Cisco Socked with Shareholder Suits

A week after Cisco Systems Inc. (Nasdaq: CSCO) announced a $2.5 billion inventory write-off (see Cisco's Inventory Woes Mount), investors and their lawyers are taking aim at the company and its officers (see Cisco Faces Another Suit).

It's common for shareholder lawsuits to emerge after a precipitous drop in stock price, regardless of cause. Cisco's case is interesting, however, because it is being hit by several suits targeting its accounting practices at a time when those very practices are coming under increased scrutiny.

“This is one of the most egregious abuses of insider trading that we have ever encountered,” says William Lerach, a partner at the law firm Milberg Weiss Bershad Hynes and Lerach LLP, which filed suit against Cisco on Friday.

Milberg Weiss is one of at least two firms that have already filed federal lawsuits in California and in Maryland on behalf of shareholders, alleging that Cisco and its officers violated federal securities laws by disseminating false and misleading information about its products, financial results, and prospects for fiscal 2001 and 2002 and beyond.

Investors typically file shareholder lawsuits after a company pre-announces negative earnings news, says Daniel Sommers a partner at Cohen Milstein Hausfeld & Toll, a firm that also handles shareholder lawsuits. Foundry Networks Inc. (Nasdaq: FDRY) and Lucent Technologies Inc. (NYSE: LU) have also been targets of similar lawsuits since the market took a nose-dive back in December (see Foundry Slapped With Shareholder Suit).

Many of these suits never make it to trial, because they are either dismissed or settled out of court. But analysts who follow Cisco think that shareholders could have a good case against the company.

“This was the biggest inventory write-off in the technology sector ever,” says Gina Sockolow, an analyst with Buckingham Research Associates (BRA). "I think the inventory write down and the implications on future earnings are so great that the suit might actually have legs. But what it comes down to is what they knew and when they knew it."

The lawsuits center around Cisco’s accounting practices, which the suits claim are in violation of Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC) rules.

According to the suit filed in California, Cisco provided excessive financing to fledgling CLECs (competitive local exchange carriers) like American Metricom, Digital Broadband Communications, Harvardnet, PSINet, and Vectris Communications even when its officers knew the service providers could not meet very minimal convenants with Cisco Systems Captial, the financing arm of the company. The suit alleges that Cisco offered these liberal terms to generate more business for the company. But many of these providers defaulted on their loans and never paid for the products that were shipped.

“In order to inflate prices of Cisco stock defendants caused the company to falsely report results for at least the 4th Q 99, 1st Q 2000, 2nd Q 2000, 3rdQ 2000, 4th Q 2000, 1st Q 2001 and 2nd Q 2001 through improper revenue recognition including recognizing as sales shipments of shell units of products not yet developed, manipulating revenue on financing arrangements with certain of its indirect customers including CLECs and failing to adequately accrue for bad debts, thereby materially overstating its revenue and net income during the class period,” reads the lawsuit filed in California.

But more than taking on risky business, the suit also contends that Cisco tried to hide this bad debt by not accounting for it properly. The suit says that the company violated the FASB Statement of Financial Standard No. 5 that requires the estimated portion of uncollectable receivable accounts be accrued in the period in which it becomes evident that it won’t be collected.

So when did company officers know there was a problem?

Sockolow says signs that Cisco was in trouble were surfacing this summer and the CLEC situation had become clear by October.

“You have to wonder if they were really caught by surprise,” she says. “The balance sheet had been falling apart since last summer. The payables and receivables had been growing, and the company was struggling to get its inventory under control. I’m not privy to all the details in the balance sheet, but it makes you wonder.”

The suit also alleges that Cisco was shipping incomplete boxes to customers and booking them as revenue, shipping the fully operational pieces in later quarters. In the summer of 1999 it allegedly shipped 14 switches to software maker Worldwide Web in Miami, Fla., recognizing $400,000 for each device. When the technicians turned on the box, nothing happened, says the complaint, and Cisco agreed to send the appropriate blades to the customer in a subsequent quarter.

The practice of shipping boxes without the appropriate blades continued into 2000. Back in November Light Reading reported that Cisco had problems shipping blades for its ONS 15454 optical transport due to a component shortage (see Cisco's Optical Customers Face Delays).

But this point may actually not mean anything in court. Why? The accounting standards do not specifically state that companies cannot recognize revenue on boxes that are incomplete or not functioning, says Doug Reynolds with FASB.

“The standard assumes that these are finished products,” says Reynolds a practice fellow at FASB. “But we don’t specifically state that anywhere. Application of the rules varies. The rules are straightforward, but it’s not as easy as it sounds to apply them.”

Cisco hasn’t issued a comment on the lawsuits and was unavailable for comment. Its stock ended at $17.33 today, down 9.5 percent from yesterday’s close.

