Opinion ID: 219549
Heading Depth: 2
Heading Rank: 1

Heading: Gateway's Officers and Transactions

Text: Gateway is a manufacturer and seller of personal computers. In 2000, Weitzen was Gateway's president and chief executive officer (CEO), Todd was its chief financial officer (CFO), and Manza was its controller. In addition to maintaining its own internal accounting systems, Gateway retained PricewaterhouseCoopers (PwC) as its outside accounting and auditing firm. Todd was responsible for Gateway's financial reporting, which included reviewing and signing financial reports. Todd also reviewed press releases, made accounting decisions, and managed Gateway's relationships with outside auditors and investors. Manza was the company's highest-ranking CPA. His responsibilities included booking transactions and preparing financial statements, such as Gateway's 10-Q (quarterly) and 10-K (yearly) reports. Todd and Manza signed the third-quarter 2000 management representation letter to PwC, which claimed that Gateway's quarterly financial statements were a fair presentation of Gateway's financial position, and that they were prepared in conformity with generally accepted accounting principles [GAAP]. Also in the third quarter of 2000, Weitzen and Todd represented in a conference call with analysts that Gateway was experiencing accelerating revenue growth. Weitzen also participated in preparing a press release claiming that Gateway had accelerated year-over-year revenue growth. In 2000, the personal computer market was weakening substantially, yet Gateway continued to claim record earnings and revenue growth. Skeptical, the SEC began investigating whether Weitzen, Todd, or Manza had misrepresented Gateway's financial condition during the second and third quarters of 2000 in order to meet Wall Street analysts' expectations. In the SEC's view, Weitzen, Todd, and Manza had misrepresented Gateway's financial status in order to cover a $110 million gap in the third quarter between the analysts' expectations and its actual revenue. Three transactions are at issue in this appeal. [1]
In the third quarter of 2000, Gateway recorded $47.2 million in revenue from a sale of fixed assets to Lockheed Martin. Contrary to Gateway's customary practice of selling Gateway-branded personal computers, the sale was mostly comprised of IBM and Sun servers. The essence of the transaction was that Lockheed would acquire the equipment for $47.2 million, and Gateway would lease it back from Lockheed. The deal was to be cash neutral for Lockheed. The parties agree that this was an unusual transaction because Gateway normally sold its own computers to consumers from its inventory, whereas this was a one-time transaction involving fixed assets manufactured by other companies. Gateway booked the sale of the fixed assets as gross revenue. Thereafter, the $47.2 million transaction was publicly reported as gross revenue in Gateway's Form 10-Q report, the third-quarter earnings release, and in a conference call with analysts. At trial, the parties disputed whether Gateway's booking of the transaction as revenue violated GAAP. They also clashed over whether the booking was at odds with the policy disclosed in Gateway's 1999 Form 10-K report, in which Gateway indicated that fixed-asset sales would be included as gains or losses in net income, whereas product sales and services would be recorded as gross revenue. What no one disputes is that absent the $47.2 million in revenue booked by Gateway from the Lockheed transaction, Gateway would not have met analysts' quarterly expectations.
Gateway's third-quarter earnings in 2000 also included $21 million derived from an incomplete sale of computers to Ven-Serv, booked as revenue. The sale was incomplete because, according to a referral agreement, VenServ was not required to pay Gateway for the computers until Gateway referred enough customers to Ven-Serv to buy them. Because Gateway had not yet referred the requisite number of customers to Ven-Serv, the sale could not properly be recorded as revenue. None of the parties presently disputes the fact that the Ven-Serv sale was improperly booked.
In the third quarter of 2000, Gateway and AOL contractually changed the timing of when fees were payable by AOL to Gateway. Prior to the change, AOL agreed to pay a fee to Gateway whenever a buyer of a Gateway computer registered with AOL. Under the modified agreement, the AOL fees were payable as soon as a Gateway computer was shipped to a customer, permitting Gateway to book revenue upon shipment. While the transaction itself was not improper, it gave Gateway a one-time revenue boost of $72 million. The SEC claimed that Weitzen misrepresented Gateway's growth as accelerated in the conference call with analysts and in a press release when he did not disclose that the third-quarter revenue was based in part on this unusual, one-time transaction, rather than on ordinary sales growth.