Tuesday, April 3, 2007
Tenet Healthcare Corp. settled an SEC civil enforcement action by agreeing to an injunction and payment of a $10 million penalty for inflating its earnings by exploiting a loophole in the Medicare and Medicaid regulations called "outlier payments." According to the Litigation Release (here):
The Commission’s complaint alleges that between 1999 and 2002, Tenet engaged in an unsustainable strategy to reach its earnings targets by deliberately exploiting the Medicare reimbursement system. Tenet’s scheme involved a loophole in the Medicare reimbursement system related to “outlier payments,” which are designed to compensate hospitals for caring for extraordinarily sick Medicare patients. Tenet’s management realized that Tenet could inflate its revenue from outlier payments by simply increasing the gross charges set by its hospitals. From 1999 to 2002, Tenet’s outlier revenue more than tripled and Tenet’s earnings goals were surpassed year after year. Tenet’s outlier growth from fiscal 1999 to fiscal 2002 accounted for over 54% of its cumulative growth in earnings per share from operations. Similarly, by fiscal 2002, Tenet’s outlier revenue comprised over 40% of its earnings per share.
In addition to the company, the complaint names four individual officers as defendants: Thomas B. Mackey, former chief operating officer and co-president; Christi R. Sulzbach, former general counsel and chief compliance officer; David L. Dennis, former CFO and co-president; and Raymond L. Mathiasen, former chief accounting officer. Dennis and Mathiasen settled the case by agreeing to pay $150,000 and $240,000 civil penalties respectively, and Mathiasen agreed to a Rule 102(e) bar from practicing before the Commission as an accountant. .
Thursday, March 29, 2007
After plowing through the upper levels of Enron's management, the SEC is now targeting two former in-house lawyers for the company by charging them with securities fraud in a civil action. The Commission filed the complaint (here) against Jordan H. Mintz, former general counsel of Enron's Global Finance group (EGF) and Rex R. Rogers, a former associate general counsel. The case concerns a transaction involving Enron's Cuiaba, Brazil power plant to one of former CFO Andy Fastow's special purpose entites, LJM, and the reporting of the transaction. According to the SEC Litigation Release (here):
Mintz, as General Counsel of EGF, was responsible for managing the related party disclosures in Enron's 2000 Proxy Statement (incorporated in its 2000 Form 10-K) and second quarter 2001 Form 10-Q, and closing a fraudulent related party transaction while knowingly or recklessly disregarding that the transaction was in fulfillment of a secret oral side agreement. Rogers, as Enron's top securities lawyer, was responsible for the timing and content of all Enron's SEC filings, including Enron's 2000 Proxy Statement, second quarter 2001 Form 10-Q and relevant 2001 Form 4 filings.
The Commission is seeking the usual remedies of disgorgement, a civil penalty, and director/officer bars against the two defendants, who deny the charges. The violations took place more than five years ago, and there is a split in the circuits whether an SEC enforcement action is subject to the five-year statute of limitations period for collection of a penalty under 28 U.S.C. Sec. 2462. Enron's lawyers, both in-house and outside counsel, have largely avoided government enforcement actions, but this case is consistent with the Commission's approach to look at the "gatekeepers" as potentially liable for reporting violations. (ph)
Thursday, March 15, 2007
The SEC is unleashing its insider trading cases with near abandon, filing and settling a case against the former CFO of a company who was working there as a consultant when he got wind of an impending takeover. Melvyn C. Goldstein was CFO of Del Laboratories, Inc. until he retired in 1997, and he returned at the end of the quarters to help out the finance department (see SEC complaint here). In 2004, he figured out that Del was in the process of being acquired by another company, and he bought shares a week before the announcement, realizing a $38,000 profit. As part of the settlement, he will disgorge his profits and pay a one-time penalty plus interest, totaling $81,498.31, according to the Litigation Release (here). The SEC Enforcement Division's current push on insider trading cases means that they will pursue even the small ones. (ph)
Thursday, March 8, 2007
The SEC obtained an asset freeze on the U.S. based account of a bank in Latvia that the Commission alleged was part of a scheme to hack into the accounts of on-line brokerage customers and engage in a market manipulation scheme. The complaint (here) does not identify the defendants, and the U.S. District Court for the District of Columbia granted issued the freeze order. According to the SEC Litigation Release (here) describes what the Commission called a "modern-day, technological version of the traditional pump-and-dump":
The Commission's complaint alleges a complex scheme that combines electronic intrusions into online brokerage accounts with a traditional market manipulation. From at least December 2005 through December 2006, one or more foreign-based unknown traders purchased, through four sub-accounts of an omnibus trading account titled in the name of Relief Defendant JSC Parex Bank and held at Pinnacle Capital Markets LLC of North Carolina, shares in 15 U.S.-based Nasdaq-traded companies. These unknown traders then hacked into unsuspecting investors' online brokerage accounts at seven major online broker-dealers and sold off investors' existing securities holdings. They then used the proceeds to buy shares on the open market of the thinly-traded issuers the unknown traders had previously purchased in their own sub-accounts. This illicit account activity artificially heightened the share price and trading volume for each of the thinly-traded issues and enabled the unknown traders to sell their holdings at a substantial profit, realizing at least $732,941 in ill-gotten gains, and possibly more. The unknown traders also used electronic means to hide their identities and mask the means by which they intruded into accounts.
