Electronic Data Systems Agrees To Pay More Than $490 Thousand To Settle SEC Investigation - Update

(RTTNews) - Tuesday, the Securities and Exchange Commission or SEC revealed that information technology services provider Electronic Data Systems Corp. (EDS | charts | news | PowerRating) agreed to pay more than $490 thousand to settle an investigation into reporting as well as books and records violations by EDS that allegedly occurred from 2001 to 2003.

The SEC noted that the Plano, Texas-based company did not disclose the cost of certain derivatives contracts adequately and also failed to disclose adequately an extraordinary transaction with a major customer, which increased its reported cash flow by $200 million in 2002. In addition, the SEC said that EDS maintained inaccurate books and records by employing inaccurate assumptions in accounting models to estimate revenues and expenses for its $6.9 billion intranet contract for the Navy and Marine Corps awarded to the company in 2000. EDS also maintained inaccurate books and records between 2001 and 2003 due to a false invoicing scheme discovered and reported by the company to SEC in 2004, b which a former employee at a former subsidiary of the company made improper payments to officials of Indian-government owned customers.

The SEC said that EDS failed to disclose the cost of certain derivatives contracts in the first quarter of 2002, while in the second quarter of the same year, it failed to disclose adequately the cost of those contracts. The SEC further said that in the third quarter of the same year, EDS selectively disclosed to certain analysts the cost and early settlement of the outstanding derivative contracts. In addition, EDS failed to disclose adequately an extraordinary transaction with a major customer that increased its reported cash flow by $200 million in the second quarter of 2002.

The SEC noted that EDS maintained inaccurate books and records between 2001 and 2003 as a result of a false invoicing scheme discovered by the company and reported by it to SEC in early 2004, by which a former employee at a former subsidiary of the company made improper payments to officials of Indian government-owned customers.

In December 2001, EDS began entering into derivatives contracts with a financial institution to reduce the expected cost of its employee stock option program in the event of an increase in the company's share price. The SEC noted that the transactions involved the purchase by EDS of "capped collar contracts", which obligated the company to buy its shares on future dates at predetermined prices, and selling put contracts, which gave the financial institution the option to sell EDS shares to the company on future dates at predetermined prices if the company's share price fell below certain levels. The transactions included "trigger" provisions linked to the company's share price, which allowed the financial institution to force immediate settlement of a contract in the event the company's share price fell below 50% of the exercise price of that contract.

The SEC noted that following the announcement by EDS in September 2002 that its earnings and cash flow would fall short of prior guidance, the company's share price fell over 50%, causing the trigger provisions in all of the company's remaining derivatives contracts to go into effect. Although all of the derivatives contracts were required by their terms to be settled by year-end in the ordinary course of business, the financial institution demanded that the company immediately settle the outstanding transactions, the SEC said. The settlement occurred on September 20, 2002 and cost EDS over $225 million.

The SEC said that the company personnel disclosed the $225 million payment to securities analysts from one broker-dealer on September 19, 2002 and to analysts from two other broker-dealers on September 23, 2002. The SEC noted that EDS did not publicly disclose the $225 million cost of settlement until November 14, 2002, when it filed its form 10-Q for the quarter ended September 2002.

The SEC said that EDC did not adequately disclose the basics that led it to report a large one-time boost to its free cash flow. Between April and mid-June 2002, EDS and a major customer negotiated a $200 million prepayment by the customer in return for monthly credits against the company invoices for services totaling $221 million over a period of 24 months, the SEC noted. Concurrently, the company and the customer negotiated a modification and a one-year extension of their computer outsourcing agreement. Further, the SEC said that the although EDS recorded several much smaller payments in the period, the company's Form 10-Q for the quarter ended June 30, 2002 failed to disclose that a $200 million prepayment came from a single, existing customer and did not represent additional business from a new customer.

EDS was awarded a five-year $6.9 billion contract in October 2000 by the US Department of Defense to build an intranet for the Navy and the Marine Corps. Over the term of the NMCI contract, EDS expected to deploy over 360,000 computer workstations. The SEC noted that the contract required EDS to make a large up-front investment to build a secure and highly advanced infrastructure capable of supporting the intranet. Under the Generally Accepted Accounting Principles, EDS was required to prepare reasonably dependable estimates of revenues and expenses over the life of the contract in order to determine whether the NMCI contract was in a loss position. The SEC said that in the first two quarters of 2002, the company prepared NMCI contract accounting models that reflected it would deploy 160,000 seats during the five-year contract term. Further, the SEC noted that EDS had an insufficient basis to assume that only 160,000 seats would be deployed over the life of the contract as the seat level assumption was inconsistent with the higher seat levels contemplated by the NMCI contract and was anticipated by EDS.

EDS acquired management consulting firm A T Kearney Inc. or ATKI in 1995 and completed the sale of that company in January 2006. The SEC noted that beginning in September 2003, EDS discovered that the head of the ATKI branch in India was diverting cash by causing ATKI to pay false invoices from dummy vendors. The employee used some of the cash between 2001 and 2003 to pay numerous bribes totaling at least $720,000 to high level employees of two Indian state-owned enterprises, who threatened to cancel their contracts with ATKI after issues arose on the implementation of the contracts. The SEC said that the payments in the form of cash transfers, gifts and services continued until it was discovered by EDS in September 2003. The Indian companies did not cancel the contracts and ATKI derived revenues from those contracts. EDS investigated and reported the matter to SEC in February 2004. Due to the false invoicing scheme, EDS incorrectly recorded the amounts in its accounting books and records.

The SEC said that EDS was ordered to pay disgorgement in the amount of $358,800 and prejudgment interest thereon in the amount of $132,102, for a total payment of $490,902 to the U.S. Treasury to settle the investigation.

EDS closed Tuesday's regular trading session at $21.73, down $0.30 or 1.36% on a volume of 3.21 million shares.

source:tradingmarkets.com