The federal agency is investigating how the company accounts for its financial reserves and related policies, according to Greg Maffei, chief financial officer for the leading PC software maker. Microsoft is cooperating with the SEC's efforts, he said.
As part of its review, the SEC is looking into allegations concerning Microsoft's accounting practices made by a former executive during a lawsuit against the company, according to a source. Details of the executive's allegations were disclosed in a Seattle Weekly article in January of this year.
The lawsuit, settled out of court last year, alleged that Microsoft set aside cash reserves during prosperous quarters and dipped into them during lean quarters, according to the paper.
Following the publication of the article, other news organizations reported on elements of the suit.
"It is really inappropriate for us to comment further," he added, noting that the review would have "no material impact on our business or financial condition."
Maffei said he learned of the SEC investigation "several months ago." The company chose to disclose the existence of the investigation now due to the fact that it had heard of rumors circulating about such a probe and wanted to be sure the information was disseminated to the financial community and investors in an accurate fashion, according to a Microsoft spokeswoman.
An SEC spokeswoman said, "We can neither confirm nor deny the existence of any investigation."
Seattle lawsuit raises questions
The article was based on allegations included in a lawsuit by Charles Pancerzewski, a former internal auditor, who brought up the company's accounting practices as part of a wrongful-termination suit.
Pancerzewski was not immediately available for comment and an attorney who represented him declined to comment on the matter.
According to the Seattle Weekly report, the former Microsoft accountant sued the company in 1997, alleging that his termination a year earlier came after he reported alleged improprieties in Microsoft's bookkeeping.
Specifically, Pancerzewski claimed Microsoft illegally set aside cash reserves during lucrative quarters and dipped into those reserves when needed. The so-called cookie jar practice has come under fire by the SEC, and was a major issue in the complaint Pancerzewski filed in federal court in Seattle.
"By setting and canceling reserves, Microsoft is able to control its reported profit and to keep its reported earnings on a smoother upward trend," the complaint alleged, according to the January 7 article.
The paper said documents filed in the case supported Pancerzewski's claims that his January 1996 termination came only after he approached his supervisors--chief operating officer Bob Herbold and former chief financial officer Mike Brown--about the practice.
Shortly afterward, Pancerzewski received his first unfavorable evaluation. The Seattle paper also quoted an email Brown allegedly sent to Pancerzewski warning that "all of the audit reports you have created so far would generally be discoverable in the U.S...and could be fertile ground for an astute litigator."
Later, the Wall Street Journal picked up the story in a short article that may have been a "trigger" for the SEC inquiry, Maffei said.
Microsoft last June was unsuccessful in getting the allegations of accounting impropriety dismissed. It settled the case late last year.
Microsoft and the principals in the case have refused to comment.
SEC digs deep
The SEC review likely encompasses the manner in which Microsoft sets aside reserves for items such as returned software or delayed and undelivered upgrades. In a larger context, the items relate to the company's accounting procedures for so-called unearned revenue.
Given the company's complex licensing agreements and upgrade caveats with customers, revenue is at times accounted for over the life of the agreement. The company has billions of dollars in unearned revenue tucked away in liability accounts until it can be shifted to an earned revenue account and reported as earnings. For example, in its fiscal third quarter, the company reported $2.06 billion in unearned revenue for its "platform" products, or Windows operating system software.
In addition, the company accounts for portions of its business differently.
The disclosure of the SEC probe in fact came during a company conference call to review changes in accounting procedures. In one change, the MSN Access Internet business will count toward revenue and costs. It was previously accounted for as a part of the company's research and development expenses.
Also, the company's consulting, product service and support, and certified professional training---once accounted for as part of the company's sales and marketing costs---will count toward the bottom line as well.
Revenues for its fiscal 1997, 1998, and 1999 will be higher than under the firm's previous reporting practices. The changes were not related to the SEC inquiry, according to Maffei.
Maffei advised the financial community to revise estimates upward by one cent to account for the change for the company's fiscal fourth quarter and fiscal 2000. The company is expected to report earnings per share of 35 cents for its fiscal 1999 fourth quarter.
Microsoft reports fiscal fourth-quarter earnings on July 19.