Two years late, 1,657 pages long, and running to almost 800,000 words, after a mammoth 93 days in court over a £3.3 billion claim – the full Autonomy judgment is finally here. Well, almost.
May 17 the Honourable Mr Justice Hildyard finally handed down his full judgment of “Britain’s biggest fraud trial” as it has been described. In contrast to most court judgments, though, the punchline of this one was revealed back in January when he found that Mike Lynch and Sushovan Hussain, the former CEO and CFO of Autonomy respectively did commit widespread fraud to inflate the company’s numbers over many years.
(Lynch sold his software company Autonomy to HP in 2011. The acquisition was disastrous for HP. After writing off three quarters of Autonomy’s value, it sold the what was left of the company to Micro Focus in 2016. Lynch founded Autonomy in 1996 based on technology invented at Cambridge University, where he received a Ph.D. and held a research fellowship in adaptive pattern recognition. He served as CEO for over 15 years.)
In January Mr Justice Hildyard released only a 23-page summary of his Autonomy judgment – now we get to see his full reasoning. The judge has gone into exhaustive detail, analysing more than 100 individual transactions and going through thousands of pages of supporting documentation. These are the main takeaways we’ve come up with so far, along with a question. (To be clear, this article only relates to case HC-2015-001324, “Autonomy and others -v- Michael Richard Lynch and another”. Lynch is currently also involved in an extradition case in the UK, linked to a criminal case in the US; the former is under appeal, and the latter has yet to be heard.)
1 – We’re STILL not finished
While Mr Justice Hildyard has now handed down the main body of the Autonomy judgment, he still hasn’t finished the “quantum” – i.e. the assessment of damages. The Stack understands a decision on quantum should not be expected before November. Lynch has also said he plans to appeal this judgment, which will further prolong the final outcome. (Justice Hildyard meanwhile has previously been robustly criticised for the "inexecusable" length of time it took him to produce a ruling in another case...) As to how much those damages to HP are likely to be, well…
2 – HP might not want to get its hopes up
While the judge has yet to finalise his decision on damages, he indicated in his January summary he “would expect the quantum to be substantially less than is claimed”, because fraud or not, Autonomy was still a “suitable acquisition whereby to effect transformational change”.
The full Autonomy judgment goes into a bit more detail on Mr Justice Hildyard’s reasoning as regards damages, reinforcing the point that HP shouldn’t expect to get the full £3.3 billion it initially claimed.
One key part of this is, critically, HP’s failure to link the fraud in Autonomy to its $8.8 billion write-down of the company, as the judge explained: “… the failure to connect the alleged fraud with the impairment means the establishment of the fraud depends on a detailed consideration of each head of claim.”
Any hope HP might have had for punitive damages was also firmly quashed in the Autonomy judgment. The judge commented: “… the calculation of loss remains an exercise of assessing proper compensation, not meting out punishment or conferring windfalls.”
He also had this to say on “synergies”: “… my provisional view is that credit should be given for synergy value where that was the strategic purpose of the acquisition and the asset has been voluntarily retained.”
Earlier in the judgment he noted HP’s projections of synergies from the purchase of Autonomy were substantial, some ranging as high as $30 billion.
3 – Darktrace’s Nicole Eagan was part of “clique” which perpetrated fraud
Nicole Eagan, former Darktrace CEO and its current Chief Strategy Officer, was Autonomy’s CMO in the time leading up to its acquisition. She was conspicuous by her absence as a witness at the trial in London. The judge said of her (along with absent potential witnesses Andrew Kanter, Autonomy’s COO, and Peter Menell, its CTO) “all of whom I have concluded were part of a clique responsible with the Defendants for the operation of the impugned ‘levers’”.
The judge noted: “Dr Lynch suggested that (like Mr Kanter) Ms Eagan declined to appear in light of the continuing investigations being made of them by the US [Department of Justice].”
Following Lynch’s departure from Autonomy, Eagan was one of those involved in his establishment of Invoke Capital, Lynch’s investment fund. At the time of the trial she served as co-CEO of Invoke-owned Darktrace, along with Poppy Gustafsson, who remains CEO.
4 – HP knew about some of the fraud before the meltdown
From the full Autonomy judgment, it is clear HP were aware of some of the fraudulent activity at Autonomy well before the company decided to write down its acquisition by $8.8 billion – and were even aware of elements before the acquisition.
