A federal judge has dismissed a securities fraud lawsuit against the former chief executive officer of computer manufacturer Gateway, a rare rebuke of the Securities and Exchange Commission that underscores how fraud cases have evolved since the Sarbanes-Oxley Act.
San Diego District Court Judge Roger Benitez granted summary judgment late last month in favor of Jeffrey Weitzen, who served as Gateway’s chief executive from January 2000 to January 2001. Weitzen and two other former executives had been facing fraud charges filed by the SEC, alleging that the men had inflated revenue figures to meet Wall Street expectations.
Marmaro
“The big takeaway from this case is that the SEC needs to examine the factual evidence against the executives it charges and not simply rely on their title or job responsibilities to try to make a fraud case,” says Richard Marmaro, Weitzen’s defense lawyer and a partner with Skadden, Arps, Slate, Meagher & Flom. “This case illustrates that the mere fact that the SEC charges a company or executive with fraud doesn’t mean they can sustain that proof in court.”
The SEC says it is still pursuing claims against the two other men charged in the November 2003 complaint, former CFO John Todd and former controller Robert Manza. Gateway itself, in 2003, without admitting or denying the SEC’s findings, agreed to a cease-and-desist order barring it from future violations of federal securities laws.
The SEC had alleged that Weitzen, Todd and Manza schemed to inflate revenue during the third quarter of 2000 to close a gap between Gateway’s anticipated revenue and analyst expectations; hid a plan to boost its numbers by increasing sales to high-risk customers; and used a variety of improper accounting actions, including the way Gateway booked revenue from an agreement with AOL Corp. According to the SEC complaint, the trio caused Gateway to overstate net income for the third quarter of 2000 by more than 10 cents per share and inflated reported revenue by $154 million.
The SEC claimed Weitzen was liable for material misstatements in Gateway’s 10-Q for that quarter and for statements made in the earnings press release for the same period. It also charged him with providing a misleading management representation letter to Gateway’s outside auditor.
Not Enough Evidence
Regardless of what Weitzen actually knew and did, however, the incident happened before Sarbanes-Oxley was passed, and hence Section 302 of the law—which compels top executives to certify the accuracy of financial statements—never applied to Weitzen’s case.
Susan Resley, a partner with Orrick, Sutcliffe & Herrington and a former SEC staff attorney, says that the decision “may have been a little different” had the false statements occurred after SOX was enacted in 2002. “In light of SOX, there are higher standards put on CEOs. The ‘I didn’t know’ and ‘I didn’t know the details,’ are not as strong of a defense now in light of the certification requirements.”
“The judge in this particular case provided a thoughtful analysis and didn’t buy into the ‘restatement equals fraud’ theory that often accompanies corporate cases.”
— Susan Resley, Orrick, Sutcliffe & Herrinton
Hochberg
Joshua Hochberg, a partner in the white collar crime practice at McKenna Long & Aldridge, agrees. “The rules requiring CEOs and CFOs to certify the accuracy of the financial reporting make it harder for executives to say ‘I had no knowledge’ or to deny involvement,” he says. “Post-SOX, intent should be easier to prove because CEOs now have to sign certifications linking them directly to the financial statements.”
Indeed, in his 16-page opinion, Judge Benitez said the SEC failed to provide enough evidence to support its claims against Weitzen. He said the SEC relied on Weitzen’s signing a management representation letter to the auditors as evidence of his “substantial participation” in drafting the bogus 10-Q. “A reasonable fact-finder could not find this to be substantial in relation to the preparation of the entire quarterly filing,” Benitez wrote.
In addition, Benitez said the SEC failed to show that Weitzen acted with scienter, or intent. And while the judge noted that there was “no debate” that Weitzen was aware of the transactions in question, “There is little evidence that he controlled those transactions or was aware of them in any but the most general sense.” Benitez also said the SEC failed to show that Weitzen knew or was reckless in not knowing that the statements in the management representation letter were false.
Resley
Still, Resley says the decision is significant. “The SEC appeared to rely largely on the ‘liability by position’ theme, that just because Weitzen was the CEO he must have known the details of all of the deals,” she says. “From the opinion, it’s clear that the judge said there wasn’t evidence supporting that theory.”
“This case demonstrates that the mere fact of a restatement without supporting evidence that there’s fraud doesn’t equate to fraud,” she adds. “The judge in this particular case provided a thoughtful analysis and didn’t buy into the ‘restatement equals fraud’ theory that often accompanies corporate cases.”
“My client is elated,” Marmaro told Compliance Week. “He feels he was totally vindicated and he can get back on with his life.”
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