John Delaney, a second-tier Brightpoint Inc. executive convicted of securities fraud last year, charges in a newly public
letter that upper management was in on the scheme.
The 2004 letter, along with certain other documents made public as part of a pending lawsuit, implicates former Chief Financial Officer Phil Bounsall, now executive vice president of locally based Walker Information. It also alleges current President Mark Howell knew the company was using improper accounting to hide losses. And it suggests CEO Bob Laikin must have known as well, but doesn't provide direct evidence.
According to investigators, the locally based wireless phone distributor in early 1999 used a sham insurance policy purchased from New York-based American International Group to spread out $11.9 million in losses that should have been reported in 1998. They say the trickery allowed Brightpoint to report pretax profit for the year 61 percent higher than it should have been.
No top brass previously had been accused of participating in wrongdoing. While the U.S. Securities and Exchange Commission in 2003 charged Bounsall--Delaney's boss--it was only for inadequate oversight of the company's books and records, not for committing fraud. The SEC said Bounsall had failed to adequately review the policy.
But the 14-page letter, written by an attorney for Delaney as he was negotiating with federal prosecutors a year later, paints a different picture. It says "Bounsall orchestrated a scheme to hide mushrooming losses," and that company principals "fully understood the details and significance" of the AIG transaction.
Not so, C. Joseph Russell, a Bose McKinney & Evans partner representing Brightpoint, told IBJ.
"I think it's pretty clear from all the evidence that's been introduced that upper management had no idea the policy was anything but an insurance policy," Russell said.
Further, he said, "The U.S. Department of Justice did a very thorough investigation of the company as a whole, and they were satisfied that no one above Mr. Delaney knew anything about this." Russell said he believes the Justice Department probe has been closed for more than a year; officials with the U.S. Attorney's Office in Indianapolis declined to comment.
According to Russell, after Delaney unleashed the allegations in the 2004 letter, he changed his story and no longer implicates upper management. But Delaney's attorney, Barnes & Thornburg partner Michael Hulka, said otherwise: "John stands by his previous statement."
The embarrassing chapter in Brightpoint's 18-year history is resurfacing now because the only defendant charged by the SEC who did not agree to a settlement is set to go to trial May 21 in Manhattan. Tim Harcharik, an independent contractor who served as the company's director of risk management, is representing himself because the stain of the scandal has left him financially devastated. He says he won't settle because he did nothing wrong.
That case has brought into the public domain hundreds of pages of previously secret depositions and internal company records that shed new light on the inner workings of Brightpoint in late 1998 and early 1999, as executives wrestled with escalating losses in a United Kingdom-based phone-brokerage unit they had decided to shut down.
According to the SEC, Delaney and Harcharik hatched the fraud in December 1998, after Brightpoint discovered losses from the faltering unit were going to be $29 million-far higher than the $13 million to $18 million it publicly estimated two months earlier.
At the time, Brightpoint shares already had fallen 60 percent for the year, and more bad news might have dealt further blows. Instead, according to the SEC, Harcharik and Delaney "devised a scheme to cover up these additional, unanticipated losses, rather than disclose them."
The solution, according to investigators, was a product hawked by an AIG subsidiary that helped companies "smooth" financial results. The SEC says Brightpoint bought $15 million in "retrospective" coverage for all the extra losses at a cost of about $15 million. Brightpoint was to pay for coverage in monthly installments over three years.
Retrospective coverage can be legitimate. A company facing lawsuits from a chemical spill, for instance, might buy coverage to limit its exposure from unfavorable court verdicts. But in this case, the SEC says, the transaction was simply a "round trip of cash," with no risk transfer. To get the accounting treatment they wanted and to throw off company auditors, the parties combined that transaction with traditional employee-theft insurance, investigators say.
Without admitting or denying wrongdoing, Delaney settled with the SEC in 2003, agreeing to pay a $100,000 fine and a lifetime ban from serving as a public company executive. Court records show he declined to provide testimony to the SEC, citing his Fifth Amendment right to avoid self-incrimination.
He became more forthcoming when a separate criminal investigation gained steam. Delaney admitted to participating in a "coordinated effort" to hide losses from investors, and he provided a wealth of information to criminal investigators that he had not provided in the SEC's civil case.
