For years, a Seattle software company's top executives kept two sets of accounting books: one with real numbers and one with "cooked" sales figures inflated much higher to lure investors, according to a complaint by the U.S. Attorney's Office.
For years, a Seattle software company’s top executives kept two sets of accounting books: one with real numbers and one with “cooked” sales figures inflated much higher to lure investors, according to a complaint by the U.S. Attorney’s Office.
Entellium Chief Executive Paul Thomas Johnston, 40, of Mercer Island, and the company’s financial officer, Parrish L. Jones, 39, of Seattle, were charged Wednesday with wire fraud for allegedly grossly inflating the company’s sales to attract more than $50 million in private capital.
Johnston and Jones were arrested at their homes Tuesday night by the FBI. Dressed in khaki prison garb, they appeared Wednesday before U.S. Magistrate Judge James Donohue in Seattle. Neither man entered a plea.
Johnston and Jones abruptly resigned from Entellium last week, and Johnston sent an e-mail to two board members in which he admitted to “grave mistakes.” The company then laid off two-thirds of its Seattle work force.
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The privately held firm develops software for small businesses to manage customer relations. It employed 60 people in Seattle and 75 in Malaysia.
According to the complaint filed by the U.S. Attorney’s Office, Johnston and Jones “devised a scheme to defraud investors in the company by representing that company revenues far exceeded the actual figures.”
The company was able to attract $50 million in private investments, which the investors may not be able to recover.
The amount includes $19.7 million from Ignition Partners, a Bellevue venture-capital firm. Ignition’s partners have said they never would have invested that much had they known Entellium’s actual revenues.
Assistant U.S. Attorney Carl Blackstone said his office is trying to track down where the money went. “There’s an awful lot of money that’s not accounted for from this company,” he said.
Blackstone also requested a detention hearing to determine whether Johnston is a flight risk. Johnston is a citizen of the United Kingdom with ties to Malaysia and Singapore, he said. Donohue set that hearing for Friday.
The judge said Jones could be released by posting his condominium as bond. A preliminary hearing is set for Oct. 23.
In a statement Wednesday, Entellium said it is cooperating with the investigation.
The complaint alleges that in 2006, Johnston and Jones told Entellium’s board of directors — which includes two Ignition partners — that the company had revenue of nearly $4 million. The actual number was just over $580,000, according to federal prosecutors.
In 2007, the complaint said, the company announced revenue of $6.3 million, when the amount was $1.4 million.
This year, it allegedly stated revenue of $5.2 million when the company brought in just $1.7 million.
Based on the higher figures, Ignition wired the company $2 million in April, according to the complaint.
The complaint included a copy of an e-mail sent from Johnston to board members Jonathan Roberts of Ignition and Pete Solvik of Sigma Partners when he and Jones resigned a week ago.
“We have both made a grave mistake to misrepresenting our revenue reporting to the board,” Johnston wrote. “Looking back at the time we thought we would be able to right the wrong and correct our representation, but we have not been able to do this. Revenues have been overstated since 2004. … Clearly, this is devastating news and something we are both regret [sic] and are deeply sorry for.”
Former employees and others were shocked and angry. Johnston had painted a rosy picture of the company’s future, they said.
“He always talked about how we were on the road to profitability,” said Phil, a former business-development employee at Entellium who wanted only his first name used because he’s looking for another job. “He said everything was very transparent, nothing hidden. He lied to us.”
Johnston, who went by the name “P.J.” and played on the company soccer team, drove a white Maserati Quattroporte, a sports car that sells for about $120,000, the employee said. Property records show Johnston and his wife took out a $1.1 million loan for their Mercer Island home in 2006.
Jones and his wife purchased a Seattle home in July 2007 for $1.28 million, according to property records.
Charles Peter Anderson, a lawyer from Los Angeles who invested in Entellium about a year ago, said he received an e-mail from Johnston in August that said the company was growing 72 percent over last year and would become profitable by next April or May.
“The money’s gone. I’m never going to get it back,” Anderson said. “Supposedly, Paul Johnston was the driving force behind Entellium. Whether that company can continue to exist looks doubtful.”
As for the discrepancy in accounting, he said, “it disturbs me that people like Ignition somehow missed it.”
Barry Abraham, a shareholder and early employee who helped Johnston bring Entellium to Seattle, said he thought the problem was an accounting error that was allowed to spiral out of control.
The problem had been weighing on Johnston and Jones for a long time, according to Abraham, who said he had talked to Johnston in the past week. “They’ve made their mistake. They’re going to pay for it,” said Abraham, who left the company in 2005.
But Abraham also blamed Ignition for lack of oversight. “Where’s the board?” he said. “Where is their responsibility?”
Ignition Partners could not be reached for comment Wednesday.
Entellium announced the sudden departures of Johnston and Parrish last week and laid off all but a handful of its Seattle staff. The company said its remaining staff in Seattle and Malaysia continue to support its customers and products.
The scheme was discovered Sept. 26 when an employee in the human-resources department found a set of cooked financial books while cleaning out the desk belonging to another Entellium executive, according to the complaint.
Discrepancies were found and the books were taken by the company’s lawyer to the U.S. Attorney’s Office.
Wire fraud is punishable by a prison term of up to 20 years and a fine of up to $250,000.
Kristi Heim: 206-464-2718 or email@example.com