RECENT SEC ENFORCEMENT CASES*
Submitted by**:
Thomas C. Newkirk
Associate Director
Susan A. Mathews
Senior Counsel
Division of Enforcement
Securities and Exchange Commission
Washington, DC
January 2003
* Parts of this outline, written by present and former employees, have been used in other publications.
** The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the Commission or of the authors’ colleagues upon the staff of the Commission.
As our capital markets continue to experience unprecedented growth and expansion, the Securities and Exchange Commission’s (“Commission” or “SEC”) enforcement program has been challenged to keep apace of market developments. In the wake of recent restatements by major corporations, the Division of Enforcement (“Division”) continues to place emphasis on the detection and prosecution of financial fraud. Insider trading, broker-dealer sales practices, violations involving mutual funds and investment advisers, and fraudulent securities offerings continue to form the core of the enforcement program. In Fiscal Year 2001, the Division brought 484 enforcement actions.
This Outline will review some of the Division’s significant recent activity. Copies of orders, administrative releases, and litigation releases concerning the cases discussed below can be accessed on the Commission’s web site at <www.sec.gov>.
I. FINANCIAL FRAUD AND OTHER DISCLOSURE AND REPORTING
VIOLATIONS
The Division’s number one priority continues to be aggressive prosecution of financial fraud and reporting cases. Actions involving false financial statements or false and misleading disclosures about matters affecting an issuer’s financial condition tend to be complex and generally demand a greater commitment of resources than other types of cases. Effective prosecution in this area is essential to preserving the integrity of the full disclosure system.
1. SEC v. Safety-Kleen Corp., Kenneth W. Winger, Paul R. Humphreys, William D. Ridings, and Thomas W. Ritter, Jr., Lit. Release No. 17891, Accounting and Auditing Enforcement Release No. 1690 (December 12, 2002), www.sec.gov/litigation/litreleases/lr17891.htm.
The SEC filed a complaint in the United States District Court for the Southern District of New York charging Safety-Kleen Corp. and four of its former senior executives with perpetrating a massive accounting fraud from at least November 1998 through March 2000. The Commission alleged that these individuals materially overstated the company's revenue and earnings in periodic reports filed with the Commission and in press releases issued by the company. According to the complaint, the defendants carried out the scheme primarily by making inappropriate quarterly accounting adjustments for the purpose of meeting Wall Street pro forma earnings expectations. They are also charged with fraudulently recording approximately $38 million of cash that was generated by entering into speculative derivatives transactions.
The complaint alleges that the fraudulent scheme was orchestrated by Paul R. Humphreys, the former Chief Financial Officer. William D. Ridings, the former Controller, and Thomas W. Ritter, Jr., the former Vice President of Accounting, assisted Humphreys. As set forth in the complaint, these executives engaged in the illegal conduct to create the illusion that predicted cost savings and business synergies from two large acquisitions were being achieved. In fact, the expected savings had not materialized, the company's business was declining rapidly, and the company was facing a severe cash flow problem. To make up for the earnings shortfall, Humphreys, Ridings and Ritter recorded, or directed others to record, numerous adjustments that were not in conformity with generally accepted accounting principles.
After the fraudulent scheme was discovered in late February 2000, the company began an internal investigation, which was conducted by a special committee of the Board of Directors. On July 9, 2001, Safety-Kleen filed restated financial statements for fiscal years 1997, 1998 and 1999. The company's restatement reduced net income over the three-year period by $534 million. Approximately $312 million, or 58%, of the restated net income was in fiscal 1999. Also on July 9, 2001, the company filed financial statements for fiscal year 2000 reflecting a net loss of $833 million.
According to the complaint, through this conduct, (i) Safety-Kleen violated the antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws, (ii) Winger violated the antifraud and periodic reporting provisions, and (iii) Humphreys, Ridings and Ritter violated the antifraud provisions and record keeping provisions. Humphreys and Ridings also violated the internal controls provisions of the federal securities laws. As relief, the Commission is seeking permanent injunctions, disgorgement of defendants' ill-gotten gains, prejudgment interest, and the imposition of civil penalties against Winger, Humphreys, Ridings and Ritter. The Commission is also seeking officer and director bars against Winger, Humphreys and Ridings.
