THE CON: Just before a merger that created a $23 billion company, execs at HBO & Company inflated revenues by $230 million through backdated contracts and side deals.
THE DAMAGE: $9 billion
THE OUTCOME: McKesson HBOC stock plummeted nearly 50 percent, causing investor losses of $9 billion. Four top executives pleaded guilty to securities fraud. The company dropped HBOC from its name and agreed to pay $960 million in a class-action lawsuit filed by shareholders.
Just months after two giants in the drug industry merged to create a $23 billion company, a routine audit in 1999 turned up major problems. As soon as word leaked that McKesson HBOC Inc. planned to reinstate its earnings due to irregular figures, its stock plummeted nearly 50 percent. Prior to merging with McKesson, execs at HBO & Company had backdated contracts and made side deals to inflate profits. Though considered one of the nation’s largest securities fraud cases, the trials in 2005 were overshadowed by media coverage of the corporate crooks at WorldCom and Tyco.
In 1999, McKesson Corporation, the nation's largest drug wholesaler, acquired HBO & Co.for $14 billion. It was a move that seemed to make sense for McKesson; the stock of HBO & Co., a medical software company, had grown more than hundredfold in the previous decade. But the ink was barely dry on the deal when auditors discovered $42.2 million in improperly recorded sales.
Within weeks of the April audit, the board had fired four top executives and revisited HBO & Co.’s accounting for the previous year. Auditors discovered fraud on a grand scale, including profits reported in 1998 as seven times greater than they actually were. According to the indictments handed out to a half dozen executives, the revenues were overstated at the end of 1999 by more than 20% – or $230 million. Several creative methods used to meet, or exceed, expectations on Wall Street. Along with backdating contracts, execs sold software to hospitals with conditional “side letters” that gave the hospitals an option to back out. These letters were kept from auditors, especially when a hospital canceled a purchase but the money stayed on the books as revenue.
Another way to boost profit was to book phony sales, as with a deal HBO & Co. struck with Computer Associates – a company whose CEO was nabbed for fraud in 2004. Just before the merger with McKesson, HBO & Co. bought $73.8 million in software from Computer Associates for resale. At the same time, Computer Associates bought $30 million in software from HBO & Co. for resale. At the time of the indictment in 2000, Computer Associates had not used or distributed the $30 million worth of HBO & Co. software. Likewise, HBO & Co. had only sold a small fraction of what it had purchased.
Prior to the merger, executives at HBO & Co. made a similar sort of arrangement with another company, which ultimately led auditors to the cooked books. In 1999, Data General Corp. bought $20 million worth of software; a few days later, HBO & Co. executives quietly bought the software back - after booking the revenue on a backdated contract.
In the wake of these revelations, seven top executives, including the chairman and chief financial officer, were fired or resigned. The board rushed to reorganize itself and recover from the stock nosedive (from $65.75 to $34.50) that occurred on the day that word leaked of the irregular audit. The company dropped HBOC from its name and hired a new executive team. In 2005, McKesson agreed to pay $960 million to settle a class-action federal shareholder lawsuit.
Four HBO executives pleaded guilty to securities fraud and other charges: former HBO president Albert Bergonzi, former chief financial officer Jay Gilbertson, and former senior vice presidents Dominick DeRosa and Timothy Heyerdahl. Richard Hawkins, the only person charged who worked for McKesson before the merger, was acquitted. The former chairman and general counsel of HBO & Co. were also acquitted.
