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UNITED STATES OF AMERICA
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In the Matter of BRIGHTPOINT, INC., Respondent
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ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934 AS TO EXCHANGE ACT OF 1934 AS TO BRIGHTPOINT, INC. |
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted against Brightpoint, Inc. ("Brightpoint" or "the Company") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 (the "Exchange Act").
In anticipation of the institution of these administrative proceedings, Brightpoint has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except as to the Commission's finding of jurisdiction over Brightpoint and the subject matter of this proceeding, which Brightpoint admits, Brightpoint consents to the issuance of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing a Cease and Desist Order Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934 as to Brightpoint, Inc. ("Order") and to the entry of the findings and imposition of relief set forth below.
On the basis of the Order and Brightpoint's Offer, the Commission makes the following findings:1
(1) This case involves Brightpoint's improper use of a purported insurance policy to reduce a $29 million loss by $11.9 million in order to report a much smaller loss. The $29 million loss occurred in connection with the Company's closing of its Trading Division2 in the United Kingdom ("UK") in 1998. As a result of this deception, Brightpoint's 1998 financial statements, as reported in the 1998 Form 10-K, overstated Brightpoint's actual net income before taxes by 61 percent. The misrepresentation was subsequently republished in registration statements filed in September 1999 and in Forms 10-K filed for 1999 and 2000.
(2) On October 2, 1998, Brightpoint publicly announced that in the fourth quarter ending December 31, it would recognize a one-time charge, ranging from $13 million to $18 million (the "One Time Charge"), arising out of losses sustained in connection with the closing of the Trading Division in the UK. However, by December 1998, Brightpoint determined that the UK losses approached $29 million, substantially more than originally thought, and Brightpoint's then corporate controller, John Delaney ("Delaney"), and its then director of risk management, Timothy Harcharik ("Harcharik"), devised a scheme to cover-up these additional, unanticipated losses, rather than disclose them.3
(3) In December 1998, Delaney and Harcharik turned to the Loss Mitigation Unit ("LMU") of American International Group, Inc. ("AIG"), which offered so-called "insurance" products specifically designed to minimize the financial statement impact of losses sustained by AIG clients. Brightpoint and AIG fashioned a $15 million "retroactive" insurance policy (the "AIG Policy") that purported to cover all of the extra UK losses. The "cost" of this $15 million policy to Brightpoint was about $15 million, which Brightpoint was to pay in monthly "premiums" over the prospective three-year life of the policy. The AIG Policy, finalized in January 1999, enabled Brightpoint to record in 1998 an insurance receivable of $11.9 million, which Brightpoint netted against the total UK losses of about $29 million, bringing the net loss to within the previously disclosed $13 to $18 million range.
(4) In substance, the AIG Policy was not an insurance policy. It was a mechanism that enabled Brightpoint to deposit money with AIG - in the form of monthly "premiums" - which AIG was then to refund to Brightpoint as purported "insurance claim payments." In drafting the AIG Policy, Delaney and Harcharik took pains to ensure that the "policy" raised no "red flags" for Brightpoint's auditors (the "Auditors"): They created a policy that looked like traditional, non-retroactive indemnity insurance with an effective date of August 1998. Moreover, once the AIG Policy was finalized, Delaney and Harcharik worked with AIG to devise a letter to the Auditors falsely stating that there would be a "probable" "insurance recovery" under the AIG Policy, when they knew that Brightpoint was, in fact, certain to recover its deposits.
(5) In October 2001, following an inquiry by the Commission's staff, the Auditors began looking more closely at the AIG Policy and determined that it was not traditional insurance. Although the Auditors questioned whether the policy was insurance at all, the Auditors decided at the very least that the policy provided retroactive coverage and, therefore, that all premium expense associated with it should have been recorded in 1998. On November 13, 2001, Brightpoint announced a restatement, which treated the AIG Policy as real insurance with a retroactive and a prospective component (the "First Restatement"). The First Restatement expensed the full policy "premium" in the fourth quarter of 1998, amounting to $15.3 million.
(6) On the day before Brightpoint announced the first restatement, Brightpoint and AIG canceled the retroactive component of the AIG Policy and agreed that AIG would refund to Brightpoint the amount by which the "premiums" Brightpoint had paid exceeded the "insurance claims payments" it received under the policy. When the Auditors subsequently learned the terms of this agreement concerning the refund, they concluded that AIG Policy was not insurance and that a second restatement was necessary to reflect the deposit nature of the arrangement. Consequently, on January 31, 2002, Brightpoint announced that it would further restate its financial statements to reflect that the AIG Policy "premiums" were only deposits with AIG.
(7) As a result of the conduct summarized below, which led to misstatements in the 1998 Form 10-K and in a registration statement filed by the Company, Brightpoint violated Section 17(a) of the Securities Act of 1933 (the "Securities Act") and Sections 10(b), 13(a) and 13(b)(2) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rules 10b-5, 12b-20, 13a-1 and 13b2-1 thereunder. In addition, Brightpoint incorrectly accounted for the 1998 losses in the First Restatement, and, as a result, violated Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1 and 13b2-1 thereunder.
