S.E.C. v. Adoni

• Decision Date: 31 August 1999
• Docket Number: No. CIV.A.97-350 (JAG).,CIV.A.97-350 (JAG).
• Citation: 60 F.Supp.2d 401
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Jacob ADONI and Victor Douenias, Defendants.
• Court: U.S. District Court — District of New Jersey

60 F.Supp.2d 401

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Jacob ADONI and Victor Douenias, Defendants.

No. CIV.A.97-350 (JAG).

United States District Court, D. New Jersey.

August 31, 1999.

Mark Kreitman, Securities and Exchange Commission, Washington, DC, for Plaintiff.

Jonathon D. Warner, Warner & Joselson, New York City, for Defendants.

OPINION

GREENAWAY, District Judge.

This matter comes before the Court on Defendant Victor Douenias' ("Defendant") motion to dismiss Count One of Plaintiff Securities and Exchange Commission's ("SEC") Complaint. The SEC has filed a motion for summary judgment seeking a ruling in its favor on all counts of the Complaint. The SEC also seeks to strike the affidavit of Defendant's attorney, Jonathon D. Warner, and portions of Defendant's affidavit submitted in opposition to the SEC's motion for summary judgment. This Court heard oral argument on January 25, 1999.¹ For the reasons discussed below, Defendant's motion to dismiss is granted and the SEC's motion for summary judgment is denied.

FACTS²

Background and SEC activity

Defendant Jacob Adoni was the President, Chief Executive Officer, and a Director of the Simone Group, Inc. ("Simone"), a former Delaware corporation engaged in the shoe and handbag business.³ Defendant Douenias, Adoni's brother-in-law, was the head of operations for Simone.⁴ Simone purchased shoes from manufacturers and in turn sold them to customers under the brand name "L.J. Simone". Simone's securities were registered with the SEC pursuant to 12(g) of the Exchange Act and were traded on NASDAQ until July 16, 1990, when the stock was delisted.⁵

In December 1992, Simone filed with the SEC a registration statement proposing the issuance of a $2.7 million rights offering.⁶ The SEC's Division of Corporation Finance raised substantial objections to the registration statement. As a result, the offering was delayed. The offering was eventually withdrawn due to accounting irregularities discovered during Simone's fiscal year end audit.

The Fraudulent Prebilling Scheme

During all time periods relevant to the instant matter, Simone financed its operations through the services of a factor, Congress Talcott ("Talcott"). Talcott loaned Simone money based on a percentage of the company's outstanding accounts receivable, as evidenced by invoices for goods that had been shipped to customers. Talcott provided Simone with a $14.5 million line of credit against which Simone could borrow, up to 80% percent from its eligible accounts receivable.

In the ordinary course of business, Simone generated invoices only after shipping merchandise in response to customer orders. Those invoices would then be submitted to Talcott to obtain financing. Around 1988 or 1989, according to Douenias, Simone had employed a computer system where the invoices were generated before the products were shipped. Talcott, upon learning of Simone's system, informed Simone that this constituted "prebilling" and it was not proper procedure.⁷ Douenias was aware of that information.

During 1992, Simone experienced severe cashflow problems. By mid-1992, the company lacked sufficient funds, on several occasions, to secure the release of its inventory from its freight forwarder. Beginning in December 1992, Simone began prebilling again. Douenias directed Simone's employees to prepare the unshipped order invoices.⁸ Douenias then kept those invoices in his office, in a separate file apart from the legitimate invoices that were generated at the time the goods were shipped to customers.

When the fraudulent invoices were printed at Simone, an entry was automatically made on the daily sales journal. The daily sales journal was generated by a clerk who worked for Douenias and who, on a daily basis, submitted the journal to Simone's accounting department. Consequently, the generation of the fraudulent invoices resulted in fraudulent misrepresentations in other corporate books and records, including Simone's daily sales journals, general ledger and accounts receivable ledger. The unshipped order invoices caused Simone's daily sales journals, the general ledger and the accounts receivable ledger to reflect approximately $1.2 million of sales revenue that was recognized as of January 31, 1993, for goods that had not yet been shipped.

