Yesterday’s enforcement action against now bankrupt auto parts giant Delphi brings together two of the SEC’s key enforcement policy statements, the Seaboard Release on cooperation and the January 2005 statement on Corporate Penalties. The partially settled enforcement action was brought against Delphi and thirteen former employees including the former CEO, CFO, Chief Accounting officer and others. The action alleged a pattern of financial fraud to increase earnings:

1) Two schemes in 2000 which increased net income by $202 million by hiding a $237 million warranty claim;2) Two improper inventory schemes in 2000 to increase reported income by $80 million, reduce inventory by $270 million and inflate cash flow by $200 by “round tripping” certain inventory, that is agreeing to sell it with a guaranteed right of return the next quarter with interest and structuring fees;3) A $20 million lump sum payment from an IT company which was in substance a loan but which was booked it as a nonrefundable rebate o past business in 2001;

4) The improper increasing in 2003 and 2004 of its Street Net Liquidity, a non-GAAP pro forma measure of financial performance used by investors and others, by hiding up to $325 million in factoring or sales accounts receivables. In one quarter the company also boosted its Street Operating Cash Flow by $30 million by manipulating the hidden factoring.

The company consented to the entry of a statutory injunction prohibiting future violations of the antifraud and books and records provisions of the securities laws. No fine was imposed.

In addition, the following settlements were entered into with former employees:

A) Alan Dawes, former CFO consented to a 5 year officer and director bar, to pay disgorgement and prejudgment interest and a penalty as well as the entry of a statutory injunction prohibiting violations of the antifraud and record keeping provisions of the securities laws;

B) Atul Pasricha, former Assistant Treasurer, consented to pay a penalty and a statutory injunction prohibiting him from aiding and abetting violations of the record keeping provisions.

C) B.N. Bahadur, principle of a private management consulting company, agreed to pay disgorgement with prejudgment interest and a penalty and to the institution of a settled C&D proceeding in which he was ordered to cease and desist from committing or causing violations of the antifraud and reporting provisions.

D) Laura Marion, former Director of Financial Accounting and Reporting at Delphi agreed to pay a penalty and to the institution of a settled C&D proceeding in which she was ordered to cease and desist from committing or causing violations of the antifraud and reporting provisions.

E) Stuart Doyle, former client executive for the IT company (see # 3 above) agreed to pay a penalty and to the institution of a settled C&D proceeding in which he was ordered to cease and desist from committing or causing violations of the antifraud and reporting provisions.

Enforcement Chief Linda Thomsen said that the case demonstrated that the “Commission will take strong action when a company and its officers engage in accounting fraud. . . ..” and that the case was particularly troubling because of the number of fraudulent schemes the company engaged in and the length of time involved. At the same time however Associate Enforcement Director Fredric Firestone said that the settlement with the company was consistent with the SEC’s statement on financial penalties for organizations, citing the company’s cooperation and remedial efforts as the reason for not imposing a penalty.

What is perhaps most interesting about the case is the settlements viewed in the context of the Seaboard Release on Penalties for Organizations. The former of course has been much discussed in view of the KPMG tax case holding portions of the Thompson memo (the DOJ analog to the Seaboard Release) unconstitutional and the recent pronouncements of the ABA and others decrying the “culture of waiver” the SEC and DOJ cooperation standards are creating. The Seaboard Release notes in part that key considerations included the scope of the fraud, how high up it went in the organization and how long it went one, reflecting to some extent the comments of Linda Thomson. The Release on Penalties focused in part on the benefit received by the company and the impact on shareholders, factors not mentioned by Associate Enforcement Director Firestone in explaining the reason no fine was imposed. Nowhere is there any mention of the company furnishing the SEC with the results of an internal investigation or waiving the attorney client privilege or work product doctrine, factors mentioned in the Seaboard Release.

Reading the comments of Ms. Thomsen together with those of Mr. Firestone suggests that perhaps even where there is a systematic, long term fraud which reaches to the highest levels of the company, the SEC may be willing to consider waiving remedies like disgorgement, prejudgment interest and penalties as to the company where the company cooperates and takes adequate remedial steps even absent a waiver of the attorney client privilege. Perhaps this is consistent with the recent statement of SEC Commissioner Atkins noting that the staff should not request waivers of privilege. If so this would be a welcome relief to the “culture of waiver.” We will have to wait and see if this is in fact the case.

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The casualties among corporate executives keep mounting in the ever-expanding options scandal.  Yesterday the government got its first guilty plea when David Kreinberg, former CFO of Comverse Technology, plead guilty to securities fraud charges.  Specifically, Mr. Kreinberg waived indictment and plead guilty to one felony count of conspiracy to commit securities fraud, mail fraud and wire fraud and a second count of securities fraud.  The charges stem from the stock options backdating and slush fund schemes that the government claims took place at Comverse from 1998 to 2006.  The conspiracy charges have a maximum sentence of five years in prison and a fine of up to $250,000 or twice the gain or loss from the offense.  The securities fraud charge has a maximum sentence of ten years in prison and a fine of up to $1,000,000.   The charges also require the payment of restitution according to the press release from the U.S. Attorney’s Office for the Eastern District of New York.

Mr. Kreinberg also settled civil charges with the SEC.  Specifically, Mr. Kreinberg consented to the entry of a permanent injunction enjoining him from violating or aiding and abetting the violation of the antifraud, reporting, record keeping, internal controls, false statements to auditors, SOX certification, and securities ownership reporting provisions of the federal securities laws.  Mr. Kreinberg also consented to the entry of an order  which requires him to pay nearly $2.4 million in disgorgement and prejudgment interest and which bars him from being an officer or director and suspends him from practice before the SEC as an accountant.  The disgorgement ordered is based on the in the money benefit from the backdated option grants which was $1,789,255.80.

To date thirty eight executives from nineteen companies have resigned, retired, been terminated or suspended in the wake of the expanding options backdating scandal.  Mr. Kreinberg is the first to plead guilt to criminal charges and settle with the SEC on civil charges based on claims of option backdating.  Since the option scandal is a priority of the Financial Frauds Task Force and criminal prosecutors and the SEC seem to be expanding their inquiries, more of the same can be expected in the future.

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