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Prepared by:

Thomas O. Gorman,
Dorsey and Whitney LLP
1801 K St. N.W.
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202-442-3000

Gorman.tom@Dorsey.com

 
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    TWO FINANCIAL FRAUD CASES AND A SOX SECTION 304 ACTION

    Based on a five-year financial fraud that began in 2002 and culminated in a $127 million 2008 restatement by Diebold, Inc., the Commission filed three actions. One settled case was filed against the company. SEC v. Diebold, Inc., Civil Action No. 1:10-CV00908 (D.D.C. Filed June 2, 2010). A second, which is in litigation, was brought against the former CFO of the company, Gregory Geswein, the former Controller and later CFO, Kevin Krakora, and the former director of accounting, Sandra Miller. SEC v. Geswein, Civil Action No. 5:10-CV-01235 (N.D. Ohio Filed June 2, 2010). The third is a settled SOX Section 304 action against the former CEO, Walden O’Dell. SEC v. O’Dell, Civil Action No. 1:10-CV-00909 (D.D.C. Filed June 2, 2010). See also Litig. Rel. 21543 (June 2, 2010).

    Each of the actions is based on the financial fraud at Diebold which resulted in over forty misstated annual, quarterly, and other reports being filed with the Commission, along with dozens of inaccurate press releases. During the five-year fraud Diebold, a manufacturer and seller of automated teller machines:

    • Improperly inflated revenue on what were called “F-term” orders, or factory orders, when shipping products. The company used improper “bill and hold” transactions which failed to comply with GAAP to materially overstated earnings. For example, in 2003 those practices resulted in the premature recognition of $29.5 million.

    • Improperly recognized revenue on a lease transaction which was subject to a side buy-back agreement. As a result of this transaction the company improperly recognized $5 million in revenue in the first quarter of 2005.

    • Manipulated its reserves and accruals. For example, in 2004 the company improperly released from a reserve $1 million in the first quarter, another $1.25 million in the second quarter and an additional $5.25 million in the third quarter. Diebold also under-accrued liabilities.

    • Improperly delayed and capitalized expenses.

    • Improperly increased the value of inventory.

    In 2008, Diebold restated its financial statements for the years 2003 through 2006 and the first quarter of 2007.

    To resolve the Commission’s action, Diebold consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and the related rules. The company also agreed to pay a $25 million civil penalty.

    The second action, against Messrs. Geswein and Krakora and Ms. Miller, is based on essentially the same conduct alleged in the complaint against the company. That case is in litigation.

    Finally, a settled action was filed naming Mr. O’Dell as a defendant. The Commission’s complaint, based on Section 304 of Sarbanes Oxley, sought the repayment of $470,016 in cash bonuses, 30,000 shares of Diebold stock and stock options for an additional 85,000 shares of stock. Those amount were paid to Mr. O’Dell during the twelve month period following the issuance of the Diebold’s 2003 Form 10-K as incentive and equity based compensation. The complaint alleges the same improper conduct as in the action against the company. It does not claim that Mr. O’Dell knew about the fraudulent conduct.

    Mr. O’Dell settled the action against him by consenting to the entry of a judgment requiring the repayment of the incentive and equity based compensation. This action follows SEC v. Jenkins, CV 09-1510 (D. Ariz. Filed July 23, 2009) in which the SEC for the first time sought the repayment of incentive based compensation under Section 304 from an executive where there was no allegation of wrong doing. In Jenkins a motion to dismiss, discussed here, is briefed and pending decision.

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