Arbitrators Slam HPE Financial Services’ CFO For ‘Altered Documents’ In DXC Case

‘A document alteration that is not disclosed is a very serious matter … Thus, no argument based on them is given weight. In sum, exhibits numbered TX 1615, TX 1616, and TX 1617 are not authentic documents because they were altered from the original, and the alteration was concealed by HPE,’ a panel of three arbitrators wrote.

A three-person arbitration panel found that Hewlett Packard Enterprise Financial Services Chief Financial Officer Ian Fowlis ‘altered’ documents submitted as evidence in a $1.3 billion debt dispute with DXC.

Fowlis has emerged as a key player in unsealed court documents related to an arbitrator’s ruling that resulted in an HPE payment of $666 million to systems integration behemoth DXC.

Fowlis scrambled in 2016 to keep the blockbuster HPE Enterprise Services spin-in merger with the systems integrator alive after the discovery of the undisclosed debt on the books of HPE Enterprise Services threatened to “jeopardize” the deal.

At the heart of the accounting dispute is $1.3 billion of capital lease liabilities – which were “intercompany leases” from HPE Financial Services to HPE Enterprise Services for technology assets such as mainframes, servers, laptops and desktops that HPE Enterprise Services used to provides services to customers.

Fowlis, according to arbitrators, was responsible for converting 10,000 “capital leases” – which are considered debt by federal regulators - into “operational leases” – which are not considered debt - prior to the 2017 merger that created DXC.

Fowlis provided an expert with an altered financial document that was submitted as evidence, and he was “not candid” during questioning by an arbitration panel, according to court documents.

“HPE argued in summation that Mr. Fowlis' document alterations are insignificant,” arbitrators wrote in their August decision that was made public Friday. “This argument is groundless. A document alteration that is not disclosed is a very serious matter … Thus, no argument based on them is given weight. In sum, exhibits numbered TX 1615, TX 1616, and TX 1617 are not authentic documents because they were altered from the original, and the alteration was concealed by HPE.”

In a statement provided to CRN, HPE said: ““We strongly disagree with the characterization of HPE’s and Mr. Fowlis’s actions as being improper or unethical. That is simply unfounded. This was an accounting dispute that has been resolved and the companies continue to have a strong partnership.”

Jamie Wine, a lawyer with Latham & Watkins, who represented DXC, said she was pleased with the decision.

“We are pleased with the panel’s unanimous award finding in DXC’s favor and adopting DXC’s presentation of the facts in this matter,” Wine said in a statement. “We are happy to have obtained this outcome for DXC.”

The capital leases were only discovered days before CSC and HPE Enterprise Services were expected to sign an initial agreement that would eventually create DXC.

The 2016 discovery of the capital leases nearly scuttled the deal after CSC’s “due diligence” consultants Deloitte & Touche alerted CSC to the capital lease liabilities.

A last-ditch proposal to convert all 10,000 leases to “operational leases” – which are not carried as debt – saved the spin in merger which HPE expected at the time the deal was closed to deliver approximately $13.5 billion in value to HPE and its stockholders on an after-tax basis.

Of the $1.3 billion, CSC agreed to pay $250 million with the remainder expected to be converted into operational leases, according to arbitrators.

Fowlis was left to convert 10,000 capital leases to operating leases, or risk having HPE absorb $1 billion in debt, per the deal. Fowlis was assigned a helper, however, arbitrators later found that “neither had ever attempted to do a large-scale lease conversion before, but HPE chose to keep the project under its own internal control.”

“What HPE represented to CSC that it would do, and what HPE actually did in the lease conversion process, are two very different things,” arbitrators found.

Months after the agreement, as CSC was preparing to officially launch DXC, they began asking HPE for updates about the lease conversions. Fowlis responded with a “white paper” about the work being done. However, Fowlis “admitted … in an internal email ‘that regardless of what the [White] paper says, these are truly capital leases.’ " arbitrators wrote.

However, in communication with CSC, Fowlis said he had reviewed the “analysis with [its] auditor, Ernst and Young (EY), who support[ed] [its] conclusion," arbitrators said. That was not the case, according to arbitrators.

“When that auditor testified at the hearing, he was not happy to see that statement because it was added after his review of the document and EY had not yet conducted its audit procedures,” arbitrators wrote. “The hearing testimony and documentary evidence revealed that several key representations made by HPE were not in fact what HPE actually did in carrying out the lease conversions.”

Arbitrators said that on April 1, 2017 – the day DXC was officially born -- HPE told DXC that it had completed its lease modifications in February 2017.

However, DXC was now under federal reporting requirements, and as its own accounting teams began to comb through the company, it soon found problems with Fowlis’ work, court filings stated.

As pressure grew on HPE to give DXC more detail about how it had transferred leases, Fowlis and HPE engaged in what arbitrators referred to as an “information stonewall.”

DXC- which was preparing its first earnings report - sent Fowlis eight requests for more information inside of 48 hours.

In turn, Fowlis hired New York based financial consultants Duff & Phelps and asked them to review his work on the lease conversions.

Arbitrators said Fowlis needed to have the leases pass the so-called “90 percent Test” in order to meet the criteria for GAAP reporting requirements as “operational leases.”

But after Duff & Phelps tested a sample batch of the 10,000 leases it found 68 percent failed.

“That information could be devastating for HPE, and Fowlis and other top executives at HPE never told DXC about that Duff & Phelps report,” arbitrators wrote. “After learning of these problematic appraisal results, Fowlis … discussed whether to redo the lease conversions, but decided not to do so. Fowlis decided instead to transmit HPE's views about the appraisal methodology, to see if this would change Duff & Phelps' conclusions.”

After a third test achieved the desired results, Fowlis sent that report to DXC, who was unconvinced, arbitrators said.

“After concluding that the leases had not been properly converted from capital leases to operating leases, on November 8, 2017, DXC sent HPE an Indemnification Notice demanding that HPE indemnify DXC for $1.019 billion in Excluded Liabilities. (DXC Arbitration Demand at 24). HPE denied its indemnification obligation.”

That landed the two sides in arbitration which ultimately led to the ruling which is detailed in the court documents.

“The evidence adduced at the hearing was equally clear that CSC executives repeatedly questioned the HPE representations about the methodology, and kept asking for more information to support the lease conversions that HPE had done,” said the arbitrator’s ruling. “In responding to the CSC/DXC data requests, HPE gave information sparingly, at best, about the conversion process, and finally just outright refused to provide more data to support the HPE methodology.”