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Case 6-10 Autonomy
Background
On November 20, 2012, Hewlett-Packard (HP) disclosed that it discovered an accounting fraud
and has written down $8.8 billion of the value of Autonomy, the British software company that it
bought in 2011 for $11.1 billion, after discovering that Autonomy misrepresented its finances. In
May 2012, HP had fired former Autonomy CEO, Dr. Michael Lynch, citing poor performance by
his unit.
The probe determined that Autonomy was “substantially overvalued at the time of its
acquisition” due to misstatements of financial performance, including revenue, core growth rate,
and gross margins.
So what is alleged to have happened? For one thing, Autonomy, as HP tells it, was selling some
hardware at a loss. During a period of about eight quarters prior to HP’s acquisition, Autonomy
sold some hardware products that had a very low margin or on which it may have even taken a
loss. It then allegedly turned around and booked those hardware sales as high-margin software
sales and booked some of the cost as marketing expense.
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Autonomy’s Position
A spokeswoman for fired CEO Lynch told Reuters that the HP allegations are “false” and
Autonomy’s management was “shocked to see” the fraud charges. Lynch said that HP’s due
diligence was intensive and the larger company’s senior management was “closely involved with
running Autonomy for the past year.”
Lynch further commented that
• HP was using this as a ruse to distract investors from its bigger problems: “People
certainly realize I’m not going to be used as Hewlett–Packard’s scapegoat when it’s got
itself in a mess.”
Exhibit 1 contains statements made by HP and Lynch in the Autonomy matter.
Exhibit 1
Statements by HP and Dr. Michael Lynch at Autonomy
HP’s Official Statement
HP has initiated an intense internal investigation into a series of accounting improprieties,
disclosure failures, and outright misrepresentations that occurred prior to HP’s acquisition of
Autonomy. We believe we have uncovered extensive evidence of a willful effort on behalf of
certain former Autonomy employees to inflate the underlying financial metrics of the company
in order to mislead investors and potential buyers.
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will take legal action against the parties involved at the appropriate time.
To: The Board of Directors of Hewlett-Packard Company
I utterly reject all allegations of impropriety.
Autonomy’s finances, during its years as a public company and including the time period in
question, were handled in accordance with applicable regulations and accounting practices.
Autonomy’s accounts were overseen by independent auditors Deloitte LLC, who have confirmed
the application of all appropriate procedures including those dictated by the International
Financial Reporting Standards used in the U.K.
I believe it is in the interest of all stakeholders, and the public record, for HP to respond to a
number of questions that I have about the allegations.
• Many observers are stunned by HP’s claim that these allegations account for a $5 billion
write down and fail to understand how HP reaches that number. Please publish the
calculations used to determine the $5 billion impairment charge. Please provide a
breakdown of the relative contribution for revenue, cash flow, profit, and write-down in
relation to:
1. The alleged “mischaracterization” of hardware that HP did not realize Autonomy
2. The alleged “inappropriate acceleration of revenue recognition with value-added
3. The allegations of incorrect revenue recognition of long-term arrangements of
hosted deals, again given the normal treatment under IFRS.
• In order to justify a $5 billion accounting write-down, a significant amount of revenue
must be involved. Please explain how such issues could possibly have gone undetected
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during the extensive acquisition due diligence process and HP’s financial oversight of
Autonomy for a year from acquisition until October 2012 (a period during which all of
the Autonomy finance reported to HP’s CFO Cathie Lesjak).
• Can HP really state that no part of the $5 billion write-down was, or should be, attributed
to HP’s operational and financial mismanagement of Autonomy since the acquisition?
• How many people employed by Autonomy in September 2011 have left or resigned
under the management of HP?
• Were Ms. Whitman and Ms. Lesjak aware that Paul Curtis (HP’s Worldwide Director of
Software Revenue Recognition), KPMG, and Ernst & Young undertook in December
2011 detailed studies of Autonomy’s software revenue recognition with a view to
optimizing for U.S. GAAP?
• Why did HP senior management apparently wait six months to inform its shareholders of
the possibility of a material event related to Autonomy?
