Auditor's Investigation Finds 70% of Sales
At Lernout & Hauspie Unit Were Fake
By John Carreyrou
The Wall Street Journal
April 9, 2001BRUSSELS -- Seventy percent of the nearly $160 million in sales booked by the Korean unit of Lernout & Hauspie Speech Products NV between September 1999 and June 2000 were fictitious, an investigation by PricewaterhouseCoopers found.
In an effort to clinch rich bonuses tied to sales targets, the Korean unit's managers used highly sophisticated schemes to fool L&H's regular auditor, KPMG, according to the Pricewaterhouse probe, which was commissioned by L&H's new management. One especially egregious method involved funneling bank loans through third parties to make it look as though customers had paid when in
fact they hadn't.* See the PwC report on L&H's accounting practices (from L&H Web site).
* See a chronology of L&H's troubled accountsL&H's new chief executive, Philippe Bodson, said that upon learning of Pricewaterhouse's findings he "was very impressed by the level of sophistication" of the fraud and "the amount of imagination that went into it." Speaking at a news conference in Brussels Friday, Mr. Bodson said the fraud at L&H Korea should become a case study in business schools.
L&H, a maker of speech-recognition software that once was one of Europe's high-tech stars, filed for bankruptcy protection late last year after admitting to widespread accounting irregularities. Its two founders, Jo Lernout and Pol Hauspie, and former CEO Gaston Bastiaens, along with several other senior executives, were forced to leave the company.
A few hours before Mr. Bodson released an abridged version of Pricewaterhouse's report, KPMG filed a lawsuit against L&H's former management in a Belgian court. The complaint alleges that former senior L&H executives "deliberately" provided "false or incomplete information" to KPMG and conspired to obstruct the firm's audits, according to a news release. Messrs. Lernout, Hauspie and Bastiaens weren't available for comment.
To fool auditors, L&H Korea used two types of schemes, Pricewaterhouse's sleuths found. The first involved factoring unpaid receivables to banks to obtain cash up front. Side letters that were concealed from KPMG gave the banks the right to take the money back if they couldn't collect from L&H Korea's customers. Hence, the factoring agreements amounted to little more
than loans.
The second, more creative scheme was set in motion after auditors questioned why L&H Korea wasn't collecting more of its overdue bills from customers. L&H Korea told many customers to transfer their contracts to third parties. The third parties then took out bank loans, for which L&H Korea provided collateral, and then "paid" the overdue bills to L&H Korea using the borrowed
money, Pricewaterhouse found.
Paying Itself
The upshot is that L&H Korea was paying itself. When the contracts were later canceled, L&H Korea paid "penalties" to the customers and the third parties to compensate them "for the inconvenience of dealing with the auditors," the Pricewaterhouse report said.
The probe also found that the bulk of L&H Korea's sales came from contracts signed at the end of quarters, so managers could meet ambitious quarterly sales targets and receive multimillion-dollar bonuses. For instance, 90% of the revenue recorded by L&H Korea in last year's second quarter was booked in 30 deals signed in the final nine days of the quarter. But L&H Korea was forced to subsequently cancel 21 of those contracts because the customers -- most of them tiny start-ups -- didn't have the means to pay.
The fraud appears to have begun in earnest when L&H bought a small Korean firm called Bumil Information & Communication Co. in September 1999 and put Bumil's management, headed by Joo Chul Seo, in charge of L&H Korea, according to a Pricewaterhouse timeline. L&H Korea, which had been reporting negligible sales until then, recorded nearly $160 million in license revenue between the time Bumil was acquired and June 30, 2000. Seventy percent of those sales turned out to be fictitious, according to Pricewaterhouse.
Plans for Lawsuits
Mr. Bodson said L&H would file lawsuits in Korea against Mr. Seo and four Korean banks that entered into factoring deals with L&H Korea: Hanvit Bank , Hana Bank , Chohung Bank and Shinhan Bank . Mr. Seo, who made $25 million from the sale of Bumil to L&H and earned another $25 million in bonuses for meeting sales targets while at the head of L&H Korea, couldn't be reached for comment. Investigators have been unable to track him down since L&H fired him in November. Mr. Bodson said Mr. Seo was last spotted in China.
On Saturday Hanvit Bank, Hana Bank, Chohung Bank and Shinhan Bank all denied colluding with former L&H Korea executives to fool L&H's auditors, and said there were no grounds for L&H to sue them.
Chronology of L&H's Troubled Accounts
Aug. 8, 2000: The Wall Street Journal reports some Korean customers claimed by Lernout & Hauspie do no business with the company. Others said their purchases were smaller than L&H reported.
Aug. 24: CEO Bastiaens steps down; former Dictaphone CEO John Duerden steps in.
Sept. 21: WSJ reports SEC probe of L&H's financial statements.
Nov. 9: L&H says it will revise financial statements for two and a half years because of "errors and irregularities"; trading of L&H stock is suspended.
Nov. 29: L&H files for Chapter 11 bankruptcy law protection, after $100 million is discovered missing in the firm's South Korean unit.
Jan. 16, 2001: Board forces CEO John Duerden to step down, replaced by Philippe Bodson.
March 4: L&H announces co-founder Jo Lernout has been forced to step down as chief technology officer. He was the last remaining senior executive from the time the accounting scandal broke.
April 6: L&H plans to announce that an new probe of its Korean operation found massive fraud; L&H will write off most of the $127 million in Korean revenue it reported in the first half of 2000.
Source: WSJ research
Hyperlink in this Article: ftp://ftp.lhsl.com/bd/pr/reports/KoreaReport.pdf