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Confirmation Frauds Sample

CAPITAL CONFIRMATION INC.

Case Studies:
Audit Confirmation Fraud
Cases Studies:

  1. Parmalat
  2. Healthsouth
  3. CF Foods
  4. American Bank Note Holigraphics
  5. Quintus CEO Alan Anderson
  6. Fila
  7. Adidas
  8. Converse
  9. Financial Asset Management
  10. Sunrise Medical
  11. Robert Quattrone
  12. Physician Computer Network
  13. Kurzweil Applied Intelligence
  14. DIGITAL LAVA, INC
  15. Coopers & Lybrand
  16. Semion Mogilevich
  17. Northstar Health Services
  18. ZZZZ Best Carpet Cleaning
  19. Kimberly Good and Steven D. Wymer
  20. Two Cases from AICPA & SEC
  21. Bio Clinic and Comfort Clinic
  22. Bank Manager Theft
  23. Allfirst Scandal
  24. Manhattan Bagel Corporation
  25. North Face
  26. BCCI Bank Failure
  27. Logo Athletic
  28. Three Point Digital
  29. Hybrid Networks

  1. SEC v Parmalat: $5 Billion Confirmation Fraud

    Parmalat Finanziaria SpA and its subsidiaries filed for bankruptcy protection in Italy on Dec. 27, 2003, following revelations that huge assets—estimated from $8 billion to $12 billion--were unaccounted for and presumed missing.

    Between January 2000 and September 2003, Parmalat raised more than $5 billion in securities offerings worldwide. Where have those funds gone? How have they been used?

    Things began to unravel in November 2003, when rumors began circulating that Parmalat would be unable to repay a $187 million outstanding bond issue—despite liquid assets that were supposed to total billions of dollars. Parmalat ultimately extinguished the issue on the last day of the repayment grace period with assistance from the Italian government and banks in an emergency financial rescue package.

    Also at this time, Parmalat first disclosed to investors the existence of a $617 million investment in a Cayman Island investment fund, Epicurum. With repayment of the $187 million bond issue looming, Parmalat reportedly tried and failed in repeated efforts to recover its investment in the fund. In representations to its auditors, Parmalat had previously portrayed the investment as an open-ended mutual fund that was liquid and accessible on short notice. As a result, the investment was classified as cash and marketable securities on Paramlat’s December 2002 balance sheet.

    However, no evidence was presented to the company’s auditors to support Parmalat’s claim at that time. As part of its third quarter 2003 review of Parmalat’s interim financial statements, Deloitte & Touche SpA included a qualification in its review report highlighting the lack of evidence available to support the valuation of the Epicurum investment and alerted regulators.

    Also in December 2003, it was revealed that a Bank of America account of a Parmalat Cayman Island subsidiary, Bonlat Financing Corp., did not exist. This account purportedly held $4.9 billion in cash and marketable securities, which represented approximately 40 percent of Parmalat’s assets.

    The nonexistent Bank of America bank account--the one with a purported balance of $4.9 billion--raises key questions concerning the confirmation process

    Grant Thorton SpA reportedly sent Bank of America a confirmation request in December 2002 asking for confirmation of the bank account. But Bank of America says it never received the request. Grant Thorton SpA received a reply in March 2003, which was printed on Bank of America letterhead and signed by a current Bank of America employee. But it is now alleged that the confirmation letter was a forgery concocted by Parmalat management.


     

  2. Healthsouth Accounting Fraud

    A conspiracy among senior officers at HealthSouth and others, to fraudulently enrich themselves by artificially inflating HealthSouth's publicly reported earnings and the value of its assets. The conspiracy also involved the filing of annual and quarterly reports with the Securities and Exchange Commission that materially misstated HealthSouth's net income, revenue, earnings per share, assets and liabilities from at least 1996 until the present. As a result of the scheme, HealthSouth's revenue and earnings were inflated by hundreds of millions of dollars on publicly filed reports.

    CEO Richard Scrushy and his accomplices would meet to discuss HealthSouth’s actual financial performance and the need to falsify those internal results before they were publicly reported. The indictment states that Scrushy, through his accomplices, caused members of the corporate accounting staff to falsify the company’s books and records. The fraud allegedly included false entries in income statement and balance sheet accounts, including property, plant and equipment accounts, cash accounts and accounts receivable, among others. According to the indictment, the co-conspirators referred to those methods as “filling the hole” or “filling the gap.”

    CEO Richard Scrushy’s 2001 Compensation

    As part of the conspiracy, Scrushy and other co-conspirators signed and filed false statements with the Securities and Exchange Commission, and sought to conceal the fraud by controlling the internal distribution of actual financial results and providing false information to federal and state tax authorities. They created 1,000’s of false documents which they provided to the company’s auditors Ernst & Young as support for the financial statements.

    In total, over $300 million of false cash was booked and as part of its own investigation, and the House Committee on Energy and Commerce chaired by W.J. "Billy" Tauzin has asked Ernst & Young to provide it with, all records relating to letters of confirmation sent out by Ernst & Young in connection with its auditing of HealthSouth’s financial statements from 1996 through the present.

    HealthSouth Executives & Officers Plead Guilty:
    Catherine Fowler, a former Vice President of Treasury and Cash Manager
    Richard E. Botts, a former Senior Vice President of Tax
    Jason Brown, a former Vice President of Finance
    Will Hicks, a former Vice President of Investments
    Aaron Beam, Chief Financial Officer
    Malcolm McVay, Treasurer
    Michael Martin, CFO
    Kenneth Livesay, Chief Information Officer
    Emery Harris, Vice President of
    William Owens, CFO
    Weston Smith, former CFO


     

  3. United States v David Burry (CF Foods)

    Burry was a general partner who managed and operated CF Foods. Burry solicited investors in CF Foods by promising them that his expertise in the wholesale candy distribution business resulted in high profits for CF Foods and, as a result, CF Foods could provide returns of 18-30% to investors.

    The returns paid to CF Foods’ early investors were paid for with the proceeds derived frominvestments made by later investors. Over time, the seemingly impressive returns paid by CF Foods to its investors gained the attention of the friends and family of both Burry and Edward Stillman, and interest in investing in the enterprise grew. Burry eventually attracted over $25 million in investments in CF Foods.

    CF Foods purportedly conducted two types of sales transactions. The portion of the business dubbed by Burry as “Sales One” was completely fictitious and fraudulent in nature. Burry was solely responsible for managing Sales One and no one at CF Foods other than Burry had any personal involvement in this aspect of the business. Sales One ostensibly involved the purchase of large quantities of “close out products” and subsequent re-sale to customers through direct shipment orders. In reality, no such transactions ever occurred.

