Deloitte and former partners slammed in release of investigation into Autonomy audit

The tribunal which upheld the record £15 million fine against Deloitte and two of its senior partners found against them on nearly all counts and scorned their demands for clemency for “cooperation,” it emerged today.

Deloitte and former partners Richard Knights and Nigel Mercer were fined and severely reprimanded last year over their failures to act with “integrity and objectivity” over the way Autonomy allegedly aggressively accounted for sales in 2009 and 2010.

The software company founded by Mike Lynch was sold to Hewlett-Packard for £8.4 billion in 2011 in a deal that quickly soured, resulting in allegations of fraud from the US buyer.

The Financial Reporting Council subsequently alleged Deloitte allowed the former tech star to flatter its crucial revenue growth figures to the tune of tens of millions of pounds, dramatically inflating profit margins.

Deloitte and the two former partners fought the case all the way to tribunal and, while the tribunal’s ruling upholding the FRC’s punishments was made in September, today was the first time its findings were fully published.

They paint a picture of an auditor and senior partners beholden to a big-spending firm and failing to hold it to account. 

Autonomy was Deloitte’s Cambridge office’s sole FTSE-100 client.

 As Knight wrote at the time: “At a personal level, the Autonomy relationship is vital to the financial success of the office... We have set ourselves a target of increasing revenues to this FTSE company by [more than] 20%”

The Tribunal cited evidence that Deloitte staff had repeatedly voiced concerns internally about Autonomy’s accounting but that the firm had not acted adequately on them.

At issue was the way that, in the third quarter of 2009, Autonomy began boosting its revenues by selling low-margin, even lossmaking, computer hardware as well as its traditional high margin software. 

Autonomy was under pressure from City investors to keep showing strong revenue growth. In one quarter, when the pace of growth fell just 3%, its shares plunged 20%.

Deloitte allowed it to blur hardware and software sales to come up with a single revenue growth figure. It also allowed it to allocate some losses on the hardware sales as marketing expenses, flattering profit margins.

In one period, profit margins were moved from 71% to 86% in this way, with $28 million of hardware losses being attributed to sales and marketing expenses, the Tribunal heard.

Knights had queried the issue with Autonomy the night before a crunch meeting with the company but the Tribunal ruled there was no evidence he gained significant response, and approved the accounts anyway.

He prefaced that email to the firm with the message: “After a glass or two of red wine and a plateful of Mrs K medieval pasta I’ve had a stab at writing the Autonomy paper on TP42… This was rattled out pretty quickly and fortified with a few liveners so as a modest bookkeeper it would benefit from the cutting edge of you software gurus…..!!”

The Tribunal concluded: “The decision to approve the allocation bears all the hallmarks of having been made under client pressure… In our opinion, Knights should not have endorsed the allocation.”

It said the approval was “misconduct” which “fell significantly below the standards expected.”

Autonomy had argued that it was buying computer hardware and selling it on to big banks at a low price to get a foot in the door to win software orders, hence its justification of the "sales and marketing" accounting.

The Tribunal quotes one Deloitte staffer who writes to Autonomy: “struggling to see how you can put together a persuasive argument for showing the cost of hardware as a marketing cost rather than a cost of sale - does this not disguise the fact that margins will indeed fall as a result of doing more hardware deals?… I feel pretty uncomfortable about this… hardware sales will grow… how long can they be deemed marketing…?"