Accounting and Auditing Issues
Interviews in California and England with former Autonomy employees, business partners, and
attorneys close to the case paint a picture of a hard-driving sales culture shaped by Lynch’s
desire for rapid growth. They describe him as a domineering figure, who on at least a few
occasions berated employees he believed weren’t measuring up.
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“The rules aren’t that complicated,” said Dan Mahoney of the accounting research business
organization Center for Financial Research and Analysis (CFRA), who covered Autonomy until
it was acquired. He said that Autonomy had the hallmarks of a company that recognized revenue
too aggressively. He said neither U.S. nor international accounting rules would allow companies
to recognize not-yet-collected revenue from customers that might be at risk.
In an interview with the British publication, The Guardian, on April 10, 2013, Meg Whitman
said that the board, which approved the Autonomy transaction, relied on audited information
from Deloitte & Touche and additional auditing from KPMG, though she said that she’s not
blaming the accountants.
“Neither of them saw what we now see after someone came forward to point us in the right
direction,” Whitman said.
Post-Legal Filings
An interesting issue is that, after Deloitte lost the Autonomy audit to Ernst & Young and
reportedly £5.422 million (about $6 million) for Autonomy’s audits during the four years prior to
2012, the firm was then free to engage in previously prohibited consulting activities that were
banned for audit firm clients under Sarbanes-Oxley.
According to filings, Deloitte earned an additional £4.44 million (about $5 million) from
Autonomy in those four years for services such as tax compliance, due diligence for acquisitions,
and other services “pursuant to legislation.” HP’s auditor Ernst & Young started doing
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Questions
1. In an analysis by the Association of Certified Financial Crime Specialists (ACFCS)
about the Autonomy merger with HP, the following statement is made: “The
scandal is prompting questions about who is to blame for the soured merger. As
details emerge, the case is spotlighting the difficulties that accountants and lawyers
face in complex mergers and acquisitions and business deals. The case also raises
the issue of what responsibility these professionals have for detecting potentially
fraudulent business records where the line between accounting discrepancies and
financial crime is blurred.” Given the facts of the case, do you believe Deloitte met
its obligations with regard to due care and professional judgment? Explain.
Deloitte and KPMG performed much of the due diligence and auditing work in the HP-
Autonomy merger. Deloitte served as Autonomy’s auditor and consultant for the four
years prior to the merger. Deloitte charged Autonomy about $7.1 million in non-audit
fees in the four years before the merger, and about $8.7 million for audit work in that
span. KPMG performed due diligence work for HP in the acquisition.
2. Meg Whitman is quoted in the case as saying that the board, which approved the
Autonomy transaction, relied on audited information from Deloitte & Touche and
additional auditing from KPMG. Given that auditing standards and legal
requirements dictate that auditors are responsible for detecting material fraud in
the financial statements of audit clients, would you blame the auditors for failing to
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uncover the improper accounting for revenue at Autonomy? Which audit and
ethical standards are critical in making that determination?
The auditors should plan and perform the audit to detect material misstatements whether
due to errors, irregularities, or fraud. The auditors should have been skeptical about the
revenue recognition of the software and tested to make sure that there were no round-trip
transactions or channel stuffing in the revenue recognition. They should have tested the
effect of the differences between IFRS and U.S. GAAP on the merger.
3. Do you believe a conflict of interest exists when audit firms earn about as much
money from nonaudit services as audit services, given they are expected to make
independent judgments on the financial transactions and financial reporting of their
audit clients? Explain by using the Autonomy case as one such example of a possible
conflict.
The conflict of interest is not so much because of the size of nonaudit fees compared to
audit fees but the influences that can develop when providing certain nonaudit services
for audit clients such as financial information systems design and installation work. In
this case a self-review threat to independence exists that cannot be mitigated through any
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Updated Information
In April 2015 a shareholder lawsuit over HP’s acquisition of British software firm named
Deloitte and KPMG as defendants, alleging they missed numerous red flags about
Autonomy’s accounting. The lawsuit also named HP’s board of directors, officers, and
former executives, alleging breach of duty and negligence for their role in HP’s
acquisition Autonomy.
HP blamed the majority of its $8.8 billion write-down on improper accounting at
Autonomy. Whitman also said HP relied on KPMG’s audits of Deloitte’s work.