(8) Brightpoint is a Delaware corporation headquartered in Plainfield, Indiana. Brightpoint provides outsourced services such as distribution, fulfillment, customized packaging, prepaid and e-business solutions, and inventory management in the wireless telecommunications and data industry. Brightpoint's securities are registered pursuant to Section 12(g) of the Exchange Act and its common stock is listed on NASDAQ's National Market under the symbol CELL.
Other Relevant Individuals and Entities
(9) Delaney, age 37, is a resident of Indianapolis, Indiana. Delaney served as Brightpoint's corporate controller and chief accounting officer from June 1996 until he left Brightpoint in September 2000. In approximately April 2001, Delaney rejoined Brightpoint as executive vice president of its Solutions Development Group and continued in that position until Brightpoint terminated him in February 2002.
(10) Harcharik, age 48, is a resident of Fishers, Indiana. At all relevant times, Harcharik was the president of World Wide Risk Management, a risk management consulting company located in Indianapolis and fifty percent owned by the father of Brightpoint's chief executive officer. Harcharik worked for Brightpoint as an independent contractor, serving as Brightpoint's director of risk management from June 1997 until he was terminated in February 2002. At all relevant times, Harcharik was physically located in Brightpoint's offices and he spent almost all of his time on Brightpoint matters.
(11) AIG is a Delaware corporation with its principal corporate offices located in New York, New York. AIG is a holding company that, through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG's primary activities include both general and life insurance operations. AIG's securities are registered pursuant to Section 12(b) of the Exchange Act and are listed on the New York Stock Exchange.
Brightpoint's UK Losses and the Genesis of the AIG Policy
(12) In the spring of 1998, Brightpoint became aware that its UK operation had suffered certain losses related to the loss or devaluation of product within the Company's Trading Division. Delaney directed Harcharik to investigate and determine the amount of loss and evaluate the possible insurance recoveries available to Brightpoint under the policies Brightpoint had at the time (the "Brightpoint Policies"). Based on the information gathered during Harcharik's investigation, Delaney initially estimated the UK losses to total between $13 million and $18 million.
(13) By the end of September 1998, given all the Trading Division's problems and its unprofitable history, Brightpoint decided to close the Trading Division in the UK. Brightpoint's Board of Directors approved the closure on October 1, 1998, and the Company issued a press release on October 2, 1998 announcing that it was eliminating the Trading Division and that the Company would recognize in the fourth quarter of 1998 the One Time Charge, which was expected to range from $13 to $18 million. After October 2, 1998, Harcharik continued to investigate the UK losses, and he gathered documentation for the purpose of making claims under the Brightpoint Policies.
(14) In early December 1998, it was clear that the amount of the One Time Charge was much greater than the original estimate and that Brightpoint's insurers were disputing coverage for the UK losses making it uncertain that there would be insurance recoveries under the Brightpoint Policies. At this point, Brightpoint was faced with the prospect of recording a much larger loss in the fourth quarter than it had previously disclosed, at least $12 million more.
(15) In mid-December, Brightpoint initiated contact with AIG. Harcharik had had some prior familiarity with AIG products designed to cover retroactive losses, and he became the point person in the discussions that ensued. From the very first discussion, Harcharik and Delaney presented Brightpoint's predicament to AIG in stark terms: That Brightpoint had issued a press release in October announcing a very specific range for the estimated loss and was now faced with a much larger loss that it did not want to disclose. Although there was initially some discussion of having AIG actually assume some of Brightpoint's risk, and in that sense issue true retroactive insurance, discussion very quickly shifted to a deposit mechanism because AIG was unwilling to take on any risk associated with Brightpoint's UK losses.4 In the transaction eventually consummated, AIG bore no insurance risk for retroactive losses covered under the policy; every dollar Brightpoint paid to AIG to cover such losses was to be returned upon Brightpoint's demand.
Overview of Relevant Accounting Principles
(16) Under generally accepted accounting principles ("GAAP"), when it is "probable" that an insured will realize an "insurance recovery" against a specified loss, the insured is entitled to record a receivable on its balance sheet in the amount of the probable recovery and, for income statement purposes, net the amount of probable recovery against the loss, thereby reducing the loss.5
(17) The recovery must be "probable." If recovery is only possible, the insured must recognize the loss to its full extent, without regard to insurance. Moreover, the recovery must be an "insurance" recovery. A recovery is not an "insurance" recovery for accounting purposes unless the insurance policy transfers some risk from the insured to the insurer. If a policy does not involve risk transfer, GAAP treats it as a financing arrangement, with all premiums to be accounted for as deposits.6
(18) In December 1998, as the Auditors were beginning field work for the year-end audit, Brightpoint presented the Auditors with schedules of the UK losses, which assumed that Brightpoint would be offsetting against those losses at least $11.9 million in anticipated insurance recoveries. To accomplish this offset, Brightpoint needed to satisfy the probability principle outlined above. However, at the time, it had no such coverage available because its insurers were already indicating that coverage under the Brightpoint Policies was doubtful. On December 22, Delaney wrote to Harcharik an e-mail saying: "I need to support for [the Auditors] the recording of an insurance receivable related to the losses in the UK (in the amount of $12MM - Whoa)."
