Dell Hit With Shareholder Lawsuit

Investors allege Dell's relationship with Intel contributed to financial mismanagement that artificially inflated the computer maker's stock price.

Sharon Gaudin, Contributor

February 2, 2007

4 Min Read

On the heels of ousting its CEO this week, Dell is facing an investor lawsuit that alleges company executives schemed to improperly account for hundreds of millions of dollars from business partner Intel.

A class action law suit filed in U.S. District Court in Austin, Tex., contends that Dell executives not only took "kickbacks" from Intel, but then used the money to artificially inflate the company's stock price. The suit also alleges the executives then used the supposedly bogus stock price to reap billions of dollars selling their Dell stock, all while earning tens of millions of dollars in bonuses and additional stock option grants.

The suit names Kevin Rollins, who was Dell's CEO until he resigned this past Wednesday. It also names Michael Dell, the company's founder who stepped back into the CEO seat this week, along with James Schneider, Dell's former CFO. PricewaterhouseCoopers, Dell's outside auditing company, is named in the suit as well.

A spokesman for Dell declined to comment on pending litigation. An Intel spokesman denied any wrongdoing on his company's part.

"We've conducted a preliminary review of the complaint. At first glance, it appears that some of the allegations with respect to Intel appear to have been completely made up," the spokesperson told InformationWeek. "While the plaintiff rehashes anti-trust allegations from other cases, there is no anti-trust claim in this case. We deny the plaintiff's allegations and plan to move quickly to defend ourselves."

Intel also declined to comment on whether the company is moving to file a dismissal or a counterclaim. "I don't think we've made a determination there," the spokesperson added. "It would be premature to talk about our strategy at this stage."

The shareholders are being represented by William S. Lerach, a prodigious class-action litigator. He's well-known in boardrooms and courtrooms, in part for his litigation against Enron, the toppled corporate energy giant. He is with the San Diego firm Lerach Coughlin Stoia Geller Rudman & Robbins.

Industry analysts say this is obviously another blow for a company that is shaking up its leadership in an effort to right the ship. Dell, which just a few years ago dominated the computer-maker business, has stumbled. Its growth rate has slipped as rival Hewlett-Packard picks up momentum and fiercely battles for the position of top PC maker in the world.

"It really hasn't been the best week, especially with the changing of hands in the CEO post," says Jim McGregor, principal analyst and research director with In-Stat. The lawsuit alleges that Dell took the money from Intel and put it in what the suit calls a "cookie jar," from which it could take or add funds to adjust the company's gross margins and net income and to manipulate or smooth out Dell's earnings.

The suit also alleges that company executives made "materially false and misleading statements" about Dell's financial condition to artificially inflate the company's stock price by assuring investors that Dell's sales and earnings were expanding and that its gross profit margins weren't diminishing.

"While the defendants were engaging in accounting chicanery in order to portray Dell as a profitable growth vehicle to the investment community, the individual defendants, while in possession of adverse non-public information, took advantage of the artificially inflated price of Dell stock to engage in massive insider selling during the Class Period," the lawsuit states. "The three individual defendants alone collectively sold almost 90 million shares of their personal holdings of Dell stock, reaping proceeds of almost $3 billion."

"It's going to be a hard argument to make, let me tell you," says McGregor. "They may have an argument on how the money was spent or accounted for, but they'll have an uphill battle with the rest of it It gets down to contractual terms with Intel. And even if Dell's numbers are inflated, maybe they're not earning as much, but they were still the number one PC vendor in the world. How much weight do you give numbers that can be played with versus the weight you give that number one standing?"Dell's shareholders aren't the only ones eyeing the company's books.

The computer manufacturers' accounting practices have come under federal scrutiny. The SEC and the U.S. Attorney's office are investigating Dell's financial reporting to see if executives participated in a practice called stock option backdating. Because of the SEC investigation, Dell was forced to delay its preliminary financial results for the third fiscal quarter of 2006, citing "the level of complexity" involved in putting the results together because of the ongoing investigation.

Jon Peddie, president of Jon Peddie Research, says Dell's leadership now has an awful lot on its plate to deal with when it should be much more focused on getting the company back on track and out of HP's reach again.

"The problem with these things is that they're tremendous management sinks," says Peddie. "The worst thing that can happen to a company that's trying to fix internal problems is to be distracted by a lawsuit. It pulls management away from what they should be doing. If shareholders want to sue Dell, they should wait until Dell has righted itself."

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