This report was originally published 7/31/09.

Huron Consulting announced an earnings restatement, changes to management and lowered guidance for the fiscal year after the close today – in short a complete disaster for shareholders.  The most surprising of these announcements relates to what appears to be accounting fraud that was instituted between certain employees of the company and four businesses the company acquired between 2005 and 2007.  It appears that purchase related payments to the shareholders of the acquired companies were not made ratably with each individual’s ownership level.  In addition, the acquired companies redistributed some of their proceeds back to “certain Company employees”.  It is not clear in the press release if these payments were made to employees of the acquired company who became Huron Consulting employees, or to employees of Huron Consulting  that were not part of the acquired company.  The former implies an attempt to incentivize existing employees to remain with Huron following an acquisition.  The latter looks like an old-fashion kick-back scheme, whereby Huron employees were receiving payments from companies they were acquiring.  Here’s the section from the press release and you can decide for yourself what transpired:

“This inquiry resulted in the discovery that the selling shareholders of the Acquired Businesses:

1) Redistributed portions of their acquisition-related payments among themselves in amounts that were not consistent with their ownership percentages (“Shareholder Payments”) at the date of acquisition by Huron. Such payments were dependent, in part, on continuing employment with Huron or on the achievement of personal performance measures; or

2) Redistributed portions of their acquisition-related payments to certain Company employees (“Employee Payments”) who were not selling shareholders of the Acquired Businesses. Such payments were dependent on continuing employment with Huron or on the achievement of personal performance measures.”

HURN did not state in its press release, which of the companies that were involved in the “redistribution” of acquisition related proceeds.  From 2005 to 2007, HURN made seven acquisitions, here are the targets and purchase price:

• Speltz and Weis – $17 million
• Galt and Company – $20 million
• Aaxis – $8 million
• Document Review Consulting – $17 million
• Wellspring Partners – $65 million
• Glass and Associates – $30 million
• Callaway Partners – $60 million

As a result of this accounting scandal, HURN’s CEO and CFO have resigned and been replaced.  In addition to the management changes and accounting restatements, HURN lowered its annual revenue guidance for 2009 and announced preliminary revenue results for the second quarter of $164-$166 million. The second quarter revenue guidance is approximately $8-$10 million below current consensus. The annual revenue guidance of $650-$680 is $40-$80 million below current consensus and compares to prior guidance of $730-$770 million. At this point the fundamentals will not matter to shareholders.  The stock was down more than 50% in after hours.

It is particularly difficult to put a value on a consulting business undergoing an accounting scandal.  It’s possible the company could rapidly lose clients and key employees, only time will tell.  As fundamentally oriented investors who place great importance on rigorous analysis and primary research we blame ourselves for not recognizing that the company would not be able to meet our revenue growth expectations in the current economic environment.  The accounting issues are a different matter. For the past few hours we’ve been trying to think of a way we could have uncovered these issues and outside of having the employees involved tell us, we can’t.  That doesn’t change the fact that we’ve made a horrible recommendation.

For those who are interested in what might be the ongoing value of HURN, our back of the envelope calculation suggests the company could earn $1.50-$2.00 in 2009 and perhaps $100-$120 million in EBITDA, before including restructuing and other non-cash charges.

We would like to state our embarrassment about our recommendation of Huron Consulting.  Credibility is paramount at PAA Research and we understand if some of our readers will question the quality of our work on a going forward basis due to what has transpired at Huron Consulting.  We know our investment process yields positive results.  For us the investment game is about the pursuit of perfection with the realization that being more right than wrong is the best you can hope for.

Clearly HURN is no longer on our recommended holdings list.  We will include today’s after hours quote of $20.25 for purposes of our performance calculations.  Obviously we’re highly disappointed, but at some point we have to recognize fraud is fraud.  We look forward to providing you with more differentiated research and quality investment ideas in the coming weeks and months.

As always, please act accordingly…

Disclaimer: The author of this report owns calls in HURN, positions can change at any time without notice.