The opinion of the court was delivered by: Martin J. Jenkins United States District Judge
FINDINGS OF FACT AND CONCLUSIONS OF LAW
Defendant Richard Hawkins was tried to the Court, without a jury, for conspiracy to commit securities fraud in violation of 18 U.S.C. § 371, for engaging in securities fraud in violation of 15 U.S.C. §§ 78j(b) and 78(ff), and 17 C.F.R. § 240.10b-5, and for making false statements to an accountant in violation of 15 U.S.C. § 78(ff) and 17 C.F.R. § 240.13b2--2. The Government was represented by Assistant United States Attorneys Timothy Crudo and Haywood Gilliam. Defendant Hawkins was represented by William F. Alderman, Walter F. Brown, Jr., Melinda Haag, and Nancy E. Harris of Orrick, Herrington & Sutcliffe LLP. The evidentiary portion of the trial commenced on January 19, 2005, and concluded on February 25, 2005. Thereafter, the parties argued the matter and submitted the same to the Court along with their proposed findings of fact and conclusions of law. After a review of the evidentiary record, the Court now enters the following Findings of Fact and renders its Conclusions of Law and finds Defendant Hawkins NOT GUILTY on all counts of the Indictment.
A. Overview of McKesson Corporation
Before the 1999 Merger With HBOC
1. McKesson Corporation is based in San Francisco, California. Before merging with HBO & Company ("HBOC") in 1999, McKesson was primarily engaged in the business of pharmaceutical distribution. McKesson had several subsidiaries or business units, the largest of which was U.S. Pharmaceuticals. McKesson Corporation's annual revenues in the 1998 timeframe were approximately $30 billion.
2. In the 1998-1999 timeframe (hereinafter, the "relevant time period"), Mark Pulido served as McKesson's Chief Executive Officer ("CEO"). Defendant Richard Hawkins became the Chief Financial Officer ("CFO") of McKesson in 1996 and served as CFO until the middle of 1999. Heidi Yodowitz served as the Controller of McKesson under Mr. Hawkins during the relevant time period.
3. Deloitte & Touche LLP ("Deloitte") served as McKesson's accounting and auditing firm before and after the merger with HBOC. Teresa Briggs, a partner at Deloitte, was Lead Client Service Partner for the McKesson account during the relevant time period. Ms. Briggs is a licensed Certified Public Accountant ("CPA"). As such, Briggs provided accounting advice on transactions to McKesson. She also had primary responsibility for supervising the Company's fiscal year-end audits, and the 1999 audit in particular. Richard Fineberg served as Advisory Partner for the McKesson account during the relevant time period. As such, Mr. Fineberg was responsible for maintaining continuity in the relationship between McKesson and Deloitte. In that role, Mr. Fineberg did not and could not provide accounting opinions or advice to McKesson.
B. Defendant Hawkins' Role at McKesson
4. As CFO of McKesson, Mr. Hawkins was responsible for McKesson's internal and external financial reporting, for the relationship with the company's outside auditors, for supervising investor relations for the company, and for the company's treasury functions. Mr. Hawkins was also involved in the issuance of McKesson securities, and in merger and acquisition activities. In addition to his responsibilities as CFO, Mr. Hawkins also had overall responsibility for the finance function of U.S. Pharmaceuticals, McKesson's largest subsidiary.
5. It was not Mr. Hawkins' practice to contact the heads of McKesson's individual business units, including U.S. Pharmaceuticals, on a regular basis to discuss their progress toward sales and other financial goals. Instead, he relied on the reports provided to him on the third and eighth days after the close of a given quarter.
6. It was Mr. Hawkins' practice to speak and meet with Deloitte regularly regarding accounting transactions.
II. McKesson's Merger With HBOC
7. During the summer of 1998, McKesson Corporation began negotiating a possible merger with HBOC, headquartered in Alpharetta, Georgia.
8. HBOC was involved in the highly-profitable health care technology business (i.e. software). Before the merger, Albert Bergonzi served as HBOC's president and CEO, David Held served as HBOC's CFO, Charles McCall served as the Chairman of HBOC's Board of Directors, and Jay Lapine served as HBOC's General Counsel.
B. Historical Picture of HBOC Sales
9. Historically, HBOC, like other companies in the software industry, had experienced a hockey-stick effect in its quarterly and annual sales. This meant that most of the deals negotiated in a quarter were signed at the very end of that quarter and most of the deals occurring in a year were consummated at the very end of the fiscal year.
C. McKesson's Due Diligence In Preparation for the Merger
10. Mr. Hawkins was responsible for overseeing the financial due diligence on behalf of McKesson in connection with the proposed merger with HBOC. During the summer of 1998, McKesson retained several outside consultants, including Solomon Smith Barney, Bear Stearns, Bain & Company, McKenzie, and Deloitte, to assist in the due diligence process.
