Recently, New Republic published a piece about Michael Saylor and MicroStrategy. While I can’t tell you anything in the piece is necessarily untrue, I take deep issue with some of the statements simply due to the fact that they took away from the real story.
(If you’re wondering what I took issue with, it’s mostly the commentary regarding Bitcoin, which became the main focus of anyone who read the article.)
The Real Story
What is lightly touched on in the New Republic article is a year 2000 SEC case brought against Saylor, other MicroStrategy executives, and individuals in the accounting department.
What the article fails to actually discuss is what happened to MicroStrategy in 2000.
I come at this as someone who’s interested in detailing historical fraud, so I’m not attempting to use this to paint MicroStrategy or Saylor with some broad brush, but instead to examine exactly what occurred in 1998–2000.
It’s January 2000 and the internet bubble is beginning to enter full blown hysteria. So is MicroStrategy, which IPOed in 1998 and has already more than 10Xed in value. The company is doing so well they’ve purchased four commercial slots for the Super Bowl — a whopping ~$8 million dollars at the time.
But trouble looms.
The Era of Accounting Fraud Begins
The beginning of the end of the internet bubble is sponsored by a slew of auditing firms that aren’t just being criminally negligent, but often committing outright fraud. These firms go from being known as “The Big Eight” to what’s today known as “The Big Four.”
The name that will resonate most for might-as-well-be-boomers like myself is the accounting firm Arthur Andersen.
Arthur Andersen helps Enron and WorldCom commit two of the largest frauds in American history and closes its doors.
But we’re not discussing Enron and WorldCom and Arthur Andersen, which devolve slightly later and at a much larger scale, we’re talking about MicroStrategy and PriceWaterhouseCoopers.
In March of 2000, MicroStrategy is forced to restate its accounting numbers for 1998 and 1999. This is very unfortunate, as the stock price, which has gone from the IPO of $6 to an unreal $333, is now set to come back to Earth. And it does so in dramatic fashion, falling an astounding ~91% in one month or so.
Exactly What Happened
If you’re a lawyer or have a keen interest in deciphering securities law, look at the SEC complaint here. If not, I’ll do my best to describe what happened between 1998–2000 at MicroStrategy (I am not a lawyer).
What the SEC alleges in the complaint is that MicroStrategy, through a series of shady accounting practices, made their books look better than they were in reality. Some of these practices included:
- leaving the date blank on contracts so they could be effectively signed right before the end of quarters to beat earnings estimates
- recognizing revenue from unsigned contracts, again to beat end of quarter earnings estimates
- counting sales for service as sales for software
- recognizing barter transactions (ie trade $5 million in software for $5 million in hardware) as sales
The SEC also uses the stock price of MicroStrategy as an example of issues inherent with their accounting numbers, as a 91% devaluation would only occur if the accounting numbers were significantly manipulated.
The end result of this action is a settlement where Michael Saylor (CEO), Sanjeev Bansal (COO), and Mark Lynch (CFO) neither proclaim guilt nor innocence, pay fines, and MicroStrategy pays a large fine, as well. Without getting into details, the defendants are also ordered to cease from ever engaging in any activity like this again and are more closely monitored for an extended period of time.
The Role of Auditors
It’s difficult to parse where auditor negligence begins and executive fraud ends in a case like that of MicroStrategy in 2000. When a testimony on auditor independence is conducted in 2000 — after MicroStrategy but before the collapse of Enron and WorldCom — professors use MicroStrategy as an example of the difficulty in auditing a company conducting fraud via the executive leadership:
But The New York Times article being referenced in the testimony also provides some glimpses into why auditors are largely to blame:
In fact, this $51 million settlement by PwC (and their insurer) far exceeds the fines paid by MicroStrategy and Saylor. It will later be discovered that auditing firms giving the thumbs up to pretty much everyone is playing a huge role in the financial bubble.
Not Off the Hook
MicroStrategy and Saylor clearly take advantage of auditing games between 1998–2000. The extent of it becomes clear in a New York Times article written after the settlement with the SEC is announced:
I walk away from this story with a few concepts resonating that don’t sit well.
- A very troubling bit in the last cited New York Times article is that a large portion of the fine was paid to the SEC in MicroStrategy stock. While individuals bring up the auto bailout of 2008 as an example of the government investing in public listed entities, that is a very different example: in one example companies that the government believed in and hadn’t committed any crimes were given taxpayer money in the hope they would succeed, in the case of MicroStrategy, a company accused of fraud is paying government fines with company shares. Paying off SEC fines in company shares feels like a conflict of interest on every level.
2. Most companies that face fraud charges and a subsequent massive downturn in stock price attempt to alter their board of directors and definitely remove the executives accused of the fraudulent acts. In this case, perhaps because ultimately Saylor is the number one shareholder, neither of these events took place.
Taking a Step Back
It’s fair to make the assessment that these fraud charges are from two decades ago and since then MicroStrategy and Michael Saylor haven’t been accused of anything nefarious. Additionally, considering the company hasn’t gone bankrupt and the stock price hasn’t gone to zero, it’s probably fair to say that MicroStrategy — while fudging the numbers between 1998–2000 — wasn’t a straight ahead scam.
The fact that Michael Saylor, the cofounder, CEO, and primary shareholder, is making reckless decisions with the company funds — be they good or bad — isn’t likely illegal and doesn’t need to be commented on to examine what happened before.
It’s still important to reflect on an individual and company’s history, and for many, understanding how CEOs made decisions in the past will help them formulate an opinion on how they believe a CEO will behave in the future. Of course, past performance is not an indicator of future results.
Stay skeptical, friends.