Saturday, March 3, 2007
The SEC filed an insider trading case against unknown purchasers of TXU Corp. call options in another example of transactions in foreign accounts buying ahead of an acquisition. The deal to take TXU private by Kohlberg Kravis Roberts, Texas Pacific Group, and Goldman Sachs was announced on February 26, but the stock began rising the previous Friday, and eventually gained over $10 per share. According to the Litigation Release (here):
[B]etween February 21 and February 23 -- prior to the public disclosure of the merger agreement -- while in possession of material, nonpublic information regarding this acquisition offer, the Unknown Purchasers, using overseas accounts, purchased over 8,020 call option contracts for TXU stock in accounts at three broker-dealers in the United States. As the complaint alleges, the call option contracts were "out of the money" and most were set to expire in March, within weeks of the purchase date. The complaint further alleges that, as a result of the increase in price of TXU stock following the Announcement, the unrealized illicit profits on these option contracts total approximately $5.4 million.
The trading occurred through three firms in Europe, according to the SEC's complaint (here). On February 21, 1,060 March 60 call options were purchased through the Credit Suisse office in Zurich, for a profit of over $450,000. The second trades, through Fimat International Banque S.A. Frankfurt Zweigniederlassung, an options firm in Germany, involved 40 March 60s and 220 April 62.50s, for a profit of approximately $150,000. The largest trades were through the UBS London office, with the purchase of 3,500 March 37.50s and 3,200 March 60s, generating a profit of about $4.7 million. There are no details in the complaint about the purchasers beyond account numbers, and it is not clear whether there is any connection between the three sets of trades. The accounts have been frozen, and the Commission filed for a TRO less than a week after the announcement, which is not unusual in cases involving overseas trading if there is a danger that the assets will leave the country. The issue now is ferreting out the actual purchasers to determine what connection, if any, they may have to the transaction. (ph)
Friday, March 2, 2007
Having been roundly criticized on Capitol Hill for perceived softness on insider trading, the SEC and U.S. Attorney's Office for the Southern District of New York announced a set of indictments and civil fraud charges related to two insider trading schemes, involving a total of thirteen defendants, that allegedly netted over $8 million in total profits. The trading involved tipping from insiders at securities firms, including information from an attorney at Morgan Stanley's compliance office -- the very place at the firm charged with preventing the misuse of confidential information. The Morgan Stanley trading involved information about pending corporate deals in 2004 and 2005, and the lawyer, Randi Collotta, was charged along with her husband, Christopher, who is also a lawyer. The other set of trading involved tipping by Mitchel Guttenberg, an executive in the institutional client department at UBS, who sold information about stock analyst upgrades and downgrades before their announcement. A press release (here) from the Southern District of New York prosecutors provides a handy table listing the various conspiracy and securities fraud charges, and four defendants have pleaded guilty. Nothing quite gets the attention of Wall Street -- and Congress -- like a good insider trading saga, and this one will certainly draw notice with two major investment firms involved. (ph)
Wednesday, February 28, 2007
The SEC brought an emergency action against a Hong Kong company, Blue Bottle Ltd., and its named owner, Matthew C. Stokes, for alleged insider trading. The SEC's complaint (here) asserts that Stokes (or others) obtained advanced information about company announcements by hacking into computer networks to view press releases and other documents shortly before the information was released into the market. They are accused of trading in advance of the information by buying or shorting the securities of twelve companies to take advantage of the effect of the news on the stock prices, reaping profits of approximately $2.7 million. The trading took place in January and February 2007, and it appears that Stokes is only a front name on the account. The SEC Litigation Release (here) describes the most lucrative trading before the release of negative earnings news:
[W]ith respect to the defendants' trading in Symantec, the complaint alleges that on January 12, 2007 at approximately 1:03 p.m. EST, the defendants began buying 10,000 SYMC Jan07 20 put contracts, which represented 20 percent of the total trading in that security for the day. Those contracts were out-of-the money when purchased. Later that same day, at approximately 1:37 p.m. EST, the defendants began buying 500 SYMC Jan07 22.5 put contracts, which represented 41 percent of the total trading in that security for the day. All of the put contracts were to expire on January 20, 2007. Essentially, buying the put options was a bet by the defendants that the price of Symantec stock would decrease. The Commission further alleges that on the next trading day, January 16, 2007, at 7:48 a.m. EST, Symantec issued a downward revision of its third quarter 2007 earnings and revenue forecast. Shortly following Symantec's announcement, the defendants began selling the put contracts, amassing a profit of $1,030,471.