11. During that process, McKesson became aware of three issues of concern relating to HBOC's accounting practices: (1) HBOC had past due receivables on some accounts; (2) HBOC was over-accruing merger-related charges; and (3) HBOC was improperly recognizing revenue on software maintenance fees. Neither McKesson nor the entities retained to perform due diligence learned that HBOC had a significant side letter practice.
D. The Merger Fell Through But Was Later Revived
12. The proposed merger fell through when the respective companies' stock began to trade apart, making the merger unattractive for McKesson investors.
13. The merger was revived in October 1998. McKesson and HBOC publicly announced their merger on October 18, 1998.
E. HBOC's CFO, David Held, Discovers Widespread Side Letter Practice at HBOC
14. During the fall of 1998, HBOC's CFO, David Held, became aware of a widespread side letter practice at HBOC. HBOC had been regularly recognizing revenue on contracts in which side letters, or separate agreements, that were not disclosed to accountants or auditors, contained contingencies on those contracts. Those contingencies precluded revenue recognition, but HBOC was recognizing the revenue anyway. Held was given a folder containing 50 or 60 side letters. Held destroyed the side letters and told no one what he had learned.
F. McKesson Executives Meet with HBOC Executives Just Before Merger
15. On January 6, 1999, just before the merger went through, Mr. Hawkins and Mr. Pulido met with Mr. Bergonzi, Mr. Held, and Mr. McCall in Atlanta. The day before that meeting, Held had met with McCall and Bergonzi and told them that he intended to raise some accounting issues at the January 6 meeting with Pulido and Hawkins, including HBOC's extensive side letter practice, that were of concern to him. Held prepared a proposed list (the "Options Memo") of those issues and presented it to Bergonzi and McCall on January 5. (Defense Exhibit ("Def. Ex.") 243.) One of the items listed was HBOC's side letter practice. The Options Memo reflected the following:
* Every remaining deal in play must come in
* Record $10.3 million in Interqual revenue accounting change (AA will challenge)
* Record all revenue with side letter contingencies
* Record all ECG processing revenue as software (5.6 million)
* Clear every judgmental reserve on the books we can find. (Id.)
16. Charles McCall, the Chairman of the Board, instructed Held not to raise some of the issues listed in the Options Memo -- including the side letter practice -- with Hawkins and Pulido at the January 6 meeting. Held promptly prepared a revised list of topics (the "Revised Memo") for discussion at the upcoming meeting. (Government Exhibit ("Gov. Ex.") 320.) The Revised Memo does not reference a side letter or contingency problem, but says instead, "Revenue: In range of estimates." After revising the memo, Held emailed Bergonzi and attached the Revised Memo. (Def. Ex. 244.) The email said, in relevant part:
Here it is. Revenues are 'in range of estimates'. *** Let me know if you want me in the discussion. May be better not to give him a chance to quiz me on what else is out there. (Id.)
17. Held testified that at the January 6 meeting with Pulido and Hawkins, he mentioned HBOC's frequent use of side letters despite being instructed not to. Held acknowledged, however, that he told the FBI, as recently as December 2004, that he did not remember if he used the phrase "side letters" or the term "contingencies" in that meeting. Held admitted that there was a big difference between the two terms in that contingencies, unlike side letters, can be appropriate contract mechanisms that do not necessarily present accounting problems.
18. The Court finds that Hawkins and Pulido were not made aware of HBOC's side letter or contingency problem at the January 6, 1999, meeting.
19. The Court finds Mr. Held's testimony not credible for several reasons. First, because Held received a promise of leniency from the Government in exchange for his testimony, the Court examines Mr. Held's testimony with greater caution than that of other witnesses. Second, Held's inability to recount whether he specifically mentioned side letters in the January 6 meeting undermines his credibility. Third, Mr. Held's admitted longstanding awareness of the widespread side letter practice at HBOC, his destruction of 50--60 side letters in the fall of 1998, and his admitted failure to tell anyone about the side letter practice, undermines his credibility. Fourth, Mr. Held's statements in the January 5, 1999, email to Al Bergonzi -- that it may be better if he is not present for the January 6, 1999, meeting so that Pulido and Hawkins have no chance to "quiz him on what else is out there" -- supports a finding that Mr. Held did exactly as he was instructed and did not expose the fraudulent accounting practices at HBOC to Pulido and Hawkins.
