The Dell Tale Starts to Unravel and it's a Bombshell

On June 4, 2010 Michael Dell stated that he was considering taking Dell Inc. private "but would not comment when asked what would make him think about the possibility more seriously," reported Reuters. Well, today we likely know the reasoning for that off-the-wall statement. The SEC charged Dell and senior executives with disclosure and accounting fraud yesterday and the story behind it is one hell of a bombshell!

The SEC lays it All Out

The SEC alleges that Dell did not disclose to investors large exclusivity payments the company received from Intel Corporation to not use central processing units (CPUs) manufactured by Intel's main rival. It was these payments rather than the company's management and operations that allowed Dell to meet its earnings targets. After Intel cut these payments, Dell again misled investors by not disclosing the true reason behind the company's decreased profitability.

The SEC charged Dell Chairman and CEO Michael Dell, former CEO Kevin Rollins, and former CFO James Schneider for their roles in the disclosure violations. The SEC charged Schneider, former regional Vice President of Finance Nicholas Dunning, and former Assistant Controller Leslie Jackson for their roles in the improper accounting.

Dell Inc. agreed to pay a $100 million penalty to settle the SEC's charges. Michael Dell and Rollins each agreed to pay a $4 million penalty, and Schneider agreed to pay $3 million, to settle the SEC's charges against them. Dunning and Jackson also agreed to settle the SEC's charges.

The SEC's complaint, filed in federal district court in Washington, D.C., alleges that Dell Inc., Michael Dell, Rollins, and Schneider misrepresented the basis for the company's ability to consistently meet or exceed consensus analyst EPS estimates from fiscal year 2002 through fiscal year 2006. Without the Intel payments, Dell would have missed the EPS consensus in every quarter during this period. The SEC's complaint further alleges that Dell's most senior former accounting personnel including Schneider, Dunning, and Jackson engaged in improper accounting by maintaining a series of "cookie jar" reserves that it used to cover shortfalls in operating results from FY 2002 to FY 2005. Dell's fraudulent accounting made it appear that it was consistently meeting Wall Street earnings targets and reducing its operating expenses through the company's management and operations.

According to the SEC's complaint, Intel made exclusivity payments to Dell in order for Dell to not use CPUs manufactured by its rival — Advance Micro Devices, Inc. (AMD). These exclusivity payments grew from 10 percent of Dell's operating income in FY 2003 to 38 percent in FY 2006, and peaked at 76 percent in the first quarter of FY 2007. The SEC alleges that Dell Inc., Michael Dell, Rollins, and Schneider failed to disclose the basis for the company's sharp drop in its operating results in its second quarter of FY 2007 as Intel cut its payments after Dell announced its intention to begin using AMD CPUs. In dollar terms, the reduction in Intel exclusivity payments was equivalent to 75 percent of the decline in Dell's operating income.

Oh How Far the Mighty Fall

Michael Dell, CEO of Dell Inc. was asked a question at the 1997 Gartner Symposium of what he would do if he owned then-troubled Apple Computer. He replied, "I'd shut it down and give the money back to the shareholders."

Steve Jobs never forgot those stinging words and in 2006 he sent an email out to Apple employees stating the following: "Team, it turned out that Michael Dell wasn't perfect at predicting the future. Based on today's stock market close, Apple is worth more than Dell. Stocks go up and down, and things may be different tomorrow, but I thought it was worth a moment of reflection today. Steve."

While it's been fun to see Apple Inc. jet past the one-time computer industry leader Dell Inc, who knew that Dell was about to crash so low in under a year's time from Steve Jobs email. Dell had fallen so far that technically they required 76% of their operating income to come from Intel in the first quarter of FY 2007. Wow, what a bombshell!

What a sad day it is to see such a one time leader fall from grace. And the news, at least for me, tarnishes Intel's image tremendously. Yes, they helped Dell from collapse perhaps, but the illegality and/or shadiness behind it – makes you want to cheer AMD on all the more. If it's true that Apple is considering such a move to the AMD platform, then good for Apple. Though time will tell on that one.

For more details on this story, see the U.S. Securities and Exchange Commission's press release.

Update - August 4, 2010: According to Reuters, Intel Corp has agreed to stop using anti-competitive practices against rivals. The report goes on to state that "Intel is now barred from offering deals to computer makers in exchange for their promise to buy exclusively from Intel. It is also required to change its intellectual property deals with AMD, Nvidia and Via."  

In InfoWorld's report we find a little more depth on this matter along with this interesting detail: "...the settlement also establishes a $10 million fund, to be established over a two-year period, for software vendors to recompile their software for better performance with competing chips. The FTC alleged that Intel's actions caused software compiled on an Intel compiler to run more slowly on other chipsets."

Comments

[Mark Ponty]

The topic is Dell's Bombshell.

The topic is Dell's Bombshell and nice try in deflecting it back to Apple.

Dell deceived the market for 20 quarters!!! That's a "crime" without a doubt. In fact 20 times a crime because they knowingly continued it for 20 consecutive quarters. Lied to analysts for 20 consecutive quarters.

Micheal Dell should go to prison for white collar crime, period! The SEC, are equally at fault by slappying Dell with only a 100 million dollar fine = 5 million dollars per false quarter. That's a joke to the profiteering that went on with a truly dead stock in reality.

The SEC should have come down on dell with a billion dollar fine. Now all companies will say that for 5 million we could lie through our teeth. What a sad joke on shareholders and on the U.S. stock market overall. I'm sure this practice goes far beyond Dell. That's what's scary.

[Jeremy]

@Mike I

Educate yourself before judging based on flawed reporting. If you don't like Apple (which is obvious), that's your problem, but get the facts straight before kicking others.

Smartphone antenna problems:
http://www.apple.com/antenna/

Press Conference and Videos of other smartphones with the same problem:

http://events.apple.com.edgesuite.net/100716iab73asc/event/index.html

I understand you'll say it's Apple propoganda, but again, that's your problem. Others who read the facts and see the videos segments noted above will conclude that the problems hailed in the PC press (and even some stupid Apple fan sites) were based on hysteria, not facts.

[Lanny W.]

@Ajkill

Ha ha ha ha! You go off topic because you see a typical feud breakout between long-time fan based rivals. Linux is a primarily a Euro thing or for poor students. You have to disguish between our having fun with our long standing "rivalry" and needing a new platform. We appreciate our leading OSs in the world vs. some geeky thing that no one wants to write software for. Got it?

[ajkll]

This is why Linux will probably overcome apple: none of the Gates/Jobs feud from the 1970s to deal with. Too much baggage.

[Mike I]

Hey Maggie, Selling a known defective product? Don't you mean Apple's new iPhone 4?!?

[melgross@usa.net]

It's easy to see how Dell has survived. First by getting a large portion of its profits from under the table dealings, without telling investors where it was coming from, and so making it seem as though operations were more profitable than they were, and apparently "working the books".

Secondly, by knowingly selling defective computers for years, and lying about it to even their largest customers.

I wonder what profits they would have had left if neither practice was undertaken.