by T. GormanPosted on Posted in SECActions

The Commission has been tried to make accounting and financial fraud issues a key focus at least since the creation of the financial fraud task force two years ago. Last week the agency brought an action against Monsanto centered on its accounting practices. This week the SEC filed a four proceedings tied to a financial fraud at Marrone Bio Innovations, Inc., a seller of biologically-based products that farmers and growers use to protect crops. SEC v. Marrone Bio Innovations, Inc. (E.D. Cal. Filed February 17, 2016). The USAO filed parallel criminal charges.

The scheme traces to at least late 2012 when Hector Absi, later the COO, directed the firm’s sales organization to forecast sales for the next year that would double current year revenue. Company accounting policy called for the recognition of revenue on a “sell-in” basis. Under this standard the firm recognized revenue from a sale to a distributor rather than a final customer – if there were no contingencies. At the time Marrone did not give “buyer protection” – a standard in the industry that allowed a buyer to manage its economic risk by permitting the return of unsold product.

Beginning in the first quarter of 2013, and continuing through the second quarter of 2014, Mr. Absi sought to accelerate revenue recognition and reach the revenue goals set by the company. He began offering company customers “buyer protection.” In the first quarter of 2013 he offered the contingency to a company customer. This was prior to the firm’s 2013 IPO. At the same time in company meetings he denied that this option was being made available to customers. Revenue was thus recognized under firm policy.

Following an August IPO the firm held its first conference call with analysts and other market professionals. During the September 2013 call the company projected $14 million in revenue for 2013, double the $7 million from the year before. Mr. Absi, who participated in the call, stated at one point that the firm was on track to meet its revenue goal. The stock responded positively.

To meet the revenue goals Mr. Absi instructed firm sales directors to offer inventory protection to distributors. When he was questioned about the policy he claimed that the CEO had directed its implementation. Subsequently, sales were made to a number of distributors who were offered the protection. The result was millions of dollars in sales where the revenue was improperly recognized.

Mr. Absi took other steps to inflate the firm’s revenue. For example, for a sale which was delivered in April of 2013 he obtained a false confirm from the distributer stating that it had been delivered in the first quarter to advance the recognition of the revenue. For a third quarter 2013 transaction where the company did not have the correct product to fill the order, he caused the wrong product to be shipped so the revenue could be recognized despite the fact that it was returned later. To cover his actions he told the outside auditors the shipment was a “mistake” resulting in the first quarter 2014 financial report disclosing a “material weakness” in controls because of the mistake. In another instance where a sale was completed on the last day of the quarter but could not be shipped that day, Mr. Absi caused the bill of lading to be backdated so it appeared the product had been shipped in the quarter.

In March 2014 the company announced its 2013 financial results. Revenue was $14.5 million. Mr. Absi touted the results on an investor conference call. Yet the results were due in part to his scheme – in the fourth quarter alone about half of the $6 million in revenue was from sales generated by the inventory protection scheme. Ultimately the firm recognized about $4 million from the improper actions of Mr. Absi. The company rewarded him with a bonus of almost $50,000, about 25% of which was tied directly to achieving the revenue target. He also exercised his employee stock options.

The next year the revenue growth could not be sustained. After revenue short falls in the first two quarters of 2014 Mr. Absi left the firm. About a week after his departure a former employee emailed the chief marketing officer about the scheme. An internal investigation resulted in a restatement in November 2015. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a). The case is pending. See also SEC v Absi (E.D. Cal. Filed February 17, 2016)(action is pending); In the Matter of Julieta Favela Barcenas, Adm. Proc. File No. 3-17121 (February 17, 2016)( action based on the financial fraud against the firm customer relations manager; settled with a cease and desist order based on Exchange Act Sections 13(b)(2)(A) and 13(b)(5); no penalty was imposed based on cooperation); In the Matter of Donald J. Glidewell, CPA, Adm. Proc. File No. 3-17120 (February 17, 216)(action against CFO; resolved with a cease and desist order based on SOX Section 304 and an order to reimburse the firm $11,789). The U.S. Attorney for the Eastern District of New York announced mail, wire and securities fraud charges against Mr. Absi. Those charges are pending.

