Accounting games with purchases of digital set-top box and kind treatment of subscribers who had stopped paying their bills lay at the base of the new indictment of four former Charter Communications executives.
Federal prosecutors charge that the executives—particularly former COO David Barford and former CFO Kent Kalkwarf—crafted schemes to overstate financial performance and prop up stock price.
This is not an embezzlement case in which any of the four executives pocketed cash from the maneuvers. All, however, had Charter stock or options that gained in value as a result of Charter's reported growth.
Barford and Kalkwarf face 14 counts of mail fraud, wire fraud and conspiracy to commit wire fraud. The former heads of two regions face fewer charges. Former Western Regions Senior Vice President Trey Smith was indicted on eight counts of wire fraud and conspiracy. Eastern Region Senior Vice President David McCall was indicted on one count of conspiracy to commit wire fraud.
Bloomberg News reported that McCall pleaded guilty Friday afternoon to conspiring with three other officers to inflate the number of reported subscribers. Sentencing was set for Oct. 17. Barford and Kalkwarf were due in court at press time.
Although the indictment describes accounting games conducted at the highest level of the company, former CEO Jerry Kent—himself an accountant at Charter's ex-auditor Arthur Andersen—was not charged. Neither was the company itself nor deep-pocketed controlling shareholder Paul Allen, who has lost about $7 billion in cash on Charter investments. Prosecutors praised Charter for its co-operation in the investigation.
Prosecutors charge that, beginning in 2000, Barford and Kalkwarf realized that Charter was falling short of financial goals. Their solution was to cut a deal with manufacturers of digital set-top converters, agreeing to pay an extra $20 on each of hundreds of thousands of boxes if the suppliers bought advertising time on Charter systems. The extra set-top costs were counted as capital spending, which doesn't affect reported revenues or profits. The advertising sales, though, would be counted as revenue and fell straight to the bottom line.
When auditor Arthur Andersen challenged the deal, Kalkwarf allegedly reworked the contracts to make it seem that the new set-top prices were unrelated to the ad purchases. Charter bought 850,000 boxes under the scheme, booking $17 million in artificial revenue. Not much compared with reported cash flow of $433 million, but it accounted for 17% of Charter's cash-flow growth for the quarter.
Prosecutors contend that, in 2001, all four ex-executives also inflated subscriber counts. First, they let non-paying customers stay on the books longer than normal policy dictated, calling the process "managed disconnects." The indictment says McCall and Smith initially protested but later instructed employees to relax non-pay policies.
Then, Charter started manufacturing accounts and giving service to certain customers. By year-end 2001, the overstatement totaled 120,000 subscribers. Again, not much compared with the 6.9 million base that Charter reported, but, if the numbers hadn't been inflated, Charter would have reported a 2% decline rather than the 1% increase reported at the time.
In cable, investors focus closely on basic-sub counts, and even a 2% drop would have drawn huge attention on Wall Street.