    The other portion of the business, known as “Sales Two,” was the “legitimate” aspect of CF Foods with real employees, real inventory, and real sales deliveries. In 1998, Sales Two reflected actual sales totaling less than $5 million, out of total reported sales of more than $140 million for the combined company sales.

    Using the invoices, shipping documents, and related business records acquired from the small amount of real candy business conducted by CF Foods, Burry systematically created phony “business records” by “whiting out” old information, typing in new information, and then photocopying the forged record so that it would be indistinguishable from a copy of an authentic business record reflecting a real transaction. Burry then logged hundreds of fictitious transactions into the computerized general ledger system for CF Foods, which generated impressive -- but false -- balance sheets, income statements, and accounts receivable listings, among others.

    Burry took these financial statements to a certified public accountant, who then prepared a review of the financial information provided to him by Burry. The accountant was never asked by Burry to conduct an audit of CF Foods, and the reports he prepared were merely summaries of the false financial information provided by Burry.

    As a result of the false information provided by Burry to his accountant, the following total sales figures were reported to investors and financial institutions:

    Sales Reported
    1994 $ 8,699,152
    1995 $ 19,026,265
    1996 $ 40,590,990
    1997 $ 83,985,013
    1998 $142,990,010
    Total $295,291,430

    By David Burry’s own admission, approximately 97% of these sales never actually occurred.

    Beginning in January 1999, in an effort to meet the increasing financial strains imposed on CF Foods as a result of demands for repayment of capital by investors in CF Foods, Burry engaged in a massive check kiting scheme, involving hundreds of checks totaling more than $70 million that were written on 20 different bank accounts controlled by Burry at First Union National Bank, PNC Bank, Commerce Bank, Fleet Bank and Bank of America. Burry’s check kiting activities eventually resulted in total losses of approximately $2.5 million to three of the financial institutions.

    Between April 7 and 9, 1999, PNC Bank notified CF Foods that its operating account was overdrawn by approximately $1 million. As a result of the overdraft problems, on Saturday, April 10, 1999, Burry admitted to Edward Stillman, a friend, that the “Sales One” portion of the CF Foods operation had been a “sham” and that no such sales ever occurred. Burry told Stillman that he had cut and pasted receipts to deceive other individuals and banks, and stated that he went to work early in the morning and stayed late into the night putting together fake business records. Burry also admitted to Stillman that he had intercepted audit confirmation requests sent out by CF Foods’ auditors by contacting various businesses and telling them that the confirmation requests had been sent out by mistake and should be returned to Burry, who then falsely confirmed the receivables balances.

    Burry also made similar admissions to other persons. On April 10, 1999, Burry told Paul Weis, who had worked as the controller for CF Foods, that “Sales One was nothing more than a Ponzi scheme” and that “I got good with white out and doctoring bank and other records.”


     

  4. American Bank Note Holographics, Inc - CEO convicted of fraud

    On August 8, 2003, a jury found that Morris Weissman, former chairman and CEO of American Banknote, had inflated his company's earnings in 1996 and 1997. Based on the false numbers, the 1998 public offering of the company's subsidiary, American Banknote Holographics, was a success, netting the company $115 million. When the accounting fraud was uncovered in early 1999, the spinoff's shares dropped from about $16 a share to $1.80 a share. The stock was delisted in August 1999. As a result of the fraud, investors were bilked of more than $100 million, prosecutors say.

    The Complaint alleges that with regard to fiscal year 1997, Macchiarulo caused ABNH to recognize improperly $1.3 million in revenue on the shipment of unusable work in process to Colorado Plasticard and approximately $6 million in revenue on the MasterCard transaction. The Complaint also alleges that Macchiarulo misled ABN's auditors in connection with their efforts to confirm the MasterCard transaction and that Macchiarulo was aware Colorado Plasticard signed a false audit confirmation with respect to the shipment of unusable work in process at fiscal year-end 1997. The Complaint further alleges that Macchiarulo signed the management representation letter in connection with the fiscal 1997 audit knowing that the letter was false and misleading.

    The Complaint also alleges that with regard to fiscal year 1998, Macchiarulo caused ABNH to recognize improperly over $5.8 million in revenue on consignment sales and shipments to warehouses during the second and third quarters and that during the fourth quarter, Macchiarulo caused ABNH to record improperly over $11.3 million in revenue on its books and records for, among other things, consignment sales, shipments to warehouses, product that was never shipped, product that was returned, and test material.


     

  5. SEC v former Quintus CEO Alan Anderson

    The Security and Exchange Commission has brought fraud charges against former Quintus CEO Alan Anderson. Quintus was a Dublin, California based developer of call center software and a Siebel Systems partner. According to the complaint, Anderson forged contracts, e-mails, purchase orders, letters, and an audit confirmation in order to boost Quintus' financial results. The complaint alleges Anderson created three fake transactions ranging in value from $2 million to $7 million in nonexistent sales and that Anderson caused Quintus to improperly recognize $3 million in revenue on a barter transaction

    The SEC further alleges that as a result of Anderson's fraud, Quintus overstated its revenue in three fiscal quarters in amounts ranging from 37% to 60% per quarter. In February 2001, NASDAQ delisted Quintus' stock, and the company is now being liquidated through bankruptcy proceedings.


     

  6. SEC v Fila

    FORMER FILA USA CEO AGREES TO PLEAD GUILTY TO CONSPIRACY TO MAKE FALSE STATEMENTS TO AUDITORS OF JUST FOR FEET, INC.

    According to the criminal information, in or around February 1999 and continuing through on or about April 23, 1999, Deloitte & Touche performed its annual audit of JFF’s financial statements for the fiscal year ending Jan. 30, 1999. As part of the audit process involving JFF’s accounts receivable, Deloitte & Touche requested certain vendors to provide written, independent confirmation of the amounts they owed JFF. This was done in the form of an “audit confirmation letter.”

