Lernout & Hauspie

Lernout & Hauspie was founded in 1987 by Jo Lernout and Pol Hauspie. After a difficult start, it quickly grew, and, in 1995, it went public on the NASDAQ. Its headquarters were in Ieper, Belgium, and in Burlington, Massachusetts. L&H had 143 million shares of common stock outstanding as of August 2000 and its stock price hit a high of $65 per share on March 14, 2000, giving the Company a market capitalization of almost $9 .3 billion at its peak. It went bankrupt in 2001. The company was seen as a representative of the new Flanders (A region divided between Belgium, France, and the Netherlands), focused on new technology rather than old industries. In 1993, American telecoms giant AT&T invested 7.5 million in L&H. In 1997 Microsoft took up an 8% stake in the company for a price of $45 million (34.5m), by which L&H got world s attention, but which also brought it under closer study and ultimately led to its downfall. This assignment is about the massive accounting fraud at Lernout & Hauspie Speech Products, from its first quarter of fiscal year1998 through its first two quarters of fiscal year 2000; L&H overstated all publicly reported revenues by total of $377 million. The Company's financial statements for 1998, 1999 and the first two quarters of b 2000 have been completely restated.

What was the Scandal?

L&H recorded fake revenue mean recorded revenue even when the sales contract was not yet been negotiated or signed. At its Korean subsidiary, L&H engaged in egregious accounting irregularities, including the recognition of entirely fictitious revenue amounting to approximately $ 189 million (All of the revenue L&H publicly reported from its Korean subsidiary, from the third-quarter of 1999 through the first two quarters of 2000, has been completely reversed and eliminated). In addition, L&H, along with defendants the Flanders Language Valley Fund ("FLV Fund") and Mercator and Noordstar NV ("Mercator"), set up 30 so-called Language Development Companies ("LDCs") and Cross-Language Development Companies ("CLDCs") which supposedly licensed millions of dollars worth of software from L&H. L&H recorded all the purported revenue it received from the LDCs and CLDCs. However, this revenue recordation was entirely improper because both FLV and Mercator were related parties to L&H and major L&H stockholders. The purpose of establishing the LDCs and CLDCs was to "pump up" L&H's

publicly reported revenues and benefit L&H's major shareholders - FLV, n Mercator and the Senior Officers. The accounting irregularities at L&H "began at the top of the company with a culture that pressured individuals to prematurely recognize revenue, to engage in backdating of contracts or swapping of contracts in other words, creating revenues freely where none should have been recognized." That statement by L&H's outside counsel, Lanny Davis, made in a December 19, 2000 interview on CNN, is a summary of the massive, systematic, far-reaching accounting fraud that was L&H.

Starting of Scandal
In 1995, L&H completed its initial public offering and commenced trading on NASDAQ. From 1987 through 1995, the Company had never been profitable and had only produced a few million dollars in annual revenues. Beginning in the third quarter of 1996, L&H expanded its business primarily through a dizzying array of acquisitions, to reach its goal of becoming the leading international provider of advanced speech and language technologies, products and services. As a result of the Companys new focuses, L&H's sales quadrupled from 1995 to 1996. What proceeded was a period of unprecedented growth for L&H, making the Company an International success story and the pride of Belgium. From 1997 to June 2000, L&H reported incredible revenue growth -bolstered by a number of acquisitions, related -party transactions, and fraudulent accounting. In 1997, the Companys total revenues increase 220% to $99.4 million from $31 million in 1996. In 1998, L&H's revenues purportedly rose 113% to $211.6 million, and by 1999, the total revenues were claimed to be $344 million. Under Bastiaens'(chairman) leadership, L&H acquired at least 20 companies during the scandal Period, throughout the scandal period, L&H engaged in numerous schemes that were intended to, and did, artificially inflate the Companys revenues, earnings and the value of L&H's common stock. As a result of defendants' far-reaching fraud, L&H would eventual admit that over $377 million of revenue from 1998 through June of 2000 was improperly recorded -- including the reversal of all revenue recorded in Korea from September 1999 through June 30, 2000.

When Scandal Came into Light?

In May of 2000, L&H acquired Dictaphone Corporation for $425 million in cash and $510.6 million in inflated L&H common stock. As a result of this acquisition, L&H became subject to more stringent SEC reporting requirements. Certain first-time disclosures in L&H's first quarterly report filed on SEC Form 10-Q on June 30, 2000, disclosed new information about L&H's purported financial success during the previous few quarters. For the first time, L&H publicly disclosed the geographic breakdown of its sales - providing surprising revelations. First, the new financial reporting revealed that a significant portion of the Company's total revenues were from two countries in Asia: Singapore and Korea. In 1999, L&H's revenue totaled $344.2 million. Of that amount, Korea contributed $62.9 million and Singapore contributed $80.3 million in revenue, while in 1998, those two countries only contributed less than $300,000 in sales. While European sales had fallen, and U.S. sales remained stagnant, Singapore sales skyrocketed from a mere $29,000 in 1998 to $80.3 million in 1999, a jump of over 276,796 percent. During the first quarter of 2000, total sales in the United States, Europe and the rest of Asia declined by 27% to $51 .8 million . At the same time, Korean sales accounted for $58.9 million, up from $97,000 a year earlier, and approximately 54% of L&H's worldwide sales of $110.7 million. Due to this extraordinary growth in the sales, On August 8, 2000, The Wall Street Journal began an investigation and merely by asking a few questions of purported "customers," the Journal's reporters (who were based in Boston) were able to reveal a wide-spread fraud that had been concealed by L&H and KPMG. On this news, the Company's common stock declined dramatically by 19% from the previous day's close of $37 per share to $29.

