Fix or Fraud?

A little more than five years ago, Richard E. Fresia was part of a new management team brought into the telecommunications subsidiary of utility company NorthWestern Corp. to help straighten out an ERP implementation gone horribly awry. On Monday, he was charged by the Securities and Exchange Commission with violating securities laws for his actions during that time. If he loses the case, he faces civil penalties, fines, and a permanent bar against acting as an officer of a public company.

According to the SEC, Fresia, CFO of NorthWestern's telecommunications subsidiary Expanets, failed to properly account for ongoing problems with receivables created by a failed new billing and accounting system. The regulator says he and NorthWestern senior executives deliberately concealed the resulting overstatement of income in the first and second quarters of 2002, allowing the parent company to raise more than $800 million from securities offerings in September and October. Two months later, NorthWestern disclosed a $50 million charge for uncollectible accounts receivable. The following year, NorthWestern declared bankruptcy.

Fresia says he sent "E-mail after E-mail" and other information to the parent company. He says he was not responsible for publicly reporting the financials, and unsuccessfully petitioned NorthWestern's controller to disclose the computer problems in the parent company's second-quarter report. He says he eventually turned over a thick binder of E-mails, time lines, and other information to the SEC, and was startled when the regulator decided to charge him.

"For the first two years of this, I thought I was going to be the [SEC's] star witness," he told CFO.com. "I was more surprised than anyone when they turned on me as well." Fresia left Expanets in 2003, and is currently CFO of ACT Teleconferencing Inc., a public company in Golden, Colorado.

Fresia joined Expanets in April 2002 as part of a new management team — which also included a CEO and CIO — hired by NorthWestern, he says, to "come in and get things straight" after it became clear that the company's ERP system was not working properly.

Like many electric and gas utilities at the time, NorthWestern formed Expanets in 1998 in hopes of cashing in on the lucrative telecommunications boom. But by 2002, according to the SEC's account, the utility had sunk more than $314 million into Expanets and had seen little return. Moreover, in February 2002, NorthWestern acquired Montana Power Co. for $1.1 billion, financing almost two-thirds of the acquisition with debt. With its historically stable liquidity and credit ratings at risk, NorthWestern announced plans to conduct an equity offering to pay down some of the debt.

At the same time, Expanets was struggling with its "EXPERT" system, which was intended to handle sales, inventory, project management, billing, collections, and financial-statement preparation. By both Fresia's own account and the SEC's complaint, the system was a mess. He says that when he arrived in April, the company hadn't rendered a bill in a month and had not been able to collect on bills in a month and a half. In addition, he says, the system was not providing the proper aging of receivables.

At issue is what happened in the next six months. "We billed $80 million a month and sent over 500,000 bills per month," says Fresia. "You couldn't fix this in Excel — you needed to have a systems fix." After six weeks on the job, he says, he was regularly alerting the parent company to the problems. However, he says, he was also being regularly assured by the CIO that fixes were imminent. "The systems integration [problems] created a hazy environment where I looked at the glass as half empty, the reporting organization looked at it as half full, and even to this day, I'm not sure who was quite right," he says.

The SEC says Fresia, knowing that receivables were aging and anticipating that some customer accounts might prove uncollectible, should have either increased the company's bad debt reserve or disclosed contingent losses related to the billing adjustments. Instead, it says, he left the bad debt reserve unchanged at its historic rate of 0.8 percent, and made no disclosure.

"As a result of Fresia's improper accounting for Expanets' uncollectible accounts receivable," says the SEC's complaint, "Northwestern overstated its income from continuing operations by approximately 19 percent and 39 percent for the second and third quarters of 2002, respectivelyÂÂÂÂ…. Moreover, in its segment reporting for Expanets, Northwestern overstated Expanets' operating income by approximately 86% and 270%, respectively, for the second and third quarters of 2002."

Fresia says, in fact, he did ask that a disclosure be included in the second-quarter filing, but was turned down. According to the SEC's account, "Northwestern personnel declined to include this proposed language in the company's 2002 second quarter Form 10-Q, at least in part, on the grounds that Fresia's proposed disclosure was submitted too late for inclusion."

"If I had a time machine and could go back, I'm not sure I would do anything differently," says Fresia. Indeed, he says his attorney asked SEC staff what it would have had him do differently, and claims he was told that Fresia should have used the whistle-blower provisions of the Sarbanes-Oxley Act. But, counters Fresia, the Sarbanes-Oxley Act was passed just two weeks before NorthWestern refused Fresia's suggested 10Q disclosure. "No one knew 15 days after the act passed what was in it."

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