U.S.S.E.C. v. Henke

• Decision Date: 31 July 2003
• Docket Number: No. C-98-4011 VRW.,C-98-4011 VRW.
• Citation: 275 F.Supp.2d 1075
• Court: U.S. District Court — Northern District of California
• Parties: UNITED STATES SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Steven J HENKE and Chan M Desaigoudar, Defendants.

275 F.Supp.2d 1075

UNITED STATES SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Steven J HENKE and Chan M Desaigoudar, Defendants.

No. C-98-4011 VRW.

United States District Court, N.D. California.

July 31, 2003.

John S. Yun, Securities & Exchange Commission, San Francisco, CA, for S.E.C.

Nina Wilder, Weinberg & Wilder, San Francisco, CA, for Steven J. Henke.

Frank R. Ubhaus, Jamie Lee Moore, Berliner Cohen, San Jose, CA, for Chan M. Desaigoud.

ORDER

WALKER, District Judge.

By this action, plaintiff United States Securities and Exchange Commission seeks civil penalties against defendant Chan M Desaigoudar for numerous violations of securities law. The case against Desaigoudar was tried before the court without a jury on December 16, 17 and 18, 2002. See Docs ##86-88. The matter was submitted upon filing of the parties' post-trial closing briefs on February 7, 2003. See Docs ##94-96. The court now makes its findings of facts and conclusions of law:

I FINDINGS OF FACT

1 Plaintiff is the United States Securities Exchange Commission (the SEC).

2 Defendant is Chan M Desaigoudar, an individual.

3 During the time in question, Desaigoudar was the chief executive officer and chairman of the board of directors of California Micro Devices (CMD), a corporation whose stock was traded on the open market. CMD, which Desaigoudar founded, supplies semiconductor and thin-film products.

4 In its 1994 Form 10-K, CMD represented that revenue from product sales is recognized upon shipment and that its financial information was presented in accordance with generally accepted accounting principles (GAAP). To recognize revenue in a particular fiscal period, CMD was required to ship the product before the end of the last day of the fiscal period. Alternatively, CMD could recognize revenue in a fiscal period by completing a "title transfer" of the goods in question if the customer previously signed documents indicating irrevocable acceptance of ownership of the goods.

5 During fiscal year 1994, which ended on June 30, 1994, CMD was experiencing cash flow problems due in part to production delays, extended payment terms to certain overseas customers and the failure of certain customers to make timely payment for goods received.

6 In order to improve the company's financial appearances and to position it for an advantageous strategic alliance that might bring in cash to alleviate the company's cashflow problems, CMD officials engaged in improper revenue recognition and accounting practices.

7 At the time, Desaigoudar was aware both of CMD's cashflow problems and of its improper revenue recognition and accounting practices.

8 In October 1993, Desaigoudar received a fax from the general manager of one of CMD's manufacturing facilities in Tempe, Arizona, discussing the company's practice in some cases of recognizing revenue for products that had not yet been shipped or manufactured.

9 In a memorandum dated January 24, 1994, Desaigoudar wrote to other company officers that attempts to collect on unpaid receivables were "dismal" and that it was "absolutely imperative that we run our company on a positive cash flow basis from now on." Pl Exh 262. Shortly thereafter, the company began to impose stricter credit terms for certain overseas customers.

10 In early 1994, Desaigoudar was aware not only that many customers owed substantial sums of receivables but that these receivables also included revenue booked for products that had not been shipped. In a memorandum dated March 18, 1994, Ron Romito, CMD's vice president and chief accounting officer at the time, referenced $3,835,000 in revenue characterized as "delayed shipment." Pl Exh 40 at 2.

11 Efforts to collect on these receivables were frequently discussed by CMD officers, including Desaigoudar, during the final quarter of fiscal year 1994.

12 On April 7, 1994, Desaigoudar, Romito and others met in Desaigoudar's office to discuss the company's current finances and the status of its ongoing collection efforts. See Pl Exhs 263, 264. These documents referred to $3,936,000 in "delayed shipment" and $4,354,000 in invoices during the third quarter for unshipped product issued at one of its manufacturing facilities, located in Milpitas, California. Pl Exh 264 at 6.

13 At the meeting, Romito emphasized the importance of cleaning up the revenue recognized in prior quarters before the end of the fiscal year by shipping as much product and collecting as much cash as possible before June 30, 1994. Desaigoudar acknowledged the importance of these goals. Desaigoudar further advised Romito not to use the term "delayed shipment" in future memoranda but instead to use the term "title transfers." Desaigoudar also urged others to keep quiet while CMD's revenue problems were being rectified.