Irregularities of L&H
L&H repeatedly recorded revenue from barter or exchange transactions where no cash changed hands. A former channel sales manager from the Burlington office of L&H said barter/swap transactions were widespread at L&H Burlington and a standard practice within the whole company, absolutely from the top down. It was the way things were done." "Everybody knew about it. Everybody acted like it was some kind of genius scheme to book revenue." The former channel sales manager understood that Bastiaens was responsible for implementing the crossquarter deals and barter transactions.

L&H also inflated earnings by prematurely recognizing revenues where no contract was signed or where the terms of the contract were not finalized. Throughout the scandal Period, defendants repeatedly booked sales, even though negotiations were still ongoing and the "customer" was under no binding obligation to purchase the product.

Wall Street Journal Investigation

When wall Street Journal started investigation about the company, the company management said that its just a rumor, but on August 11, 2000, The Wall Street Journal reported that L&H's had commissioned a mid-year interim audit of the company by KPMG, the Company's regular auditors. In announcing the "interim audit," L&H spokesman Ron Schuermans proclaimed, "We're doing this to send a positive signal to the market. We're confident that, when the audit is completed, all our revenue figures as we have reported them will be confirmed." August 13, 2000 Chairman Bastiaens stated, in press release, We have no doubt that the auditors will confirm that during the first two quarters of 2000 L&H Korea had strong revenues and a very solid business base, as already publicly reported. We have commissioned this audit because we're determined to remove any possible uncertainty about the integrity of our financial results." On August 18, 2000, The Wall Street Journal reported that on July 27, 2000, Bastiaens purchased 625,000 shares of L&H stock for $40.00 per share and the price represented a premium of 34% above the stock's closing price of $29. 88 per share and, according to an L&H spokesperson, reflected Bastiaens' "bullish" stance. This suspicious transaction was intended to give the appearance of insider confidence in the Company, to artificially inflate the price of L&H stock and to distract investors from concerns over L&H's financial condition. On August 25, 2000, L&H was still maintaining that the Company's accounting practices were proper. On September 22, 2000, The Wall Street Journal reported that L&H had confirmed that the SEC commenced a formal investigation into L&H's accounting practices. As was later revealed in October 18, 2000 and February 5, 2001 Wall Street Journal articles, the SEC originally began an informal investigation of L&H in January of 2000. In April of 2000, the SEC sent a letter to KPMG Belgium requesting information about L&Hs

accounting practices. This informal probe involved a number of questions concerning possible related-party transactions. The Company, however, was uncooperative and did not provide all necessary information to the SEC. As a result, the SEC began a formal investigation. September 28, 2000, The Wall Street Journal reported that Lernout attended a news conference and issued a strongly worded denial of allegations that L&Hs surge in Asian revenues was generated by related-party transactions. The market did not share Lernout's confidence and faith. In response L&H's third quarter warning, and on-going disclosures through The Wall Street Journal , L&H shares plunged 30% to close at $9.75 per share a three year low. On October 18, 2000, The Wall Street Journal reported that L&H was refusing to provide the SEC with the names of the investors behind the thirty corporate customers that were the focus of the SEC investigation, and who accounted for approximately 25% of the 1999 revenues and 10% of 1998 revenues. While L&H acknowledged that it helped start the 30 companies and initially financed their operations, the Company maintained that the firms are owned by unnamed independent investors interested in developing new applications for L&H speech software. To quell the circulating allegations, L&H released new details about the operations of the 30 companies. The new information, however, only raised further questions about their viability and independence from L&H. For example, of the 17 companies L&H agreed to discuss, none has any direct employees. Seven companies are relying on L&H employees to do work for them and have agreed to repay L&H for its services. On November 9, 2000, L&H issued a press release announcing that as a result of past accounting "errors and irregularities" the Company would need to restate the most recent 2 1/2 years of financial statements. In reaction, on November 9, 2000, both NASDAQ and EASDAQ suspended trading. Prior to the suspension, the price of L&H on the NASDAQ market fell as low as $6.2188. After trading finally resumed on December 8, 2000, the stock plummeted to $1.40 per share and continued its free fall to trade below $1 per share from December 12 to December 15, 2000. In April 2001, L&H revealed that 70% of the almost $160 million in Korean revenue was entirely fictitious.