In part because of that cooperation, Judge Larry McKinney last July decided not to send Delaney to prison. Instead, the judge ordered eight months of home detention.
During the sentencing hearing, Delaney said: "All of us at Brightpoint knew it would cast the company in a bad light to admit that we had suffered somewhere between $13 million and $18 million in losses as part of discontinuing the U.K. operations. We just couldn't bear to admit it was far worse. And so the AIG policy was a way for us to continue to think that we were better business executives than we really were and for no one else to know of our failings."
Fallout from deal
Controversy over AIG's role in the Brightpoint deal and other questionable transactions contributed to the 2005 ouster of AIG CEO Maurice R. "Hank" Greenberg. As head of the world's largest insurer, Greenberg was among the most powerful executives in the industry.
Both AIG and Brightpoint settled with the SEC in September 2003 without admitting wrongdoing. Brightpoint agreed to pay $450,000 and AIG $10 million. At the time, an SEC official lambasted AIG, saying it "did not come clean. On the contrary, AIG withheld documents and committed other abuses."
In particular, the SEC says AIG for months failed to turn over an internal 1997 White Paper outlining a new product mirroring what Brightpoint bought. The paper--circulated to dozens of AIG managers--openly acknowledged that accounting rules were specifically designed to avoid "income smoothing," but nonetheless set forth ways to get around them.
In late 2004, AIG agreed to pay an additional $126 million in penalties to settle civil and criminal investigations into the deal with Brightpoint and transactions with Pittsburgh-based PNC Financial Services Group.
By contrast, Brightpoint appeared to have had its house in order. By the time the SEC brought charges, it had parted ways with Delaney, Harcharik and Bounsall--the only officials accused of fraud or inadequate oversight. Bounsall received $1 million in severance when he left in April 2002.
In addition, Brightpoint's board, along with company founder Laikin, had taken a series of steps to reduce the risk of future accounting problems, including tightening internal controls and sharpening corporate governance.
But Delaney contends that the employees who left weren't the only ones culpable.
His attorney wrote in the 2004 letter that top brass normally would be deeply involved in major transactions like the one with AIG but kept hands off because "they knew that the transaction lacked substance and they were not interested in being associated with the deal."
The letter noted that, as part of the AIG transaction, Brightpoint provided the insurer a $7.5 million letter of credit--a move that significantly limited the amount of money it could borrow for other uses.
"Given Brightpoint's corporate culture, it was impossible that the AIG insurance policy ... could be entered into by Brightpoint without the explicit or implicit approval of all levels of executive management of the company," the letter said.
Delaney admits he initially didn't fess up to his own wrongdoing. He had been interviewed at least a half dozen times by attorneys for Blank Rome Tenzer Greenblatt, a New York firm conducting an internal investigation for Brightpoint, before he says the truth poured out of him during a meeting in New York the evening before he was scheduled to testify before the SEC.
"I will never forget the deep, deep emotional and spiritual challenge that I faced ... during preparation to testify in front of the SEC," Delaney said at his sentencing hearing. "I knew that others at Brightpoint had already testified in front of the SEC and had not been truthful.
"I disclosed the full truth ... regarding the insurance policy and the inappropriate accounting. It came out of me kind of like a volcano because it had built up so long inside of me."
Court records show that until Delaney changed his story, Delaney's and Bounsall's accounts were largely in sync. After Delaney's changed, Blank Rome went back to Bounsall and said that because of the discrepancies, he would need to hire separate counsel.
"Mr. Bounsall reiterated that he testified truthfully before the SEC and would not have testified any differently even had he known of Mr. Delaney's potential contradictions beforehand," according to a Blank Rome summary of the discussions. Bounsall did not return calls and e-mails from IBJ.
Much of the letter from Delaney's attorney focuses on an earlier transaction with New Jersey-based Chubb Corp. that Delaney says was also illegitimate. He said that deal, struck a short time before he joined the company in 1996, allowed Brightpoint to avoid recording a $750,000 loss stemming from stolen phones by borrowing an equal amount from the insurer.
Russell, the Brightpoint attorney, scoffed at the allegation. "There was never a prior incident in which a similar arrangement was made," he said. "It just didn't exist."