    The criminal information alleges that during the course of JFF’s annual audit, an executive vice president of JFF caused the company’s accounting department to record an additional $1.4 million in fictitious accounts receivable allegedly due to JFF from Fila as of Jan. 30, 1999. This had the result of causing JFF’s income to be overstated by approximately $1.4 million. According to the charges, the executive vice president sent Epstein an audit confirmation letter, requesting that Epstein, on behalf of Fila, confirm to Deloitte & Touche that Fila actually owed JFF approximately $1.4 million “for advertising that ran or merchandise sold prior to January 30, 1999.” Epstein, knowing that the information contained in the audit confirmation letter was false, and that Fila did not, in fact, owe JFF approximately $1.4 million, signed it and sent it to Deloitte & Touche. Subsequently, Deloitte & Touche included the f alse financial information when preparing JFF’s annual financial reports for public filing with the Securities and Exchange Commission. As a result, JFF’s earnings for the fiscal year ending Jan. 30, 1999, as stated in its annual audited financial statement and SEC filings, were overstated by at least approximately $1.4 million, thereby defrauding the shareholders of JFF

    “As the president and CEO of Fila USA, Mr. Epstein clearly crossed the legal line and entered into this conspiracy to submit false statements to the auditors,” said U.S. Attorney Alice H. Martin. “In doing so, he undermined the integrity of the independent auditor process and deprived the investing public of true financial facts relating to Just For Feet, Inc.”


     

  7. SEC v Adidas

    ADIDAS EXECUTIVE TIMOTHY R. MCCOOL AGREES TO PLEAD GUILTY TO CONSPIRACY TO MAKE FALSE STATEMENTS AND TO FALSIFY THE BOOKS AND RECORDS OF JUST FOR FEET

    According to the criminal information, in or around February 1999 and continuing through on or about April 23, 1999, Deloitte & Touche performed its annual audit of JFF’s financial statements for the fiscal year ending Jan. 30, 1999. As part of the audit process involving JFF’s accounts receivable, Deloitte & Touche requested certain vendors to provide written, independent confirmation of the amounts they owed JFF. This was done in the form of an “audit confirmation letter.”

    The criminal information alleges that during the course of JFF’s annual audit, an executive vice-president of JFF caused the company’s accounting department to record a total of approximately $2.2 million in accounts receivable allegedly due to JFF from adidas as of Jan. 30, 1999. This had the result of causing JFF’s income to be overstated by approximately $2.2 million. In fact, according to the information, adidas owed JFF no more than approximately $40,000 as of Jan. 30, 1999.

    According to the charges, the executive vice president sent McCool an audit confirmation letter, requesting that McCool, on behalf of adidas, confirm to Deloitte & Touche that adidas actually owed JFF $2.2 million “for advertising that ran or merchandise sold prior to January 30, 1999.” McCool, knowing that the information contained in the audit confirmation letter was false, signed it and sent it to Deloitte & Touche. Subsequently, Deloitte & Touche included the false financial information when preparing JFF’s annual financial reports for public filing with the Securities and Exchange Commission. As a result, JFF’s earnings for the fiscal year ending Jan. 30, 1999, as stated in its annual audited financial statement and SEC filings, were overstated by at least approximately $2.2 million, thereby defrauding the shareholders of JFF.


     

  8. SEC v Converse

    Ex-Converse VP to plead guilty in Just For Feet case

    Steven Dodge was charged Thursday in a one-count criminal filing, according to U.S. Attorney Alice Martin of the Northern District of Alabama. The 54-year-old Massachusetts resident will cooperate with the federal government's ongoing investigation into JFF's finances, Martin says. According to the charges, Dodge reported to JFF auditor Deloitte & Touche that Converse owed JFF approximately $412,000 for advertising and merchandise sold prior to Jan. 30, 1999.

    However, the statements were falsified, Martin says

    Deloitte & Touche performed audits for JFF from Feb. 1999 through April 23, 1999, on the previous fiscal year ended that Jan. 30. Deloitte & Touche had requested certain vendors to provide written, independent confirmation of the amounts they owed JFF. Martin says that during the audit, a JFF executive vice president falsely reported that Converse owed the additional $412,000. The false financial information was included in Securities and Exchange Commission filings.

    Founded in 1977, JFF went public in 1994 and filed for bankruptcy in 1999 after becoming the nation's second-largest athletic shoe chain. It later was acquired by New York-based Footstar Inc. Just For Feet earned $35 million in 1997 and 1998 combined - the government alleges that at least a quarter of that was fabricated.

    "Once again in this investigation we see a vendor more concerned about maintaining a corporate account than being accountable to corporate investors with truthful audit confirmation statements," Martin says in a statement. "This type of complicity in a criminal conspiracy to defraud investors will meet with prosecution."


     

  9. SEC v Financial Asset Management, James B. Rader and Debra L. Kennedy

    Between 1996 and January 2000, the Defendants raised over $593 million from approximately 280 investors by grossly overstating the investment performance and market value of the Fund's holdings. Among other things, Michael Berger, the Fund’s investment advisor, created phony account statements that portrayed the Fund as profitable, with hundreds of millions of dollars in assets in an account at FAM, the Fund's executing broker. In reality, the Fund held no assets at FAM, and had lost in excess of $394 million of investors' money during the late 1990s through an investment strategy centered on the short-selling of Internet stocks.

    As part of his ongoing fraud, Berger falsely represented to the Fund's administrator, the Fund's auditor, and the Fund's investors that FAM held the vast majority of the Fund's cash and securities. Berger also fabricated phony account statements purportedly from FAM, which detailed the fictitious trading the Fund was supposedly conducting through FAM

    Throughout the relevant period, Berger had a close professional and personal relationship with Respondent James Rader, and the Fund maintained a brokerage account at FAM. By virtue of its role as an executing broker for the Fund, FAM collected substantial commission income from the Fund's trades. In fact, between 1996 and 1999, the commissions generated by the Fund's trades accounted for at least 10-33% of FAM's annual revenues.

    Contributing to Berger's Scheme to Mislead the Fund's Auditors The Fund engaged Deloitte and Touche (Bermuda) ("Deloitte") to audit its financial statements for the years ended December 31, 1996, 1997 and 1998. Each year, as part of its audit process, Deloitte, through the Fund's administrator, Fund Administration Services (Bermuda) Limited (the "Fund administrator"),2 sent audit confirmation requests to FAM. Debra Kennedy responded to these requests on behalf of FAM. Each request sought a list of any investments that the Fund held at FAM, and requested FAM to furnish its response to Deloitte.

    In each of the three years in question, just before the audit confirmation letters were sent out, Berger requested that Kennedy send FAM's responsive information directly to him, rather than to Deloitte, because he was purportedly "collecting responses" for the auditors. Notwithstanding the unusual nature of Berger's request, and without consulting Deloitte, Kennedy complied with Berger's request. Thus, each year Kennedy, with Rader's approval, prepared cover letters on FAM letterhead addressed to Deloitte, attached copies of the requested Fund account statements that FAM had received from Bear Stearns, and forwarded the package to Berger without any notification to Deloitte.

