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Joaquin M. Sena
LOCAL COUNSEL: James A. Howell (CA Bar No. 92721)
UNITED STATES DISTRICT COURT
Plaintiff Securities and Exchange Commission alleges: SUMMARY 1. This case involves revenue recognition fraud at Critical Path, Inc., a San Francisco-based e-mail outsourcing firm. In late 2000 and early 2001, defendantWilliam H. Rinehart, the head of Critical Path's North and Latin American sales forces, engaged with other persons in a scheme to inflate the company's revenue and earnings. Rinehart directed his sales force to arrange-and in each instance personally participated in-certain transactions for which Critical Path improperly recorded revenue of approximately $6.3 million for the fourth quarter of fiscal 2000. Rinehart then falsely stated in a letter to Critical Path's auditors that all of the company's sales were bonafide. Defendant Jonathan A. Beck, a vice president of sales at Critical Path, participated in one of these fraudulent transactions, for which Critical Path improperly recorded revenue totaling approximately $2.125 million. Defendant Kevin P. Clark, a regional vice president of sales at Critical Path, participated in certain transactions for which Critical Path improperly recorded revenue totaling approximately $2.15 million. 2. While the fraud was underway, Beck illegally sold a total of 27,348 shares of Critical Path stock on January 17 and 18, 2001-just before Critical Path announced its inflated fourth quarter and fiscal year 2000 financial results-based on information he possessed about the fraud and the company's true financial condition. Clark illegally sold a total of 16,325 shares of Critical Path stock on January 16 and 18, 2001, based on information he possessed about the fraud and the company's true financial condition. 3. As a result of the revenue recognition fraud, Critical Path filed materially incorrect financial statements with the Commission on November 14, 2000 for the quarter ended September 30, 2000, and on January 18, 2001 issued a press release announcing materially incorrect financial results for the quarter and year ended December 31, 2000. The fraud was uncovered in February 2001. In April 2001, Critical Path restated its financial results for the third quarter and revised results for the fourth quarter and full year 2000, as follows:1
4. By engaging in the acts alleged in this complaint, Rinehart, Beck, and Clark violated, or aided and abetted violations of, the antifraud, books and records, internal accounting controls, and reporting provisions of the federal securities laws, and unless enjoined by this Court will continue to do so. JURISDICTION 5. This Court has jurisdiction pursuant to Sections 21(d) and (e), 21A and 27 of the Securities Exchange Act of 1934 (Exchange Act) [15 U.S.C. Sections 78u(d) and (e), 78u-1 and 78aa]. The Commission requests that the Court permanently enjoin each of the defendants from engaging in further violations; impose civil penalties upon Rinehart, Beck, and Clark for participating in the accounting fraud; bar Rinehart from acting as an officer or director of any reporting company; and order Beck and Clark to disgorge the amounts by which they were unjustly enriched, plus prejudgment interest, and pay civil penalties for insider trading. 6. The defendants, directly or indirectly, used the means or instrumentalities of interstate commerce, or of the mails, or the facilities of a nationalsecurities exchange in connection with the transactions, acts, practices, and courses of business alleged in this complaint. 7. Certain of the acts, practices, and courses of conduct constituting the violations of law alleged in this complaint occurred within this judicial district. INTRA-DISTRICT ASSIGNMENT 8. Assignment to the San Francisco Division is appropriate pursuant to Civil Local Rule 3-2(d) because a substantial part of the conduct alleged in this complaint occurred in the County of San Francisco, in the Northern District of California. DEFENDANTS 9. Defendant William H. Rinehart, age 38, was at all relevant times the head of Critical Path's North and Latin America sales forces. He held this position from November 1998 until February 2001, and for part of that period was the head of the company's worldwide sales. At all times relevant, Rinehart resided in San Francisco, California. 10. Defendant Jonathan A. Beck, age 33, was employed by Critical Path, Inc. from November 1998 until February 2001. During the relevant period he was a vice president of sales. Beck resides in San Francisco, California. 11. Defendant Kevin P. Clark, age 36, was employed by Critical Path, Inc. from November 1998 until February 2001. During the relevant period he was a regional vice president of sales. Clark resides in Pleasanton, California. THE ISSUER 12. Critical Path is a California corporation with principal offices in San Francisco. From its initial public offering in March 1999 to the present, Critical Path's common stock has been registered with the Commission pursuant to Section 12(g) of the Exchange Act [15 U.S.C. Section 78l(g)] and has been quoted on the Nasdaq Stock Market. The company is a provider of Internet messaging infrastructure products and services. MID-2000: CRITICAL PATH PREDICTS IT WILL BE PROFITABLE
