Opinion ID: 2725
Heading Depth: 2
Heading Rank: 3

Heading: Fraud Regarding Adelphia's Operating Performance

Text: 21 The government also alleged that Defendants misrepresented three key indices of Adelphia's performance: (1) its basic cable subscriber growth; (2) its success in rebuilding its cable systems; and (3) its pro forma earnings, measured in terms of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). 5 These misrepresentations allowed Adelphia to appease investors and comply with covenants under its bond indentures, and they affected indices used to set interest rates under its various bank loans. They were disseminated to the public through Adelphia's SEC filings and quarterly press releases, and through conference calls, conferences, and road shows with investors. Given Adelphia's rapid expansion, and the associated cash flow deficits, investors were paying particularly close attention to the indices Adelphia manipulated. 22
23 The government provided proof that Adelphia distributed materially misleading cable subscriber growth numbers to the public from 2000 to 2002. Timothy Rigas directed or approved fraudulent quarterly earnings press releases, and John Rigas knew of and approved them. Karen Chrosniak, Adelphia's Director of Investor Relations, testified that Timothy Rigas and others directed her to add subscribers to the earnings releases to artificially increase Adelphia's reported basic subscriber growth rate. 6 24 The government argued that Timothy Rigas directed the fraudulent inflation of Adelphia's basic subscriber number and basic subscriber growth rate by adding, in 2000, subscribers from companies in Brazil and Venezuela in which Adelphia owned an interest. The government contended that including the subscribers artificially increased Adelphia's reported pro forma basic subscriber growth rate. The third quarter 2001 report was also increased, again at Timothy Rigas's instruction, to include 60,000 home security system subscribers, even though the home security subscribers were tallied separately from the cable subscribers and those home security subscribers who also had cable would, in effect, be double counted. Finally, after he learned that his projections to analysts had fallen short, Timothy Rigas instructed Chrosniak to inflate the 2001 year-end number of subscribers to the Powerlink internet service by including 7,000 pending installs—subscribers who had signed up for service but not yet started making payments to Adelphia as the service had not yet been installed—as actual subscribers. As a result of the fraudulent increases in subscriber growth rates, the year-end 2000 subscriber growth rate was reported as 1.3 percent and the year-end 2001 figure was reported as 0.5 percent. The actual figures were 0.5 percent and negative 1.2 percent. 25
26 Adelphia expended between $1.5 and $2 billion annually to rebuild its cable system to provide digital cable and high speed internet access to its subscribers. As this enhanced technology was critical to the company's long-term health and the annual expenditures on it were substantial, investors closely followed the status of the Rebuild Program. But they were misled by Timothy Rigas, who, during road shows, investor conferences, and shareholders' meetings, fraudulently overstated the percentage of Adelphia's systems that had been upgraded to higher bandwidth and two-way communication capabilities. Adelphia also gave these inflated numbers to its bank lenders. 27
28 Several witnesses testified that investors commonly use EBITDA to assess the earnings from operations of cable companies. Brown testified that he told John Rigas Adelphia's real EBITDA and how it compared with its competitors' results. Brown also told John Rigas what would happen if Adelphia reported the actual EBITDA: Adelphia would default on some of its public debt, its stock price could decline, and its interest expenses and the cost of borrowing from banks would increase. While John Rigas told Brown that Adelphia needed to get away from using what Brown described as accounting magic to manipulate the numbers, he never told Brown to stop manipulating the numbers. 29 The accounting magic used to manipulate EBITDA comprised two schemes: (1) fraudulent allocations of management fees that the RMEs owed to Adelphia and (2) wash transactions with Adelphia's suppliers. 7 Brown explained that he would arbitrarily inflate the management fees that an RME owed to Adelphia, and then record a corresponding interest expense that Adelphia owed the RME. The interest expense would ensure that there was no real cost to the RME as a result of the scheme but, because it was interest, it would not be included in Adelphia's EBITDA. As a result, then, this scheme—which Timothy Rigas went along with—artificially inflated Adelphia's EBITDA. 30 In his testimony about the wash transactions, Brown indicated that Timothy Rigas discussed, and then implemented, schemes with two separate equipment suppliers, Motorola and Scientific Atlanta. The effect of the wash transaction schemes was to increase Adelphia's EBITDA by $87.1 million. In these schemes, Adelphia increased the price it paid to Motorola and Scientific Atlanta for digital converter boxes, and Motorola and Scientific Atlanta agreed to pay Adelphia the amount of the increase for advertising and market support. Because the payments to the equipment suppliers were booked as capital expenses, and the payments from the suppliers were booked as revenue, this scheme artificially inflated the EBITDA. 8 According to Brown, Timothy Rigas instructed him to book nearly $20 million in increased advertising revenue even before the two equipment suppliers agreed to the wash transaction scheme; Adelphia never provided any advertising services for these suppliers. 31