Not a bad profit on an investment made for only a couple days, at most. From the SEC complaint, it appears that approximately $1.6 million is still in the U.S., while about $1 million has joined Elvis in leaving the building. The Commission likely moved now to keep the money here, and will have to continue its investigation of the source of the well-timed trades through civil discovery. This kind of trading is sure to draw the interest of the Department of Justice. The U.S. District Court for the Southern District of New York froze Blue Bottle's assets and ordered a hearing for March 7, although any individuals who might want to claim the money are unlikely to show up and risk an immediate arrest on criminal charges. (ph)
Friday, February 23, 2007
Just in time for the end of Carnival, two Brazilians settled an SEC insider trading civil suit arising from purchases in the target of an impending tender offer. The defendants are Luiz Gonzaga Murat was the chief financial officer and investor relations director at Sadia S.A., a Sao Paulo frozen food company, and Alexandre Ponzio De Azevedo, who formerly worked for ABN AMRO's Brazilian affiliate. Sadia planned a tender offer for Perdigão S.A., another Brazilian company, and ABN AMRO's investment banking unit advised on the deal. According to the SEC's Litigation Release (here):
[O]n April 7, 2006, representatives of an investment bank met with Murat and another Sadia executive to propose that Sadia make a tender offer for Perdigão. According to the complaint, Murat proceeded to purchase American Depositary Shares ("ADSs") of Perdigão both later the same day and subsequently on June 29, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to Sadia. The complaint alleges that Murat's holdings totaled 45,900 ADSs of Perdigão by the time Sadia announced the tender offer. On July 17, 2006, the price of Perdigão ADSs increased to $24.50, up $4.25 (21%) from the previous closing price. According to the complaint, Murat had imputed illicit profits of $180,404 from his unlawful trading.
The Commission's complaint against Azevedo alleges that he learned of the possible tender offer on April 11, 2006, in his capacity as an employee of ABN AMRO assigned to the tender offer financing team, and that ABN AMRO later placed Perdigão on a list of securities in which ABN AMRO employees could not trade. According to the complaint, Azevedo subsequently purchased 14,000 ADSs of Perdigão on June 20, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to ABN AMRO. Azevedo sold 10,500 ADSs on July 17, 2006, one day after Sadia had publicly announced its tender offer for Perdigão. According to the complaint, Azevedo realized illicit profits of $52,290 on the 10,500 ADSs he sold on July 17 and had imputed profits of $14,875 on his remaining 3,500 ADSs.
Murat agreed to pay $184,028 in disgorgement and a civil penalty of $180,404, while Azevedo will pay $68,215.45 and a civil penalty of $67,165.
