Darktrace has appointed Ernst & Young to review its key financial processes and controls following accusations that it inflated its growth rates prior to its IPO in April 2021.
The Cambridge-headquartered cybersecurity company said it was “confident that Darktrace’s independently audited public company financial statements fairly represent Darktrace’s financial position and results”.
At the start of the month it was accused by US hedge fund Quintessential Capital Management of including “simulated or anticipated sales to phantom end-users through a network of resellers” in its figures.
“The board believes fully in the robustness of Darktrace’s financial processes and controls. As a sign of that confidence, we have commissioned this independent third-party review by E&Y. We look forward to the outcome of this review,” said chair Gordon Hurst.
Shares in the business dropped to £1.98 following the report, well below the price at IPO of £3.30 and a peak of £9.45 in October 2021. However since the rapid and robust rebuttal of the short seller accusations, it has since recovered, standing at £2.69 today.
“We targeted Darktrace with a deep investigation into its business model, selling practices, international partnerships, and sales force,” Quintessential Capital Management stated in its report.
“We are sceptical about the validity of DT’s financial statements and fear that sales, margins, and growth rates may be overstated and close to a sharp correction.
“DT seems to have repeatedly used marketing activities to channel funds back into its partners as payment for apparently fictitious purchases. These alleged channel-stuffing and round-tripping activities may have involved shell companies in offshore jurisdictions manned by individuals with ties to organised crime, money-laundering and fraud.
“We are of the opinion that Darktrace’s financial statements may not be relied upon as the company looks like a sophisticated replica of the Autonomy debacle.”
Poppy Gustafsson, CEO of Darktrace, was previously corporate controller at Autonomy – also founded in Cambridge – which specialised in software for sorting large data sets. That company was accused of irregular accounting practices relating to its $11.7 billion sale to Hewlett-Packard in 2011.
HP sued its founder Mike Lynch and former chief financial officer Sushovan Hussain. The latter is serving a prison term in the US for fraud relating to the sale, while Lynch is battling against extradition to the US to face fraud charges himself after the High Court found in 2022 that he and Hussain had defrauded HP by inflating the value of Autonomy. He denies the charges.
Darktrace was founded in 2013 by Gustafsson, Dave Palmer, Emily Orton, Jack Stockdale and Nicole Eagan, in part using funds provided by Lynch.
Gustafsson described the allegations from Quintessential Capital Management as “unfounded inferences”, adding: “I stand by my team and the business I represent.”
The report went on to claim: “We have detected a pattern of transactions suggesting that a portion of Darktrace’s past recurring software sales may instead be one-off sales of hardware appliances. Accounting anomalies involving deferred revenue suggest possible problems with DT’s revenue recognition, providing a potentially misleading picture about the company’s cash generation.
“Increasing competition, questionable product value, front-loading of existing contracts, high churn rates and lack of sustainable cash generation point to a rapid, possibly sharp, deterioration. Employment, website traffic and search volume metric suggest a sharp slowdown may be underway.”
A Darktrace spokesperson said earlier this month that the company has “rigorous controls in place across our business to ensure we comply fully with IFRS accounting standards”.