SEC Settles Financial Fraud Action
Financial fraud is an enforcement priority of the SEC. A financial fraud task force was formed in July 2013 to focus on this traditional staple of enforcement. A data analysis group was formed at the same time to give the task force a new big data type approach under which computers would aid with prospecting for fraudulent financial statements. Some commentators dubbed this Robocop. While the group may be working on approaches to creating Robocop, to date that has not happened. With or without Robocop, the SEC continues to focus on financial fraud actions.
One financial fraud action brought last year is In the Matter of AirTouch Communications, Inc., Adm. Proc. File No. 3-16033 (August 22, 2014). The SEC has now partially settled that action and an Order entered.
The proceeding named as Respondents the firm Hideyuki Kanakubo, its founder and former CEO, and Jerome Kaiser, its former CFO. The shares of AirTouch are quoted on the OTC Pinks. The shares are not registered with the SEC under the Exchange Act. It develops and sells telecommunications equipment designed to integrate mobile phones into landline systems within a consumer’s home.
The scheme alleged in the Order has two facets. The first involved improper revenue recognition. Specifically, in early 2012 the company developed a new product called U250. AirTouch was designed for sale to Mexico’s largest provider of landline telephone services.
In July 2012 AirTouch entered into a contract with a Florida based provider of logistics and fulfillment services regarding the product. Under the arrangement about $1.7 million in U250 product would be held by the Florida entity. That entity would execute a Purchase Order for the equipment. At the same time AirTouch and the Florida firm executed an Agreement under which no product would be delivered, and no payment due, unless and until the Mexican entity actually ordered and paid for the product.
In October 2012 AirTouch’s controller provided the firm’s outside independent accountant with a copy of the Purchase Order from the Florida company. The accountant was not provided with a copy of the related Agreement. Messrs. Kanakubo and Kaiser did not inform the outside accountant or the independent directors on the board about the Agreement when discussing the Purchase Order from the Florida entity. AirTouch did not receive any payment from the Florida company.
On November 14, 2012 the firm voluntarily filed a Form 10-Q for the third quarter of the year. It reported net revenues of $1,031,747, recognizing revenue from the Purchase Order. If that sum had not been recognized, the firm would not have had positive revenue. Recognizing the revenue under the circumstances here, however, was contrary to the firm’s stated revenue recognition policies and GAAP.
In the second part of the scheme, AirTouch used the Purchase Order to secure a $2 million loan from a shareholder. During 2012 Messrs. Kanakubo and Kaiser solicited a short term bridge loan from an AirTouch Shareholder. That Shareholder was told in an October 2012 e-mail about the shipment of product under the Purchase Order to the Florida firm. The Shareholder was also furnished with a copy of the Purchase Order, but not the related Agreement. The firm and Shareholder entered into an agreement under which $2 million was loaned to AirTouch in return for a promissory note and stock options.
Subsequently, Mr. Kanakubo approved a $15,000 bonus to Mr. Kaiser for his work on raising capital. He also awarded himself a bonus in the same amount in connection with unused vacation time.
In January 2013 the AirTouch board of directors initiated an internal investigation regarding the net reported revenues in the Form 10-Q for the third quarter of 2012. At the time Mr. Kaiser furnished the chairman of the audit committee with the Purchase Order but not the related Agreement. When the board of directors finally received the Agreement a restatement of the third quarter was directed. In February 2013 the firm filed a Form 8-K announcing the errors in revenue recognition and stating its intention to file an amended Form 10-Q. That filing has not been made.
The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b).
AirTouch and Mr. Kanakubo consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, for a period of five years Mr. Kanakubo is prohibited from serving as an officer or director of any issuer whose shares are registered pursuant to Section 12 of the Exchange Act or that is required to file reports pursuant to Section 15(d) of that Act. He also agreed to pay a civil money penalty of $50,000 and disgorgement of $15,000 which represents the profits gained on the conduct described, according to the Order. The Order does not provide for the payment of prejudgment interest.