    This circumvention of the audit confirmation process, in addition to the acts discussed below, made it possible for Berger to perpetrate his fraudulent scheme. Each year, upon receipt of FAM's audit response package, Berger removed the attached Bear Stearns account statements, substituted fictitious year-end account statements designed to appear as if generated by FAM, and sent them (sometimes via facsimile from a fax machine reprogrammed to appear to be from FAM) to Deloitte. In two of the three years in question, the fictitious year-end account statements were sent along with a forged cover letter purportedly coming from Kennedy. One year, a FAM employee provided Berger with an Airborne Express envelope addressed to Deloitte (which Berger used to send the fictitious FAM statements) that inaccurately showed FAM in Ohio as the sender/return addressee of the envelope.

    The fabricated FAM account statements materially overstated the assets and investment performance of the Fund. In reliance on these statements, Deloitte issued unqualified audit reports on the Fund's financial statements for its 1996, 1997 and 1998 fiscal years. These audited financial statements were erroneous and misleading and were sent to investors in the Fund. Had the Respondents sent FAM's audit confirmation responses directly to Deloitte in any of the three years in question, Berger's fraudulent scheme would likely have been instantly exposed.


     

  10. SEC v Sunrise Medical

    To meet earnings targets and achieve bonuses, a number of top managers at Bio Clinic, a Sunrise Medical subsidiary, engaged in a scheme to understate expenses and inflate assets. To hide the scheme from the auditors, managers engaged in three types of concealment

    1. (1) they programmed the computer systems to suppress printing of certain accounts so that a print-out of the accounts receivable subsidiary ledger did not add to the total presented:
    2. (2) they divided a large, and presumably material, misstatement into smaller (and less material) transactions; and
    3. (3) they falsified audit confirmation evidence.

     

  11. USA v Robert Quattrone

    Conspiracy to Commit Securities Fraud, Bank Fraud and Mail Fraud, and to Make False Statements to Auditors

    In the course of that annual audit of Suprema’s financial statements, officers and employees of Suprema directed QUATTRONE, on behalf of Battaglia, to submit false audit confirmations to BDO, Suprema’s auditors. The audit confirmations sought verification by the customer accomplices that legitimate sales had occurred and that the amounts reflected on Suprema’s financial statements as receivables were in fact due and owing by Battaglia. As defendant QUATTRONE and his coconspirators well knew, the sales and receivables figures set forth on the audit confirmations for Battaglia were false. Defendant QUATTRONE signed, or caused the signing of, the false audit confirmations to conceal the fact that Suprema had recorded false and fictitious sales and accounts receivables from Battaglia on its books and records and consequent ly in its financial statements.

    On or about July 31, 1996, defendant ROBERT QUATTRONE signed a false audit confirmation on behalf of Battaglia & Company in the amount of $1,590,640

    The Impact on the Price of Suprema’s Common Stock As a result of the false and misleading statements made by Suprema concerning its business and financial condition, its past financial performance, and its business practices, the price of Suprema’s common stock was inflated artificially. In or about June 1996, when Suprema offered approximately 1,500,000 shares in a secondary offering, the shares were offered to the public at a price of $5.50 per share. In or about August 2000, when Suprema made its next stock offering, the stock was offered at approximately $8.00 per share. By November 2001, when Suprema made it third such offering, its common stock was offered at $12.75 per share, more than double what it had sold for five years earlier. By December 2001, just prior to NASDAQ’s suspension of trading of Suprema stock, Suprema’s common stock was trading as high as approximately $14.00 per share

    On or about December 19, 2001, Suprema’s Chief Financial Officer (“CFO”) and Controller each resigned. On or about December 21, 2001, Suprema issued a press release announcing the resignations and stating that Suprema was undertaking a review of its prior reported financial results. On that same day, the NASDAQ suspended trading on Suprema stock; trading on Suprema stock never resumed. On or about February 24, 2002, Suprema filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code, which was converted to a Chapter 7 liquidation shortly thereafter. On or about March 1, 2002, NASDAQ delisted Suprema’s stock. Suprema and its subsidiaries are now defunct entities.


     

  12. SEC v Physician Computer Network

    The Securities and Exchange Commission has settled alleged fraud cases against six PCN executives and a former customer. The SEC alleged that PCN inflated net income by $31.2 million in 1996 and $26.1 million during the first nine months of 1997.

    Under the settlement, John Mortell, former president and CEO, will pay a $75,000 fine and be permanently barred from acting as a corporate officer or director. Former CEO Thomas Wraback will pay a $60,000 fine and accept a 10-year ban. He also cannot act as an accountant for a public company for five years.

    Four other PCN executives agreed to fines of up to $30,000, with two of them accepting five-year bans on public accounting. A former customer agreed to pay a $15,000 fine for providing a false audit confirmation letter.

    PCN imploded in the late 1990s following a financial scandal. WebMD Corp., Elmwood Park, N.J., now owns much of PCN's assets.


     

  13. US v Bernard Bradstreet

    Bernard F. Bradstreet is the former President and Chief Financial Officer of Kurzweil Applied Intelligence, Inc. After an earlier false start, the Kurzweil IPO closed on August 17, 1993. Thereafter, as required, Kurzweil submitted Forms 10-Q for the quarters ending July 31, 1993 and October 31, 1993. Each of these submissions contained fraudulently-inflated revenue figures indicating that Kurzweil was profitable when, in fact, it was operating near or at a loss.

    Thomas E. Campbell, Kurzweil's vice president in charge of sales and Debra J. Murray, Kurzweil's treasurer and also a vice president, conspired to and actually did "book" as revenue the anticipated proceeds of a number of contingent sales which occurred in time periods covered by the prospectus and the Forms 10-Q. Along with David R. Earl, Kurzweil's vice president in charge of operations, the four engaged in a scheme to conceal the fraud from the company's auditors and underwriters.

    The indictment set forth 14 improperly-booked "sales" (and alluded to a fifteenth) as overt acts in the conspiracy count. The transactions in question, which took place between June 1992 and January 1994, were of two basic types: (1) those in which, near the end of a fiscal-year quarter, a Kurzweil salesperson had forged a prospective customer's signature to a sales quote; and (2) those in which the prospective customer had signed a sales quote, but had conditioned its agreement to purchase Kurzweil equipment on the occurrence of some event not within Kurzweil's control, such as a future commitment from a third-party purchaser.

