Delphi Executives Named in Suit Over Sales Practices
The Wall Street Journal

By Jeffrey McCracken

Oct. 5, 2005

A detailed lawsuit filed against Delphi Corp. by two state pension funds and one of Europe's biggest employee-pension funds alleges the auto-supplier's senior executives encouraged inventory deals with a bank and two other companies that artificially boosted profits from 1999 to 2002.

The accounting moves, which involved selling inventory at the end of a quarter and booking the proceeds as income and cash flow from operations, are being examined in a securities-fraud investigation by the Securities and Exchange Commission and a related criminal probe by the Department of Justice.

Delphi has previously acknowledged it overstated earnings in past years, in part through deals involving third parties. But it is unclear whether senior executives were aware of the improper accounting, and details have been scant.

The suit alleges that Alan S. Dawes, Delphi's chief financial officer at the time, and other senior executives arranged approximately $440 million in deals in which Delphi sold scrap and unusable equipment to improve earnings during difficult quarters after Delphi was spun out from General Motors Corp. in 1999.

These deals helped Delphi meet or exceed quarterly earnings expectations for its first 19 quarters, according to the suit. After a quarter closed, Delphi reacquired the inventory, the suit alleges.

Delphi's senior management was so pleased with the inventory practices that a vice president of logistics once distributed a companywide memo praising the program and telling others to copy it, the suit alleges. Managers were also told to visit the plants where the inventory had been sold to "learn from their methods," according to the 290-page lawsuit.

The lawsuit was filed last Friday in federal court in New York. The $7 billion public pension fund for Oklahoma school teachers is named as the lead plaintiff. Others suing include the $16 billion Mississippi public-employees pension fund, which provides benefits to about 310,000 current and future state employees; Stichting Pensioenfonds ABP, the $178 billion pension fund for 2.2 million government and university workers in the Netherlands; and Raiffeisen Kapitalanlage-Gesellschaft, a mutual-fund firm based in Vienna with $40 billion in assets.

The lawsuit is being handled by the New York law firm of Bernstein Litowitz Berger & Grossman, which had a key role in the class-action suit in the WorldCom Inc. securities litigation that resulted in a $6.13 billion recovery.

Delphi spokesman Lindsey Williams declined to comment on the lawsuit. He said current Delphi executives or board members mentioned in the suit would not be made available to comment. Attempts to reach Mr. Dawes and Delphi's former chairman and chief executive, J.T. Battenberg III, were unsuccessful. Mr. Battenberg, who was also named as a defendant, announced his retirement in February, just a week before the SEC investigation was revealed. He stepped down this summer.

The suit cites deals in 1999 and 2000 involving a Tennessee purchasing-management firm called Setech. The suit alleges these deals, valued at about $145 million and involving inventory from Delphi sites such as plants in Kokomo, Indiana, and Reynosa, Mexico, artificially inflated Delphi's pretax income by $60 million in 1999 and $16 million in 2000, a period when Delphi traded near its $20-a-share peak. Delphi has previously acknowledged the amount by which pretax income had been inflated, but not details of the transaction or any involvement by Setech.

Setech's chief financial officer, Richard Eddinger, declined to comment on the lawsuit, but confirmed his company has been contacted by the SEC as part of its year-long Delphi investigation. The lawsuit adds to the mountain of problems at Delphi, which is trying to avoid filing for bankruptcy-court protection and is seeking help from GM and the United Auto Workers union.

Delphi, which has acknowledged that it is under federal investigation, completed an internal investigation in June, resulting in the restatement of earnings for 2001-2003. Mr. Dawes and several senior treasury executives were also forced out earlier this year as a result of the investigation.

Delphi has never given the names of the third parties it sold the inventory to. The suit cites several "confidential sources," such as former GM employees, Delphi managers, Setech officials and others as the source of its information.

The suit says many of the most egregious deals stopped in 2002, one quarter before Sarbanes-Oxley kicked in, but management spent the next two years trying to hide or make up for the artificial boost to their bottom line.

The suit names as defendants Delphi, the accounting firm of Deloitte & Touche, six former or current Delphi executives, 15 former or current board members, nine investment banks and three other companies Delphi did business with. Former parent GM wasn't named as a defendant.

Deloitte & Touche spokeswoman Deborah Harrington said her firm hadn't been served with the lawsuit and declined to comment.

The other companies that the suit alleges helped Delphi "present the investing public with a materially false and misleading picture of the company's cash flow, earnings and debt," are Bank One Automotive Group, since acquired by J.P. Morgan Chase & Co., and BBK Ltd., an automotive-turnaround firm based in Southfield, Michigan. J.P. Morgan spokesman Joseph Evangelisti declined to comment on the suit. BBK founder B.N. Bahadur said he hadn't seen the suit and declined to comment. Bank One and BBK have previously acknowledged being contacted by the SEC over the matter.

The suit says Delphi disguised a $200 million loan in December 2000 from Bank One as a sale of precious metals. Delphi used this money to report record cash flow from operations of $268 million for 2000, which was considered significant at the time because the rest of the auto industry was suffering from vehicle-production cuts, the suit alleges.

Delphi's actual cash flow from operations for the year was $68 million. It also didn't record the loan as a debt. A few weeks later, in January after the year-end close, Delphi bought back the assets, the suit alleges.

The suit says Delphi did about $89 million in similar buyback deals with BBK in 2000 and 2001. Quoting an unnamed "confidential source" that worked in the senior executive office of BBK, the suit claims Mr. Dawes was "directly involved in the transactions" with BBK and had a close relationship with Mr. Bahadur.

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