Appeals court faults Oracle in shareholder suit

The $1 billion lawsuit against the company and several of its officers, including CEO Larry Ellison, now will be returned to the lower court for another review and ruling. The plaintiffs allege that Oracle gave misleading information suggesting that financial performance would be better than it actually was. They also charge that some executives timed the sale of shares accordingly.

The decision comes at an awkward time for Oracle. The software maker is awaiting a ruling in a separate, federal antitrust, case, in which the U.S. Department of Justice is seeking to block the company's controversial and closely watched hostile takeover bid for PeopleSoft. Courtroom observers have said the judge in the merger case will take into consideration whether an appeals court would overturn his decision.

In the shareholder lawsuit, the U.S. District Court of Appeals for the 9th Circuit in San Francisco found that Oracle and several officers--Ellison; Jeff Henley, chairman and former chief financial officer; and Edward Sanderson, a former executive vice president--made statements "contrary" to the facts regarding whether Oracle would meet its third-quarter 2000 sales projections. The court also found that Ellison's January 2001 sale of Oracle stock, which totaled $900 million, was "highly inconsistent with his prior trading history" and that the company had maintained "improper revenue accounting records."

"Together, the false representations, both as to current facts and future estimated profits and sales, as well as the improper revenue adjustment and unusual stock sales, provide a basis for the cause of action against Oracle and each of its three top executives," Judge Warren Ferguson stated in court filings. Ferguson was one of three members of the appeals court panel who reviewed the case.

Oracle maintained that the setback would not derail its defense. "We believe that the allegations in that complaint are wholly unsupported by any evidence, and we are confident that Oracle will prevail when the litigation is concluded," Deborah Lilienthal, Oracle spokeswoman, said in a statement.

The class action lawsuit, initially filed in U.S. District Court in San Francisco by Local 144 of the Nursing Home Pension Fund in March 2001, alleged that Oracle released its 11i Suite in May 2000 with numerous defects. The plaintiffs argue that as customers became aware of the defects and the economy began to sour, Oracle covered up the losses by creating phony sales invoices and improperly recognizing past customer overpayments as revenue.

The company as a result was able to post second-quarter earnings of 11 cents per share rather than the 8.5 cents that Oracle actually earned, according to the allegations. When Oracle issued its fiscal second-quarter report in December 2000, its share price rose appreciably to $32.

Oracle also forecast earnings of 12 cents a share for its third fiscal quarter and revenue of $2.9 billion. The company, Ellison, Henley and Sanderson also later made comments reiterating that the company's growth estimates were achievable, given that orders for the 11i Suite were strong.

Several weeks after Oracle issued its second-quarter results and its forecast for the third quarter, Ellison in January sold 29 million shares for nearly $900 million, and Henley sold 1 million shares for approximately $32 million.

Then, in March 2000, Oracle issued a warning about its third-quarter profit and revenue, citing a slowing economy. Oracle's shares fell the next day to $16.88 from $19.50.

Shareholders allege that the company and the executives had known much earlier that Oracle would miss its third-quarter forecast and sold some of their stock based on that knowledge. The appeals court judges apparently felt the same way.

"To begin with, a number of large deals were either lost or delayed early in the third quarter. Four of those deals alone would have totaled up to $186 million. These deals account for nearly 75 percent of the total third-quarter shortfall. It was clear by December 2000 and January 2001 that these deals had either fallen through entirely or would not take place during the third quarter," Ferguson noted in the court's opinion.

"It is reasonable to believe that Oracle had known, prior to its March 1 (third quarter) report, that it would not reach its projected earnings, particularly since Ellison acknowledged that 'I was involved in an awful lot of these deals,'" Ferguson added.

The judges also noted that the "timing of stock sales is also suspicious," especially in light of Ellison not engaging in any Oracle stock sales for five years prior to that point.

But of greater concern to the judges was the state of Oracle's bookkeeping.

"Finally, and very importantly, there are the improper revenue accounting records," the appeals court stated. "Oracle maintained a debit account containing money that customers had inadvertently overpaid to Oracle...plaintiffs allege that Oracle credited the amount of the debit memos as revenue, thereby artificially inflating the amount of revenue reported on December 14 at the end of the second quarter."

For example, Oracle created more than 46,000 debit memos, which acted like invoices, in November 2000 as a means to "clean up" the account, the court filing stated. One of the expert witnesses for the plaintiffs, a former financial analyst for a recovery, audit and cost-containment firm, alleged that the debit memos were the same as creating an actual invoice for a real product sale.

"The expert told plaintiffs that the Oracle records reveal that pharmaceutical company Eli Lilly had overpaid $15,582.55 to Oracle in 1997 and that Oracle had never refunded the money. When the expert asked an Oracle credit analyst about the debit memo, the credit analyst told her that it was not an invoice for a real sale, that no money was due...in other words, Oracle 'booked the $15,582.55 as revenue,'" the court wrote.

"More importantly, the documents themselves appear to establish improper revenue adjustment. Each of the debit memos lists a 'credit' in the amount of the overpayment and clearly states 'revenue' at the start of the line item. Each of the credit line items offsets a debit of the same amount that is identified as a 'receivable,' which reveals that the funds apparently moved from the receivable to the revenue account," Ferguson stated in the court's opinion.