G. The Merger Takes Effect
20. The merger took effect, as planned, on January 12, 1999. The combined company became known as McKessonHBOC.
H. Consequences of the Merger
21. After the merger, what had been HBOC became the Information Technology Business ("ITB") unit of McKessonHBOC. The ITB unit was the only subsidiary of McKessonHBOC involved in the sale of software. After the merger, Albert Bergonzi, who had been president of HBOC before the merger, remained on as president of the ITB unit. David Held, who had been promoted to Chief Financial Officer of HBOC in October 1998, remained on as CFO of the ITB unit. Charles McCall, who had been Chairman of HBOC's Board of Directors, stayed on as Chairman of the combined company's Board. Jay Lapine, who had served as General Counsel for HBOC, stayed on as General Counsel for the ITB unit.
22. Deloitte continued to serve as McKessonHBOC's accounting and auditing firm.*fn1 Briggs and Fineberg retained their respective roles as Lead Client Services Partner and Advisory Partner. Ray Lockwood, a partner in Deloitte's Atlanta office, was to be the primary Deloitte contact person for McKessonHBOC's ITB unit.
23. McKesson's 1999 fiscal year ended on March 31, 1999; HBOC's 1999 fiscal year ended on December 31, 1998. The newly-formed McKessonHBOC would conform to what had been McKesson's fiscal year, and accordingly, McKessonHBOC's 1999 fiscal year would end March 31, 1999. During the quarter beginning on January 1, 1999, and ending on March 31, 1999, McKessonHBOC had securities registered pursuant to § 12(b) of the Securities and Exchange Act (15 U.S.C. § 781). McKessonHBOC stock traded on the New York Stock Exchange from the time that the merger closed through April 30, 1999, the relevant time period here.
24. In January 1999, after the merger took effect, Mr. Hawkins, Ms. Yodowitz, Ms. Briggs, and Mr. Lockwood became aware that two pre-merger HBOC contracts -- totaling $5.7 million -- on which revenue had been recognized by HBOC in the quarter ended December 31, 1998, contained contingencies. Specifically, the two transactions were contingent on the approval of the buyer companies' boards, which approval had not been obtained in the December quarter. Accordingly, Mr. Hawkins, Ms. Yodowitz, Ms. Briggs, and Mr. Lockwood determined that the revenue should not have been recognized for that quarter and reversed the revenue. Another $10 million, related to the Interqual product, that HBOC had improperly recognized as revenue before the merger was also reversed.
III. January to March 1999 -- Projected Revenues, Earnings Updates, and the Market
A. The Market's Skepticism of the Healthcare Technology Field
25. During the first three months of 1999, investors were skeptical of the healthcare information services industry. Healthcare information companies were struggling. Prices for shares of stocks in the industry were underperforming in the market.
26. The market's skepticism extended to the newly-formed McKessonHBOC. The market was particularly skeptical about the McKesson-HBOC merger and did not believe that McKessonHBOC would be able to meet its financial forecasts. McKessonHBOC's stock price was volatile and declined steadily during the March quarter.
B. Projected Revenues and Earnings Updates
27. Throughout the March quarter, David Held, CFO of the ITB unit, provided Mr. Hawkins and other members of management at the parent company his written analysis of the ITB unit's financial outlook. The first analysis prepared by Held was sent to Hawkins and others on January 20, 1999, and updates were provided throughout the rest of the March quarter. Held's analyses reflected his evaluation of the ITB unit's revenue and trends.
28. As of January 20, 1999, Held forecast that the ITB unit's software revenue for the March quarter would total $155 million. (Def. Ex. 23.)
29. As of January 25, 1999, Held projected software revenue for the quarter at $140-142 million. (Def. Ex. 411.)
30. On January 25, 1999, McKessonHBOC issued an earnings release for the period ended December 31, 1999. Because $15.7 million in revenue had been reversed due to the accounting errors discovered by Hawkins, Yodowitz, Briggs, and Lockwood, HBOC did not meet consensus guidance for software revenue for that quarter.
31. Later that day, in a conference call with analysts, Mr. Hawkins stated that McKessonHBOC's earnings per share estimate for the March 1999 quarter was $.60--.61. Mr. Pulido stated during the call that the company anticipated that the ITB unit would experience 20% revenue growth going forward. McKessonHBOC also projected that software revenue for the March quarter would reach $120 million. The $.60-.61 earnings per share guidance was based on achieving $120 million in software revenue. Internally, the software revenue goal for the quarter was set at $140-150 million to provide an incentive for ITB's sales force to complete sales. It was typical for the internal revenue goal to be higher than the public guidance.
32. On February 5, 1999, Mr. Held sent another update to management, in which he forecast that software revenue for the quarter would total $123,725,000. (Def. Ex. 26.) Mr. Held spent 3--4 hours on the telephone with Mr. Hawkins, Ms. Yodowitz, and Mr. Pulido walking through the February 5 updated analysis. Mr. Held's February 5 update revealed that only $5 million in software revenue had been recognized by McKessonHBOC (through its ITB unit) in January 1999, the first of three months in the quarter in which $120 million had been publicly projected.
