• The Danger of Doing Favors for Your Friendly Publicly Traded Company
  • April 8, 2004 | Author: Shannon Callaghan Reese
  • Law Firm: Trenam, Kemker, Scharf, Barkin, Frye, O'Neill & Mullis, Professional Association - Tampa Office
  • Most businesses have vendors that they have dealt with for many years who have supported them through thick and thin. Personal relationships are developed and mutual trust and confidence grows over the years. The companies' relationship partners play in charity golf tournaments together, serve together on community boards, and recognize that the growth of their business is mutually beneficial. From the customer's standpoint, a valued vendor is an incredible asset. In times of short supply, the customer can expect to get at least his fair share of product. At all times, he has a point person that he can rely on to deal with supply problems, inventory allocation, or new product education.

    After years of constant support from the vendor's point person, imagine the dilemma that you face, as a customer, when your vendor's key salesperson approaches you and asks for a favor. It really is nothing that will affect your business in any way. He simply wants you to help him take an aggressive position on a proposed sale of product to your company. You know that you have some interest in the product, but you are not sure yet that it will fit your needs. On the other hand, your vendor's representative explains that he needs to book the sale before the end of December so that he can meet his personal sales goals and assist the company in making its sales budget.

    You know that he works for a publicly traded company and you have commiserated with him over the years about the pressures he always faces in meeting his sales goals and the general pressure in the company for everyone to pitch in to make sure that the company achieves its projected sales numbers. Moreover, to protect you he is willing to give you a side letter of agreement that will allow you to cancel the order by January 15 if you ultimately decide that you do not wish to purchase the product. The vendor's sales representative explains to you that he cannot show the right of cancellation on the actual purchase order because that would affect his company's ability to recognize the revenue. Since you know that you will have made up your mind by January 15, you approve the transaction.

    Such a favor, when your vendor is a publicly traded company, could well result in a claim against your company, and any of the individuals involved in the transaction, for violation of the anti-fraud provisions of the federal securities laws, as well as federal laws governing internal accounting controls and record keeping requirements for publicly traded companies.

    On September 8, 2003, the Securities and Exchange Commission announced that it filed a lawsuit in federal district court against Vincent Steckler claiming that Mr. Steckler aided and abetted a publicly traded company, Legato Systems, Inc., in violating the antifraud provisions of the federal securities laws. Press Release, Securities and Exchange Commission, SEC Charges Former Logicon Executive, No. 2003-108 (September 8, 2003); See 15 U.S.C. §§ 78j(b), 78m(a), 78m(b)(2)(A), 78m(b)(5); 17 C.F.R. §§ 240.10b-5; 240.1362-1, 240.12b-20, 240.13a-13. Mr. Steckler, who was an executive at a privately held company, allegedly assisted two sales executives at Legato in drafting a side letter which would give Mr. Steckler's company the option to cancel a transaction for the purchase of software. Because Legato's finance department was not aware of the side letter, Legato improperly recognized the revenue on the order, resulting in improperly overstating its net income for the quarter ended September 30, 1999.

    Vendors should also be wary if a customer asks for a similar favor. On September 18, 2003, the SEC filed a similar lawsuit against David Slayton and Brian Wiegand, the respective chief financial officer and chief executive officer of NameProtect, Inc. Press Release, Securities and Exchange Commission, SEC and U.S. Attorney Charge Former Homestore Executives, No. 2003-120 (September 18, 2003). The SEC claimed Slayton and Wiegand aided and abetted Homestore, Inc., a customer that provided real estate listings, in violating the antifraud provisions of the federal securities laws by engaging in "round-trip" transactions to overstate revenue. The Commission alleged that Homestore paid NameProtect for services in amounts in excess of actual rates. In exchange, NameProtect used the excess funds to purchase advertising from media companies who then bought advertising from Homestore. Homestore then improperly recorded the funds as revenue. Slayton and Wiegand consented to the entry of an administrative cease-and-desist order.

    In civil litigation involving private individuals, the United States Supreme Court several years ago in Central Bank of Denver v. First Interstate Bank of Denver, 114 S. Ct. 1439 (1994), eliminated aiding and abetting liability in most civil lawsuits claiming violations of the federal securities laws. However, the SEC continues to have the authority to bring aiding and abetting claims for violations of the federal securities laws and, in the current environment, appears ready, willing, and able to do so. In the Steckler case, the SEC seeks injunctive relief and monetary penalties. It is unlikely that Mr. Steckler ever thought that he would have exposure to claims of violating the federal securities laws simply because he was doing a favor for a valued vendor. Worse yet, in the Homestore matter, the SEC conducted a joint investigation with the Justice Department, exposing the principals in the transaction to criminal fines and potential jail sentences. There is a new twist on the old cliché about deals that just don't meet the smell test. When dealing with a publicly traded company, a deal that is too good to be true, or smells bad, may also be an invitation to costly litigation against the SEC, even when your own company is privately held.