Two former executives of McKesson HBOC were indicted late last week in what was called one of the largest financial reporting frauds in U.S. history. The government accused the pair of falsely inflating company revenue from 1997 to 1999 by hundreds of millions of dollars.
A 17-count indictment announced late last week by federal prosecutors in San Francisco alleges that Albert Bergonzi, 50, and Jay Gilbertson, 40, former HBO & Co. co-president and co-chief operating officer, "systematically defrauded HBO shareholders and the investing public" in a scheme that resulted in shareholder losses of $9 billion. Bergonzi and Gilbertson shared the top post at Atlanta-based HBO before it was acquired by San Francisco-based drug distributor McKesson Corp. in January 1999 for $14 billion and renamed McKesson HBOC.
"This case is the poster child for the devastating effect of financial fraud by corporate management," U.S. Attorney Robert Mueller said in a written statement.
Separately, the Securities and Exchange Commission filed a civil complaint on related charges against Bergonzi and Gilbertson. Dominick DeRosa, a former HBO vice president who was also named in that complaint, quickly settled with the SEC for $411,000 and an agreement not to serve on a corporate board for five years.
"The defendants violated the antifraud, internal controls, and books and records provisions of the federal securities laws," SEC officials said in a written statement. The SEC also alleges that "Gilbertson violated the rule against lying to auditors."
All told, the fraudulent accounting artificially boosted HBO's revenue by $271.3 million for the period from January 1998 to March 1999, according to the indictment.
"This is one of the largest financial reporting frauds ever, both in terms of the scope of the scheme and the impact on innocent investors," Helane Morrison, district administrator of the SEC's San Francisco office, said in the written statement.
"Mr. Gilberston maintains his innocence and intends to vigorously contest the charges," said Robert Plotkin, Gilbertson's attorney of the Washington firm Paul, Hastings, Janofsky & Walker.
Berganzi's attorney, Joseph Russoniello of the San Francisco firm Cooley Godward, said his client will "self-surrender" sometime this week and will enter a not-guilty plea.
A Wall Street darling throughout the 1990s, HBO's shady accounting practices first came to light in April 1999, when an annual review by auditors unveiled the first signs of irregularities. Shares slid almost 50% on the news to $34 per share from $65 per share, socking a $9 billion punch to McKesson HBOC's market value in a single day.
According to the indictment, Bergonzi and Gilbertson went to great lengths to help HBO meet or beat Wall Street analysts' expectations of the company's performance.
In 1998 and the first quarter of 1999, HBO recorded millions of dollars in phantom software revenue, according to the indictment. Much of that revenue was created by signing software contracts with more than a dozen hospitals that were accompanied by "side letter agreements."
Those agreements, which were allegedly hidden from auditors, gave the hospitals the ability to back out of their contracts even though HBO was recording the revenue, the indictment said.
Montgomery, Ala.-based Baptist Health, an organization mentioned in the indictment as having been given one of the side agreements, was unfamiliar with the indictment. "I haven't seen and don't know anything about it, nor does anyone else at Baptist Health," said Bill Colmer, vice president of information systems at the six-hospital system.
Another contract in which HBO was said to have improperly recorded revenue involved WellPath Community Health Plans, Chapel Hill, N.C. Sandy Scherer, WellPath's director of public relations and marketing, said the company was aware of the investigation. "We are cooperating," she said.
Many of the side letters were also backdated to give the appearance that sales had been recorded in earlier quarters, prosecutors charged.
Documenting a pattern of embellishing sales to inflate performance, the U.S. attorney's office argued that at the end of each quarter from March 31, 1998, through Sept. 30, 1998, Gilbertson "simply determined how much was needed to make up the shortfall, then directed fraudulent entries to company books in whatever amount was necessary."
Gilbertson left HBO in November 1998 to become the president and COO of Atlanta-based WebMD. In July 1999, he resigned from that post as news of the HBO accounting fraud became public.
In June 1999, HBO fired Bergonzi as part of an executive shake-up that sent four top officers packing, including then-Chairman Charles McCall.
Despite his perch at the top of the company during the alleged fraud, McCall wasn't charged in the indictment.
In another component of the scheme to defraud investors, Gilbertson and Bergonzi allegedly entered a $30 million resale agreement with Islandia, N.Y.-based Computer Associates and recorded revenue before any inventory had been resold. That practice, according to the indictment, is prohibited under generally accepted accounting principles.
As of last week, "Computer Associates has neither made use of nor distributed any of the $30 million in HBOC software products," according to the indictment.
Also according to the indictment, Bergonzi "concealed the true nature of the transaction" in deals he orchestrated between HBO and Redwood Shores, Calif.-based Oracle Corp. as well as Westborough, Mass.-based Data General Corp.
An official at McKesson HBOC declined to comment on the indictments but said the company took steps immediately following the discovery of accounting irregularities to "strengthen our accounting controls and procedures," said Larry Kurtz, the company's vice president of corporate communications and investor relations.
"We have in place the systems and procedures, as well as the corporate culture, to make sure our financial results are accurately determined and reported," Kurtz said.
Deanna Bellandi and Ed Lovern
contributed to this report