An interesting aspect of the case is that neither defendant ever set foot in the United States in connection with the transaction, and none of their trading involved an American company or even any communications that passed through the U.S. The jurisdictional hook is the securities of each company, which are traded on the New York Stock Exchange as ADS. Under Section 10(b) of the Securities Exchange Act, the general antifraud prohibition applies to any person who "directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . ." The fact that the securities of the target trade on the NYSE brings the case under the Act, although it is a fair question whether conduct wholly outside the United States with only a tangential connection to this country should be subject to a civil enforcement action by the SEC. The trades were placed in Brazil, and the companies were incorporated and operated there, but the transaction ultimately occurred in New York, bringing it into the SEC's cross-hairs. The case shows the long arm of the insider trading prohibition. (ph)
Thursday, February 22, 2007
Veritas Software Corp. settled an SEC securities fraud action alleging that the company engaged in accounting fraud, including round-trip transactions with AOL to increase revenues. The company, which was acquired by Symantec Corp. in 2005, was also accused of smoothing out its earning through "cookie jar" accounts to keep up the appearance that revenue and earnings were not fluctuating, which is anathema to Wall Street. The SEC Litigation Release (here) describes the accounting problems:
- In the fourth quarter of 2000, Veritas artificially inflated reported revenues in connection with a $20 million transaction with AOL and smaller transactions with two other Internet companies. In the three round-trip transactions, Veritas agreed to "buy" online advertising in exchange for the customer's agreement to purchase software from Veritas at inflated prices. To conceal the true nature of the AOL transaction, the company structured and documented the round-trip as if it was two separate, bona fide transactions, conducted at arm's length and reflecting each party's independent business purpose. In addition, the company lied to and withheld material information from its independent auditors about the AOL transaction and the other two transactions.
- AOL improperly recognized revenue on the round-trip transaction and reported materially misstated financial results to its own investors. Through its conduct, Veritas aided and abetted AOL's fraud.
- During 2000 through 2002, Veritas engaged in three improper accounting practices to manage its earnings and artificially smooth its financial results. Specifically, Veritas improperly (a) recorded and maintained excess accrued liabilities, employing "accrual wish lists" and "cushion schedules"; (b) stopped recognizing professional service revenue it had fully delivered and earned upon reaching internal targets; and (c) inflated its deferred revenue balance. As with the round-trips, the company took concerted steps to conceal these improper practices from its independent auditors.
In addition to the usual "sin-no-more" injunction, which will have little effect because Veritas has disappeared, the company will pay a $30 million civil penalty. (ph)
Thursday, February 15, 2007
Ryan Brant, the founder and former CEO of Take-Two Interactive Software Inc., which inflicted the "Grand Theft Auto" videogame on the world, entered a guilty plea and settled an SEC action related to options backdating. Brant resigned as CEO of Take-Two in October 2006, as the company's internal investigation of its options practices reached a conclusion, and now admits to having received a large slug of options with favorable strike prices based on after-the-fact selections of the issuance date over a seven-year period. The SEC settlement calls for Brant to pay disgorgement of $4,118,093, prejudgment interest of $1,143,513, and a $1,000,000 civil penalty (see SEC Litigation Release here).
The criminal part of the case involves a new, but familiar, sheriff on the options backdating beat: Manhattan DA Robert Morgenthau. His office is well-known for its involvement in various white collar crime cases, including the recent prosecution of former Tyco CEO Dennis Kozlowski and former CFO Mark Swartz on larceny charges, In this instance, Brant pled guilty to first degree falsification of business records, and will pay an additional $1 million to the City and State of New York. While the offense, a Class E felony, is punishable by up to four year imprisonment, the plea agreement only calls for the fine, a significant benefit for Brant in avoiding jail time. According to a press release (here) issued by Morgenthau's office:
In a seven year period, from 1997 to 2003, BRANT received ten backdated option grants for a total of approximately 2.1 million shares of Take-Two stock, all of which he exercised before resigning from the company in October 2006. For example, Take-Two’s records reflect that, on February 22, 2002, fifteen people received grants of 511,000 stock options, 100,000 of which went to BRANT. On February 22, 2002, Take-Two stock closed at $15.25 per share, the lowest price during the company’s February to April 2002 fiscal quarter. In fact, however, the decision to award many of those options was not made until mid-April 2002, when the stock price was above $20 per share. Take-Two’s business records, including purported Compensation Committee minutes, were falsified after the fact to reflect the earlier grant date.
On the "Where's Waldo" front, it is interesting that the Southern District of New York does not appear to be involved in the case, and has yet to file criminal charges in any of the options-timing cases. If the Manhattan DA has gotten into the game, can the SDNY's prosecutors be too far behind? (ph)
Wednesday, February 14, 2007
The Dow Chemical Company settled an SEC civil action regarding violations of the Foreign Corrupt Practices Act related to about $200,000 of payments to Indian officials by "a fifth-tier foreign subsidiary of Dow." According to the SEC Litigation Release (here):
The complaint alleges that the Dow subsidiary, DE-Nocil Crop Protection Ltd. ("DE-Nocil"), headquartered in Mumbai, India, manufactured and marketed pesticides and other products primarily for use in the Indian agriculture industry. According to the complaint, beginning in 1996, DE-Nocil made approximately $39,700 in improper payments to an official in India's Central Insecticides Board to expedite the registration of three DE-Nocil products. Most of these payments were made through agreements with contractors which added fictitious charges on its bills, or issued false invoices, to DE-Nocil. The contractors then disbursed these extra funds, at DE-Nocil's direction, to the CIB official. The complaint also alleges that from 1996 and to 2001, DE-Nocil made $87,400 in improper payments to state officials in order to distribute and sell its products.