Program: The Second Annual Dorsey Enforcement Forum will be held on Wednesday February 24, 2016 beginning at 1:00 p.m. Three panels of experts will discuss: 1) Trends in SEC enforcement; 2) FERC and CFTC market manipulation actions; and 3) Current developments in Financial Services Regulatory Enforcement. The program will be video cast, webcast and live in Washington, D.C. at the Willard Office building, 1455 Pennsylvania Ave. Lunch will be available beginning at noon; open bar at the conclusion of the program. No charge but registration is required (here) or if attending in person by emailing my assistant at Romodan.hanan@dorsey.com

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by T. GormanPosted on Posted in SECActions

Travel, entertainment and gifts tied to inadequate controls are recurrent themes in FCPA cases. Many of these cases involve the use of agents and center in China. Each of these recurrent items appear in the most recent FCPA actions brought by the DOJ and the SEC. Those center on PTC Inc. and its Hong Kong and Shanghai subsidiaries which acted as a unit (collectively the “China subsidiary”). In the Matter of PTC Inc., Adm. Proc. File No. 3-17118 (February 16, 2016).

PTC designs, manufactures and sells Product Lifecycle Management System software – software that manages a product from design through distribution. The firm is based in Massachusetts. The parent company exercised substantial control over its China subsidiary, including setting its financial goals and at times reviewing proposed transactions.

The China subsidiary routinely hired third parties it called business partners. Those firm were used to find deals. Many of those deals involved Chinese state owned enterprises. The partners were paid commissions. Despite the risk of these arrangements, PTC failed to conduct a “sufficient review of the business capabilities or ethics programs of these business partners,” according to the SEC’s Order.

During contract negotiations with SOEs, Chinese government officials and the business partner often requested that they be furnished with overseas “training.” Frequently that training involved a one day visit to the firm’s headquarters which was either preceded or followed by significant travel and entertainment of the officials by firm employees. That travel included items such as trips to New York City, Washington, D.C., Los Angeles and Honolulu. Leisure activities, sight seeing and other activities were included in the trips which at times lasted for several days.

The trips were frequently paid out of the commissions of the business partner. The China subsidiary was given documentation for the commissions by the business partner. The China subsidiary tracked the overseas travel payments made by business partners to or for the benefit of firm SOE customers on spreadsheets kept separate from its books and records.

From 2009 through 2011 the China subsidiary sales staff also provided at least $274,313 in gifts and entertainment directly to Chinese government officials. The value of the gifts ranged from $50 to $600 in violation of the firm’s corporate governance and internal controls policies. Frequently, the gifts were items such as small electronics, gift cards, wine and clothing. Overall from 2006 through 2011 the Chinese subsidiary provided improper payments totaling $1.5 million while earning about $11.85 million in profits from sales contracts with SOEs whose officials received the improper payments.

During the period PTC failed to devise and maintain an adequate internal accounting controls system. Specifically, in 2006, 2008 and 2010 the firm investigated compliance issues at the China subsidiary but failed to identify the issues. At the same time the firm failed to undertake periodic comprehensive risk assessments of the China subsidiary and did not have an independent compliance staff. The firm thus failed to properly vet business partners, police for corrupt payments and monitor and supervise the senior sales staff at the China subsidiary.

In 2011 the firm discovered the improper payments. It promptly conducted an internal investigation and, upon completion, self reported the results to the Commission. The firm also took a number of remedial steps including terminating the senior staff members at its China subsidiary who were involved in the improper conduct and other steps.

The Order alleges violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter with the SEC, the firm consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay disgorgement of $11,858,000 along with prejudgment interest. A penalty was not imposed in view of the terms of the settlement with the DOJ. At the same time an employee of the China subsidiary entered into the Commission’s first deferred prosecution agreement with an individual.

To resolve criminal charges with the DOJ, PTC entered into a non-prosecution agreement. The firm also agreed to pay a $14.54 million penalty.

Program: The Second Annual Dorsey Enforcement Forum will be held on Wednesday February 24, 2016 beginning at 1:00 p.m. Three panels of experts will discuss: 1) Trends in SEC enforcement; 2) FERC and CFTC market manipulation actions; and 3) Current developments in Financial Services Regulatory Enforcement. The program will be video cast, webcast and live in Washington, D.C. at the Willard Office building, 1455 Pennsylvania Ave. Lunch will be available beginning at noon; open bar at the conclusion of the program. No charge but registration is required (here) or if attending in person by emailing my assistant at Romadan.hanan@dorsey.com

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