A Financial Fraud Case Based On A Sham Barter Transaction
The Commission filed a settled accounting fraud case on Friday which had shades of Enron, Homestore, and Stoneridge. SEC v. Retail Pro, Inc., Case No. CV 08-1620 (S.D. Cal. Sept. 5, 2008). Each of those massive financial fraud cases involved at least in part barter deals later clamed to be sham transactions. At the time, of course, the deals helped inflate the revenue and profits of the company to make Wall Street expectations.
Retail Pro, while clearly not on the same scale as these massive cases, is based on the same kind of accounting scheme: a sham barter transaction. The Commission’s complaint names as defendants the company; Barry Schechter, at times an officer of the company, but during the relevant period a consultant the SEC claims is a control person, de facto officer and a South African Chartered Accountant; Ran Furman, the former CFO; and Harvey Braun, another former CFO. It alleges that the defendants engaged in a scheme to improperly inflate the revenue of the company for the second and third quarters and at fiscal year end.
Specifically, in the second quarter of 2004, the three individual defendants caused Island Pacific to improperly record $3.9 million in revenue from a sham transaction with an Australian software company that was a start up, QQQ Systems Pty Limited. Under the terms of the agreement, Island Pacific licensed certain software to QQQ in return for either $3.25 million to be paid in two installments or 20% of QQQ’s net sub-licensing fees up to $4 million. A side agreement executed at the same time called for Island Pacific to purchase certain software from QQQ.
According to the Commission, the transaction did not have any economic substance and was a sham. Including this transaction in the financial statements of Island Pacific caused its revenues to be overstated by 140% in the second quarter of 2004, 29% for the nine months ended third quarter 2004 and 22% for the 2004 fiscal year.
To conceal the scheme from the outside auditors, the complaint alleges that the three individual defendants forged and backdated documents in an effort to demonstrate that the revenue had been properly recognized. Mr. Schechter also sold 637,750 shares during the period for more than $1.5 million.
To resolve the case with the company and two of the individual defendants:
• Island Pacific consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions;
• Mr. Schechter consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions, the entry of an order requiring him to pay disgorgement of over $488,000 plus prejudgment interest and a civil penalty of $120,000, barring him from serving as an officer or director of a public company for ten years and agreed to the entry of an administrative order suspending him form practicing before the Commission as an account; and
• Mr. Braun consented to the entry of a permanent injunction prohibiting future violations of the antifraud and books and records provisions and an order requiring him to pay a civil penalty of $75,000 and barring him from serving as an officer or director of a public company for a period of five years.