Zenefits director faced accounting issues at previous firm
Zenefits director faced accounting issues at previous firm
Zenefits CEO Parker Conrad shows his office in San Francisco, Calif., on Friday, November 7, 2014.Liz Hafalia/The ChronicleWhen Zenefits disclosed that its brokers had illegally sold insurance without a proper license, the San Francisco startup, valued at $4.5 billion, made clear who was at fault: founder and CEO Parker Conrad.
                  Not only did Conrad resign, but a person close to the matter insisted that Lars Dalgaard, a general partner at Andreessen Horowitz and a director at Zenefits, had repeatedly and unsuccessfully tried to counsel Conrad. For example, Dalgaard told Conrad that Zenefits needed a larger board and that the company should slow down its hiring.Dalgaard’s role on the four-member board was especially important because he was the only person who was not a Zenefits employee. As the only outside director, Dalgaard’s responsibility was to provide crucial perspective and guidance to the company. After all, he previously ran a successful software firm, having sold SuccessFactors to German software giant SAP in 2012 for $3.6 billion. The deal cemented Dalgaard’s reputation as a major player in Silicon Valley.Article continues below this adYet SuccessFactors had problems of its own. In 2011, a major accounting firm that had audited SuccessFactors’ statements concluded that its accounting controls contained “material weaknesses,” according to company documents.“SuccessFactors has not maintained effective internal control over financial reporting as of December 31, 2011,” KPMG wrote in the company’s annual report.Clearly, correlation is not causation. But company executives around Silicon Valley, particularly those on the boards of unicorns (companies worth more than $1 billion), would be well advised to take note of past mistakes and govern boards with more than a casual eye toward all kinds of compliance, whether it concerns accounting or licensing regulations.Neither Dalgaard nor Andreessen Horowitz would comment on the record for this story.CEOs like Dalgaard at SuccessFactors don’t personally handle accounting. But under the Sarbanes-Oxley Act, they are personally responsible for it. They must vouch that their public financial reports are accurate.Article continues below this adFor KPMG to fault SuccessFactors’ accounting was significant, and unusual. Accounting firms typically sign off on their clients’ quarterly and annual financial reports without controversy.“It’s a big deal,” said Hillary Sale, a professor of law who specializes in corporate governance at Washington University in St. Louis. “It’s a very unusual statement for an auditor to make, and they are essentially outing the company.”David Larcker, a professor of accounting and director of the corporate governance research initiative at Stanford Graduate School of Business, said KPMG’s report did not necessarily mean that SuccessFactors’ financials were inaccurate. Rather, there was a greater chance that the numbers could be wrong.“As a company, you do not want the assessment in your annual report,” Larcker said.Andreessen Horowitz referred me to a former SEC commissioner who downplayed the importance of the KPMG note. Joseph Grundfest, now a law professor at Stanford, said the SEC did not force SuccessFactors to restate any numbers. Had the SEC found evidence of accounting problems, the agency would have sued the company.Article continues below this adAnd if there was accounting fraud, SAP would have written down the value of the acquisition, which it did not do.SuccessFactors and KPMG did not even plan to file an annual report because of the acquisition, according to the person close to the situation. Once it was clear the deal was not going to close in time, they moved quickly to close the books and did not include information about fees related to the acquisition, according to the person. Neither SAP nor government regulators deemed it an issue.Such auditor notes are not uncommon, the person said.But of the 751 companies KPMG audited in fiscal 2011, the firm cited only 17 of them, including SuccessFactors, for ineffective accounting controls, according to Audit Analytics, a research firm in Massachusetts. In total, only 173 out of 4,070 public companies, or 4.2 percent, audited that year received such notices.Furthermore, in March 2010, a SuccessFactors sales executive approached his superiors and said the company was improperly counting existing customers who renewed their software subscriptions as new customers, booking their business as new revenue.Article continues below this ad“It was systemic throughout the organization,” said the former executive. “The accounting was really a mess.”The former executive spoke to The Chronicle on condition of anonymity, because he fears his actions could prevent him from getting another sales job. He said SuccessFactors eliminated his job in December 2010. A couple of months later, he approached the SEC as a whistle-blower and spoke to investigators several times. However, he does not know if the SEC is continuing the probe.More by Thomas LeeThe SEC declined to comment, and there is no indication regulators ever acted further on the matter.So why would SAP purchase a firm whose own auditor said the company did not effectively control the way it reported numbers? A SAP representative declined to comment.Article continues below this adIn any case, it didn’t matter. SuccessFactors released the annual report after SAP had already bought the company and shareholders got paid. By then, Dalgaard had cemented his reputation as a superstar.The compliance situations at Zenefits and SuccessFactors are, of course, different. But the two companies have more than a few things in common. They were both fast-growing firms that aggressively sold human resources software to business customers. And both companies ultimately struggled to prove that they were following all the rules.
                  Thomas Lee is a San Francisco Chronicle columnist. E-mail: tlee@sfchronicle.com Twitter: @ByTomLee
                March 4, 2016|Updated March 4, 2016 4:13 p.m.Thomas Lee is a business columnist for the San Francisco Chronicle. He is the author of “Rebuilding Empires,” (Palgrave Macmillan/St. Martin’s Press), a book about the future of big box retail in the digital age. Lee has previously written for the Star Tribune (Minneapolis), St. Louis Post-Dispatch, Seattle Times and China Daily USA. He also served as bureau chief for two Internet news startups: MedCityNews.com and Xconomy.com. 