The complaint alleges that, in addition to these payments, DE-Nocil also made improper payments to Indian government officials consisting of an estimated $37,600 for gifts, travel, entertainment and other items; $19,000 to government business officials; $11,800 to sales tax officials; $3,700 to excise tax officials; and $1,500 to customs officials. In sum, over a six-year period, DE-Nocil distributed an estimated total of $200,000 in improper payments through federal and state channels. According to the complaint, none of these payments were accurately reflected in Dow's books and records, and Dow's system of internal accounting controls failed to prevent the payments.
Problems with bribery in countries with rapidly developing economies is nothing new, and Dow is the latest multinational to run afoul of the greater restrictions on illicit payments to win business. Dow paid a $325,000 civil penalty and agreed to an administrative cease-and-desist order with the Commission. (ph)
Friday, February 9, 2007
Federal prosecutors and the SEC filed criminal and civil insider trading charges against a father, two of his sons, and a family friend for transactions in the securities of the company where the father was an executive and later in companies retaining the accounting firms of one son and the friend. The defendants in the criminal case, who entered guilty pleas, are Zvi Rosenthal, who was a vice president of Taro Pharmaceuticals Industries, Inc., his sons Amir and Ayal, and Amir's childhood friend, David Heyman. The SEC suit also alleges insider trading by Oren Rosenthal, Zvi's third son, Amir's father-in-law, and Amir's supervisor. Ayal worked at PricewaterhouseCoopers, and Heyman worked at Ernst & Young. They admitted tipping Amir about pending mergers before the public announcement of the transactions, and Amir in turn tipped his supervisor. The SEC Litigation Release (here) describes the insider trading at Taro Pharmaceuticals:
In its complaint, the Commission alleged that Zvi Rosenthal, a Vice President at Taro, abused his position at Taro by systematically stealing material, nonpublic information concerning 13 separate company announcements, including earnings results and pending generic drug approvals by the Food and Drug Administration. Zvi then traded on the information and passed it on to his family members who then traded in Taro stock and options. Typically, Zvi provided information to his son, Amir Rosenthal who traded in personal accounts he controlled, and in the account of the family- owned and controlled hedge fund, Aragon Partners, LP.
The Commission alleged that the gains and losses avoided total $3.7 million over a period from 2001 to 2005. In addition to managing the family hedge fund -- which seems to be another way of saying he managed the family's investments -- a press release issued by the U.S. Attorney's Office for the Eastern District of New York (here) states that Amir is an attorney in New York City. According to court records, there is an attorney with the same name admitted to practice in New York in 2006 after graduating from a New York area law school. An AP story (here) states that Zvi Rosenthal has a prior fraud conviction, which means his sentence may be higher if the court applies the Federal Sentencing Guidelines' criminal history provisions. (ph)
Thursday, February 8, 2007
The SEC filed a civil insider trading case against Donald A. Erickson alleging that he bought call options in Magnum Hunter Resources, Inc. (MHR) while the company was negotiating a possible merger. At the time of the trading in January 2005, Erickson was a director and chairman of the company's audit committee. In that role, he was responsible for ensuring that MHR had the requisite internal controls, and so likely was aware of the prohibition on insider trading. According to the SEC's Litigation Release (here):
In its complaint, the Commission alleges that in late December 2004, Donald A. Erickson, while serving as audit committee chairman and a director of MHR, purchased MHR call options during the time MHR was exploring a possible merger or sale of the company. The complaint alleges that Erickson was briefed regularly on the status of negotiations and participated in key decisions regarding the Cimarex deal. The complaint also alleges that in mid-January 2005—just two trading days before the public announcement of the merger, and one day after he attended a board meeting addressing the status of negotiations with Cimarex—Erickson exercised his call options and acquired 30,000 shares of MHR stock. According to the Commission, Erickson purchased and exercised the options based on material, nonpublic information about MHR’s merger negotiations and, ultimately, the Cimarex deal.
