Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Marshall School of Business
University of Southern California
Rev. 05-26-11
Lernout & Hauspie Speech Products
Teaching Note
Purpose of Case
The Lernout & Hauspie Speech Products (L&H) case tells a true story (with no disguise of
names or figures), written from public sources, about how a high-technology darling of
Belgium engaged in fraudulent financial reporting and business practices and, because of these,
finally went bankrupt.
The case was written to raise issues related to fraudulent financial reporting at top executive
levels in a corporation. The case is useful for discussing the pressures self-imposed by
ambitious entrepreneurs and by the environment in which they operate that may lead them to
Professors Kenneth A. Merchant, Wim A. Van der Stede, and research assistant Xiaoling (Clara) Chen wrote this teaching note as
an aid for instructors using the Lernout & Hauspie Speech Products case. The 2003 teaching note was revised in 2011 with the help
of Professor Martine Cools.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
Case Summary
Founded in 1987 by two Belgian entrepreneurs, Jo Lernout and Pol Hauspie, L&H reported
spectacular growth in the late 1990s. It then used its soaring stock to buy rival companies and
became a world leader in speech technology and software. By early 2000, the company had a
market value approaching $10 billion, with major investors that included stalwarts like
Microsoft and Intel. L&H had joint headquarters in Ieper (Belgium) and Burlington
(Massachusetts) and its shares were primarily traded on NASDAQ.
In September 2010, a Belgian court found the companys co-founders, Mr. Hauspie and Mr.
Lernout, as well as former CEO Bastiaens and another senior manager guilty on various charges
relating to financial fraud, including falsification of annual accounts, forgery, and market
manipulation. Mr. Hauspie, Mr. Lernout, and the senior manager were all sentenced to 5 years
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
429
Suggested Assignment Questions
1. Is there anything unique about L&H that made the company prone to engage in fraudulent
accounting practices?
2. Which were the questionable business (accounting) practices that L&H engaged in?
Classify each practice as acceptable, unethical, or fraudulent. Are such practices smart? Are
they legal?
3. Do you believe KPMGs claim that its auditors have been fooled by L&H? If yes, how
could the auditors have been fooled so easily? If you dont believe they were fooled, why
Case Analysis
The instructor can start the class discussion with the first assignment question: Is there anything
unique about this company that that made it prone to engage in fraudulent accounting
practices?
Students will list various factors that increased the likelihood of manipulative behaviors at L&H
because they either provided motivation for manipulative behaviors or created opportunities for
such behaviors. These may include:
2. Belgiums national pride and broad public interest in the companys success;55
4. Aggressive growth targets;
5. No differentiation of products or services, hence, little diversification of risk or little
6. Aggressive expansion into foreign countries (new markets in general) without solid market
analysis and intimate knowledge of local management.
After the students have identified these (and other) factors, the instructor can ask if these
characteristics are unique to L&H. None of these factors is individually unusual, but the
combination of having all in one corporation is worrisome. Indeed, Stefaan Top, a Belgian
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
venture capitalist, comments that the combination of ambitious entrepreneurs and a government
that sorely wanted a local tech champion was a combustible mixit was dangerous.56
If time permits, the instructor can also ask the students to think about the similarities and
dissimilarities between the L&H case and recent corporate calamities due to accounting
After identifying the factors that contribute to fraudulent business (accounting) practices, the
instructor can turn to assignment question 2: Which were the methods of accounting
manipulations that L&H used? The instructor can ask the students to classify each method as
one of the following:
Acceptable business practice;
The major methods to be discussed include the following:
1. Factoring of unpaid receivables to banks to obtain cash up front. Side letters from L&H
gave the banks the right to take the money back if they couldnt collect from L&Hs cus-
2. Established LDCs (Language Development Companies) and reached license agreements
with them under which the LDC would do software development on its own as a franchise
3. L&H Korea reported fictitious customers and sales.
(Outright Fraudulent.)
4. The bulk of L&H Koreas sales came from contracts signed at the end of quarters, so
managers could meet ambitious quarterly sales targets and receive large bonuses. For
instance, 90% of the revenue recorded by L&H Korea in the second quarter of 2000 was
booked in 30 deals signed in the final 9 days of the quarter.
(Unethical but legal if the sales contracts are real. This example also highlights how the
Do you believe KPMGs claim that its auditors have been fooled by L&H? If yes, how
could the auditors have been fooled so easily? If you dont believe they were fooled, why
did they go along with the aggressive financial reporting?
KPMG accused the former top management of L&H of signing off on revenue inflation tactics,
of lying about key business structures within the company, of influencing others to give false
information to KPMG auditors, and of orchestrating a campaign to minimize their involvement
in the events that have led to the calamitous downfall of the company.
However, sudden changes in revenue figures should have raised a red flag (at least, so it seems
in hindsight). For example, L&H saw huge revenue growth in Singapore in 1998. In 1999,
On the other hand, the auditors may have been fooled because they did not understand the
relatively new and complex speech products business. They also may have exhibited
confirmation bias by signing off on a prominent, growing client that they clearly wanted to
retain. Or was auditor independence compromised in some other way (e.g., because of other
management services with their client)?
But, if auditors are so easily fooled, then what role do they play, or which assurances do they
offer, for the functioning of the capital markets?
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
432
What could have been done to prevent the fraudulent behaviors from taking place at L&H
(or to prevent similar scandals from taking place at other companies in the future)?
1. If investors and auditors had paid more attention to analysts warnings (Actually,
financial analysts had been suspicious of L&Hs financial results as far back as 1997. In
February 1997, Lehman Brothers Brian Skiba issued a report, claiming that L&Hs growth
in the U.S. and Europe was much lower than investors had assumed, and that the company
was not coming clean. Bastiaens denied it, but in a conference call, he refused to give a geo-
graphic breakdown of sales.59 However, investors kept ignoring such warnings by the
analysts).
3. If Belgium (as well as other capital markets, such as those in the U.S.) had more strict
regulations for financial reporting and corporate governance
5. If the company had had an effective board of directors and audit committee
Do recent corporate governance reforms provide any better safeguards to try and
prevent major corporate calamities?
Corporate governance reforms have been enacted the world over, yet the debate continues as to
their effectiveness. This is obviously a complex and multifaceted discussion, but instructors
58 Pascal Dendooven, KPMG Blijft Aansprakelijk voor Schade L&H. Toch Nog een Vis in het Net, De Standaard, September 23,
2010. For a broader discussion on the issue of corporate liability, see Hunting Corporate Criminals, The Economist, August 31,
2000.
59 Ibid. 1.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
433
Case Use
Depending on the number of class periods the instructor wants to spend on the topic of ethical
behavior in general, and that involved in financial reporting in particular, the L&H case could
be used effectively in conjunction with other cases in this area, such as Don Russell:
