The Aspen Account (18 page)

“All right. Well, I finished looking through the revenue contracts, and they didn’t support the revenue the company was recording. I recalculating everything for the past year and concluded X-Tronic was overstating revenue by three times what they should have reported. Profits were overstated by much more.”

Sarah was digesting this news. She needed to focus on the facts and understand the mechanics of what Michael had found—only then could she piece everything together to discover what had happened to Kurt.

“So how does this work?” she finally asked. “I’m no accountant. Break it down for me.”

“Okay,” Michael said, arranging some of the scraps of notepaper the librarian had given him on the tabletop. It seemed he had written things on each piece before she arrived. “X-Tronic’s a software company, right?”

“Right.”

“So what do they sell?”

“Software.”

“They sell software
licenses
: the right to use their software for a period of time—often three years, but the terms can vary.”

“Okay.”

“But they only develop software for businesses, mostly large corporations. So they also sell different types of software products attached to their main operating system software. They have inventory applications for manufacturers, payroll applications for companies that don’t outsource payroll services, purchasing applications, accounts payable, revenue and accounts receivable, and corporate accounting and financial reporting applications.”

Pausing a moment, he appeared to refocus his explanation, as if he was worried he might fail to communicate the significance of what he had discovered. “The business software helps a corporate client with their accounting. Everything a company needs for its employees to record all the accounting activity, keep track of all the money coming in and going out, all the business transactions and journal entries, all that. Everything needed to create management reports so that the big suits can make the right decisions about whether to open a plant, lower prices, purchase a competitor, fire a manager, kill a product, or get a new loan from a bank so they don’t run out of money at the end of the month. Everything, right?”

 “Yeah, I get it.” She had been watching him point to the variously labeled bits of paper on the table, depending on what he was trying to describe. She had not seen this side of him before: he spoke fast and jumped around the different business issues faster even than her brother had the few times he had described his job to her. Seeing this behavior gave her confidence—even if she couldn’t grasp everything he was saying, he wouldn’t lead her astray in his analysis of what he had seen in the company. In short, he knew what he was talking about.

“So,” Michael continued, “a sales rep at X-Tronic sells a mixed bag of products in one large contract to a big corporation. Everything is broken down by license and product. The contract says a company will pay so much for twenty users for the payroll license for three years, thirty users for accounts payable licenses for three years, twenty users for revenue licenses for three years, and so on. They usually bundle the products and license levels to give corporate clients a good deal, et cetera. Okay?”

“Sounds like a mess to me, but yeah, I’ve got the gist of it.” Sarah felt suddenly exhausted. Her mind was working fast, and so far she was keeping up with his explanations, she had to stay on her toes. Part of her wanted to take a moment to digest what he was saying, but she didn’t want to break his momentum. She sensed he was about to get to the most important part.

“Well, here’s the thing with the accounting rules,” he said. “If a company pays X-Tronic three million dollars for the license rights to use a bunch of different software products for three years, X-Tronic can’t record that as three million dollars in revenue.”

This confused her. “Why not? They made the sale, right? They have a signed contract? They got the money, right?”

“Oh, yeah, they get the money right away. The problem is, technically they haven’t
earned
the money yet.”

“What do you mean they haven’t earned it? They must have spent a fortune developing their software products. They sold the software to a company to use. They get the three million. You don’t call that revenue?”

Michael shook his head. “Like I said, they didn’t
sell
the software. What they sold were license agreements so that the company could
use
the software over a three-year period. The three million they get is a
prepayment
for those three years. Just like if a person had to pay their rent for three years in advance—the place they rent from would have to break those prepayments into thirty-six even amounts and recognize the revenue as each of those months occurs.”

“Why the hell would a company pay that much in advance?”

“That’s just the way this kind of contract works. I’m sure they could be modified if the company wanted to. The point is, from an accounting point of view, the three million is supposed to be booked to an account called ‘unearned revenue.’ In other words, X-Tronic can’t consider the money actual revenue until time passes during the term of the contract: the three years.”

Sarah felt a little overwhelmed, but despite the complexities of what Michael was describing to her, she felt as if she understood. The company had collected money in advance for services it would perform over the next three years, but it was reporting in the accounting statements that it had already performed the services, thus fraudulently declaring the money
earned
revenue instead of
unearned
revenue. She still didn’t have all the ins and outs, but she got the thrust of it: X-Tronic was using bad documentation and false calculations to pretend it had made more revenue and profits during the year than it actually had.

“In any accounting fraud,” Michael continued, “it’s really hard for just one person to cook the books. Companies generally have a lot of checks and reviews in place, so you typically need at least two people: one to lie about the numbers, and the other, the reviewer or supervisor, to cover up the lie. If you have more than two people, it’s even easier to cover things up. Now, everyone in accounting has different responsibilities, so of course the fraudsters can’t be just anybody
—
they have to be the right people.”

“And X-Tronic has the right people doing this?” 

“Oh, I think so,” Michael said. “I think they have the CFO, the two COOs, and the CEO, as well as some others. That’s everyone important for the revenue contracts. With a team like that, they could make up almost any number they wanted for revenue as long as it wasn’t so inflated it might raise a red flag for a stock trader or a security analyst.”

Sarah considered this. The implications of a fraud this big by the top executives at one of the largest software companies in the country was enough to make even the most veteran investigative journalist salivate.

But suddenly her emotions took over, and despite all the financial crimes Michael was trying to explain to her, Sarah came back to the only reason why any of this mattered to her. Somehow, her brother had fallen into this nest of vipers at X-Tronic. Between the shock she felt and the grave concern she saw on Michael’s face, she could only imagine what must have been going through Kurt’s mind since he discovered the same crimes and tried to sleuth out their sources. She wanted to hurt everyone who had robbed her of her brother, but she forced herself to maintain control. She was out of her element and knew she must rely on Michael, not only as a journalist’s source but also as an expert analyst on financial crimes.

“So you think I should write about it,” she said. “You want me to expose them.”

“Yes—but not yet. I still haven’t gotten all the information about what’s happening.”

She knitted her brows. “How much more do you need?”

Michael shrugged. “I’m working with someone to determine all the potential criminal aspects of what we’ve seen. He’s really smart, and I trust him. He’s helped me out before, and I think he can help me now. He’ll understand this stuff better than anyone, so I want to check with him in case I’m missing some angle on what’s happen or why.”

“And you can’t tell me who they are, I suppose?”

“Sorry, I wish I could,” Michael said honestly.

Sarah hated not having answers, but she liked Michael and trusted his judgment. “You think there’s something more going on besides the inflated revenue, don’t you?” 

Michael shifted around some more scrap paper, looking up at her just long enough to make sure she was watching as he pointed to the different pieces of paper. “From what I can tell, X-Tronic is creating a huge one-year spike in revenue this year,” he said, stabbing a piece of paper in the center of the new pattern he had created. “It looks like they’ve been doing it the past few years, too, but by not as much. This year they’re doing it to almost every contract. It’s not sustainable.”

“What do you mean, ‘not sustainable’?”

“Well, say they entered into new contracts this year for three hundred million. Normally they would report revenue of a hundred million this year, a hundred million next year, and a hundred million the year after. But since they’re reporting everything up front, they’re really digging themselves into a hole in future years. In future years a stock analyst would definitely see a drop in revenue, which is a huge red flag that something’s wrong with the company’s numbers.”

“X-Tronic could just do it again next year?” she offered.

“They could try, but they’d start out in the hole because of the two hundred million they can never record as revenue in future years—even though they have to keep servicing those contracts.”

“So they’re eventually going to get caught!”

“Normally, yes. These things are short-term lies. They always get caught after a number of years of lying, if not sooner—there is usually no escape in the end. That’s what happened to Enron, and it happened to Bernie Madoff. In the end, time almost always catches up to this type of accounting lies. But if the merger with Cygnus goes through, X-Tronic can hide the numbers forever, because all their accounts get revalued. It’s called an
open balance sheet
audit. It’s something unique—happens only once: when one company gets bought by another. The bought-out company’s accounting records get revalued in order to be merged with the other company. And in future years it’s too complicated to make accurate comparisons of premerger versus postmerger financial results, because the company’s operations are now combined with another company’s operations.”

Sarah knew he was trying to explain everything to her in the simplest terms he could, but it was still a little confusing to wrap her mind around. To her, the important thing was that X-Tronic would legally be able to reset the accounting records—erasing its fraud and starting the books fresh—if it got taken over by Cygnus. It was as if the accounting lies were the bodies of people the mafia had killed, and Cygnus was a new casino they could build on top of the unmarked graves to make sure the bodies were never found. Cygnus wouldn’t even know it had inadvertently helped X-Tronic cover up the crimes.

“And you think most or all of the top executives are involved?” she asked.

“I don’t see how they could not be.” 

“You said the CFO, Jerry Diamond?”

“Almost certainly.”

Sarah realized that this was matching closely with some of the documentation Kurt had mentioned in the notes she found. “You need to be careful. You’re heading down the same path Kurt must have been on. You may even be farther down it than he got. If they find out what you’re doing, they’ll kill you, too.”

Michael nodded. “I think someone’s following me. Not all the time, but sometimes I see a black Mustang with tinted windows, and I’m sure it’s the same one every time.”

“You should tell someone.”

“I’m telling
you
,” he said, as if that were enough. “I’m telling you because, if anything happens to me, I don’t want you to keep digging around in all this. Print an article about everything you have, but don’t wait for more information. Put this out in the open so it’ll be harder for someone to come after you. You have to promise me that. I’m the best source you’re ever going to get inside X-Tronic. Trust me. If I’m gone, you can’t continue. Cut and run and put up a giant red flag for the whole world to see, and wait for the cavalry. They’ll come, I guarantee you. You have to promise me you’ll stop if something happens to me.”

Sarah was a little surprised how calmly Michael spoke of his own potential death, and it was sweet the way he was trying to protect her. But there was no way she would stop investigating the story and print some unfounded article if something happened to him. The more time she spent with Michael, the more she liked him, but as far as she was concerned, X-Tronic was more her investigation than his. And no one could ever ask her to stop digging for the truth.

“Promise me,” Michael repeated.

“I promise,” she said just to satisfy him.
I promise to do everything I can to hurt those bastards who killed Kurt. I promise to push even harder if something happens to you. And I promise never to give up, no matter how many years I have to search before I find the truth about everything that’s going on in that company.

Michael seemed content with her response. She watched as he slowly picked up the scraps of paper he had used to help explain the fraud. On each piece, he had written the name of a person at X-Tronic, a division of the company, or a department or accounting concept or transaction type. What she couldn’t help noticing, though, were all the extra pieces of paper pushed to the side that he hadn’t pointed to during his explanation. On one, he had written
Cooley & White
. She realized that Michael must have been making extra notes for himself before she arrived. He was still trying to figure this all out! He had a lot of the pieces, but not all of them. As she watched him pick up the pieces of paper, she had the eerie feeling that they were looking at the barest tip of the rot. They had no idea how deep it went, or what they were really up against.