The SEC Prevails At Trial On A Financial Fraud Case
The SEC concluded its litigation arising out of the financial fraud at RenaissanceRe Holdings Ltd. (“RenRe”) with the entry of judgment last week against James N. Stanard, the former CEO of the company, following a six day trial. The court found in favor of the Commission on all claims. SEC v. Stanard, Case No. 06 Civ. 7736 (S.D.N.Y. Filed Sept. 27, 2006).
The Commission’s complaint alleged a financial fraud predicated on a round trip sham transaction used to smooth RenRe’s earnings. The scheme had two parts. First, the company purported to assign a discount $50 million of its recoverables to Inter-Ocean Reinsurance Company, Ltd. for $30 million in cash, a net transfer to that company of $20 million. RenRe booked income of $30 million at the time the agreements were executed. The second contract appeared to be a reinsurance agreement with Inter-Ocean. In fact, this agreement lacked any economic substance. Rather, the agreement was used to refund the $20 million paid under the first agreement to RenRe at a later date.
In substance, the two contracts were a round trip transaction that lacked any meaningful economic substance. Nevertheless, RenRe accounted for the transaction as if it involved a real reinsurance contract that transferred risk between the two companies. As a result of this accounting treatment, the company materially understated income in 2001 and materially overstated income in 2002 at which time it made a so-called claim under the sham agreement and received the $20 million payment Inter-Ocean had held all along for RenRe.
At the conclusion of the trial, the court found Mr. Stanard liable. Specifically, the court concluded that Mr. Stanard wanted to engage in a transaction to achieve a specific balance sheet effect without economic reality. Accordingly, the court determined that Mr. Stanard violated the antifraud provisions of both the Securities Act and the Exchange Act. In addition, the court found that Mr. Stanard violated Exchange Act Section 13(b)(5) and that he aided and abetted violations of Sections 13(a) and 13(b)(2) along with the related rules. The court permanently enjoined Mr. Stanard from future violations of these provisions and imposed a civil penalty of $100,000. An SEC request for an officer director bar, however was rejected.
Previously, the SEC settled with two other defendants in this action and, in a separate case, with the company. The initial complaint in this action also named as defendants Martin J. Merritt, the former controller and Michael W. Cash, a former senior executive of a wholly owned subsidiary of the company. Mr. Merritt settled at the time the complaint was filed, consenting to a partial final judgment which prohibits future violations of the securities law and an order which bars him from serving as an officer or director in the future. A determination of civil penalties and disgorgement was deferred. Mr. Merritt, a CPA, also consented to the entry of an order suspending him from appearing or practicing as an account before the Commission under Rule 102(e). In the Matter of Martin J. Merritt, CPA, Adm. Proc. File No. 3-12462 (Oct. 27, 2006).
Mr. Cash settled with the Commission on November 8, 2007. In that settlement, he consented to the entry of a permanent injunction prohibiting future violations of the antifraud and internal controls provisions and from aiding and abetting violations of the books and records provisions. In addition, he consented to the entry of an order requiring him to pay a civil penalty of $130,000 and barring him from serving as an officer or director of a public company for five years. Litigation Release No. 20360 (Nov. 8, 2007).
The company settled in a separate action. SEC v. RenaissanceRe Holdings Ltd., Case No. 07 CV 865 (S.D.N.Y. Feb. 6, 2007). In that settlement, the company agreed to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions and to pay a civil penalty of $15 million. The company also agreed to retain an independent consultant.