The Commission also alleges that Erickson's Form 4 (here) filed in connection with the option purchase was false because it did not disclose the actual date of the transaction, instead listing it as occurring on January 31, 2005, after the announcement of the deal. (ph)
The SEC filed a civil securities fraud complaint (here) against two former financial executives at Engineered Support Systems, Inc. alleging that they backdated options over a six-year period. Gary C. Gerhardt is the former CFO and Steven J. Landmann is the former Controller, and they are accused of backdating options worth over $15 million for senior executives at the company. The Commission alleges that Gerhardt and Landmann personally profited by $1,906,300 and $518,972 respectively. Landmann settled the case and agreed to pay disgorgement of $518,972, prejudgment interest of $108,099, and a civil penalty of $259,486, along with a permanent bar from serving as an officer or director of a public company. Gerhardt did not settle and appears to be fighting the civil action. According to the SEC's Litigation Release (here):
The complaints allege that, from 1997 through 2002, Gerhardt instructed Landmann to backdate company stock option grants to coincide with historically low closing prices of Engineered Support's common stock. The company's stock options vested at the time of grant, allowing the option recipients to obtain immediate cash profits. In addition, the complaints allege that, on at least two occasions, Gerhardt ordered Landmann to cancel previously issued Engineered Support stock options that had fallen out-of-the-money and to reissue them with new backdated grant dates and exercise prices, to bring them back in-the-money. The complaints also allege that Gerhardt directed Landmann to issue additional Engineered Support stock options to nonemployee directors in excess of authorized amounts, from which these directors received a total gain of approximately $6 million.
As part of the scheme, Gerhardt and Landmann allegedly caused Engineered Support to misrepresent in its Forms 10-K and proxy statements filed with the Commission that all stock options were granted at the fair market value of the stock on the date of the award. Engineered Support also failed to report the additional compensation its executives had received through in-the-money option grants. In addition, the company failed to disclose the repricing of options that had fallen out-of-the-money, or the granting of stock options to nonemployee directors in excess of authorized amounts.
Thursday, January 11, 2007
Former Comverse Technology, Inc. general counsel William Sorin settled an SEC civil enforcement action for his role in back-dating options grants at the company. According to the SEC Litigation Release (here), Sorin will pay "$1,670,915.03 in disgorgement, of which $1,007,201.58 represents the 'in-the-money' benefit from exercises of backdated option grants. In addition, Sorin will pay $817,509.07 in prejudgment interest thereon, and a $600,000 civil penalty, for a total of $3,088,424.10." Sorin entered a guilty plea in November 2005 to a charge of conspiracy to commit securities, mail and wire fraud. Former Comverse CFO David Kreinberg also has pleaded guilty and agreed to settle the SEC case, paying a total of $2,394,917.68 (see SEC Litigation Release here). Former Comverse CEO Kobi Alexander remains in Namibia fighting extradition back to the United States to face an array of fraud, conspiracy, obstruction, and bribery charges. According to an article posted on AllAfrica.Com (here), Alexander "has decided to invest in low-cost, solar-powered housing for 100 low-income residents of Kuisebmond in Walvis Bay [Namibia]." Don't hold your breath waiting for him to land in the United States any time soon. (ph)
Wednesday, January 10, 2007
Federal prosecutors charged former Aspen Technology, Inc. CEO David L. McQuillin with securities fraud in a criminal information alleging various accounting violations. The violations occurred in 2001 and 2002, when McQuillin, then Aspen's co-chief operating officer, was involved in a "bake-off" with the other COO competing to succeed Lawrence Evans as CEO of the company. While McQuillin won, he used methods that have led him into the criminal case, according to a press release (here) issued by the U.S. Attorney's Office for the Southern District of New York:
From January 2001 through September 2002, MCQUILLIN was the Co-Chief Operating Officer (“COO”) of Aspen, which was in the business of developing and selling computer software to oil refineries and other process industries. During the time that MCQUILLAN was co-COO of Aspen, he was in a competition – or so-called “bake-off” – with his co-COO to become the next CEO of Aspen. In the course of this “bake-off,” during which MCQUILLIN’s performance was evaluated largely on Aspen’s software revenues, MCQUILLIN engaged in a scheme to inflate the software revenues Aspen reported to the investing public. MCQUILLIN became the CEO of Aspen in October of 2002.