(19) Brightpoint eventually used the AIG Policy to satisfy this probability standard. In constructing the AIG Policy, Brightpoint faced two accounting obstacles: First, the policy had to look like insurance. If it looked like a deposit, Brightpoint would not be able to net anticipated recoveries against the loss. Second, the policy could not look like retroactive insurance, i.e., insurance designed to cover a loss already quantified and known, because Brightpoint might then be required to expense the full $15 million "premium" immediately. Under GAAP, the insured is obligated to recognize the full premium expense associated with a retroactive policy at the time it recognizes the benefits of the policy. (SFAS No. 113)
The AIG Policy
(20) The AIG Policy consists of two governing documents: The Binder of Coverage (the "Binder") and the policy itself. The Binder was executed on January 6, 1999, but was dated effective August 1, 1998. The Binder states the policy period to be the three-year period August 1, 1998 to August 1, 2001. The AIG Policy provides two separate limits of coverage: Limit A and Limit B. Limit A has an aggregate limit of $15 million, while Limit B has a per loss limit of $15 million.
(21) Although not referred to in the policy as "retroactive," Limit A effectively provides broad retroactive coverage. The policy contains an insuring clause that provides: "The Company shall indemnify the Insured for Loss of Assets unless otherwise excluded by the terms and conditions of this policy." This insuring clause is applicable to both Limit A and Limit B. However, Limit B is subject to a laundry list of exclusions, while Limit A has no exclusions. Thus, virtually every "Loss" of "Assets" is covered under Limit A up to an aggregate amount of $15 million. Limit B, on the other hand, essentially provides prospective fidelity insurance coverage, which is severely circumscribed by the exclusions.
(22) The Binder reflects a single, indivisible premium applicable to both limits. The total premium is $15,302,400, but this aggregate figure is never set forth. Instead, the Binder provides only a list of the elements constituting the premium: It provides that the premium shall be payable as follows:
(23) Neither the policy nor the Binder states how much of the premium is applicable to Limit A and how much is applicable to Limit B. Because the AIG Policy provides for a single premium applicable to both Limits, and Limit B theoretically provides infinite coverage, i.e., $15 million per loss, the AIG Policy on its face at least appears to involve risk transfer. However, according to the internal AIG deal sheet, which reflected the agreement between Brightpoint and AIG, Limit A was fully pre-funded by Brightpoint: The premium Brightpoint paid for Limit A coverage was $15 million plus a $100,000 fee that AIG charged for putting the deal together. Limit B was intended to provide traditional prospective fidelity coverage. According to the deal sheet, the premium for Limit B was $202,400.
(24) The policy specifically provides that it is non-cancelable, and the Binder states that the premium "shall be fully earned as of the date of this binder agreement," meaning that AIG was entitled to be paid the full premium from the very first day of coverage. The policy also contains a clause providing that if claims made under the policy at any point exceeded the dollar amount of premium paid to that point, AIG would not be obligated to pay further claims until Brightpoint paid all remaining premiums due, except for $302,400 - an amount that coincides with the unstated Limit B premium and $100,000 fee. This provision meant that AIG could never be out of pocket under Limit A, the retroactive component of the AIG Policy.
(25) The policy contains no express provision granting Brightpoint the right to a refund if Brightpoint ended up paying more in premiums than it was claiming in losses - a scenario that might have occurred, for example, if Brightpoint ultimately succeeded in obtaining some coverage under the Brightpoint Policies. However, there was an oral understanding between AIG and Harcharik that Brightpoint would receive such a refund, and the mechanism for obtaining that refund was to submit a claim under the very broad definition of coverage, which allowed Brightpoint to receive payment for just about any claim submitted under Limit A up to an aggregate maximum of $15 million.
(26) Brightpoint accounted for the AIG Policy as if it were prospective fidelity insurance. It expensed the premiums monthly over the three-year life of the AIG Policy, and it netted "probable recoveries" under Limit A against the UK losses, purporting to rely on the probability principle outlined above.
(27) Given the true substance of the AIG Policy, Limit A was not insurance because there was no transfer of risk. Limit A was not even a financing arrangement because AIG was not extending credit to Brightpoint. The only money Brightpoint was entitled to receive under the Limit A was money that it first deposited with AIG - deposits on which AIG paid no interest. Accordingly, the premium payments should have been accounted for as deposits.
The Negotiations Between Brightpoint and AIG
(28) From the first discussions between Brightpoint and AIG, Delaney and Harcharik made clear to AIG that Brightpoint needed a policy to reduce the One Time Charge and that the final policy had to "pass the insurance test" with Brightpoint's auditors. Delaney explained to AIG that Brightpoint needed about $15 million in insurance coverage to bring the One Time Charge within the $13 million to $18 million range previously announced in October 1998. Delaney also told AIG that while Brightpoint expected to receive some recoveries for the UK losses under the Brightpoint Policies, the claims under those policies would not be resolved by the year-end. Thus, the AIG Policy was necessary to establish for the Auditors that there was a probability of sufficient insurance recovery.