As the judge noted, post-acquisition HP had full access to Autonomy’s books and auditor Deloitte’s working papers – which were reviewed by EY, HP’s auditors.
“In the event, HP and its advisors did in fact discern many of the matters now complained of. They did not cause any great concern at that time.
“Of note in relation to HP’s hardware case, it does seem that from early on in the aftermath of the Acquisition, they were aware of Autonomy’s hardware sales,” said Mr Justice Hildyard.
One of the key elements of HP’s case against Lynch and Hussain was Autonomy’s use of essentially value-less sales of hardware to customers, often at a loss. Autonomy started selling hardware in mid-2009, when confronted with a “major disaster”, as described by Hussain, of the collapse of two OEM deals with Adobe and Microsoft. Faced with a shortfall in sales, Autonomy did a deal with Morgan Stanley, acting as a reseller for Hitachi, to sell the bank $20 million of hardware for just $13.5 million on 30 June 2009. After this, Autonomy continued to use similar arrangements to bolster its sales figures when needed.
He also highlighted a presentation by EY to the HP Audit Committee on 16 November 2011, after the acquisition had closed, where 11% of the $1 billion “Autonomy portfolio” was attributed to hardware: “That information does not appear to have given rise to any question or surprise, nor created an issue for anyone at HP.”
During the trial HP’s CFO, Cathie Lesjak, claimed she didn’t pay attention to this section of the presentation, but the judge said: “In light of its prominence, I cannot accept it went unnoticed: again, however, it caused neither surprise nor concern.”
While HP and Autonomy were negotiating the acquisition, Autonomy provided HP with details of its top 40 contracts. Here too the judge noted HP had an opportunity to enquire about hardware sales.
“Some of the top 40 contracts showed that Autonomy sold hardware, not restricted to appliances, and some of KPMG’s draft questions were about this; but [Manish] Sarin [an HP director] and HP never questioned how much hardware Autonomy sold,” said the judge.
While this is, as they say, a “bad look” for HP, it does not take away that the details of these hardware sales were ultimately fraudulent, and designed to inflate Autonomy’s sales figures.
5 – HP’s fraud accusations came first, evidence followed
Before making the dramatic $8.8 billion write-down of Autonomy’s value, and alleging $5 billion of this was due to fraud, HP had opportunities to flag issues with Autonomy’s accounts and business – but failed to do so, the judgment shows.
Following the ousting of CEO Léo Apotheker, architect of the Autonomy deal, in November 2011, and the resignation and firing respectively of Hussain and Lynch in May 2012, Autonomy COO Joel Scott came forward as a whistleblower. Scott raised concerns about Autonomy’s hardware sales to HP management, which then started an investigation.
Alongside this, HP also carried out a “rebasing” exercise on Autonomy’s accounts, “to establish what Autonomy’s business actually comprised and to strip out from the accounts revenues referable to business which HP would be unlikely or had decided not to continue”.
This exercise, completed in July 2012, found Autonomy’s “rebased” 2010 operating profit margin was the same as before, at 36%, while its 2011 margin fell slightly from 24% to 21%. For 2011, the review found only $2 million definitely didn’t comply with IFRS accounting standards, although it found another $114.3 million was “not IFRS compliant probable”.
In August 2012 HP carried out an impairment analysis of its business units, including Autonomy. “HP concluded that no impairment was required, and that the carrying value of Autonomy should be maintained at the $11bn that HP had paid in October 2011,” said the judge.
And yet, three months later HP made the infamous $8.8 billion write-down of Autonomy – using Scott’s whistleblowing and accounting irregularities as justification for alleging fraud.
“The curiosity of this is not only that the earlier decision had been against impairment, but also the lack of any documentary evidence of any calculation of what amounts were to be attributed to the wrongdoing. Ms Lesjak herself seemed unable to explain this,” said Mr Justice Hildyard.
He noted elsewhere HP’s chief communications officer told Lesjak “We are getting a lot of push back from media that they cannot understand how the accounting issues at [Autonomy] could result in a $5 billion writedown” and asked “We'd like to create a simple graphic that demonstrates the impact of the reduced revenue starting point, margin and growth rate to the DCF model. Is there someone on your team that we could work with to produce something?”
The judge said: “Ms Lesjak plainly had not seen any analysis of this kind. She asked Mr Levine what he had… Mr Levine stated in an email to Ms Lesjak dated 30 November 2012 that: ‘All I have is the attached. We've never formally prepared anything to attribute the irregularities to the amount of the write down.’”