The SEC filed civil securities fraud charges (complaint here) against McQuillin, Evans, and Lisa Zappala, Aspen's former CFO. Two outside companies are described as assisting in the revenue recognition scheme by providing assurances to auditors about the timing and legitimacy of software contracts. McQuillin was also charged with conspiracy, although his alleged co-conspirators have not yet been identified. The government usually proceeds with a grand jury indictment in these types of cases, so look for a wider range of charges to be brought in the near future, perhaps with other defendants included. It will be interesting to see if anyone outside the company is charged with aiding the revenue recognition scheme. (ph)
Friday, December 22, 2006
The SEC sued two former Tyco Inc. executives for fraud, and it's not the well-known former CEO Dennis Kozlowski and former CFO Mark Swartz, who are serving time after their convictions for grand larceny for diverting money from the company. Instead, the Commission sued Richard D. Power and Edward Federman for their role in a scheme to pump up the company's revenue through a sham transaction that was allegedly at the behest of Kozlowski and Swartz. According the the SEC Litigation Release (here):
The Commission's complaint alleges that Power and Federman inflated Tyco's operating income by hundreds of millions of dollars through the use of a sham transaction. In that transaction, Tyco charged authorized dealers of Tyco's ADT Security Services, Inc. (ADT) subsidiary a "dealer connection fee" whenever the company purchased security monitoring contracts from them. However, the connection fee was fully offset by a simultaneous increase in the purchase price ADT allocated to the dealers' security monitoring contracts. Thus, the transaction lacked economic substance. No additional money changed hands as a result of the dealer connection fee transaction. The sham transaction was designed by Power immediately following Tyco's 1997 merger with ADT Ltd. Federman subsequently defended the transaction when concerns were raised in meetings with Tyco's independent accountant. His defense was successful, and the income inflation from the transaction continued unabated. The complaint alleges that the transaction inflated Tyco's operating income by $567 million from the company's fiscal year 1998 through its fiscal quarter ended December 31, 2002.
The complaint alleges that Power and Federman further inflated Tyco's operating income by means of fraudulent acquisition accounting, including the pre-acquisition reduction of asset valuations and overstatement of liabilities in connection with several of Tyco's most significant business acquisitions. In addition, Federman engaged in the improper use of accounting reserves to enhance Tyco's reported financial results, directing the reversal of reserves at Tyco's fiscal year-end to offset an unanticipated $40 million compensation expense.
A third executive responsible for booking the transactions, Richard (Skip) Heger, settled the SEC case by agreeing to pay $450,000 in disgorgement, interest, and a civil penalty. Tyco settled an SEC enforcement action in April 2006 (Litigation Release here) related to the same transactions and paid a $50 million civil penalty. Securities fraud charges against Kozlowski and Swartz are still pending. (ph)
Friday, December 1, 2006
The U.S. Attorney's Office for the Southern District of California and the SEC filed criminal and civil insider trading charges against Robert Gallivan for trading in the shares of five California community banks before they were acquired. According to the SEC Litigation Release (here):
Prior to the public announcement of proposed mergers involving Valencia Bank & Trust (announced August 6, 2002), Monterey Bay Bank (announced April 8, 2003), Sun Country Bank (announced April 30, 2003), Mid Valley Bank (announced September 16, 2003) and Harbor National Bank (announced December 1, 2003), Gallivan obtained nonpublic information that each of the five banks was engaged in negotiations to be acquired.
To settle the SEC case, Gallivan paid $106,711, prejudgement interest, and a double penalty of of $213,422. Gallivan also entered a guilty plea to four counts of securities fraud. (ph)
Tuesday, October 31, 2006
Delphi Corp. and a number of its former senior executives, most prominently CEO J.T. Battenberg and CFO Alan Dawes, were accused of securities fraud by the SEC in connection with the company's accounting for four transactions. The SEC Litigation Release (here) describes the four items that affected the company's earnings, revenue, or cash flow:
In 2000, Delphi engaged in two fraudulent accounting and disclosure schemes, which had the purpose of and ultimately resulted in Delphi hiding a $237 million warranty claim asserted by its former parent company and inflating its net income by $202 million.
In the fourth quarter of 2000, Delphi entered into two improper inventory schemes, through which it agreed to sell approximately $270 million of metals, automotive batteries and generator cores to two third parties at year end, while simultaneously agreeing to repurchase the inventory in the following quarter for the original sales price, plus interest charges and structuring fees. The purpose and result of the schemes was for Delphi to inflate its cash flow from operations by $200 million, engineer $270 million in inventory reductions and improperly report $80 million in net income.