14 Desaigoudar assigned Romito the task of determining how any write-off would be presented to investors. Desaigoudar, in agreement with other officers, advised that write-offs be characterized as cost of sale as opposed to a reduction in revenue because a higher revenue figure was preferable in the eyes of potential investors.

15 On May 3, 1994, CMD issued a press release announcing its results for the third fiscal quarter ending March 31, 1994. That press release, which listed Desaigoudar as a contact person, improperly included $3.9 million in second quarter revenue and $4.3 million in third quarter revenue for product that had not been shipped.

16 During the final quarter of fiscal year 1994, on May 5, 1994, CMD and Hitachi Metals Limited (Hitachi) announced that Hitachi had concluded its purchase of 880,000 CMD shares at a price of $24 per share as part of the companies' strategic alliance.

17 In July 1994, the company wrote off $12 million in revenues, but falsely attributed nearly all of the write-off to causes such as product returns, bad debt and warranties when in fact, between $5 and $7 million of the write-off resulted from unshipped product.

18 On August 4, 1994, with Desaigoudar's prior review and approval, CMD issued a press release with its fourth quarter and 1994 fiscal year results for the period ending June 30, 1994. The press release stated that CMD was taking a $12.7 million write-off in the fourth quarter, including $5.3 million for returned product, $1.7 million in cost of sales charges for terminated distributors and $1.3 million in bad debt expenses.

19 The August 4, 1994, press release also overstated CMD's revenues by including products shipped to freight forwarders rather than real customers.

20 Even though Desaigoudar knew that the write-off was necessitated by recognizing revenue for unshipped product, he nonetheless knowingly or recklessly misrepresented the write-off as a move to "strengthen the distribution channel in the Far East" because of the "top line distributors" who purportedly would become available as a result of CMD's strategic alliance with Hitachi. During the conference call, Desaigoudar further misrepresented the cause of the write-off by suggesting that CMD eliminated certain distributors because the company had received unsolicited requests for its products in other countries.

21 In response to the high volume of calls to the company concerning its reported fiscal year 1994 results, CMD decided to send a letter to shareholders. Desaigoudar authored a portion of the letter stating that the company's recent write-off was due to reforms to its distribution channels as the result of its strategic alliance with Hitachi. Desaigoudar falsely represented that the company expected to resell the inventory it had taken back from distributors, even though there was no basis to have made that statement.

22 On September 20, 1994, Desaigoudar and other company officers signed a representation letter to CMD's outside auditors, Coopers & Lybrand, falsely stating that the company's financial statements were fairly presented, that all material transactions had been properly recorded, that there were no accounting irregularities and that the company's receivable balance was correct. Desaigoudar testified that he did not read the representation letter before he signed it; accordingly, he recklessly signed a materially false or misleading representation letter to CMD's outside auditors.

23 On September 23, 1994, Desaigoudar and other company officials also signed CMD's Form 10-K filing for the fiscal year 1994. The Form 10-K, which was filed with the SEC on September 28, 1994, contained the annual revenue numbers that had appeared in the company's August 4, 1994, press release. The filing also falsely claimed that CMD had recorded a $5.3 million charge because it had terminated distributors as a result of the Hitachi strategic alliance. Desaigoudar admits that he reviewed a draft of the annual report containing these figures; hence, Desaigoudar knew that the revenue figures contained in the Form 10-K were false.

24 As part of his written plea agreement in related criminal proceedings, Desaigoudar admitted that during fiscal year 1994, he "became aware that customer accounts' [sic] receivable balances were far too high, that these balances were aging and would be difficult to collect. I understood that unless these problems were corrected by fiscal year end, we would have to reduce the value of accounts' receivable by substantial write-offs and/or write-downs. These problems were symptomatic of widespread accounting fraud at [CMD], including the booking of revenue for goods that had not been shipped or, in some cases, even manufactured. I should have known, based on documents and other information available to me, about the nature and scope of this fraud and should have undertaken additional remedial steps before the end of fiscal year 1994." Pl Exh 282 at 2.

25 Desaigoudar claims that he was deliberately deceived by other company officials concerning the state of CMD's financial affairs. Desaigoudar contends that he did not receive many of the communications...