    At trial, the government introduced evidence regarding these transactions and several others, the defendants' knowledge of the nature of these transactions, and the defendants' efforts to conceal the nature of these transactions from Kurzweil's auditors and underwriters. These efforts included the creation of side agreements, not shown to the auditors, which memorialized the conditions of unfinalized sales Kurzweil had recorded as revenue; the forging by Kurzweil personnel of responses to audit "confirmation letters" which the auditors had sent to Kurzweil customers to confirm the details of certain recorded sales; the pretextual shipment of Kurzweil products to a storage facility in order to create, on the books, the illusion of shipment to customers; and the giving of false explanations of the high and ever-growing percentage of Kurzweil revenues made up of accounts receivable


     

  14. SEC CHARGES FORMER SALES VICE PRESIDENT OF DIGITAL LAVA, INC. WITH INFLATING REVENUES

    The SEC filed a complaint against Peter J. Webb, age 50, of Southlake, Texas, the former Vice President of Sales for Digital Lava, Inc., for inflating revenues for Digital Lava's fiscal quarter ended Sept. 30, 2000, (Q3 2000). Webb engaged in fraudulent sales practices to increase Digital Lava's revenue by 54% during Q3 2000, which resulted in Digital Lava reporting false financial information in its Form 10-Q for that quarter. On March 21, 2001, Digital Lava restated its Q3 2000 revenues from $1.7 million to $1.1 million.

    During Q3 2000, Webb entered into several transactions with Digital Lava's dealers that involved placing contingencies, some documented in side letters, on the sale of a new product called Firestream. Webb concealed the contingencies from Digital Lava's management and its auditors, which caused Digital Lava to improperly recognize revenue on these sales. As a result, Digital Lava overstated revenue from its Firestream sales in Q3 2000 by $598,000, or 54%.

    In a related administrative proceeding announced today, the Commission also charged Robert C. Cloyd, former Vice President of Sales for Three Point Digital, one of Digital Lava's dealers, with causing Webb's violation. Cloyd provided a false audit confirmation to Digital Lava's auditors for $319,000, which represented the largest transaction Digital Lava reversed in Q3 2000.

    Digital Lava’s stock was previously listed on the Nasdaq Stock Market until its dissolution on Jan. 30, 2002.


     

  15. Class Action Lawsuit v Coopers & Lybrand

    Coopers failed to obtain sufficient competent evidential matter with respect to the purported "sales" to Hoffman. The Company sent Hoffman a confirmation, dated April 3, 1995, for $3,330,072.00 purportedly due the Company as of March 31, 1995, which was to be signed and returned to Coopers. Although Hoffman purportedly sent back the confirmation to Coopers, signed on April 10, 1995, confirming the exact amount due, the amount confirmed was incorrect because it included an invoice in the amount of $221,184.00 dated March 30, 1995 for which a credit in the same amount was issued that same day. There was, therefore, a material discrepancy between the amount confirmed by Hoffman and the amount Hoffman purportedly owed Happiness

    Hoffman confirmed that it owed Happiness $221,184.00 more than it should have owed -- it was incumbent upon Coopers to further investigate the Hoffman receivables, which it failed to do.

    The auditor also should consider whether there may be oral modifications to agreements, such as unusual payment terms or liberal rights of return. When the auditor believes there is a moderate or high degree of risk that there may be significant oral modifications, he or she should inquire about the existence and details of any such modifications to written agreements.

    One method of doing so is to confirm both the terms of the agreements and whether any oral modifications exist. Nevertheless, Coopers blindly accepted an incorrect audit confirmation as valid audit evidence and failed to further investigate a material discrepancy.

    As a result of its failure to properly confirm, according to GAAS, a material amount of Happiness' sales and accounts receivable for FYE 1995, Coopers issued an unqualified opinion on Happiness' 1995 FYE Financial Statements when such financial statements materially overstated the Company's revenues, income from operations, income before income taxes, net income, accounts receivable, total assets and retained earnings. Had Coopers properly performed the confirmation and other audit procedures in accordance with GAAS, it would have detected that the material amounts of sales to Hoffman and Wow Wee and others were a sham, and it would have uncovered the fraud.


     

  16. United States v Semion Mogilevich

    Mogilevich and his two partners created and controlled a public company called YBM with the intent to inflate fictitiously inflate earnings by representing to investors and securities regulators that the company was extremely profitable to raise the stock price of YBM so the executives could profit unjustly and enrich themselves by selling stock at highly inflated prices.

    As part of the fraud scheme to inflate earnings, the executives manipulated the audit confirmation process to provide false information to their auditors, Deloitte & Touche and Parente Randolf Orlando and Carey, investors, vendors and customers. Wire & Mail Fraud:

    1/26/97 Fax of false audit confirmation to FE & CE Co. in New York from MAGNEX RT in Hungary re. $5.6 million in sales
    1/26/97 Fax of false audit confirmation to Big Enterprises in New York from MAGNEX RT in Hungary re. $2.3 million in sales
    7/2/97 Fax of false “sales” audit confirmation from Kofa Ltd. in Russia to Deloitte re. $1.37 million in sales
    7/3/97 Fax of false “sales” audit confirmation from Amadeus Holdings Ltd. in Canada to Deloitte re. $2.8 million in sales
    7/3/97 Fax of false “sales” audit confirmation from Big Enterprises in Russia to Deloitte re. $2.3 million in sales
    1/30/98 Fax of false “sales” audit confirmation from Amadeus Holdings Ltd. in Canada to Deloitte re. $3.1 million in sales
    2/24/98 Fax of false “sales” audit confirmation from Orgion Co. in Nevis to Deloitte re. $3 million in sales
    3/5/95 False “account payable” audit confirmation in the amount of $49,000 for the 1994 audit year mailed to Parente Randolf Orlando and Carey from FNJ Trade Management in CA
    3/5/95 False “account payable” audit confirmation for the 1994 audit year mailed to Parente Randolf Orlando and Carey purportedly from Comspan in CA
    4/7/95 False “account payable” audit confirmation for the 1994 audit year mailed to Parente Randolf Orlando and Carey from FNJ pertaining to an “account receivable” of $699,985 for the 1992 audit year; and one from Andrew Gaspar in CA pertaining to a “commission”

    Over $32 million was falsely reported on the books in 1997. From 1996 to 1998 Mogilevich and his partners proceeds’ from the sales of their inflated stock totaled over $58.95 million.


     

  17. SEC v Jeff Bergman

    From June 1993, to at least mid-1995, certain executives at Northstar Health Services, Inc. including its former chief executive officer, engaged in a fraudulent scheme to inflate the revenues of Northstar. Bergman participated in the fraud involving the falsification of Northstar’s financial statements for its fiscal year ended December 31, 1994 by providing Northstar with false checks and a false audit confirmation to support Northstar’s recording of fictitious consulting fees earned by a Northstar subsidiary from Breaux Corporation. In turn, these false documents were provided to Northstar auditors.