In the fourth quarter of 2001, Delphi solicited a $20 million lump sum payment from an IT company in return for Delphi providing new business to the IT company. Delphi agreed to repay the $20 million over five years, with interest, which made the payment, in substance, a loan to the IT company. However, in order to meet earnings forecasts for the quarter, Delphi improperly accounted for the $20 million payment as if it was a nonrefundable rebate on past business, rather than a liability.
From 2003 to 2004, Delphi hid up to $325 million in factoring, or sales of accounts receivable, in order to improperly boost non-GAAP, pro forma measures of Delphi's financial performance that were relied upon by investors, analysts and rating agencies. Hiding this factoring allowed Delphi to overstate materially its "Street Net Liquidity," a pro forma measure, during that two-year period. In addition, in one quarter, Delphi also manipulated the hidden factoring to create a false $30 million boost in its "Street Operating Cash Flow," another pro forma measure.
Note that the transactions appear at the end of the year, or bridge two years, so that the prior year's financial statements were dressed-up for Wall Street. The numbers involved are not all that large, at least for a company with billions of dollars in annual revenues, but the deals provided the last little bit of earnings to make the quarterly/annual numbers, or hide problems in Delphi's auto parts business from Wall Street, at least for a little while. The company entered bankruptcy in 2005, and by settling the SEC action it gets itself all ready to emerge from that process, most likely under the control of a private equity firm. The firm will not have to pay a penalty, and the Litigation Release notes that Delphi's cooperation in the investigation earned it a pass on having to make a payment.
The 2000 warranty issue implicates Delphi's former parent, General Motors, in the accounting issues. According to the SEC's complaint (here), Battenberg and Dawes met with GM executives to resolve a dispute about how much Delphi owed GM for warranty claims from before the spin-off. At a meeting, GM executives apparently suggested "asymmetrical" accounting for the payment so that the effects on each company would appear differently. Needless to say, such a suggestion, if true, would cast doubt on GM's books if it did not properly record the transaction in order to help Delphi hide the true nature of the $237 million payment to settle the claim.
Naming Delphi's former CEO Battenberg, who retired just before disclosure of the SEC investigation, shows that the SEC is serious about holding senior management responsible. The only high level executive to settle the case was former CFO Dawes, who agreed to a a five-year ban from serving as an officer or director of a public company, and to pay disgorgement of $253,000, interest of $134,000, and a $300,000 penalty. The company's former chief accounting officer and its treasurer are also named and have not agreed to settle. Dawes will likely play a key role in the case, assuming he is cooperating. There is an ongoing grand jury investigation of the transactions, and Dawes may have agreed to a guilty plea in that phase if there is sufficient evidence of criminal conduct, which would probably entail cooperation in any criminal and civil cases. Once again, the former CFO can be the key witness in an accounting fraud case that targets the CEO of a company. (ph)
Friday, October 27, 2006
A common means of committing a fraud is to target small groups with whom the perpetrator shares a common characteristic that engenders a degree of trust. Many frauds prey on ethnic groups, as demonstrated by an SEC civil injunctive action filed against Hyun Soo Jang and Kangsan Kim for targeting Korean investors in the Los Angeles area. According to the SEC Litigation Release (here), Jang and Kim operated through two now-defunct securities firms, Unus Capital Management, Inc. and PeopleN Investment Corp., to defraud forty investors of approximately $4.5 million. According to the SEC:
The complaint alleges that Jang and Kim did not use investor funds to purchase securities as promised. Instead, according to the complaint, Jang, age 39, formerly of Los Angeles, Calif., and Kim, age 34, of Anaheim, Calif., misappropriated the funds entrusted to them, including about $2.5 million taken by Jang, and $500,000 taken by Kim and Unus. The complaint also alleges that Jang used an additional $500,000 to repay existing investors with money that had been deposited by new investors.
The Commission's complaint alleges that, between January 2003 and August 2005, Unus attracted investors through broadcasting morning stock market reports hosted by Jang and Kim that were aired on Korean-language radio stations. As alleged in the complaint, after being contacted by interested investors, Jang and Kim falsely portrayed Unus and PeopleN as established and regulated entities. The complaint alleges that Jang and Kim misrepresented PeopleN as a broker that was registered and a member of various securities industry organizations, such as the New York Stock Exchange, the Securities Investor Protection Corporation and The Nasdaq Stock Market, Inc. In addition, the complaint alleges that Jang and Kim continued to hold out Unus as a registered investment adviser even after the firm had withdrawn its registration with the California Department of Corporations.
Interestingly, the Commission also issued its Litigation Release in Korean (here). (ph)