33. On February 8, 1999, McKessonHBOC again stated publicly that the ITB unit was expected to grow revenues at more then 20% and expand operating margins. Mr. Hawkins and Mr. Pulido also met with analysts in New York and reiterated that the company expected $.60--.61 in earnings per share and 20% growth, including in software sales.
34. On February 23, 1999, Mr. Held sent Mr. Hawkins and others at the parent company another update of his financial analysis. He projected software revenue of $142,104,000 for the March quarter. (Def. Ex. 411.) However, at that point, less than $12 million in software revenue had been recognized for the March quarter. (Gov. Ex. 141.) Mr. Hawkins was made aware of this revenue figure in early March 1999.
35. On March 11, 1999, Mr. Held sent an update of his financial analysis to Hawkins and others, in which he projected software revenues of $126 million for the March quarter. (Def. Ex. 36.) Mr. Hawkins was aware of Wall Street rumors that McKessonHBOC was not going to make its projected numbers for the March 1999 quarter.
36. On March 12, 1999, McKessonHBOC held an analyst call to, inter alia, confirm that McKessonHBOC would achieve consensus estimates. The company also confirmed that it would achieve its software revenue projection of $120--130 million for the quarter. Mr. Hawkins reiterated in that call that the earnings per share estimate was $.60--.61.
37. On March 18 or 19, 1999, Held provided management, including Mr. Hawkins, with another updated projection for the ITB unit's software revenues for the quarter: $126,026,000. (Def. Ex. 476.) In that update, a potential $25 million transaction with Oracle Corporation was listed as an "upside." That $25 million would, if the deal went through, be in addition to the approximately $126 million that was being projected.
38. On March 23, 1999, Mr. Hawkins was made aware that software revenue that had been recognized for the March quarter had grown only to $40 million. However, it was common knowledge that in the software industry, most deals were negotiated and signed at the very end of the quarter.
IV. The Oracle Transaction
39. Toward the end of March 1999, McKessonHBOC and Oracle Corporation attempted to negotiate a two-sided transaction. On one side, McKessonHBOC would buy $20 million worth of Oracle database products. On the other side of the transaction, Oracle would either purchase $25 million worth of HBOC software or would pay McKessonHBOC $25 million as an exclusivity fee for access to McKessonHBOC's customer base (or "channel"). At the request of McKessonHBOC's Chief Information Officer ("CIO") Carmen Villani, Mr. Hawkins was involved in those negotiations. Mr. Bergonzi, president and CEO of McKessonHBOC's ITB unit was also involved in the Oracle negotiations.
40. After Mr. Hawkins got involved in the negotiations, he telephoned David Held, the ITB unit's CFO, and asked him to research various accounting issues related to the proposed transaction with Oracle. He asked Held to discuss the transaction with Deloitte's Atlanta office and told Held he would discuss the deal with Deloitte's San Francisco office.
41. Thereafter, in the last few days of March 1999, Mr. Hawkins contacted Teresa Briggs at Deloitte to discuss the potential Oracle deal. Mr. Hawkins told Ms. Briggs about both sides of the transaction -- that McKessonHBOC would purchase $20 million of Oracle software and Oracle would either purchase $25 million of HBOC software or would pay a $25 million exclusivity fee for access to McKessonHBOC's channel. Because the exclusivity fee option was the preferred alternative, Briggs focused her research on that. Briggs advised Hawkins that if the Oracle exclusivity payment was linked and contingent on McKessonHBOC's purchase of Oracle products, the transaction was a wash and revenue could not be recognized. She told him that separating the contracts physically would not make revenue recognition permissible. She also said, however, that if the transactions were separate so that they were not contingent upon one another (i.e. if Oracle paid an exclusivity fee for access to McKessonHBOC's channel and McKesson bought Oracle software using normal purchasing patterns that represented the fair value of the goods and services exchanged), revenue on the exclusivity fee could be recognized.
42. Ms. Briggs could not refer Mr. Hawkins to any specific authoritative accounting literature that prohibited revenue recognition on "linked" transactions. Briggs knew that "[t]here wasn't anything specifically written on that topic at the time, but [software revenue recognition on two-way deals] was one of the issues that [the Financial Accounting Standards Board's Emerging Issues Task Force] was looking at."
43. Briggs told Hawkins that to recognize revenue on the Oracle transaction, McKessonHBOC's purchase of Oracle software would need to occur in line with its historical pattern of software purchases from Oracle.
44. Mr. Hawkins understood Ms. Briggs' concerns about recognizing revenue on the Oracle deal to be that the fair value of the exclusivity fee could not be adequately ascertained such ...