$12.5 Million Recovery After Financial Results Turn into Pipe Dream

July 18, 2012

How many different types of accounting fraud can a company perpetuate at once? That was the question facing lead plaintiff Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund and its attorneys at Robbins Geller in their recently settled action against Northwest Pipe Company and its former CEO and CFO.

Northwest Pipe is a Vancouver, Washington-based company that manufacturers high-pressure steel piping and tubing for use in water infrastructure projects, hydroelectric power systems, wastewater systems and other applications. In November 2010, and again in April 2012, the company was forced to restate its historical financial results to account for millions of dollars in understated expenses and prematurely booked revenues stemming from at least 12 separate alleged accounting schemes.

For example, plaintiffs alleged that the company’s former CEO was at the helm of a scheme to prematurely recognize revenue on purchased steel. Northwest Pipe accounted for its large water transmission projects under a “percentage of completion” method, which allowed the company to recognize revenues based on the costs it had incurred in connection with a given project, so long as such costs fairly represented the percentage of a project’s completion. The complaint alleged that when Northwest Pipe needed to increase its reported revenues for a given quarter to meet Wall Street expectations, the former CEO would demand that the company’s plant managers order more steel regardless of whether it was needed for a given project at that time, and in some instances before the company even had contracts in place that could utilize the steel.

Defendants also artificially inflated the company’s revenues and earnings by concealing material liabilities caused by penalty provisions, liquidated damages and back charges claimed by the company’s customers as a result of shoddy or late work performed by Northwest Pipe. Instead of correctly accounting for such costs, the former CEO concealed such penalties from investors by converting the penalties into discounts on future work to be performed by Northwest Pipe. Such arrangements created off-balance-sheet liabilities, which were never disclosed to investors. This practice also allowed Northwest Pipe to avoid accruing losses on unprofitable contracts and resulted in the artificial inflation of Northwest Pipe’s reported “backlog,” which was a critical metric that investors and Wall Street analysts used to assess the strength of the company’s future revenues.

In yet another scheme, defendants inflated the company’s earnings by manipulating expenses relating to the depreciation of assets. Notwithstanding defendants’ representations that the company depreciated some equipment over a three to 18 year schedule, defendants caused Northwest Pipe to depreciate its equipment at a rate of under 4% a year – a rate which was patently inconsistent with the stated useful life of such equipment.

Defendants also routinely falsified the assignment of costs in order to make unprofitable contracts appear profitable. To accomplish this, defendants intentionally assigned costs from money-losing contracts to profitable contracts, and improperly reassigned labor hours budgeted for profitable contracts to money-losing contracts. This deceptive practice allowed Northwest Pipe to circumvent accounting rules that require the accrual of a loss on money-losing contracts at the time a loss is known.

Defendants’ alleged fraudulent practices eventually caught up with them. In a somewhat bizarre turn of events, the head of the company’s Water Transmission Division blew the whistle on his own CEO by instructing subordinates to call the company’s fraud reporting hotline and report the alleged fraud. An internal investigation ensued, and a year later the company issued a massive restatement which revealed that defendants had overstated the company’s earnings by $44 million between 2006 and the second quarter of 2009.

In December 2010, following the company’s November restatement, lead plaintiff filed a consolidated complaint. The consolidated complaint was the culmination of a year-long investigation by plaintiffs and their counsel, and included allegations from 10 former Northwest Pipe employees who corroborated many of plaintiffs’ claims. In February 2011, Northwest Pipe and its former CEO and CFO filed motions to dismiss the consolidated complaint. The motions to dismiss asserted that plaintiffs had failed to allege loss causation – that the disclosure of the alleged fraud was causally related to plaintiffs’ losses. Defendants also contended that plaintiffs had failed to meet the rigorous standards for pleading defendants’ scienter, or intent.

In August 2011, following comprehensive briefing by the parties, the court denied defendants’ motions to dismiss. First, the court held that plaintiffs had adequately alleged loss causation, finding that stock drops linked to multiple disclosures that the company’s financial filings would be delayed and that the SEC was investigating the company’s revenue recognition practices were “sufficiently linked to defendants’ prior statements about the company’s financial results and are sufficient to plausibly allege loss causation.” Furthermore, the court held that plaintiffs had alleged a strong inference of scienter, finding that plaintiffs’ numerous allegations, considered collectively, were sufficient to meet their burden of alleging an “inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.”

Following the denial of defendants’ motions to dismiss, the parties began to participate in discovery. As part of the discovery process, Northwest Pipe produced over 3.2 million pages of documents to plaintiffs regarding the claims at issue in the complaint. Plaintiffs carefully reviewed the documents produced by defendants for evidence to support their claims. During the discovery process, the parties participated in several mediation sessions, and in July 2012, an agreement was reached to resolve the action for $12.5 million. The settlement is subject to court approval.

“This was a highly complex action that required plaintiffs to unravel over a dozen alleged accounting improprieties in order to plead their claims,” said Christopher M. Wood, an associate in Robbins Geller’s San Francisco office, who, together with partner Christopher P. Seefer, prosecuted the action. “The strong recovery in this case appropriately reflects the strength of plaintiffs’ claims, while recognizing the significant hurdles plaintiffs would have had to overcome to prevail on intricate accounting claims at trial and on any potential appeal.”

Richard v. Northwest Pipe Company, et al., No. 3:09-CV-05724-RBL (W.D. Wash.).

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