David Sutherland, a partner and fraud examiner in Rachin Cohen & Holtz LLP, was driving to a client when he heard a CNN announcement that LucidCom, a newly emerged provider of network infrastructure and connectivity products, reported strong fourth-quarter earnings and announced a 14 percent jump in the company’s stock. David quickly picked up his cell phone and dialed the number of his friend who was recently laid off from Net ledger, a company LucidCom acquired just a few months prior.
David made a few other calls, and in a matter of weeks, he learned that Net ledger had assets that were practically worthless to LucidCom and that those assets were reported as goodwill instead of written down after acquisition. For David, this change in the allocation of the purchase price represented a big red flag. When a company acquires another company, it is common to assign part of the purchase price to assets and part to goodwill. The assets are recorded at fair market value, and the remainder of the cost is assigned to goodwill. David questions whether LucidCom was being honest about the disclosures and causes of growth.
1. Were the earnings impressive because of the company’s productivity and sound business strategy or because LucidCom took advantage of an acquisition and toyed with financial reports?
2. What type of fraud is represented in this case?
3. Can you think of ways this type of fraud can be prevented?