U.S. v. Natelli
| Decision Date | 19 April 1976 |
| Docket Number | D,1036,Nos. 1035,s. 1035 |
| Citation | 527 F.2d 311 |
| Parties | Fed. Sec. L. Rep. P 95,250, Fed. Sec. L. Rep. P 95,378 UNITED STATES of America, Appellee, v. Anthony M. NATELLI and Joseph Scansaroli, Defendants-Appellants. ockets 75--1004, 75--1008. |
| Court | U.S. Court of Appeals — Second Circuit |
John S. Martin, Jr., New York City (Martin, Obermaier & Morvillo, New York City, Philip A. Lacovara, Washington, D.C., Betty J. Santangelo, New York City, and Hughes, Hubbard & Reed, Washington, D.C., of counsel), for defendant-appellant Natelli.
Charles A. Stillman, New York City (Morrison, Paul, Stillman & Beiley, Peter H. Morrison, Benjamin Zelermyer and Edward D. Tanenhaus, New York City, of counsel), for defendant-appellant Scansaroli.
Franklin B. Velie, Asst. U.S. Atty., New York City (Paul J. Curran, U.S Atty., and Jed S. Rakoff, Audrey Strauss and John D. Gordan, III, Asst. U.S. Attys., of counsel), for appellee.
Victor M. Earle, III, and Cahill Gordon & Reindel (Howard J. Krongard, William E. Hegarty, Mathias E. Mone, George Wailand, New York City, of counsel), for Peat, Marwick, Mitchell & Co. as amicus curiae.
Cravath, Swaine & Moore, New York City (John R. Hupper, Robert Rosenman and J. Barclay Collins, New York City, of counsel), for American Institute of Certified Public Accountants as amicus curiae.
Before HAYS, MULLIGAN and GURFEIN, Circuit Judges.
Anthony M. Natelli and Joseph Scansaroli appeal from judgments of conviction entered in the United States District Court for the Southern District of New York on December 27, 1974 after a four week trial before the Hon. Harold R. Tyler and a jury. Judge Tyler imposed a one year sentence and a $10,000 fine upon Natelli, suspending all but 60 days of imprisonment, and a one year sentence and a $2,500 fine upon Scansaroli, suspending all but 10 days of the imprisonment.
Both appellants are certified public accountants. Natelli was the partner in charge of the Washington, D.C. office of Peat, Marwick, Mitchell & Co. ('Peat'), a large independent firm of auditors, and the engagement partner with respect to Peat's audit engagement for National Student Marketing Corporation ('Marketing'). Scansaroli was an employee of Peat, assigned as audit supervisor on that engagement.
Appellants were charged and tried only on Count Two of a multi-count indictment against other defendants connected with Marketing.
Count Two of the indictment charged that, in violation of Section 32(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78ff(a), 1 four of Marketing's officers and the appellants, as independent auditors, 'wilfully and knowingly made and caused to be made false and misleading statements with respect to material facts' in a proxy statement for Marketing dated September 27, 1969 and filed with the Securities and Exchange Commission (SEC) in accordance with Section 14 of the 1934 Act, 15 U.S.C. § 78n.
The proxy statement was issued by Marketing in connection with a special meeting of its stockholders to consider inter alia a charter amendment increasing its authorized capital stock and the merger of six companies, including Interstate National Corporation ('Interstate') into Marketing.
Count Two of the indictment further charged that appellants, in attempting to reconcile net sales and earnings as originally reported in the annual report for the fiscal year ending August 31, 1968 with the amounts shown in the statement of earnings in the proxy statement, filed less than a year later, created an explanatory footnote that was materially false and misleading. 2 It was alleged that 'as the defendants well knew but failed to disclose . . . (a) approximately one million dollars, or more than 20%, of the 1968 'net sales originally reported' had proven to be nonexistent by the time the proxy statement was filed and had been written off on (Marketing's) own internal books of account; (b) net sales and profits of 'pooled companies reflected retroactively' were substantially understated; and (c) net sales and profits of (Marketing) were substantially overstated.'
Count Two charged further that the proxy statement also contained an unaudited statement of earnings for the nine months ended May 31, 1969 which was materially false and misleading in that it stated 'net sales' as $11,313,569 and 'net earnings' as $702,270, when, in fact, as the defendants well knew, 'net sales' for the period were less than $10,500,000 and Marketing had no earnings at all.
