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Business Objects Gets Wells Notice

An imminent civil charge regarding backlog reporting could involve Sarbanes-Oxley violations.

Business Objects


dropped sharply Wednesday after the vendor of business intelligence software disclosed that the

Securities and Exchange Commission

is likely to file civil charges over the company's disclosure practices.

Shares of the French-owned firm closed down 97 cents, or 4.7%, to $19.73.

In a press release early Wednesday, Business Objects said it received a Wells notice indicating the SEC staff will recommend a civil proceeding against the company unless it is convinced otherwise. The complaint will focus on Business Objects' practice of not disclosing its backlog of unshipped orders, the company said.

But according to several accounting experts, it's possible the issue speaks to management's alleged failure to disclose material information to investors required by the Sarbanes-Oxley Act and the SEC's management discussion and analysis rule.

In any case, an investigation of this nature by the SEC "creates a very bad impression and is likely to be an overhang on the stock," said Pacific Crest analyst Brendan Barnicle, who downgraded the stock when the issue first surfaced in April in a one-sentence disclosure in the company's 10-K SEC filing.

The April disclosure was buried under a barrage of other bad news when the company announced first-quarter earnings that missed Wall Street estimates by a wide margin, sending the stock into a one-day plunge of 23% that has never been made up.

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On the surface, the SEC's charge is very puzzling, since there is no rule mandating disclosure of backlogs by software companies, according to several accounting experts and a spokeswoman for the Financial Accounting Standards Board, or FASB. In fact, the very notion of backlog for enterprise software, a product that is generally shipped electronically, seems strange.

Business Objects, along with other enterprise software companies, doesn't recognize revenue until a product is actually shipped to a customer. If a product has been sold but not shipped -- perhaps because the company has not yet completed its credit check of new customers, or because a last-minute technical glitch needs to be fixed -- the sale then becomes backlog until it is sent to the customers, said Don Markley, the company's senior director of investor relations.

If a sale happened late in the quarter and the software wasn't shipped until the next quarter, but the company recognized the revenue in the earlier quarter, that would constitute a regulatory violation. But Markley said that the SEC told Business Objects that revenue recognition is not at issue.

The company denied doing anything improper, and said in its Wednesday statement that it "intends to vigorously defend its position in this matter."

While there is no requirement to merely disclose backlog, Jeff Brotman, a professor of accounting at the University of Pennsylvania, said if "the backlog was related to a material issue and that issue was not disclosed, it could be a violation of the management discussion and analysis (MD&A) rule." Moreover, Sarbanes-Oxley requires executives to certify that financial statements are true and accurate in all material aspects, not just true according to generally accepted accounting principles, Brotman said in an interview.

Jack Ciesielski, publisher of the Baltimore-based

The Analyst's Accounting Observer

, called backlog "a messy area that is very tough on software makers. Deciding the fair value of when a product is shipped in parts (as software may be) is not easy." However, he also cited the MD&A rule, saying "There is no requirement to disclose

software backlog, but you have to disclose forward information about known trends."

Brotman and Ciesielski emphasized that they were speaking about general practices and had no direct knowledge of accounting practices at Business Objects.