But according to the letter, the similar coverage was arranged by Howell, then the company's chief financial financial officer, and by Sid Laikin, a broker for Consolidated Insurance. Sid Laikin--who is Bob Laikin's father--has long brokered coverage for the company.
"The scheme establishes that Howell and others in upper management of Brightpoint had knowledge of the impropriety of these types of 'insurance' policies before the AIG transaction was even conceived and looked to them as creative ways of improving Brightpoint's financial statement," the letter says.
It says that after Ernst & Young completed its audit of the company's 1998 financials, Howell expressed relief and "told Delaney how strange it was that just a few years ago, Brightpoint had $750,000 taken care of with an insurance scheme, and now it had a similar problem and resolution that was 10 times that amount.
"Delaney ... took Howell's statement to mean that Howell clearly understood at the time that by covering both losses with insurance schemes, Brightpoint had dodged bullets on two separate occasions."
In his Blank Rome interview, Howell recalled his comment about the 1998 audit differently. And he said: "I am not involved in insurance issues. I don't know about insurance premiums. ... It would be impossible for me to manage this business if I dealt with each piece of minutiae."
Delaney said it was Sid Laikin who introduced an initial version of the AIG coverage to the company in late November or early December 1998.
After Delaney expressed concern about its cost, "Sid told him not to worry because Bobby [Laikin] ... had charged Sid with covering these losses, no matter what the cost," the letter from Delaney's attorney says. "Sid said that it was his responsibility as the insurance broker for the company to make sure that such events ... were insured.
"Delaney took Sid's comment to mean that ... Brightpoint was to have insurance coverage for any additional losses identified irrespective of the cost, and that would afford the company the ability to avoid having to recognize, as immediate expense, these 'additional' losses."
Sid Laikin could not be reached by phone or e-mail for comment. But in a deposition, he shot back: "I believe this is an absolute lie. I don't believe ... Bob Laikin ever said to cover these no matter what the cost."
In an earlier interview with Blank Rome, Delaney acknowledged "he had no direct knowledge that Bob Laikin was involved in any discussions regarding the losses or the policy, and that he did not know for certain how Sid Laikin knew about the need for the policy."
It's not clear from court documents which officials at the outset thought the company was buying legitimate coverage with true risk transfer. According to court records, Brightpoint initially was seeking up to $5 million in coverage. But Delaney says officials soon began throwing in other losses, some with only tangential ties to the United Kingdom, in an effort to conceal them.
Delaney says he soon began having regrets. In March 1999, following what he called a "religious experience," Delaney approached Bounsall and said he should cancel the policy. Bounsall instead said he would begin setting aside reserves that would allow the company to phase it out, according to the letter from Delaney's attorney.
It's not clear what put the SEC on Brightpoint's trail. After the probe began, Delaney said, he asked Bounsall whether he thought the AIG coverage could land them in jail. He said Bounsall laughed off the notion.
Once the SEC came calling, E&Y decided to scrutinize the policy. At the very least, the auditing firm concluded, Brightpoint should have taken the financial hit for the entire cost of the coverage in 1998. In November 2001, Brightpoint restated financials to reflect that view.
Just two months later, it restated again. The reason: Auditors had learned that a day before the first restatement, Brightpoint had canceled the AIG coverage and received a full refund. The SEC says the refund proved the arrangement never had been insurance, just an accounting scheme to hide losses.
In a deposition, E&Y partner Stephen Blowers said he was at a loss why Brightpoint did not tell the auditing firm about the cancellation before the first restatement.
"It made me challenge the integrity of management," Blowers said. "I did not reach a conclusion as to the integrity of management. I reached the conclusion that management either 'A' didn't have integrity, wasn't trustworthy, or 'B' incompetent, and either one was equally bad."
After that, Blowers said, E&Y recommended that the board launch the internal investigation. Around the same time, E&Y informed Brightpoint that it wouldn't continue auditing the company unless Bounsall was removed from any accounting or financial responsibilities. Board minutes show he was dismissed the next month.
In his deposition, Blowers said, "I can tell you [Bounsall] withheld information that he knew or should have known was relevant to the initial restatement because I personally explained in excruciating detail the different accounting it would have."
In court papers, E&Y takes its lumps, as well. Auditors acknowledge that, when they were conducting their audit of 1998 financials, they never asked to look at the AIG policy.