(29) Harcharik was keenly aware of the accounting issues. At the outset, he proposed that the policy contain both retrospective and prospective components. He wanted a prospective component to be part of the policy because, if Limit A stood alone, it would be too obvious that Brightpoint was paying $15 million in premiums for $15 million of coverage. In the course of the two-week negotiation, Harcharik and Delaney discussed in detail other "red flags" they wanted to avoid so as not to alert the auditors that the policy was not insurance.
(30) One such "red flag" was the problem associated with bifurcating the premium on the face of the contract between the retroactive and prospective portions of the policy. Harcharik made clear to AIG that he did not want the premium to be explicitly bifurcated in the contract because that would show that the cost of Limit A was $15 million. Harcharik did not want the total premium amount of $15.3 million even to be tallied in the contract. Instead, Harcharik wanted the premium to be reflected simply as three untallied components, consisting of an initial down payment, 32 monthly payments, and a $7.5 million letter of credit ( "LOC"). Harcharik did not want the $15.3 million sum to be readily apparent to the Auditors because such a substantial premium might have caused the Auditors to question the bona fides of the policy.
(31) AIG also counseled Harcharik and Delaney that the AIG Policy should contain "no reference to an experience account" and that all refunds of premium back to Brightpoint should be through loss claim payments. An experience account or commutation provision refers to an insurance mechanism by which the insured is refunded premium at the end of the policy if there were few loss experiences over the course of the contract. AIG advised that such a provision would raise "red flags" with the Auditors.
(32) To avoid having an express refund mechanism in the policy for excess premiums paid, Harcharik and AIG reached an oral agreement, not written into the AIG Policy, that AIG would be "extremely flexible" in refunding premiums to Brightpoint through "claim payments," requiring little to no documentation from Brightpoint on the nature of the losses.7 Harcharik and AIG agreed that the retrospective coverage would be as broad as possible and there would be no exclusions to coverage in the policy for those losses. AIG documented the terms of this oral agreement with Harcharik in an internal AIG memorandum called "Loss Mitigation Unit Deal Sheet" (the "Deal Sheet"). The Deal Sheet, in relevant part, states the following:
...Brightpoint had already taken a charge for the [trading] division...assuming the $15M of insurance recovery would happen. Brightpoint's auditors, . . . , wanted more evidence that an insurance recovery was possible. Otherwise, Brightpoint would be in a position to possibly restate the charge already taken...The feedback from [the Auditors] was that they wanted a letter from AIG explaining the use of the policy in case there are no proceeds paid by [Brightpoint's other insurer] ...If for some reason [Brightpoint's other insurer] pays the loss or a portion of the loss, the $15M [million] or the balance after a partial loss payment by AIG would have to be returned as well. This would be returned under a future claim submitted by Brightpoint under Sub-Limit A. THUS, SUB-LIMIT A WAS MADE TO BE EXTREMELY BROAD AND ANY PAYMENTS MADE SHOULD ALWAYS BE MADE WITHOUT LIMITATIONS BY COVERAGE; ONLY LIMITATIONS TO PREMIUM RECEIVED.
(Emphasis in original.) Along the same lines, another internal AIG memorandum states:
AIG is not at risk for this arrangement and maintains the benefit of collecting cash without giving interest on the float. There were no specific required timeframes established for AIG's payments under the policy (due to the fact that the policy was purposely constructed so as to not appear as a finite risk policy for accounting reasons) and the verbal agreement was that AIG would pay within a reasonable time period.
(Emphasis in original.)
(33) On January 6, 1999, AIG and Brightpoint executed the AIG Policy by signing the Binder. The original version of the Binder had a date line, indicating that it was signed on January 6, 1999. That same day, Delaney sent Harcharik an email stating:
The binder you signed (I looked at it again) has January 6, 1999 (in one case 1998) all over it. This is not good and that copy must be destroyed and on [sic] with an August date executed.
(34) AIG and Harcharik then executed a second version with only the August 1, 1998 effective date appearing in the document. Later that day, Brightpoint issued a press release stating that the One-Time Charge was "expected to be approximately $17.6 million ... which is consistent with the previously-announced estimate." Both Brightpoint's President8 and its then Chief Financial Officer approved in advance Brightpoint's purchase of the AIG Policy without adequately reviewing the transaction.
AIG's Confirmation to the Auditors
(35) In connection with the Auditors' 1998 year-end audit, the Auditors asked Brightpoint to obtain from AIG a letter confirming the probability that Brightpoint would recover at least $11.9 million under the AIG Policy, which was the amount Brightpoint was seeking to offset against the $29 million UK losses. After working through numerous drafts with Harcharik, AIG signed and provided a letter to Harcharik, dated January 27, 1999, which stated "we [AIG] believe it is probable that Brightpoint will recover no less than $11,900,000 in proceeds, net of deductibles, under the Policy." AIG faxed a copy of the letter directly to the Auditors. On the basis of this confirmation, the Auditors approved Brightpoint's accounting for the insurance receivable and allowed Brightpoint to offset the UK losses by $11.9 million in probable insurance recoveries.
