SEC Settles Earnings Fraud Action With Firm, Officers
One way to meet earnings targets is to accelerate the recognition of revenue. Another is to fabricate it. That is precisely what the defendants did in the Commission’s latest financial fraud action. SEC v. Lime Energy Co., Civil Action No. 1:16-CV-8088 (S.D.N.Y Filed October 17, 2016).
Lime was in the business of planning and delivering clean energy solutions to facilitate client goals regarding energy efficiency. Lime centered is business on three markets: the utility market, the public sector and institutional market and the commercial and industrial market. Its clients included utilities, energy service companies, government entities, educational institutions and commercial and industrial businesses as well as property owners and managers.
Four of the firm’s senior officers were named as defendants: James Smith, Julianne Chandler, Joaquin Almeida and Karen Raina. They were, respectively during the period, the executive vice president of operations, the corporate controller, the vice president of operations for the new Utilities Division which is the center of the actions here and the director of operations for that division.
The Utilities Division was the fastest growing segment of the company in 2010. It recognized revenue using the percentage of completion method. The firm’s internal accounting controls did not require documentary support for journal entries given to Lime’s company financial reporting personnel. Rather, reliance was placed on only assurances from operations personnel that in fact supporting documents existed.
Beginning in at least 2010 Mr. Almeida, along with Ms. Raina who reported to him, sought to have revenue recognized on some projects for which the firm did not have documentation for the corresponding costs – that is, prior to the time it would be recognized under firm policy. Employees who recorded the costs were directed to book expenses prematurely. As a result, in the Utilities Division Lime’s records reflected costs for several projects where there were customer agreements but for which the supporting documents had not been received. Revenue was thus improperly recognized.
In November 2011 the firm filed a Form 8-K with the Commission, together with a press release, indicating that the firm’s revenue for the first three quarters of the year was $75.4 million. Projected revenue for the fourth quarter was expected to be $47 to $53 million and, according to the release, $122.4-128.4 million for the year. Subsequently, the Public Sector and Utilities Division targeted these projections.
In January 2012, when it appeared that November would be a bit “light,” Ms. Chandler had the books for November re-opened. Appropriate journal entries were prepared and uploaded to the system, reflecting additional revenue. This resulted in millions of dollars in revenue being improperly recorded and recognized in Lime’s November 2011 books and records.
Following the additions to November, a year end “push” was discussed by defendants Smith, Almeida and Raina. The Utilities Division staff was then instructed to prepare the necessary journal entries to reflect millions of additional dollars in revenue for recognition in December 2011. The revenue was for contract that hand yet to be executed by firm customers. The necessary agreements would be executed in January 2012.
In late January and early February 2012 defendants Raina and Chandler also arranged for the firm to recognize additional revenue on what were called “pipeline projects” — those for which the project had been presented to but not agreed with the client. Eventually this resulted in the recognition of millions of dollars in revenue prematurely along with some that was fabricated. In March 2012 the firm filed its annual report on Form 10-K. It reported firm revenue for the year of over $120 million, an amount just over the firm’s internal revenue target for the year.
In May 2012 Lime entered into a subscription agreement to sell one million shares of common stock to board members at the most recent NASDAQ Capital Market closing price for the shares. The prospectus contained the 2011 annual financial statements. The firm received about $2.5 million from board members in exchange for one million shares.
Two months later, as a result of a partial internal investigation by Lime’s CFO, the firm announced that its financial statements for 2010 and 2011 could not be relied upon. During the following investigation defendants Almeida, Raina, Smith, Chandler and a Utilities Division bookkeeper involved in the scheme, were terminated. By year end the firm announced, based on an expanded investigation, that its financial statements for 2008 and 2009 could no longer be relied upon.
In July 2013 Lime filed restated financial results for 2008-2011 and the first quarter of 2012. The company concluded that over $5 million in revenue had improperly been recognized in 2010 and $16 million in 2011. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B).
Each defendant agreed to settle with the Commission. The firm agreed to pay $1 million. Defendant Smith will pay a $50,000 penalty and be barred from serving as an officer or director of a public company for five years. Defendant Chandler agreed to pay a $25,000 penalty, to an officer/director bar for five years and, in a separate action, to be suspended from appearing and practicing before the Commission as an accountant with the right to apply for reinstatement after five years. Defendant Almeida agreed to a permanent officer/director bar. Defendant Raina agreed to pay a penalty of $50,000. CEO John O’Rourke and then CFO Jeffrey Mistarz reimbursed the company, respectively, $67,728 and $118,196.01 for cash bonuses and certain stock awards received during the period, obviating the need for a SOX clawback action.