OUTSIDE DIRECTORS NAMED IN SEC FINANCIAL FRAUD CASE
SEC v. DBH Industries, Inc., Civil Action No. 0:11-cv-60431 (S.D. Fla. Filed Feb. 28, 2011) and SEC v. Krantz, Civil Action No. 0:11-cv-60432 (S.D. Fla. Filed Feb. 28, 2011) are two fraud actions arising from the demise of military bullet proof vest manufacturer DBH Industries, otherwise known as Pont Blank Solutions. The company is now in bankruptcy. The former action is a settled financial fraud case. The latter action names as defendants the outside directors and audit committee members of the company.
DHB Industries centers on a massive financial fraud orchestrated by its then chief executive officer, David H. Brooks, with the assistance of the former chief financial officer, Dawn Schlegel and the former chief operating officer, Sandra Hatfield. According to the SEC’s complaint, from 2003 through 2005 there was a wide ranging accounting, financial and disclosure fraud at the company. Mr. Brooks, for example, is alleged to have taken at least $10 million out of the company through a series of fraudulent transactions involving a related company which he controlled. Millions of dollars of company funds were misappropriated through the use of credit cards, checks and in cash. The funds were used for personal expense and to support an extravagant and lavish life style.
Throughout the period the company lacked internal accounting and reporting controls. This permitted senior management and others to manipulate the accounting records. As a result of the lack of controls the reported gross profit, net income and other key figures in the earnings releases and pubic filings were manipulated.
In October 1, 2007 the company undertook a comprehensive restatement for 2003, 2004 and 2005. The restatement eliminated all of the previously reported profits for 2003 and 2004.
Point Blank settled with the Commission, consenting 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).
Krantz is one of the few Commission actions brought against outside directors and audit committee members. Building on the financial fraud alleged in the action against the company, the Commission’s complaint against the directors claims that because of their loyalty to David Brooks, and their own self-interest, they ignored a series of red flags and facts which essentially permitted a massive financial fraud to continue while they served on the board.
Each of the defendant directors is alleged to have lacked the impartiality to serve as independent board or audit committee members because they were longtime friends and neighbors, and had personal relationships with, Mr. Brooks that “spanned decades.” As a result the three directors willfully ignored concerns raised by the auditors, ignored material weakness letters, ignored the auditors concerns about inventory valuation and a series of other red flags including the initiation by the Commission of an enforcement investigation.
The complaint alleges violations of Exchange Act Sections 10(b) and 14(a) and aiding and abetting DHB’s violations of Section 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). This case is in litigation.
These are not the first actions arising out of the financial fraud at Point Blank. Previously Mr. Brooks and Ms. Hatfiled were charged in criminal fraud cases. U.S. v. Brooks (E.D.N.Y.). Both were convicted of fraud, insider trading and obstruction of justice following an eight month jury trial (here). Ms. Schlegel pleaded guilty to criminal charges. The SEC also brought actions against Mr. Brooks, Ms. Hatfield and Ms. Schlegel. SEC v. Brooks, Civil Action no. 07-61526 (S.D. Fla. Filed Oct. 25, 2007); SEC v. Schlegel & Hatfield, Civil Action No. 06-61251 (S.D.Fla. Filed Aug. 17, 2006). In a related action the Second Circuit rejected a proposed settlement of consolidated class and derivative actions where Mr. Brooks sought to obtain an exemption from SOX Section 304 liability (here).
Program: On March 1, 2011 Celesq and West Legal Education are sponsoring a web cast at noon: The Changing Landscape of Insider Trading Enforcement by Mr. Gorman http://www.celesq.com/programs/view/the-changing-landscape-of-insider-trading-enforcement