    Northstar never rendered any consulting services to Breaux, and Breaux never owed the amounts to the Company. In fact, Breaux was actually a corporation Begman used to direct investments. Bergman’s fraudulent conduct enabled Northstar to overstate its revenue by $167,750 for fiscal 1994. As a result, Northstar’s financial statements for fiscal 1994 were materially misstated. These material misstatements were included in Northstar’s Form 10-KSB filed with the Commission for fiscal 1994, and in Northstar’s Registration Statement on Form SB-2 that went effective on May 18, 1995.


     

  18. ZZZZ Best Carpet Cleaning

    In the 1980’s, a small company founded by a high school student grew into the highly glamorized story of ZZZZ Best Carpet Cleaning. It highlighted how a single executive could circumvent the paper confirmation process to provide auditors the paper evidence needed to take a company public and bilk banks and investors out of $100 million.

    In later discussions, Mark Morze, the company’s CFO, detailed how he used white out and a copy machine to create over 10,000 false documents including false bank statements. To complete the confirmation fraud, Mark paid a friend $10,000 for the use of the friend’s name and address as the contact information for the audit confirmations. ZZZZ Best’s accountants sent the audit confirmations to the friend’s address and received back official looking confirmations that “verified” ZZZZ Best’s accounts.

    ZZZZ Best was a Los Angeles-based company specializing in carpet cleaning and insurance restoration. Prior to allegations of fraud, and its declaration of bankruptcy in 1988, ZZZZ Best was touted as one of the hottest stocks on Wall Street. In 1987, after only six years in business, the company had a market valuation exceeding $211 million, giving its "genius" president a paper fortune of $109 million. In reality, the company was nothing more than a massive fraud scheme that fooled major banks, two CPA firms, an investment banker, and a prestigious law firm.


     

  19. SEC v Kimberly Goodman

    Broker Dealer Confirmations

    1. signed at least twenty audit confirmation letters falsely verifying the portfolio balances of Wymer's clients;
    2. orally misrepresented account balances directly to Wymer's RSI clients;
    3. provided Wymer with the blank RSI forms which he used to forge RSI documents for the purpose of reporting fictitious trades and portfolio balances to his clients; and
    4. received approximately $313,000 in undisclosed cash and gifts from Wymer in return for assisting Wymer in his fraudulent scheme.

     

  20. Joint Meeting AICPA & SEC

    Joint Meeting with SEC Staff
    October 22, 1996
    SEC Headquarters-Washington, D.C.

    The AICPA SEC Regulations Committee meets periodically with the staff of the SEC to discuss emerging technical accounting and reporting issues relating to SEC rules and regulations.

    ACCOUNTING AND AUDITING ENFORCEMENT MATTERS

    George Diacont, Chief Accountant of the Division of Enforcement, briefed the Committee on recent enforcement cases. Areas of focus include:

    • False confirmations - The staff recently made a criminal referral of a friend of an officer of a public company. The friend gave the auditor a false confirmation of a $1.5 million debt to the company.
    • false confirmations - In another case, a board member of a public company solicited a false confirmation from a customer.
    • Auditors should be aware of the possibility of false confirmations and exercise appropriate skepticism based on the circumstances surrounding a confirmation (for example, in connection with the confirmation of unusual, last minute transactions), thus potentially requiring additional audit procedures.

     

  21. Bio Clinic and Comfort Clinic

    This case focuses on the underlying schemes perpetrated by certain employees and business associates of Bio Clinic, for the purpose of misrepresenting the financial position of the company and its affiliates during fiscal years 1994 and 1995. The facts of this case were taken from Accounting and Auditing Enforcement Release No. 1110 / February 24, 1999 from the Securities and Exchange Commission

    During fiscal years 1994 and 1995, Robert S. Barton, a Certified Public Accountant, was vice-president of finance for Bio Clinic Corporation. In order to meet predetermined earnings targets, Barton devised a scheme to report fraudulently prepared financial statements. Assistant Controller, Sharon Longview, and accounting manager, Christie Rockwood, conspired with Barton to execute the scheme. To conceal the improper entries, Barton also enticed the manager of information systems, Vicki Kranawetter, and external computer consultant, Luther Robinson, to change the accounting software.

    By the end of fiscal year 1995, expenses were fraudulently reduced by at least $19.6 million. Pre-tax earnings were overstated by over 16% in fiscal year 1994 and over 40% in fiscal year 1995. In addition, Bio Clinic violated periodic reporting, internal controls, and record keeping provisions of federal securitieslaws.

    DECEIVING THE AUDITORS

    Sunrise Medical’s internal auditors, who were performing work to assist the external auditors in the annual audit, received copies of Bio Clinic’s altered subsidiary ledgers for Accounts Receivable and Property and Equipment.

    The falsified ledger posed a problem because it included invoices that had already been paid. In accordance with generally accepted auditing standards (GAAS), the audit procedures planned by the external auditor included the confirmation of a sample of Account Receivables with Bio Clinic's customers. Therefore, a customer who had already paid an invoice would most likely not confirm the account receivable. The rush surrounding the audit’s completion led a person on the internal audit team, who was assisting the external auditors, to allow Longview and another employee to fax the requests for confirmation to the audit sample of customers. However, instead of confirmation requests, Longview and her employee inserted blank pages into the fax machine; the resulting facsimile transmission reports printed by the fax machine were attached to the real confirmation requests. The falsified documents were shown to the auditors as proof that the confirmation requests had been faxed. By the end of fiscal year 1994, Barton, Longview, and Rockwood had overstated Bio Clinic's Accounts Receivable and Property and Equipment by at least $3.5 million and $2.3 million, respectively. By the end of fiscal year 1995, the total overstatement of Accounts Receivable and Property and Equipment (due to the improperly transferred expenses) had reached $8.8 million and $4.9 million, respectively.


     

  22. Bank Manager Theft

    Excerpts from “Are you in control of your money?”

    By Maurice Hyman, director of Barlev (UK Plc), investigative auditors. 02-10-2003

    The overriding question following yet another recent fraud disclosure - this time about a 32-year-old bank manager who stole more than £2m in order to purchase exotic birds, a large house and luxury cars - is how he was able to remain undetected for four years when the bank was regularly audited to the highest professional standards, supposedly?

    As in the recent case of the disgraced London headmistress, the local bank manager had risen to his position of trust and responsibility after a period of 10 years working with the bank.