Brightpoint's Misrepresentations to the Auditors
(36) As part of its audit procedures, the Auditors obtained during the 1998 audit a management representation letter from Brightpoint that enabled the Auditors to form an opinion as to whether Brightpoint's financial statements presented fairly, in all material respects, the financial position, results of operations, and cash flow of Brightpoint, in conformity with GAAP. This letter, dated January 26, 1999, falsely represented that the financial statements were fairly presented and that all financial records and significant contracts were made available to the Auditors. Further, the letter falsely stated that no material transactions were improperly recorded in the accounting records underlying the financial statements, that there was no fraud involving management, and that no events or transactions occurred subsequent to December 31, 1998 that would have materially affected the financial statements.
Brightpoint's Publication of the Material Misstatements
(37) Brightpoint publicly reported the material misrepresentations about its 1998 operating results, stemming from the improper accounting for the AIG Policy, in the Company's 1998 10-K, which was filed with the Commission on March 31, 1999. Subsequently, Brightpoint republished the misrepresentations in a registration statement filed with the Commission on September 27, 1999. The registration statement incorporated by reference the misrepresented operating results in Brightpoint's 1998 10-K. In addition, it republished the 1998 financial data in its Form 10-K filed for 1999 and 2000.
The First Restatement
(38) In September 2001, the Commission's staff issued a subpoena to the Auditors for its workpapers relating to Brightpoint's 1998 One-Time Charge. The subpoena led the Auditors to reconsider Brightpoint's 1998 accounting for the UK losses. In the course of this review, the Auditors learned for the first time that (1) the AIG Policy had not been executed until January 1999; (2) the policy contained retroactive coverage; and (3) the policy was "non cancelable by either party and the entire premium [was] deemed earned at the inception of the policy," meaning that Brightpoint was obligated to pay the full $15.3 million in the fourth quarter of 1998.
(39) At the end of October 2001, the Auditors informed Brightpoint that it had incorrectly accounted for the AIG Policy and would have to restate its 1998 financial statements. However, following meetings with representatives of Brightpoint, including its then Chief Financial Officer, the Auditors determined that Brightpoint needed to restate its 1998 financial statements by expensing the full premium on the AIG Policy, rather than treating the premiums as a deposit.
(40) On November 13, 2001, the Company issued a press release announcing the First Restatement. The press release stated that: "Upon further review, the Company and its independent auditors now believe that premium expense should have been accrued at the date the Company entered into the [AIG Policy], rather than over the prospective policy period because the Company could not allocate the costs of the policy between the retroactive and prospective coverage." The First Restatement expensed the full policy "premium" in the fourth quarter of 1998, amounting to $15.3 million, and reversed the monthly premium expense recorded in 1999 through 2001. While the First Restatement essentially corrected Brightpoint's bottom line for 1998, it left intact the $11.9 million in probable insurance recoveries under the AIG Policy as an offset against the $29 million UK loss, in effect treating the AIG Policy as real retroactive insurance.
The Second Restatement
(41) A few days before Brightpoint's November 13th press release, Brightpoint had told the Auditors that Brightpoint was in negotiations with AIG to terminate the AIG Policy. Brightpoint represented to the Auditors that, under the anticipated termination agreement, Brightpoint would simply "walk away" from the policy without any further exchange of money between AIG and Brightpoint. The November 13 press release addressed the subject of termination, stating that "[t]he Company believes that it will recognize a gain in the fourth quarter of 2001 related to the termination of the retroactive portion of the insurance policy, which will result in the complete reversal of the remaining accrual."
(42) The termination agreement was actually executed on November 12, 2001, one day before the November 13 press release. However, Brightpoint did not notify the Auditors that the agreement had been finalized. The executed agreement essentially provided for full rescission of the Limit A part of the AIG Policy. Under the agreement, Limit A was terminated, with Brightpoint to receive a refund of about $2.3 million - just about the amount of premiums it had paid in excess of claims recovered. The agreement also provided that Limit B would continue in force for an annual premium of $97,000.
(43) The Auditors did not learn until mid-December 2001 that the Company had received some cash back under Limit A. Upon learning of the refund, the Auditors asked to see the termination agreement, which they were given on January 14, 2002. After reviewing the termination agreement, the Auditors determined that Limit A was not real insurance and that Brightpoint had to restate its restatement, using the deposit method.
(44) On January 31, 2002, Brightpoint announced that "the Company has now determined that the appropriate accounting method for the agreement is deposit accounting... Deposit accounting requires treating the Company's payments under this agreement as deposits rather than as premiums and the Company's receipts under the agreement as withdrawals rather than claims paid by the insurance company...."