The United States Attorney's Office for the Southern District of New York has filed related criminal charges against Humphreys and Ridings. Ridings has entered a guilty plea and is waiting to be sentenced. Ridings also consented, without admitting or denying the allegations in the Commission's complaint, to the entry of a final judgment permanently enjoining him from violating the antifraud and record keeping provisions of the federal securities laws. He also agreed to be permanently barred from serving as an officer or director of a public company and to pay $28,476.14 of disgorgement and prejudgment interest.
Simultaneous with the filing of the complaint, and without admitting or denying the Commission's allegations, Safety-Kleen consented to the entry of a final judgment permanently enjoining it from violating the antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws. Ritter consented, without admitting or denying the allegations in the complaint, to the entry of a final judgment permanently enjoining him from violating the antifraud and record keeping provisions of the federal securities laws. A civil penalty was not imposed against Ritter, and disgorgement and prejudgment interest were waived, based on his sworn statement of financial condition.
In a related matter, the Commission instituted a settled cease-and-desist proceeding against Susan Moore, Safety-Kleen's former financial reporting manager. Moore consented to the entry of the order instituting proceedings without admitting or denying the findings therein, including findings that, as directed by her superiors, she participated in the preparation of financial statements that, in the exercise of reasonable care, she should have known were not in conformity with generally accepted accounting principles. Moore was ordered to cease and desist from causing violations and any future violations of the periodic reporting and record keeping provisions of the federal securities laws.
2. SEC v. 800 America.com, Inc., et al., Lit. Release No. 17863; AAE Release No. 1674 (Nov. 25, 2002), www.sec.gov/litigation/litreleases/lr17863.htm.
On November 21, 2002, Judge John S. Martin of the United States District Court for the Southern District of New York granted the Commission's application for preliminary relief pending the final determination of the Commission's case against 800 America.com, Inc. ("800America"), an Over-the-Counter Bulletin Board company and purported internet retailer; David Elie Rabi ("Rabi"), chief executive officer, chief financial officer, and a director of 800America; and Tillie Ruth Steeples ("Steeples"), an undisclosed control person of 800America. The Commission alleged that the defendants falsified financial results for 800America since at least 2000, unlawfully sold unregistered stock through nominee accounts, failed to disclose the criminal histories of Rabi and Steeples, and made other misrepresentations.
Specifically, the court's order provides that, pending the final determination of the case: (a) the defendants are preliminarily enjoined from violating antifraud, registration, books and records, and other provisions of the federal securities laws; (b) defendants' assets and certain nominee brokerage accounts are frozen; (c) the defendants are required to submit accountings; (d) a temporary receiver has been appointed over 800America; (e) Rabi and Steeples are enjoined from acting as officers or directors of public companies and from participating in the offering of penny stocks; (f) the defendants must repatriate assets held abroad; (g) the defendants are prohibited from destroying documents and other evidence; and (h) the defendants are prohibited from tampering with witnesses, suborning perjury or otherwise impeding this case.
The complaint charges violations of registration, antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws thereunder. As final relief, the Commission seeks permanent injunctions, disgorgement of all ill-gotten gains plus prejudgment interest; civil penalties; and, against Rabi and Steeples, final penny stock and officer and director bars and a forfeiture of stock under their control. The litigation is pending.
See also SEC v. 800 America.com, Inc., et al., Lit. Release No. 17835; AAE Release No. 1674 (Nov. 13, 2002), www.sec.gov/litigation/litreleases/lr17835.htm. (filing for emergency relief)
3. SEC v. Phillip E. White, Lit. Release No. 17855, AAE Release No. 1671 (Nov. 21, 2002), www.sec.gov/litigation/litreleases/lr17855.htm.
On November 21, 2002, the Securities and Exchange Commission ("Commission") filed a civil action in the United States District Court for the Northern District of California against Phillip E. White ("White"), formerly President, Chief Executive Officer, and Chairman of the Board of Directors of Informix Corporation ("Informix" or "Company"). (Informix was a multinational database software and information asset management company whose stock was traded on Nasdaq National Market System. On July 2, 2001, after selling its database software subsidiary, Informix was renamed Ascential Software Corporation.) In its Complaint, the Commission alleges that White concealed secret side agreements that rendered revenue recognition improper on certain transactions that Informix had included in its financial statements for its fiscal year ended December 31, 1996. To further his scheme, White made false statements and representations concerning the existence of these secret side agreements to members of Informix's financial staff and to Informix's independent auditors. White did this to avoid triggering a restatement of Informix's 1996 financial statements. Informix's 1996 financial statements, and the independent auditors' unqualified report thereon, were included in Informix's 1996 Annual Report, Securities and Exchange Commission Form 10-K ("Form 10-K"), which Informix had filed with the Commission on March 31, 1997. The same financial statements and unqualified audit report were incorporated by reference in Form S-8 registration statements ("Form S-8"), which Informix filed on July 16, 1997. (The Forms S-8 registered twelve million shares of Informix stock for sale to employees.) White signed the Form 10-K and Forms S-8. According to the Complaint, White violated, or aided and abetted violations of, antifraud, periodic reporting, and record-keeping provisions of the Securities Act of 1933 ("Securities Act") and Securities Exchange Act of 1934 ("Exchange Act").