    The regular internal audit checks and their review by the organization’s audit committee, as well as the annual external audit that generally includes the customer's written confirmation of their balances, did not detect the fraud. Furthermore, it is surprising that other employees of the bank were not suspicious of the manager's changing lifestyle with his two Mercedes and Porsche cars.


     

  23. Allfirst Scandal

    In June of 2002, John M. Rusnak, the Allfirst Financial Inc.currency trader who lost $691.2 million through 'sophisticated' scheme of fake trades and false entries was indicted for bank fraud.

    Rusnak, 37, of Mount Washington, hid millions in losses over a five-year period by manipulating internal controls and entering fictitious trades and data into Allfirst's books and records

    To help avoid detection, the indictment says, Rusnak created a fictitious businessman with a mail drop at a Mail Boxes Etc. in New York to confirm a bogus currency trade with Allfirst's independent auditors.

    To conceal his fraud, Rusnak rented a mailbox around Jan. 20, 2001, and created a fictitious businessman, David Russell, to provide Allfirst's independent auditors with a false confirmation of a fake option contract that Rusnak had entered into the bank's books.

    Rusnak was fired from Allfirst along with six co-workers and supervisors who failed to detect the losses. Those employees are: David M. Cronin, executive vice president and treasurer; Robert F. Ray, senior vice president of treasury funds management and Rusnak's immediate supervisor; Jan N. Palmer, senior vice president of investment operations; Larry Smith, a clerk in the bank's operations unit; Michael Husich, head of internal audit; and Lou Slifker, also with internal audit.


     

  24. US v Allan Boren and Eric Cano (Manhattan Bagel Corporation)

    Manhattan Bagel Corporation’s stock was registered with the SEC and publicly traded on the NASDAQ under the symbol BGLE. For three plus years ending in 1998 Boren and Cano inflated revenues of the company’s subsidiary, I&J bagels, in order to commit fraud and personally benefit from the increase in the stock’s value.

    To commit the fraud, the indictment states that Boren and Cano circumvented the internal accounting controls which “were sufficient to provide reasonable assurances that I&J, and thereby Manhattan Bagel, had properly maintained accountability for its assets.” The two created fake bagel sales to two purported wholesaler customers, Veatch Carlson (a lawfirm) and Peerless Maintenance Company (an office cleaning service). The Executive Director of Veatch was Boren’s brother (Borini), and the owner of Peerless was the Executive Director’s brother-in-law (Tuttle).

    To hide the fake sales from Manhattan Bagel’s auditors, Ernst & Young, Boren and Cano had Borini, Tuttle, their assistants, their office managers and others sign or forge signatures on audit confirmations that Ernst & Young either mailed or faxed verifying the false account balances. When Ernst & Young called to verbally confirm the information, Borini, Tuttle, their assistants, their office managers and others verbally confirmed the information and then responded in writing as well.

    As a result of the fraud, the Manhattan Bagel’s stock fell more than 35% in one day a record trading.


     

  25. SEC v North Face

    The SEC has settled civil charges with the former CFO of North Face and two other former top executives stemming from an alleged scheme to inflate financial results.

    Christopher Crawford, the former CFO, Todd F. Katz, former vice president of sales, and Richard Tyrer, former vice president of western-region sales, settled with the commission.

    In 1997 and 1998, Crawford and Katz engaged in a series of schemes to boost North Face's results. As a result, North Face, a wholly owned subsidiary of VF Corp., overstated its revenue and gross-margin recognition by fraudulently recognizing revenue on barter transactions and by fraudulently recording consignment sales as completed, regular sales.

    Crawford, Katz, and Tyrer tried to conceal the true nature of the improperly reported transactions from North Face's auditors and from a special audit-committee investigation.

    Crawford made material misrepresentations and omissions to the auditors "in an attempt to hide his misconduct."

    Katz and Tyrer also conspired to keep their fraud from being discovered. "They persuaded a customer of the company to lie to the internal investigators and senior management, and to sign false documents, knowing that the information would be relied upon by the auditors," the SEC noted in its settlement.

    Tyrer and Katz persuaded a second customer to sign a false confirmation letter, which also was relied upon by the auditors, the commission also claimed.

    Crawford was ordered to disgorge nearly $29,000 and to pay a civil penalty of $30,000. while Katz was ordered to pay a civil penalty of $40,000.

    The commission also proposed to have Crawford's civil penalty added to a fund for the benefit of victims of the conduct alleged in the complaint


     

  26. BCCI Bank Collapse

    The bank of BBCI collapsed after the discovery that more than $2.2 billion of assets had been misused.

    Abu Dhabi's chief representative on BCCI's board, and Sheikh Zayed's trusted financial manager, Al Mazrui, defrauded Abu Dhabi of, up to $2.2 billion, in addition to having presided over the failures of two Hong Kong banks in 1983 with total losses of capital and depositor losses amounting to several hundred million dollars.

    In an effort to persuade the Government to make a substantial capital injection into the bank to salvage the company, BCCI's officers confirmed that the Bank had experienced severe financial difficulties and disclosed the misuse of $2.2 billion of managed funds on behalf of the Ruling Family.

    Price Waterhouse, in the roll of advisor to the Bank of England, stated that Al Mazrui had his own accounts at BCCI's bank-within-a-bank, ICIC, which showed that he received funds in 1986 and earlier from no-risk transactions involving BCCI shares in which he was guaranteed against possible loss. Price Waterhouse told the Bank of England that Al Mazrui confirmed a fictitious loan made to the Crown Prince of Abu Dhabi by BCCI, but claimed that he did not remember signing the false confirmation. Al Mazrui told Price Waterhouse that his signature must have been forged, before confessing to all to Abu Dhabi authorities in April, 1990.

    More than two years after the collapse of BCCI, Al Mazrui remained in place as the head of Abu Dhabi's working group to deal with BCCI-related problems. Al Mazrui was neither fired, nor resigned, from the positions of trust he clearly violated.

    Given the facts, Al Mazrui's continued role in handling Abu Dhabi's response to the collapse of BCCI, raises questions as to why he was allowed to stay. One possible explanation is that Sheikh Zayed and the ruling family are remarkably tolerant of incompetence, deception, fraud, and the personal enrichment of top advisors. An alternative explanation is that Al Mazrui's improprieties had previously been sanctioned by higher-ups, or were consistent with ordinary practices in the Emirate.


     

  27. US vs. Logo Athletic

    Two former executives of Logo Athletic have agreed to plead guilty and cooperate with the government’s ongoing investigation into the finances of Just For Feet, Inc.