(45) Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibits fraud in connection with the purchase or sale of a security. In particular, Rule 10b-5 prohibits any person from making any untrue statement of a material fact, or omitting to state a material fact, using any device, scheme or artifice to defraud, or engaging in any transaction, practice, or course of business which operates as a fraud. A misstatement or omission is material if there is a substantial likelihood that it would have been viewed by a reasonable investor as "having significantly altered the `total mix' of information made available." TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988).
(46) To violate Section 10(b) and Rule 10b-5, a person must also act with scienter, Aaron v. SEC, 446 U.S. 680, 701-02 (1980), which is "a mental state embracing intent to deceive, manipulate, or defraud," Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), and which can be shown by proof of intentional or reckless conduct. Novak v. Kasaks, 216 F.3d 300, 312 (2d Cir. 2000), cert. denied, 531 U.S. 1012 (2000); Press v. Chem. Inv. Serv. Corp., 166 F.3d 529, 537-38 (2d Cir. 1999). Knowledge, or reckless disregard, of the fraudulent scheme or the undisclosed information will also satisfy the scienter requirement. See, e.g., McDonald v. Alan Bush Brokerage Co., 863 F.2d 809, 814 (11th Cir. 1989); Woods v. Barnett Bank of Fort Lauderdale, 765 F.2d 1004, 1010 (11th Cir. 1985); IIT v. Cornfeld, 619 F.2d 909, 923 (2d Cir. 1980).
(47) Reckless conduct is conduct "which is `highly unreasonable' and which represents an `extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it." Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir. 1978). Such recklessness may be demonstrated through "defendants' knowledge of facts or access to information contradicting their public statements." Novak, 216 F.3d at 308. Proof of scienter can be inferred from circumstantial evidence. Herman & MacLean v. Huddleston, 459 U.S. 375, 390-91 n.30 (1983).
(48) Brightpoint violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by knowingly or recklessly engaging in conduct resulting in material misstatements in Brightpoint's Forms 10-K for the years ended December 31, 1998, 1999 and 2000. As described above, Delaney and Harcharik planned and executed a fraud that involved entering into a transaction with AIG for the sole purpose of misrepresenting Brightpoint's losses as insured losses. Brightpoint further participated in the scheme by filing periodic reports containing material misrepresentations and omissions. An issuer may violate the antifraud provisions if it makes misstatements or omissions of material fact in periodic reports or other public reports to investors. SEC v. Koenig, 469 F.2d 198 (2d Cir. 1972); SEC v. Great American Industries, Inc., 407 F.2d 453 (2d. Cir 1967), cert. denied, 395 U.S. 920 (1969); see SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454 (1969).
(49) In reports filed with the Commission, Brightpoint grossly overstated its operating results by 61% for the year ended 1998. It is well established that information concerning the financial condition of a company is presumptively material. Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 167 (2d Cir. 1980); see also SEC v. Blavin, 557 F. Supp. 1304, 1313 (E.D. Mich. 1983), aff'd, 760 F.2d 706 (6th Cir. 1985). Materiality judgments involve both quantitative and qualitative considerations. See Statement on Auditing Standards ("SAS") No. 47, Audit Risk and Materiality in Conducting an Audit, ¶¶ 6 and 7; Staff Accounting Bulletin ("SAB") No. 99, 64 Fed. Reg. 45150 (1999); see also Ganino v. Citizens Utilities Co., 228 F.3d 154, 163 (2d Cir. 2000) (adopting SAB No. 99 as useful guidance on materiality issues). One qualitative factor that weighs heavily in the finding of materiality is whether senior management knew of or took part in the financial statement fraud. See Appendix to SAS No. 53, The Auditor's Responsibility to Detect and Report Errors and Irregularities, at ¶ 3; SAS No. 19, Client Representations, ¶ 5. In light of the fact that these accounting improprieties were committed by Brightpoint's then controller and Chief Accounting Officer, it is substantially likely that a reasonable investor would have viewed the misstatement as significantly altering the total mix of information made available when purchasing Brightpoint securities.
(50) Brightpoint acted with scienter because the conduct and knowledge of its officer is attributed to the Company. See, e.g., Sharp v. Coopers & Lybrand, 649 F.2d 175, 182 n.8 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982) (affirming liability of accounting firm for its employee's conduct); SEC v. Management Dynamics, Inc., 515 F.2d 801, 811-13 (2d Cir. 1975) (affirming an antifraud injunction against a company based on the conduct of an officer acting within the scope of his authority); In re Sunbeam Securities Litigation, 89 F. Supp. 2d 1326, 1340 (S.D. Fla. 1999) (scienter of officers is properly imputed to the corporation). The scienter of Brightpoint's then controller and Chief Accounting Officer demonstrates the company's scienter: Delaney knowingly planned and directed a scheme to defraud public investors. Delaney entered into a transaction with AIG whereby Brightpoint deposited money with AIG and obtained the right to later withdraw the money as needed. Delaney worked together with AIG to conceal the true nature of the transaction by manipulating the language of the contract so that it would appear as a real insurance policy and not as a deposit-withdrawal transaction. Delaney used this transaction to mislead Brightpoint's auditors and obtain the desired accounting objective, allowing Brightpoint to offset its losses by $11.9 million in "insurance proceeds" from this transaction. Delaney also arranged for the signing and filing of public reports that he knew contained misrepresentations concerning the true nature of this transaction and the true extent of Brightpoint's losses.
