "vendor-financed" as well.

And your smartphone that would cost $600-$700 to buy outright but you get it for less than $250 with a two year "contract" — you may not recognize it as a "vendor financing" but that's exactly what it is.

What do you think many of the leasing programs are? Yep, most leases are "vendor financing" in pretty transparent disguise.

To blame dotcom bust (and demise of the whole industry) on "vendor financing" and Fiorina is either financially idiotic or cynically political — you decide which one is which, depending on the authors.

You are absolutely correct.

The practice of vendor financing, and a more direct method called vertical integration is widely used and common.

The correct accounting methods for reporting these arrangements are regulated by FINRA and the SEC.

When a company makes a error in judgment or just puts the figure on the wrong line in the report, the regulators are sure to follow it up with fines and sanctions.

In fact these accounting methods are constantly changing to make company balance sheets more transparent, and violations are often unintentional but yes, some companies have used gaps in the regulations and exploited them. (Like Enron)

Whatever the case was with Lucent would not have been Fiorina’s responsibility due largely to her position at the time and the timeline but it’s easy for someone to make claims about a complex subject and create intentional confusion.

I think maybe some of these same people should try to work their way through a Apple balance sheet and their 10K. (talk about vertical integration!)

I am not a Carly supporter. But I resent these kinds of hit pieces.

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