13. On July 19, 2000, Critical Path reported a loss for the second quarter of fiscal 2000 of $20.2 million or thirty-four cents per share (excluding special charges). When the company's chief executive officer announced these results, he predicted that for the fourth quarter of 2000 Critical Path would, for the first time, report a profit (excluding special charges). 14. In October 2000, Critical Path's chief executive officer publicly stated that the company was increasing its fourth quarter revenue estimate from $54 million to $56 million and reiterated his earlier prediction that the company would earn its first quarterly profit-one cent per share. On November 2, Critical Path issued a press release reiterating that guidance. RINEHART AND OTHERS CONCLUDE THAT CRITICAL PATH WILL
15. By the final week of December 2000, however, Rinehart and others at Critical Path concluded the company would not achieve the revenue and earnings goals the company had announced. Critical Path's president told Rinehart to get approximately $4 million in "back pocket" deals (meaning fictitious sales that would be recorded as revenue only if needed). The president also told Rinehart that when the purported customers failed to pay, Critical Path could use its bad debt reserve to absorb the losses. 16. Generally Accepted Accounting Principles (in particular, AICPA Statement of Position 97-2) required that Critical Path satisfy the following four criteria prior to recognizing revenue on the sale of its software: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the vendor's fee is fixed or determinable, and (iv) collectibility is probable. With the delivery criterion in mind, on December 27, 2000 the president e-mailed Rinehart: "Make sure that any deals which may be completed after year end have had software shipped before year end." Rinehart relayed this instruction to Beck, Clark and other sales managers. AT RINEHART'S INSTRUCTION, CLARK AND OTHER SALESMEN ARRANGE A $2 MILLION FICTITIOUS SALE 17. Rinehart and other Critical Path sales personnel, including Beck and Clark, implemented the plan to get "back pocket" deals. On or about December 29, 2000, Clark and another Critical Path salesman called a former employee-who was working for a ticket brokerage firm-to ask him to sign a product "evaluation" agreement to help Critical Path with its year-end numbers. Clark assured the former employee that the agreement would expire in thirty days and that there was a 99 percent chance that Critical Path would not need to use it. But on or about January 5, 2001, Clark and another salesman met the former employee at a bar and arranged for him to sign-and backdate to December 29, 2000-a software license agreement ostensibly committing the ticket brokerage firm to pay Critical Path approximately $2 million. Rinehart signed the software license agreement on behalf of Critical Path. In fact, neither party ever intended to honor the contract, and Rinehart and Clark knew this. 18. On or before January 9, 2001, Beck learned that Critical Path had entered into a sham $2 million software license agreement with the ticket brokerage firm referred to in paragraph 17 above. 19. When Critical Path initially announced its fourth quarter results in January 2001, it included in revenue the $2 million recorded for the fictitious software license agreement with the ticket brokerage firm. In April 2001, after completing an internal investigation and its annual audit, Critical Path permanently reversed this revenue. RINEHART, BECK, AND ANOTHER SALESMAN ARRANGE A SECOND $2 MILLION FICTITIOUS SALE 20. Beginning in late-December 2000, Rinehart, Beck, and another Critical Path salesman arranged a fictitious transaction with a near-bankrupt Internet shopping provider. Rinehart had a Critical Path salesman contact a former colleague, who now worked for the Internet shopping provider. The former colleague agreed to"evaluate" Critical Path software, but warned the Critical Path salesman that under no circumstance would his company purchase the product. Beck knew that Rinehart's purpose in instructing the sales force to prepare evaluation agreements and ship software before year-end was to further the scheme to improperly record revenue in the fourth quarter 2000. Following Rinehart's instruction, on or about December 29, 2000, Beck directed the other Critical Path salesman to prepare a non-binding software evaluation agreement between Critical Path and the Internet shopping provider. On or about January 5, 2001, Rinehart told Beck and the other Critical Path salesman to prepare a software license agreement for the Internet shopping provider and that Critical Path would record revenue-in the fourth quarter 2000-for the transaction. The other salesman forged the signature of the Internet shopping provider employee on the agreement, ostensibly committing the company to pay Critical Path $2.125 million. Rinehart signed the software license agreement on behalf of Critical Path. Neither Critical Path nor the Internet shopping provider ever intended to honor the contract, and Rinehart, Beck, and others at Critical Path knew this. Beck understood that-as part of the deception-the deal with the Internet shopping provider would be written off as bad debt during the first quarter 2001. 