In order to understand the theory of the government's case, we must retrace our steps to the beginning of the Peat engagement at Marketing. The jury could permissibly have found the following facts.
Marketing was formed in 1966 by Cortes W. Randell. It provided to major corporate accounts a diversified range of advertising, promotional and marketing services designed to reach the youth market. In April 1968 Marketing had its first and only public offering of stock. Peat was not its auditor at the time.
Peat took on the engagement in August 1968 after checking with the previous auditors that there had been no professional disagreement with management. Natelli, the partner in charge of Peat's Washington office, undertook the engagement to audit the financial statements of Marketing for the fiscal year ended August 31, 1968, and Natelli assigned Scansaroli to serve as supervisor on the engagement.
In late September or early October 1968 (after the close of the fiscal year), Randell and Bernard Kurek, Marketing's Comptroller, met with both appellants and discussed the method of accounting that Marketing had been using with respect to fixed-fee programs. In the fixed-fee program, Marketing would develop overall marketing programs for the client to reach the youth market by utilizing a combination of the mailings, posters and other advertising services offered by Marketing. Randell explained that Marketing and the client agreed upon a fixed fee to be charged for participating in the various programs. Randell stated that the company believed that it was proper to recognize income on these fixed-fee contracts at the time the clients committed themselves to participate in the programs presented to them by the account executives, and that this was the accounting method that had been used in preparing the financial statements for the period ended May 31, 1968, which had been distributed to stockholders.
After considering alternative methods of accounting, Natelli concluded that he would use a percentage-of-completion approach to the recognition of income on these commitments, pursuant to which the company would accrue that percentage of the gross income and related costs on a client's 'commitment' that was equal to the proportion of the time spent by the account executive on the project before August 31, 1968 to the total time it was estimated he would have to spend to complete the project.
The difficulty immediately encountered was that the 'commitments' had not been booked during the fiscal year, and were not in writing. The Marketing stock which had initially been sold at $6 per share was selling in the market by September 1968 for $80, an increase of $74 in five months. A refusal to book the oral 'commitments' would have resulted in Marketing's showing a large loss for the fiscal year--according to Kurek's computations, a loss of $232,000.
Scansaroli, upon Natelli's order, attempted to verify the 'commitments,' the sales not previously included in the company records, in a rather haphazard manner by telephone to representatives of companies which had purportedly indicated some intent to use Marketing's services. Pursuant to Randell's urging, Scansaroli did not seek any written verifications. He accepted a schedule prepared by Kurek which showed about $1.7 million in purported 'commitments.' He also received from the account executives forms indicating estimates of the gross amount of the client's commitment, the printing and distribution costs to be incurred on the program, and the account executive's estimate of the percentage of completion of the program.
On the basis of the above, Natelli decided not only to recognize income on a percentage-of-completion basis, but to permit adjustment to be made on the books after the close of the fiscal year in the amount of $1.7 million for such 'unbilled accounts receivable.' This adjustment turned the loss for the year into a handsome profit of $388.031, showing an apparent doubling of the profit of the prior year.
Appellants were not charged with a criminal violation with respect to this decision. It may be observed, however, that in the footnote to the audited financial statement for 1968 explaining this method of accounting for 'Contracts in Progress,' no indication is given of the flimsy nature of the evidence that such client 'commitments' actually existed.
After the 1968 audit had been given a full certificate by the auditors on November 14, 1968, Natelli in December 1968 told the officers of Marketing that in the future Peat would allow income to be recorded only on written commitments, supported by contemporaneous logs kept by the account executives with respect to each contract. A form letter was drafted to spell out a binding contractual commitment to be signed by each client.
In the meantime, following the issuance of the 1968 audited annual report and before the September 1969 proxy statement, seven companies were acquired largely in exchange for Marketing stock, in reliance on the 1968 annual report.
Things began to happen with respect to the $1.7 million of 'sales' that had been recorded as income after fiscal year end. Within five months of publication of the annual report, by May 1969, Marketing had written off over $1 million of the $1.7 million in 'sales' which the auditors had permitted to be booked.
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