SEC Charges Sham Agreements, Round-Trip Transactions

The Commission brought a financial fraud action centered on misconduct seemingly drawn from its traditional cases in the area: sham agreements and round-trip transactions, all designed to artificially inflate the share price for a sale of securities. SEC v. Campion, Civil Action No. 16-cv-8940 (S.D.N.Y. Filed November 18, 2016).

Defendant Gavin Campion was the president of KIT Digital, Inc., a purveyor of software and services to facilitate the use of video content on the internet. At the time of the transactions here Kafeil Isaza Tuzman was the CEO of the firm and Robin Smyth was the CFO. Messrs. Tuzman and Smyth were previously named as defendants in a Commission enforcement action.

Beginning in December 2010, and continuing for the next year, Messrs. Campion, Tuzman and Smyth executed a scheme in which KIT entered into at least a dozen sham licensing agreements with twelve different entities. KIT’s typical licensing agreements required periodic fees or payments by customers in exchange for providing specific software and services. The company recognized the fees or payments as revenue when software was delivered and services rendered.

In contrast, the sham licensing agreements were structured as perpetual licenses. A single license fee was payable in installments under the terms of the agreements. This structure permitted KIT to recognize the entire fee at the date of the licensing agreement as long as the specified product was delivered on the contract date, the fee was fixed or determinable, and collection was probable.

KIT did not deliver any software or other products under the sham agreements. To the contrary, the claimed licensees were assured that they were not expected to pay any fees. The licensees cooperated in some instances because the entities were under the control of a former officer and continuing associate of KIT. In other instances the licensees extended an accommodation to the defendants.

To make it appear that KIT was generating revenue from these transactions, Messrs. Tuzman and Smyth arranged for a series of round trip cash transactions. Under those arrangements KIT moved its cash through off-shore accounts and cooperating intermediaries who forwarded the money back to the firm. The returning cash was then booked as revenue. In other instances acquisition agreements were structured to make it appeared that KIT was paying in part for the acquisition. In fact the cash was diverted back to KIT and booked as revenue.

As the scheme unfolded KIT made an offering of its securities. Specifically, on September 20, 2011 the firm completed the sale of 3.2 million shares of its common stock pursuant to a Form S-3 shelf registration statement. The supplement had become effective in October 2010 after being executed by Messrs. Tuzman and Smyth.

The sham transactions fraudulently inflated KIT’s reported revenue. In the fourth quarter of 2010, for example, revenue was falsely inflated by at least $7.5 million or over 24% and by 7.5% for the year ended December 31, 2010. In 2011 revenue was falsely inflated in each quarter in similar amounts and for the year by over 9.3%. The quarterly and annual financial statements with fraudulently inflated revenue were filed with the Commission. During the period Defendant Campion was awarded salaries and cash bonuses and performance-contingent stock.

Following the close of trading on November 21, 2012 KIT filed a Form 8-K announcing that because of irregularities in its historical financial statements there would be a restatement of those financial statements for the years ended December 31, 2010 and 2011 as well as for certain quarters. At the end of 2012 NASDQ halted trading in KIT’s shares and later delisted the stock. The firm filed for bankruptcy protection under Chapter 11 in April 2013.

The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The case is pending. The Manhattan U.S. Attorney’s Office filed a parallel criminal action. See Lit. Rel. No. 23690 (November 18, 2016).

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