The allegations of overstated revenue and financial fraud at Entellium are sparking a debate in the Seattle technology community about board oversight and the role of audits at venture-backed companies.
Now we’ve learned this: Moss Adams, the accounting firm for Entellium, says it never completed a full audit of the Seattle software startup. The information comes a day after the top two executives were charged with wire fraud in federal court Wednesday for allegedly “cooking the books” at the software startup.
Moss Adams’ chief practice officer Neal West said his firm was engaged to perform audits on Entellium in “multiple years,” but did not complete any of the audits and therefore never issued any reports or opinions. West did not know which years the audits were started and why they were never completed, but said his office is looking into it.
“We did not complete any audits and therefore never issued any opinions on their financial statements,” West said. “We’re still in the midst of looking at our records on this and beyond that I’m not able to comment.”
Asked if Entellium was using any other accounting firms, West said “not to my knowledge.”
It was unclear whether Entellium or its board requested audits. Ignition Partners, one of the largest venture backers of Entellium, did not immediately return calls seeking comment on the audit question.
There is some disagreement among investors, lawyers and accountants as to whether an audit actually would have uncovered fraudulent activities at Entellium.
“It surprised me there wasn’t an audit, but I don’t know what went into that decision,” said Alan Smith, a partner at the Fenwick & West law firm in Seattle. Smith said startups often get an audit after the first major funding rolls in.
Smith added: “Even the best-intended directors that are active and engaged are going to have a difficult time uncovering something like this if management is determined to hide it.”
Bill Bryant, a venture capitalist at Draper Fisher Jurvetson, agreed.
“Entellium should have at least had a review, but that may not have caught the fraud,” he said. “Enron and WorldCom had full audits, and people still didn’t catch on to what was going on for a number of years.”
Roger Clark, an accountant with the Seattle office of Grant Thornton, said an audit of Entellium’s business most likely would have uncovered discrepancies in revenue.
“It was likely that an audit was never done on this company,” said Clark. “You test the numbers the company gives you, and then you see if those numbers match the auditing work.”
In this case, an auditor would have investigated key customer contracts, revenue recognition, receipts and other factors, he said.
While Clark said it is common for venture capital firms to request audits before making an investment, he added that they are sometimes waived in tough times due to the added expense.
In the Entellium case, Clark said it appears that executives allegedly adjusted revenue with the hope of making up the shortfall in future quarters. In the end, Clark said, “they got trapped.”
“It is really a disaster for everyone involved,” Clark said. “It is a personal disaster for the two officers. It is a disaster for the venture funds that lost their money. And it is a disaster for employees who were trusting their leaders.”
– Eric Engleman, eengleman@bizjournals.com
– John Cook, johnharoldcook@gmail.com
14 responses so far ↓
1 Former Entellium executives charged with fraud // Oct 9, 2008 at 5:02 pm
[...] Here’s the latest in the ongoing Entellium saga. We’ve learned that Moss Adams, the accounting firm for Entellium, [...]
2 Anon // Oct 9, 2008 at 5:17 pm
So, audit engagement letters were executed, signed by either the CEO, the CFO or both? Was there any knowledge at the board level that audit engagements were initiated? Was there followup regarding the audit. How about from the standpoint of Moss Adams (a good firm), if audits were not completed in multiple years, were they started? Is there a pattern that would be alarming here, to be engaged but not to complete the audit. Seems difficult that if there was an engagement, without follow thru that such a situation would be allowed to repeat over and over year after year. Certainly, Moss Adams would be skeptical about such a client, fees aside.
The argument about a board not getting too much into the weeds is definitely correct, but it just seems that from the information available that this is hard to miss. Were the investor monitoring burn on a regular basis.
Movie … son of an enron? any takers.
3 Undone // Oct 9, 2008 at 6:57 pm
Well how come the board never insisted on completed audits! There you have it. These guys were done in by PJ’s presentations that they forgot something called the audit - knowing well that they had these accounting firms in there….Now coming to think about it - the auditors were always there when a board meeting took place. Something to ponder…
4 Undone // Oct 9, 2008 at 7:03 pm
so made it look like “hey the auditors are here”! so all must be well….
5 Anon // Oct 9, 2008 at 7:22 pm
How frequent were the board meetings? annual, semi-annual, quarterly, monthly?
6 ac // Oct 9, 2008 at 8:00 pm
Maybe i’m missing something, but this all doesn’t seem that hard. Entellium’s a SAAS model, right? So they make their money with [#subs] x [cost-per-sub-avg], right?
So either
1) J&J were faking all of these numbers, in which case other people needed to know that something was wrong, or
2) nobody on the board did simple math.
This isn’t Enron or Worldcom. This isn’t a complicated business with lots of hidden assets. (If it was, who invests in a company that makes $4M and has a lot of hidden assets?) It’s a simple business and shouldn’t have required a full audit for reasonably intelligent people to know that something was wrong.
7 a // Oct 9, 2008 at 9:20 pm
gotta agree with ac here. look people it just isn’t that hard to add up numbers - you get bank statements, you get revenue and collections, you do the math. at this scale there is nothing complicated about it - nothing at all.
8 Anonymous // Oct 9, 2008 at 10:39 pm
What about the board in all of this? Were they in on it?
9 Steve // Oct 9, 2008 at 11:10 pm
The company was initially rooted in Malaysia, a country in South-East Asia which is famous for the lousy government and accounting frauds(check their stock market(KLSE) reports). So don’t expect the auditors will be able to finish their audits.
10 Mark // Oct 10, 2008 at 12:23 pm
Even non-profits perform basic audits to compare reported receipts against bank accounts, and sample bank transactions to check for fraud indications.
The VC-provided board members were lazy and incompetent.
11 NetAmigo // Oct 10, 2008 at 8:28 pm
I never seize to be amazed at the utter stupidity and incompetence at times of board of director members. They always seem to be asleep at the stick. They seem only to be outdone by consultants. Actually, I think many of them know or suspect fraud and wrongdoing but they look the other way so as not to rock the boat and/or gain a personal financial advantage. I see this happen oftentimes with company employees when fraud is rampant in a company and, also, with consultants working for fraud ravaged companies, such as CPA auditors. It is really a fairly lonely walk these days if you stand up and speak out against management corruption. It tends to make one unemployable as well. I think that is one reason corruption it is so prevalent.
12 Entellium, economy dominates party talk // Oct 15, 2008 at 10:00 am
[...] however, noted that they require audits of all companies that have started generating revenue. (We reported last week that Entellium’s accounting firm never completed an audit.) And many agreed that a [...]
13 Eastsider // Oct 30, 2008 at 5:43 pm
I think Ignition and the other board member investors have no one to blame but themselves. I have seen these guys in action. They are enormously distracted and asleep at the switch. Based on news accounts, the company overstated revenue by 4x. Particularly given the small size of the company, this is such a gaping disparity it boggles the mind that there was no apparent scrutiny. None of this justifies the fraud and the perps should hang, but please…
14 Someone with some sense. // Dec 26, 2008 at 9:05 pm
I agree that the Board of Directors share some guilt in this situation. What is the purpose of sitting on a board if you are not going to ask the tough questions?
Parrish does not appear to be to be as culpable. His guilt is in allowing his boss to step down for and implicate them both in that scheme. Everyone has a boss and often does what that person tells them to do.
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