(51) The final element necessary to establish a violation of the antifraud provisions is that the violative activity occur in connection with the purchase or sale of a security. This requirement is construed broadly. Superintendent of Ins. of State of N.Y. v. Bankers Life and Casualty Co., 404 U.S. 6, 12 (1971). Material misrepresentations or omissions contained in annual and quarterly reports and press releases are made in connection with an order, purchase, or sale of securities. See SEC v. Benson, 657 F. Supp. 1122, 1131 (S.D.N.Y. 1987); SEC v. Jos. Schlitz Brewing Co., 452 F. Supp. 824, 829 (E.D. Wis. 1978); Softpoint, 958 F. Supp. 846, 862-863, aff'd 159 F.3d 1348 (2d Cir. 1998). The material misstatements and omissions described above were contained in annual reports filed with the Commission, as well as in Brightpoint's press releases and registration statement. Accordingly, these material misrepresentations and omissions were in connection with the purchase or sale of Brightpoint's securities. Brightpoint thus violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(52) Section 17(a) of the Securities Act is violated when, in the offer or sale of securities, a person makes material misrepresentations or omits to state material facts that are necessary to prevent statements that are made from being misleading. Information is "material" if there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or if the information would significantly alter the total mix of available information. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). To establish liability for violations of Section 17(a)(1) of the Securities Act, the Commission must show that the defendant acted with scienter. Ernst & Ernst v. Hochfelder, et al., 425 U.S. 185, 201 (1976).9 In the Second Circuit, reckless conduct satisfies the scienter requirement. In re Complete Management, Inc., 2001 WL 314631, at *8 (S.D.N.Y. 2001); Sirota v. Solitron Devices, Inc., 673 F.2d 566, 573 (2d Cir.), cert. denied, 459 U.S. 838 (1982).
(53) Here, the registration statement filed by Brightpoint in September 1999 contained false and misleading statements regarding Brightpoint's operating results for the year ended 1998. Further, the misstatements were material because, as a result of the fraudulent conduct of its then senior accounting officer, the Company grossly overstated its net income by 61 percent, and it is substantially likely that a reasonable investor would view this information as altering the total mix of information made available when purchasing Brightpoint securities. Delaney acted with scienter because he knew about the material misstatements and omissions contained in Brightpoint's registration statement. As discussed above, Delaney's scienter establishes the Company's scienter. Therefore, Brightpoint violated section 17(a) of the Securities Act.
(54) At all relevant times, Brightpoint was a reporting company and subject to the provisions of Section 13(a) of the Exchange Act. Section 13(a) and Rule 13a-1 require issuers to file periodic reports with the Commission and to keep this information current. Rule 12b-20, which applies to all reports filed pursuant to Section 13 of the Exchange Act, requires disclosure of such additional information as may be necessary to make the required statements not misleading. Implicit in these provisions is the requirement that the information reported be true, correct and complete. See United States v. Bilzerian, 926 F.2d 1285, 1298 (2d Cir.), cert. denied, 502 U.S. 813, 112 S. Ct. 63 (1991); SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). No showing of scienter is necessary to establish an issuer's violation of the corporate reporting provisions, Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1. See SEC v. Wills, 472 F. Supp. 1250, 1268 (D.D.C. 1978). Consequently, an issuer violates the reporting provisions if it files materially false or misleading reports or omits information necessary to render the statements made not misleading. See SEC v. Koenig, 469 F.2d 198, 200 (2d Cir. 1972); see also Kaufman & Broad, Inc. v. Belzberg, 522 F. Supp. 35, 42 (S.D.N.Y. 1981)(Rule 12b-20).
(55) As described above, Brightpoint's annual reports contained material misrepresentations and omissions concerning the UK losses and the insurance available for those losses. Moreover, Brightpoint's First Restatement contained further misrepresentations and omissions concerning the accounting treatment for the AIG Policy. Accordingly, Brightpoint violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder.
(56) Section 13(b)(2)(A) of the Exchange Act requires issuers to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect its transactions and dispositions of assets. Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain an adequate system of internal accounting controls. Scienter and materiality are not elements of primary violations of either provision. See SEC v. McNulty, 137 F.3d 732, 740-741 (2d Cir. 1998); SEC v. WorldWide Coin Investments, Ltd., 567 F.Supp. 724, 749 (N.D. Ga. 1983). Brightpoint violated Section 13(b)(2)(A) of the Exchange Act by failing to make and keep books, records and accounts that accurately, and in reasonable detail, reflected its transaction with AIG, which included inaccurate entries relating to the First Restatement. Moreover, Brightpoint failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit preparation of financial statements in accordance with GAAP, thereby violating Section 13(b)(2)(B) of the Exchange Act. The Company's internal controls were not sufficient to prevent numerous false accounting entries to be recorded without proper basis or support.
