Issuers Should Carefully Monitor Agreements and Arrangements — Or The SEC Will
Yesterday the SEC brought another in what has become a series of cases based on claims that a company helped another falsify its financial statements. This time the SEC brought an cease and desist action against Motorola, Inc. for entering into a “price support” agreement with Adelphia Communications Corporation. http://sec.gov/litigation/admin/2007/34-55725.pdf According to the Order for Proceedings, the purpose of the arrangement was to help Adelphia artificially inflate its Earnings Before Interest, Taxes, Depreciation and Amortization by reducing operating costs. According to the SEC the agreement involves a round-trip of cash between Motorola and Adelphia.
In bringing the action the SEC alleged that Motorola should have realized that the agreement lacked any economic substance. The Order for Proceedings claimed that Motorola should have seen a series of red flags, which included that fact that this was the first time a vendor had ever requested a price increase. Motorola agreed to the entry of a C&D, and to the payment a total of $25 million in disgorgement and prejudgment interest. The action against Motorola is the latest in a series of such cases. For example, last year the SEC brought a civil injunctive actions against:
Scientific-America claiming that it entered into a price support agreement with Adelphia to help inflate the latter’s earnings by $43 million. The case settled with the entry of a consent injunction and the payment of $20 million in disgorgement. SEC v. Scientific-Atlanta, (S.D.N.Y. June 22, 2006). http://www.sec.gov/litigation/litreleases/20096/lr19735.htm.
Ronald Ferguson and four other former senior executives of General Re for aiding and abetting AIG in improperly inflating its loss reserves by almost $500 million. The case is pending as are parallel criminal charges. SEC v. Ronald Ferguson, et al., (S.D.N.Y. Feb. 2, 2006), http://www.sec.gov/litigation/litreleases/2007/lr19975.htm.
Gary Bell and twelve other employees and agents of vendors to U.S. Food Services, a subsidiary of Royal Ahold, for executing false audit confirmation. Several defendants agreed to settle for consent decrees and fines, while others are litigating with the SEC. SEC v. Gary Bell, et al., (D.D.C. Jan 18, 2007), http://www.sec.gov/litigation/litreleases/2007/lr19975.htm
All of this suggests that issuers should carefully monitor agreements and other arrangements entered into with other companies. In conducting that due diligence it is important to follow up. One of the “red flags” missed by Motorola is the fact that it requested a letter of assurance from Adelphia stating that the arrangement complied with all applicable laws and regulations, but the company never received one and failed to follow up on the request.