Exclusive IBM's board of directors has started an investigation into claims that its sales numbers were manipulated, leading to executives securing big bonuses. If the board fails to take any action, it may face a lawsuit to claw back millions of dollars from top staff.
In late March, just days before IBM was sued for securities fraud, the IT giant's board received a demand letter from attorneys representing shareholders.
The letter, according to sources familiar with the matter, asked the board to investigate allegations that later surfaced in the securities lawsuit: that the company, under former CEO Ginny Rometty and current CEO Arvind Krishna, deceived shareholders by unlawfully manipulating mainframe revenues in a way that misled investors and inflated executive bonuses.
Our sources tell us that if the IBM board fails to deal with the allegations, a derivatives lawsuit is expected to follow in which the plaintiffs will try to claw back millions of dollars worth of bonus payments made to executives.
A shareholder derivatives lawsuit is brought by shareholders on behalf of a corporation. It is filed against corporate leaders – company board members, officers, or others – alleged to have neglected their fiduciary duty.
We're told IBM's board has engaged a law firm to investigate the fraud allegations. If the board takes no action to address the supposed fraud, the plaintiffs should then be able file a derivatives claim in the company's name.
Assuming the court finds sufficient merit in the plaintiffs' claim to allow a derivatives case, and if the plaintiffs prevail, most of any damage award would belong to the company – which would benefit shareholders, but would not go to them directly.
A legal scholar who spoke with The Register on background for lack of familiarity with this specific case said it's unusual for shareholders to present the board with a demand letter because unless you can show the board is conflicted or acting in self-interest, shareholders generally aren't allowed to initiate a derivatives case.
IBM did not respond to two requests to confirm or deny the existence of the demand letter.
Buried on page 38 of a 10-Q filing with the SEC last week, however, Big Blue disclosed it had received and responded to such a missive.
"On March 25, 2022, the Board of Directors received a shareholder demand letter making similar allegations [to the securities class-action lawsuit] and demanding that the company's Board of Directors take action to assert the company's rights," IBM noted in the submission, a detail that so far has gone unreported.
"A special committee of independent directors has been formed to investigate the issues raised in the letter."
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The securities fraud claim [PDF] against IBM was filed on April 5 in New York, on behalf of the June E. Adams Irrevocable Trust. It names as defendants not only IBM, but current and former corporate leaders including Rometty, former CFO Martin J. Schroeter (now CEO of IBM spin-off Kyndryl), current CFO James J. Kavanaugh, and current CEO Arvind Krishna.
Since the lawsuit was initially filed by law firm Milberg Coleman Bryson Phillips Grossman, LLC, it has been joined by at least five other law firms representing other IBM shareholders. In June, the court recognized Iron Workers Local 580 Joint Funds as the lead plaintiff.
The complaint contends that IBM between April 4, 2017 and October 20, 2021 "improperly and in violation of Generally Accepted Accounting Principles ('GAAP') embarked on a fraudulent scheme to shift billions of dollars in revenues from its mainframe line of business to its Strategic Imperatives and CAMSS line of business."
... a fraudulent scheme to shift billions of dollars in revenues from its mainframe line of business to its Strategic Imperatives and CAMSS line of business
CAMSS is an abbreviation for Cloud, Analytics, Mobile, Security and Systems, business segments that were designated as strategic imperatives by IBM's leadership. The complaint argues that IBM instituted a bonus scheme that rewarded execs and encouraged IBM salespeople for the sale of CAMSS products. As a result, revenue arising from mainframe sales got reclassified as CAMSS sales, which boosted bonuses even as it misled investors – by giving shareholders an untrue picture of the IT giant's sales performance – it is claimed.
The Register spoke with two former IBM sales employees who were unaffiliated with the litigation and had between them more than forty years of experience with Big Blue. They described manipulative sales reporting – not all of which is necessarily unlawful – as a common practice, not only at IBM but at other large enterprise software firms.
"Think of it as, like, the worst kept secret," said one, who described one way IBM salespeople adjust sales figures to their own advantage. "It all starts with the CRM system, the customer relationship management system. IBM uses SugarCRM, but they make it very easy when you get a deal.
"You go through a bunch of checkboxes and you check off which categories pertain to this deal and how much of it is services, how much of it is hardware, how much in particular is cloud-based or analytics. And this is the big thing with the CAMSS, right? To check off all the boxes pertaining to CAMSS and then you allocate a percent to that."
That is to say, you only have to assign a small part of the sales deal to CAMSS to record it as a CAMSS win.
The other described various dubious directives that salespeople had to comply with, which steered salespeople toward meeting management goals and discouraged rocking the boat.
For example, this individual described IBM Z Linux part number manipulation. "A very common practice was to create a duplicate part number," this former IBMer explained. "It's a unique part number but there's no difference in product or delivery."
That makes no difference to the customer, we were told, but the way products got categorized affected sales staff and executive compensation.
The issue before the court in New York is whether flexible accounting of this sort, to the extent it can be documented, violated the law or IBM misled investors. If IBM's board finds no corrective actions are necessary, a successful derivatives complaint could return millions paid in unwarranted executive bonuses to company coffers. ®
Editor's note: This article was updated to clarify that the demand letter was sent in late March, just before the securities lawsuit was filed in April, as confirmed by the 10-Q filing.