When the accounting department added the fraudulently recorded sales to the general ledger, the sales were booked and recognized as revenue. At the January 31, 1993, fiscal year end, Simone's financial statements reflected approximately $1.2 million of improperly recognized revenue. Simone presented these financial statements to its auditors, KPMG, in connection with the 1993 fiscal year end audit.

In April 1993, while conducting revenue and sales-cutoff tests as part of its audit of Simone's 1993 fiscal year, KPMG discovered serious discrepancies between dates that appeared on Simone's fraudulently generated invoices and the company's shipping records. The auditors determined that Simone had recorded and recognized approximately $1.2 million of revenue from the fraudulent invoices, and questioned Adoni about them. Adoni admitted to KPMG's Supervising Auditor, Richard B. Grant, that the receivables purportedly represented by the fraudulent invoices were uncollectible and should be written off. KPMG resigned the audit engagement immediately thereafter, citing an inability to rely on the representations of management. Simone reported KPMG's resignation in a Form S-K filed with the SEC on May 5, 1993. At or around that same time, Simone withdrew its registration statement with the SEC for the public offering. Thereafter, the SEC launched an investigation into Simone's fraudulent bookkeeping.

The SEC instituted this action on January 21, 1997. The SEC charged Defendants with violations of Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934. The SEC's Complaint seeks civil penalties and an injunction prohibiting Defendants from committing future violations of the securities laws. Defendant Adoni settled with the SEC and this Court entered a Final Judgment and Order against him on October 29, 1997. Defendant Douenias remains in this case as the sole defendant.

DISCUSSION

Defendant's Motion to Dismiss Count One

Count One of the SEC's Complaint alleges that Defendant violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. Defendant asserts that Count One of the Complaint must be dismissed pursuant to Federal Rule of Civil Procedure 12(b)(6).

Standard for Motion to Dismiss

A motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) may be granted only, if accepting all well-pleaded allegations in the complaint as true, and viewing them in the light most favorable to the Plaintiff, the Plaintiff is not entitled to relief. See Nami v. Fauver, 82 F.3d 63, 65 (3d Cir.1996); Holder v. City of Allentown, 987 F.2d 188, 194 (3d Cir.1993). The complaint "must set forth sufficient information to suggest that there is some recognized legal theory upon which relief may be granted." District of Columbia v. Air Florida, Inc., 750 F.2d 1077, 1078 (D.C.Cir.1984). This Court may not dismiss the SEC's Complaint unless it can "prove no set of facts" that would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); Graves v. Lowery, 117 F.3d 723, 726 (3d Cir.1997).

Section 10(b) of the Exchange Act

Section 10(b) of the Exchange Act provides that:

It shall be unlawful for any person, directly or indirectly ...

* * * * * *

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C.A. § 78j. Rule 10b-5 promulgated thereunder provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange.

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5 (1999). "The purpose underlying section 10(b) and the rules adopted under it is to insure that investors obtain disclosure of material facts in connection with their investment decisions regarding the purchase or sale of securities." Angelastro v. Prudential-Bache Securities, Inc., 764 F.2d 939, 942 (3d Cir.1985), cert. denied, 474 U.S. 935, 106 S.Ct. 267, 88 L.Ed.2d 274 (1985).

To establish a violation of Section 10(b) and Rule 10b-5, the SEC "must prove by a preponderance of the evidence all five of the following elements:" (1) a misrepresentation, or an omission (where there was a duty to speak), or other fraudulent device; (2) materiality in the case of a misrepresentation or omission; (3) in connection with the purchase or sale of a security; (4) scienter; and (5) the involvement of interstate commerce, the mails or a national securities exchange. S.E.C. v. Jakubowski, 912 F.Supp. 1073, 1079 (N.D.Ill.1996) (citations omitted); see also Angelastro, 764 F.2d at 942 n. 5. "The Supreme Court has declared that section 10(b) must be read `flexibly, not technically and restrictively.'" Angelastro, 764 F.2d at 942 (quoting Superintendent of Ins. v. Bankers Life and Casualty Co., 404 U.S. 6, 12, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971)).

Defendant argues that the SEC cannot show ...