The Complaint alleges that, at the end of July 1997, Informix's financial staff and independent auditors discovered the secret side agreements White was concealing. Informix's Board of Directors immediately forced White to resign from the Company. Informix ultimately restated its 1996 financial statements to reflect substantial decreases in its earnings and income caused by, among other things, discovery of the two side agreements White concealed and various other side agreements. Informix's amended 1996 Form 10-K revealed that, instead of earning net income of $97.8 million as Informix originally reported, Informix suffered a net loss of $73.6 million in 1996.
The Commission seeks a Final Judgment permanently enjoining White from violating, or aiding and abetting violations of the antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws; barring White from acting as an officer or director of any public company; and requiring White to pay civil money penalties.
Separately on November 21, 2002, the Office of the United States Attorney for the Northern District of California ("USAO") announced that it had indicted White for federal criminal securities, mail, and wire fraud. The civil and criminal actions are the result of investigations by the Commission, the USAO, and the San Francisco office of the Federal Bureau of Investigation.
Previously, the Commission instituted and simultaneously settled an administrative proceeding against Informix. See Informix Corp., Admin. Proc. No. 3-10130; SA Rel. No. 33-7788; SEA Rel. No. 34-42326; AAE Rel. No. 1215 (Jan. 11, 2000). The Commission also previously filed a civil complaint, and obtained a default judgment, against Walter Königseder, an Informix Vice President. See SEC v. Walter Königseder, Civil Action No. 00-3668 (MJJ) (N.D. Cal. May 17, 2001) (Order), Lit. Rel. No. 17016, AAE Rel. No. 1398 (May 23, 2001).
4. SEC v. Andrew S. Fastow, Litigation Release Number 17762, Accounting and Auditing Enforcement (AAE) Rel. No. 1640 (Oct. 2, 2002), www.sec.gov/litigation/litreleases/lr17762.htm.
The SEC filed a civil enforcement action against Andrew S. Fastow, the former chief financial officer of Enron Corp., alleging violations of the anti-fraud, periodic reporting, books and records, and internal controls provisions of the federal securities laws. The Commission is seeking disgorgement of all ill-gotten gains, including all compensation received subsequent to the commencement of the alleged fraud, civil money penalties, a permanent bar from acting as a director or officer of a publicly held company, and an injunction from future violations of the federal securities laws. The Commission brought this action in coordination with the Justice Department's Enron Task Force, which filed a related criminal complaint against Fastow.
The complaint allegations stem from Fastow's conduct relating to six transactions. Three of the transactions, RADR, Chewco, and Southampton, were the subject of the Commission's earlier settled action against Michael Kopper. Those transactions were part of an alleged scheme to hide Fastow's and Kopper's interest in and control of certain entities in order to keep those entities off Enron's balance sheet. This was done, according to the complaint, for self-enrichment and to mislead analysts, rating agencies, and others about Enron's true financial condition. As to Fastow's role in RADR, Chewco, and Southampton, the complaint alleges that Fastow secretly nominated certain of the owners of these entities, funded certain of their investments through undisclosed loans, collected undisclosed fees, and demanded and received under-the-table payments, including payments to himself and his family members disguised as yearly $10,000 non-taxable gifts.
Two of the remaining three transactions, the Nigerian barges and the Cuiaba transaction, are alleged to have been sham sales - best described as secret asset-parking arrangements. In one of these sales, a sale of an interest in certain Nigerian barges to a financial institution, Fastow is alleged to have personally promised that the financial institution would be taken out of its so-called investment and later arranged for an entity he controlled to buy the financial institution's interest at a pre-arranged rate of return on a pre-arranged time table.