(57) Rule 13b2-1 prohibits any person from directly or indirectly falsifying, or causing to be falsified, any book or record subject to Section 13(b)(2)(A). Scienter is not an element of a violation of Rule 13b2-1. McNulty, 137 F.3d at 740-741.
(58) As described above, Brightpoint's then Chief Accounting Officer knowingly falsified or caused others to falsify Brightpoint's books, records, and accounts, which were subject to the requirement by Section 13(b)(2)(A) of the Exchange Act that such books, records, and accounts be accurate. Brightpoint's then Chief Accounting Officer prepared, caused others to prepare, or gave substantial assistance in the preparation of falsified financial records that understated Brightpoint's true expenses on the income statement, overstated the Company's assets on the balance sheet and failed to properly account for the AIG Policy. Further, the then Chief Accounting Officer circumvented whatever internal accounting controls did exist at the Company. Moreover, both Brightpoint's President and its then Chief Financial Officer approved the AIG transaction without adequately reviewing a transaction that had a substantial impact on the Company's financial statements. Thus, Brightpoint violated Rule 13b2-1.
Brightpoint has undertaken and agreed to cooperate fully with the Commission in any and all investigations, litigations or other proceedings relating to or arising from the matters described in the Offer. In connection with such cooperation, Brightpoint has undertaken:
1. To produce, without service of a notice or subpoena, any and all documents and other information requested by the Commission's staff;
2. To be interviewed by the Commission's staff at such times as the staff reasonably may direct;
3. Upon the request of the Commission's staff, to waive any applicable privilege with respect to Brightpoint's internal investigation concerning the matters addressed in this Offer;
4. To appear and testify truthfully and completely without service of a notice or subpoena in such investigations, depositions, hearings or trials as may be requested by the Commission's staff; and
5. That in connection with any testimony of Brightpoint to be conducted at deposition, hearing or trial pursuant to a notice or subpoena, Brightpoint:
a. Agrees that any such notice or subpoena for Brightpoint's appearance and testimony may be addressed to its attorney, Alan Lieberman, Esq., Blank Rome LLP, 405 Lexington Avenue, New York, NY 10174-0208, and served by regular mail with a copy to Robert J. Mittman, Esq. Blank Rome LLP, 405 Lexington Avenue, New York, NY 10174-0208; and
b. Agrees that any such notice or subpoena for Brightpoint's appearance and testimony in an action pending in a United States District Court may be served, and may require testimony, beyond the territorial limits imposed by the Federal Rules of Civil Procedure.
In determining whether to accept the Offer, the Commission has considered these undertakings.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to by Brightpoint in its Offer. 10
Accordingly, it is hereby ORDERED that:
Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, Brightpoint shall cease and desist from committing or causing any violations, or committing or causing any future violations, of Section 17(a) of the Securities Act and Sections 10(b), 13(a) and 13(b)(2) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13b2-1 thereunder.
By the Commission.Jonathan G. Katz
Secretary
__________________
1 The findings herein are made pursuant to Brightpoint's Offer and are not binding on any other person or entity in this or any other proceeding.
2 The Trading Division was involved in the purchase of wireless handsets from sources other than manufacturers or network operators and in the sale of those handsets to other trading companies dealing in the secondary market.
3 Brightpoint terminated Delaney and Harcharik in February 2002, after the Commission's investigation was underway.
4 In this respect, Harcharik proposed that AIG and Brightpoint share in the litigation risk associated with Brightpoint's anticipated insurance coverage litigation under the Brightpoint Policies, with both AIG and Brightpoint splitting the proceeds if the litigation was successful. However, AIG viewed this proposal as a losing proposition.
5 Statement of Financial Accounting Standards ("SFAS") No. 5; Emerging Issues Task Force ("EITF") No. 93-5 (concerning environmental insurance); Statement of Position ("SOP") 96-1 (concerning environmental insurance).
6 When a policy affords retroactive coverage, it is not regarded as insurance for accounting purposes unless there is either an underwriting risk or a timing risk associated with the policy. When a loss has occurred and is known at the time the policy is written, there can be underwriting risk if the dollar amount of the loss is not fully known. Alternatively, if at the time the policy is written the dollar amount is both known and fixed, there can still be a timing risk if the actual payout may be delayed for many years. In such circumstances, the insurer might set the premium on the assumption that it will not have to pay for ten or twenty years. The risk is that payment may actually become due at an earlier time.
7 Over the life of the policy, Brightpoint's "claims" were paid upon the submission of a letter, saying simply that a loss had been sustained. AIG paid the claims without requiring further documentation.
8 Brightpoint's President was also its Chief Operating Officer.
9 The Commission need not show scienter to establish violations of Sections 17(a)(2) and (3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 697 (1980).
10 Brightpoint has agreed to pay a $450,000 civil penalty in a parallel civil action.
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