He added: “There was no documentary evidence produced to show how it was that Ms Lesjak was satisfied that the factors resulting in the write- off were attributable to accounting improprieties, disclosure failings and misrepresentation.
“… the fact is that remarkably little was provided by the Claimants to support their case that the impairment was the consequence of the revelation of fraud in the course of an in-depth forensic inquiry. Equally little was provided by the Claimants to substantiate the effect of the alleged fraud on the various “buckets” they had identified.”
He added: "Ms Lesjak was, in my assessment, prone not to remember things which tended to embarrass her now or cast doubt on her cultivated image as prudent, assiduous and a safe pair of hands.”
On the other hand, the judge was more persuaded by Lynch and Hussain’s argument that HP chose to write down the value of Autonomy to avoid having to write down the value of its own software business and other units.
Mr Justice Hildyard also noted in the Autonomy judgment that HP had to use “crazy” discount rates, with a “nonsensical” result to reduce the value of HP’s business to match its declining share price. This resulted in changing Autonomy’s weighted average cost of capital (WACC) from 9.5% in August 2012 to 16% in October 2012 – which alone accounted for $3.6 billion of the write-down amount.
It was only after this that HP stepped up its efforts to investigate fraud in Autonomy, and uncovered the detailed evidence which would ultimately be presented at this trial.
6 – The evidence against Lynch and Hussain is extensive
However HP executives did or did not feel about elements of Autonomy’s accounts and sales practices, the full Autonomy judgment makes very clear the extent to which Lynch and Hussain worked to inflate the company’s performance artificially.
To take the “hardware sales” element of the case as an example, Mr Justice Hildyard is very clear that what Autonomy was doing – buying hardware and hiding the expenses, then reselling it usually at a loss, without Autonomy software – was wrong. Over the period in consideration – 2009 to 2011 – Autonomy sold more than $100 million of hardware products.
“… whatever its purpose at inception, the hardware reselling strategy soon and, increasingly, became an addictive means of meeting market expectations of revenue maintenance and growth,” said the judgement.
“What the Defendants asserted to be the purpose of the programme either initially was, or as soon as the size of the potential revenue source was apparent became, a pretext to justify accounting for the hardware revenue as part of the software business revenues without separate identification.”
Later, summarising his judgment for this section, Mr Justice Hildyard said: “The true purpose of the hardware reselling strategy/programme lacked any commercial justification and was dishonest. The true purpose had to be camouflaged in the way it was presented to Deloitte and the Audit Committee in order to obtain their approval for an accounting treatment which concealed it.
“The Defendants were well aware of this.”
In the “VAR case” section, the judge compiled a separate 352-page schedule of all the fraudulent VAR transactions. Autonomy, under the direction of Lynch and Hussain, would make a “sale” to trusted VARs at the end of a quarter in order to meet or beat sales projections.
The VARs would then not pay the invoices, or would otherwise be compensated by Autonomy either through a sale to a real customer, or by Autonomy’s purchase of unneeded goods or services.
In one example, covering transactions with MicroLink, a reseller which Autonomy eventually bought, the judge found: “The total fees invoiced by Autonomy for the 11 transactions comprised in VT1 amounted to $15,317,488, of which only $2,098,772 was ever paid by MicroLink to Autonomy, and even then, the payment was funded by a reciprocal purchase by Autonomy.
“Both Defendants were involved in the subsequent purchases from MicroLink by Autonomy, and I have concluded … that each was aware that their true or driving purpose was to put MicroLink in funds to pay down some of its debt to Autonomy to fulfil the assurances given to MicroLink that it would not be left ‘holding the bag’,” the judgment added.
Similarly, and in exhaustive detail, the judge found Lynch and Hussain had “guilty knowledge” of almost all the wrongdoings alleged by HP – barring the “other transactions” section of the case. As he noted in his January summary, HP “substantially succeeded” in its claims.
As to what happens now: while HP and the defendants wait for Mr Justice Hildyard’s decision on damages, Lynch is still fighting against his extradition to the US – a battle which could go to the Supreme Court.
In the US Lynch is facing 17 criminal charges, including wire fraud and securities fraud, which could carry a substantial prison sentence if he’s found guilty. Hussain was convicted of 16 counts, including wire fraud, in 2018, and sentenced to five years imprisonment.
With this case not quite over, and a long US trial yet to start, the long and toxic story of Autonomy and HP is far from finished.