Global Insight Perspective | |
Significance | Former Delphi executives are expected to face civil fraud charges following an investigation by the Securities and Exchange Commission. |
Implications | The investigation has led to Delphi entering bankruptcy and could see executives facing criminal prosecution. |
Outlook | The long-term cost has been great for the short-term returns, as Delphi was forced to enter Chapter 11, but it should emerge as a more focused entity. |
Following a 27-month investigation by the U.S. Securities and Exchange Commission (SEC), former executives and employees of Delphi could face civil fraud charges, reports the Detroit News, citing sources close to the situation. These include the company's former vice-president of treasury, mergers and acquisitions John Blahnik; former director of financial accounting Laura Marion; and Paul R. Free, Delphi's former chief accounting officer. The investigation could also result in officials at other companies facing charges for improper transactions with the component supplier.
Investigation Reveals Accounting Irregularities
The investigation began after IT company EDS told the SEC in June 2004 about a US$20 million loan that it had granted to Delphi in 2001 that the component supplier booked as income. Following a probe, the SEC began a formal investigation in August 2004. This has revealed that Delphi used improper methods to inflate earnings, cash flow and revenue, accounted some loans from suppliers as "rebates", and engaged in false transactions. Specific charges include:
- The failure to notify its board and credit ratings agencies of up to US$300 million in European credit lines held between 1999 and 2004.
- The recording of sales of precious metals to Bank One in December 2001 for US$200 million. This, however, did not leave the factory, and was part of a deal that would see Delphi buy back the metals at a later date for an undisclosed price. Neither of these details was disclosed at the time, and it enabled the supplier to improperly increase its income by US$100 million.
- The booking of sales of scrap metal due to be sent to landfills as electronic inventory to boost cash flow.
- A US$237 million payment made by Delphi to General Motors (GM) that was improperly accounted.
The conclusion of a 10-month internal accounting investigation in March 2005 caused Delphi to lower its stated 2000 cash flow by US$200 million, its 2001 earnings by US$265 million and its 2002 net income by US$24 million, as well as adjusting the net loss made in 2003 by US$46 million. It also resulted in the resignation of Free and vice-chairman and chief financial officer (CFO) Alan Dawes, who were followed out the door by other lower- and middle-level executives from the finance division later in the year.
Charges Expected Before End of October
The SEC's charges are expected to be disclosed by 31 October, and most of the former executives who are being investigated have waived their right to the statute of limitations until then. Lawyers for the former Delphi executives have argued that they did not personally profit from the improper accounting methods, and contend that until corporate reforms in 2002 following the Enron scandal, the practices that took place at Delphi were commonplace.
Outlook and Implications
The revelations which led to the investigation into accounting issues at Delphi were one of the major reasons behind Delphi's entry into Chapter 11 bankruptcy protection in October 2005. With the help of these transactions, the company had managed to meet or exceed every quarter's earnings expectations between its spinning off from GM in 1999 and 2003.
Executives have been looking towards settlements with the SEC, but the commission has sought stiff fines of up to US$1 million for the former officers, and a corporate penalty could be imposed on the supplier. A criminal investigation is also being prepared into the fraud, which is being led by the Justice Department's fraud section. Lead prosecutor, Jack Patrick, has been in Detroit in recent weeks working on the case, which also involves the Federal Bureau of Investigation (FBI) and the U.S. Postal Inspection Service.
The decision by former executives to improperly account for transactions no doubt delayed Delphi's fall into financial turmoil in the short term, but greatly increased problems when the irregularities were discovered. However, it has meant that the company has had to face up to issues such as unprofitable supply contracts, the streamlining of its North American operations with the shedding of job and factories, and the focusing on more lucrative businesses. Whether Delphi's restructuring plans will be affected by the investigation remains to be seen, but had officials previously been more honest regarding the company's financial results, it is unlikely that the Chapter 11 process would have ever occurred.