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6 READING BETWEEN THE LINES

of defense, an affirmation by independent auditors that the statements have

been prepared in accordance with GAAP, assures that the numbers are reli-
able. A few examples from recent years indicate how severely an overly
trusting user of financial statements can be misled.

Mercury Plunges
In January 1997, Mercury Finance’s controller was reported to have disap-
peared3 after the company reduced its 1996 earnings to $56.7 million from
an originally reported $120.7 million. The used-car loan company’s co-
founder and chief executive officer, John Brincat, contended that the irregu-
larities necessitating the restatements were apparently “the result of
unauthorized entries being made to the accounting records of the company
by the principal accounting officer,” the missing James A. Doyle.4 On Janu-
ary 28, the day before the earnings revision, Mercury’s stock closed at
$14.875 a share. When trading in the shares reopened on January 31, the
price plunged to $2.125.
As the story developed, controller Doyle’s attorney denied that his client
had disappeared. Rather, “He decided with the advice of counsel to no
longer participate in the charade taking place at Mercury Finance.”5 Speak-
ing through his lawyer, Doyle added that he was cooperating with a federal
investigation of the company.
Thickening the plot was the provision in CEO Brincat’s management
contract whereby he was not entitled to any bonus in any year in which
earnings per share rose by less than 20%. Doyle had no such bonus
arrangement, leading some observers to wonder what motive he would have
had to falsify the financials. Additional earnings revisions announced along
with the 1996 restatement indicated that Mercury did not, after all, achieve
the 20% target in 1994 or 1995, even though Brincat received bonuses of
$1.4 million and $1.6 million, respectively, for those years.6 In any case,
Brincat resigned as chief executive officer on February 3. A year later he
stepped down from the company’s board and agreed to repay part of his
1994–1996 bonuses.
Also in February 1998, Mercury announced that it would file for bank-
ruptcy. By then, the company had revised its originally reported 1996 profit
of $120.7 million to a net loss. In hindsight, the financial statements had in-
corporated unrealistic assumptions about the percentage of Mercury’s low-
income borrowers who would fail to keep up their loan payments. The
auditors had certified the results, despite the telltale warning sign that the
statements showed Mercury earning more than double the historical aver-
age return on equity (see Chapter 13) of other companies in its business.
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The Adversarial Nature of Financial Reporting 7

Securities analyst Charles Mills of Anderson & Strudwick likened such im-
probably superior performance to a human running a two-minute mile.7

MicroStrategy Changes Its Mind

On March 20, 2000, MicroStrategy announced that it would restate its
1999 revenue, originally reported as $205.3 million, to around $150 mil-
lion. The company’s shares promptly plummeted by $140 to $86.75 a
share, slashing chief executive officer Michael Saylor’s paper wealth by over
$6 billion. The company explained that the revision had to do with recog-
nizing revenue on the software company’s large, complex projects.8 Micro-
Strategy and its auditors initially suggested that the company had been
obliged to restate its results in response to a recent (December 1999) Secu-
rities and Exchange Commission (SEC) advisory on rules for booking soft-
ware revenues. After the SEC objected to that explanation, the company
conceded that its original accounting was inconsistent with accounting
principles published way back in 1997 by the American Institute of Certi-
fied Public Accountants.
Until MicroStrategy dropped its bombshell, the company’s auditors had
put their seal of approval on the company’s revenue recognition policies.
That was despite questions raised about MicroStrategy’s financials by ac-
counting expert Howard Schilit six months earlier and by reporter David
Raymond in an issue of Forbes ASAP distributed on February 21.9 It was re-
portedly only after reading Raymond’s article that an accountant in the au-
ditor’s national office contacted the local office that had handled the audit,
ultimately causing the firm to retract its previous certification of the 1998
and 1999 financials.10

No Straight Talk from Lernout & Hauspie

On November 16, 2000, the auditor for Lernout & Hauspie Speech Prod-
ucts (L&H) withdrew its clean opinion of the company’s 1998 and 1999 fi-
nancials. The action followed a November 9 announcement by the Belgian
producer of speech-recognition and translation software that an internal in-
vestigation had uncovered accounting errors and irregularities that would
require restatement of results for those two years and the first half of 2000.
Two weeks later, the company filed for bankruptcy.
Prior to November 16, 2000, while investors were relying on the audi-
tor’s opinion that Lernout & Hauspie’s financial statements were consis-
tent with generally accepted accounting principles, several events cast
doubt on that opinion. In July 1999, short-seller David Rocker criticized