 Finally, in a document dated April 27, 2001, and filed with the SEC on May 3, 2001, L&H reported its sales in 1998, 1999 and the first half of 2000 were overstated by $373 million mean that the Company admitted that all of the Korean revenue from September 1999 through June 30, 2000 would be restated and removed.

The Audit Committee Report concluded, in part, that: (a) L&H had improperly recorded as much as $277 million in revenue during 1998, 1999 and the first half of 2000; (b) that the Company should reverse all of its Korean revenues recorded during 1999 and 2000, amounting to approximately $182 million; and (c) that software license revenues from twenty-four of the thirty start-up companies were incorrectly booked because those companies were not buying software from L&H, but rather, were paying L&H employees to develop future products - in effect, funding L&H's research and development.

Outcome of Scandal
Lernout and Hauspie were found guilty of fraud and given the maximum sentence requested by the prosecution - five years imprisonment, although two years of that is suspended. They were each fined 24,789. Directors Nico Wilaert and Gaston Bastiaens were given the same sentences, although three years of Bastiaens' sentence were suspended. Tony Snauwaert, responsible for helping to build up the network of fictitious clients who made LHSP look so attractive to investors had received two years, with one suspended, and was fined 2,478 The company's former financial director Carl Dammekens received a six-month suspended sentence and was fined 2,478. Eight other executives were acquitted. Auditors KPMG, likewise, were found not to be responsible. However, their representative William Van Aerde was found to have been "careless" in his handling of the matter and fined 2,478. KPMG paid $115 million in a similar case in 2004. This is not the first time KPMG has shelled out money to settle a shareholder lawsuit stemming from its audit work. In March 2003, the firm agreed to pay $125 million to settle class-action lawsuits related to its audit of Rite Aid, which in the late 1990s overstated earnings by $1.6 billion.

What were Regulators doing at the time of Scandal?

The fact that L&H was listed on the Belgium stock exchange, where the reporting and listing rules are much less stringent than in United States, also made the company prone to engage in fraudulent accounting practices as the chances of being detected were minimal.

KPMG Belgium, a member of KPMG Int'l, is a public accounting firm, employing 950 partners and staff in six cities in Belgium. L&H became an audit client of KPMG Belgium after it acquired the accounting firm of Behets, Boes & Co., which had been auditing L&H since the late 1980s. KPMG effectively served as an adjunct to L&Hs accounting department during fiscal years 1998 and 1999. KPMG auditors and consultants were present at L&H at the end of every quarter during the scandal Period and worked closely with L&H on the preparation of the quarterly financial statements. Moreover, given the fact that KPMG was making the final decision regarding which entries would and would not be recorded, its conduct made KPMG complicit in the preparation of the false quarterly financial statements. In a startling breach of its duty to act as the public's "watchdog" KPMG participated in, and had actual knowledge of, the fraud perpetrated at L&H during the scandal period. In particular, KPMG advised L&H to backdate contracts to create the appearance that revenue recognition was appropriate. Most importantly, KPMG had complete knowledge of one of the most important facts which ultimately lead to the uncovering of the fraud by The Wall Street Journal: the fact that many, if not all, of the LDCs had the exact same business addresses. Recognizing that such facts indicated strongly that the transactions were improper, KPMG (Klynveld Peat Marwick Goerdeler) knowingly or recklessly violated generally accepted auditing standards in the United States ("GAAS").

Impact of Company Default

Many people, especially in West Flanders, were blinded by the company's success and lost large sums of money on L&H stock. The Flemish Government had become a major investor in the company through and during one of L&H's cash crunches. It guaranteed 75 percent of a bank loan to the company. Investors and Government both were hit hard when the company went bankrupt. After the bankruptcy, now the speech recognition of Lernout & Hauspie is used in the Speech option in the control panel of Microsoft Windows XP and is abbreviated as LH, and the elements of grammar checker developed by Lernout & Hauspie are certainly using in Microsoft Office.

Conclusion and Some Changes Made in Regulations

In sum, L&H was a financial house of cards propped up by accounting gimmicks and trickery to create the appearance of a financially successful company. In truth, however, L&H was nothing more than an illusion of financial prosperity. Fraudulent, unethical accounting practices and poor corporate governance are the main reasons for bankruptcy. To prevent fraudulent behaviors from taking place, companies need to enhance corporate governance. This can be achieved, such as setting up audit committee as well as other subcommittees. Many countries set up new regulation to enhance the corporate governance. For example, the US developed SOX in 2002. In this law, it states that a majority of the board of directors must be independent directors. A compensation committee of the board and a nominating/corporate governance committee of the board must be comprised entirely of independent directors (Sarbanes- Oxley Act, 2002). Increase in responsibilities and requirements of auditors and the "rules of the road" (that govern the way in which financial statements are prepared so that different financial statements are comparable) is developed.

References
http://online.wsj.com/article/SB972508598799909346.djm.html http://www.dailyfinance.com/2010/09/21/lernout-hauspie-convicted-fraud-speechrecognition-founders/ http://online.wsj.com/article/SB976143929804554337.html