    Thomas Shine, former president of now-defunct Logo Athletic, Inc., and currently senior vice president of sports and entertainment marketing worldwide for Reebok International Ltd. plead guilty to conspiracy to submit false statements to JFF auditors and to falsify JFF books and records. Logo Athletic filed for bankruptcy in 2000, and its assets were purchased by Reebok in 2001.

    According to the criminal information, in February 1999 and continuing through April 23, 1999, Deloitte & Touche performed its annual audit of JFF’s financial statements for the fiscal year ending Jan. 30, 1999. As part of the audit process involving JFF’s accounts receivable, Deloitte & Touche requested certain vendors to provide written, independent confirmation of the amounts they owed JFF. This was done in the form of an “audit confirmation letter.”

    During the course of JFF’s annual audit, in order to cover an additional $700,000 in fictitious accounts receivable purportedly due to JFF from Logo Athletic as of Jan. 30, 1999, a JFF executive vice president requested that Shine, on behalf of Logo Athletic, sign an audit confirmation letter confirming to Deloitte & Touche that Logo Athletic actually owed JFF approximately $700,000 “for advertising that ran or merchandise sold prior to January 30, 1999.” Shine, allegedly knowing that the information contained in the audit confirmation letter was false, and that Logo Athletic did not, in fact, owe JFF approximately $700,000, signed it and sent it to Deloitte & Touche.

    Subsequently, Deloitte & Touche included the false financial information when preparing JFF’s annual financial reports for public filing with the Securities and Exchange Commission. As a result, JFF’s earnings for the fiscal year ending Jan. 30, 1999, as stated in its annual audited financial statement and SEC filings, were overstated by at least approximately $700,000, thereby defrauding the shareholders of JFF.

    “Audit confirmation letters are sent by independent auditing firms in order to validate information which a corporate client is supplying. The intentional falsification of such letters undermines the auditing effort, and helps to perpetrate fraud on investors,” said U.S. Attorney Alice H. Martin.

    Carmen S. Adams, Special Agent in Charge of the Birmingham Field Office, Federal Bureau of Investigation stated “These charges represent the continuation of a concerted effort to hold those accountable who perpetrate a fraud against Corporate America. This is a top priority for the FBI as illustrated by the fact that nationwide, there are over 150 Corporate Fraud cases under investigation, 16 of which involve losses exceeding $1 billion dollars. Over 2,500 cases involve securities and commodities fraud. Hopefully, the Just for Feet investigation will send a message that regardless of the sophistication of the techniques utilized to deceive investors, Corporate Fraud will be exposed, aggressively investigated, and prosecuted.”


     

  28. Robert Cloyd and Three Point Digital

    COMMISSION INSTITUTES AND SETTLES PUBLIC CEASE-AND-DESIST PROCEEDINGS AGAINST ROBERT CLOYD

    On June 25, the Commission instituted and simultaneously settled public cease-and-desist proceedings against Robert C. Cloyd, a former Vice- President of Three Point Digital, Inc. The Commission found that Cloyd fraudulently misled the auditors of Digital Lava, Inc. about the terms of a transaction between Three Point Digital and Digital Lava

    The Commission's Order found that Three Point Digital was the integrator and largest distributor of Digital Lava's Firestream system. In September 2000, Three Point Digital purchased approximately $319,000 in Firestream systems from Digital Lava. The Commission further found that Digital Lava's Vice President of Sales gave Cloyd a side letter providing that Three Point Digital did not have to pay for the Firestream systems until it re-sold the systems to customers.

    According to the Commission's Order, when Digital Lava's auditors sought confirmation that no undisclosed agreements or contingencies existed related to this transaction, Cloyd confirmed the transaction without disclosing the contingency as documented in the side letter. The Commission found that Cloyd's actions caused a violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and ordered Cloyd to cease and desist from committing or causing any violation and any future violations of these provisions. The Commission accepted an offer of settlement submitted by Cloyd.


     

  29. SEC vs. Hybrid Networks

    Ikon, a Hybrid customer, purchased materials from Hybrid Networks with an absolute right of return. Hybrid recorded the revenue from these transactions without an allowance. To conceal the right of return from auditors and senior management, Hybrid personnel modified the Ikon purchase order held in Hybrid’s files. When specifically asked to confirm that there was no absolute right of return, Ronald Davies, working for Ikon, prepared a misleading response to a confirmation request.

    On June 28, the Commission instituted and simultaneously settled an administrative proceeding against Ronald G. Davies, a former Executive Vice President of Ikon Office Solutions. The Commission alleges that Davies fraudulently misled the management and auditors of Hybrid Networks, Inc. (Hybrid) about a side letter he had received from a Hybrid salesperson.

    The Commission's Order alleges that Ikon was the largest customer of Hybrid. In December 1997, Ikon purchased approximately $1.8 million in modems from Hybrid, representing 35% of Hybrid's revenue for the quarter and 15% of Hybrid's revenue for the year. The Commission further alleges that a Hybrid salesperson sent Ikon a side letter providing Ikon with an absolute right to return the products. The salesperson concealed this letter from Hybrid's management, causing Hybrid to dramatically overstate its revenue and income in its 1997 financial statements.

    According to the Commission's Order, when Hybrid and its auditors sought confirmation that Ikon had received no right of return, certain Hybrid employees asked Davies to conceal the side letter. Davies, while refusing to lie to Hybrid, sent a response to the auditors which implied that no side letter existed.

    The Commission sued Hybrid Networks for issuing false financial statements in connection with its November 1997 initial public offering and for the first quarter following the IPO. The Commission also charged former Vice President of Sales Gustavo Ezcurra and former Regional Sales Director Craig Stein with fraud in connection with the issuance of the false financial statements. In addition, the Commission charged former President and Chief Executive Officer Carl S. Ledbetter with failing to implement internal accounting controls reasonably sufficient to prevent the fraud. In a related administrative proceeding, the Commission charged Ronald G. Davies, a former executive for one of Hybrid customers, with being a cause of the fruad.

    The Commission alleges that Hybrid falsely inflated its 1997 revenue and income through a series of improper and fraudulent transactions. Hybrid subsequently restated its financial results for the period, reducing 1997 revenue from $14.3 million to $4.1 million (representing a 249% overstatement of revenue) and increasing net loss from $13.6 million to $21.6 million (representing a 37% understatement of net loss). The Company's rapidly deteriorating financial situation led to a decline in Hybrid's stock price from a post-IPO high of $24 to approximately $2 before NASDAQ delisted the Company in December 1998.