-- Marguerite Reardon, senior editor, Light Reading http://www.lightreading.com

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rcj_98 12/4/2012 | 8:31:36 PM
re: Cisco Socked with Shareholder Suits What are you talking about this was a article based on facts. Foundry, Oracle and several other vendors have gotten similar lawsuits. This makes you really think about ciscos practices. As a shareholder of cisco I question them myself. I don't think an article like this will bring cisco any further down than what it already is.
flanker 12/4/2012 | 8:31:36 PM
re: Cisco Socked with Shareholder Suits You are playing with fire. Please stay away from stories like this. You will bring down the entire industry: vendors, operators, investors, analysts, press.

light_saber 12/4/2012 | 8:31:35 PM
re: Cisco Socked with Shareholder Suits "When the technicians turned on the box, nothing happened, says the complaint"

Your journalistic ramblings are so unfunny. Get a life.

may the force be with you
aa 12/4/2012 | 8:31:35 PM
re: Cisco Socked with Shareholder Suits My opinion:

Whats wrong in reporting things as they are (or will be). Just because you are long cisco doesnt
mean you shamelessly defend everything it does!

The lawsuits only touch a small part of all the
accounting shenanigans that Cisco engaged in in the last 3-5 years. To a financially savvy and
technically capable observer it is obvious that this company's growth spurt was largely a myth
and the balance sheet shows much of that problem. Infact there was an article in Barrons a year or so back (at the height of hype) about a lot of them. These include stock options, acquisitions, financing etc. Look at an article by Bill Parish who has been critical of this company for a long while to get enlightened and to remove the rosy shades from your eyes!
Opto-Prozac 12/4/2012 | 8:31:35 PM
re: Cisco Socked with Shareholder Suits Maggie - can you write about technology for once, and not scandal?

I heard you have never worked in any industry even related to telecom/datacom. Is this true?

And why do you only contribute to these boards through aliases?
all-software-are-buggy 12/4/2012 | 8:31:34 PM
re: Cisco Socked with Shareholder Suits Hello Hello..
This is a free country. This is not china... this is not cuba.. this is the land of the free and the country of the brave...

Lightreading or anybody can question Cisco or any other buggy software/networking company regarding anything ranging from buggy software products to accounting practise. It aint fire..its normal thing...so just relax sir...

If a industry is build on honesty, ethics, quality and moral values..nobody can bring it down...
StartUpGuy1 12/4/2012 | 8:31:34 PM
re: Cisco Socked with Shareholder Suits Cisco has boasted on numerous occasions of their visiblity into their business on a daily basis. Their relentless focus on weekly/daily forecast updates from the sales staff reveals that Cisco should have known in Calendar Q4 or before that there business was slowing down and that their customers in the CLEC space were not paying their bills.

The real culprit here is the belief by upper management at Cisco that they were immune to any slowdown and that by upping the pressure on their sales teams, they could make up the ANY deficit. With their building boom and hiring binge, Cisco management did not manage their growth in a manner that was consistent with the fiscally conservative heritage that they started from during the John Morgridge tenor at Cisco.

This situation looks alot like the IBM of the late 70's and early 80's. Invicible and Arrogant.
But look what happened to IBM in the late 80's and early 90's.

IBM remade their entire company. Cisco's challenge will be to see if they can make the hard choices necessary for them to remake themselves to the lean mean company that they were during the growth days..

photonic 12/4/2012 | 8:31:33 PM
re: Cisco Socked with Shareholder Suits
This article is the biggest piece of junk you will find any where. All the article does is paste stuff from the lawsuit and pass it off as if hell is breaking loose. PLEASE! Give me a break!

Any lawsuit ever filed against any company after their stock price is depressed reads exactly identical. If you have guts, why don't you paste material from the lawsuits against other companies?

Cisco's write offs, vendor financing deals, bad debts, defaults etc are all a small percentage when compared to the revenue and cash flow they generate.

Compare these same items as a percentage of revenues and cash flows for companies like Sycamore, Redback and other light reading darlings and you will notice that they are in bigger hole than light reading believes they are.

I will bet a lawsuit is coming against Sycamore, which is much deserved that the one against Cisco. I will wait and see if Maggie has the guts to write a similar scathing piece of junk against them.

Maggie, you don't even understand the accounting stuff and yet you write an article on it as though you are a leading expert. All you did is paste stuff from the lawsuit that these wall street lawyers filed. Guess what these lawyers' sole reason for existence is? To file lawsuits like this.

Get real folks.

Belzebutt 12/4/2012 | 8:31:31 PM
re: Cisco Socked with Shareholder Suits Didn't LR write about the Nortel lawsuits? And so what if they "copy/paste" from the lawsuit, the article clearly says "alleged". Give me a break, how are you supposed to write an article on a subject if every time you have to make sure to cover all the other possible subjects. Would you like her to include Cisco's balance sheet in every article?
cfaller 12/4/2012 | 8:31:31 PM
re: Cisco Socked with Shareholder Suits I heard this morning that a Cisco executive was arrested by the FBI for embezzlement of $10M.

I'm hoping LR will check their sources and report this. I can't wait to see the message boards light up with Cisco shareholders going through the roof!
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