21. When Critical Path initially announced its fourth quarter results in January 2001, it included in revenue the $2.125 million recorded for the fictitious software license agreement with the Internet shopping provider. In April 2001, after completing an internal investigation and its annual audit, Critical Path permanently reversed this revenue. RINEHART AND OTHER SALESMEN ARRANGE A BACKDATED $2 MILLION CONTRACT THAT WAS SUBJECT TO MATERIAL CONDITIONS 22. In January 2001 Critical Path salesmen were attempting to sell software to a company that provides Internet access to schools. The customer conditionally entered into a $2.221 million software license agreement, after its chief executive officer insisted on a "unilateral way out of the contract." With the companypresident's authorization, Rinehart issued side letters to the customer on behalf of Critical Path. One of the letters stated that the agreement was "subject to veto and termination at the sole discretion" of the customer. The other extended the payment terms and stated that if the customer "determines in its sole discretion that adequate funding is not available," the project would terminate and the customer would owe no additional money to Critical Path. The $2.221 million contract, signed by the customer on or about January 5, 2001, was backdated to December 2000. 23. When Critical Path initially announced its fourth quarter results in January 2001, it included in revenue the $2.221 million recorded for the purported software license agreement with the provider of Internet access to schools. In April 2001, after completing an internal investigation and its annual audit, Critical Path permanently reversed this revenue. CLARK ARRANGES FOR A SALES AGREEMENT TO BE BACKDATED 24. In late December 2000, Clark concluded that he would not be able to close, before the end of the year, a sale he was negotiating-worth $146,000-with a company that created and operated entertainment web sites. Heeding Rinehart's instruction-that deals not concluded until January could still be counted as revenue in the fourth quarter if Critical Path shipped software to the customer before year-end-Clark shipped software to the prospective customer in December. In early January 2001, the customer agreed to purchase the software. To enable Critical Path to include revenue from this sale in its fourth quarter 2000 results, Clark directed a subordinate to backdate the contract to December 2000. Critical Path included this sale in the fourth quarter results it initially announced. Rinehart signed the software license agreement on behalf of Critical Path. In April 2001, after completing the internal investigation and annual audit, Critical Path removed the transaction from its fourth quarter results and included it in its first quarter 2001 results. RINEHART MISLEADS CRITICAL PATH'S AUDITORS 25. On January 12, 2001, Rinehart signed a management representationletter to Critical Path's auditors. It contained the following statements that Rinehart knew were false:
BECK'S AND CLARK'S UNLAWFUL INSIDER TRADING DURING
26. On January 17 and 18, 2001, Beck sold 27,348 Critical Path shares for proceeds of $668,412. On January 16 and 18, 2001, Clark sold 16,325 shares of Critical Path stock for proceeds of $392,115. Beck and Clark sold these shares at least in part because they knew that the company had recorded a material amount of revenue in the fourth quarter from backdated and fictitious software license agreements, and that if the market learned of Critical Path's true financial results, the company's stock price would fall. 27. Beck and Clark also knew the company's blackout rules did not permit them to sell company stock when they did. On November 30, 2000, all Critical Path employees had received an e-mail from the company's stock administrator saying that the trading window for Group A&B Insiders (which Beck and Clark knew included sales managers like themselves) would be closed from December 6, 2000 until the close of business on the second day following the company's announcement of its fourth quarter results. Also on November 30, 2000, the stock administrator e-mailed Critical Path's worldwide staff an "URGENT reminder re Insider Trading Policy" and attached to it a copy of Critical Path's insider trading policy, which warned against trading on material nonpublic information and prohibited Group B Insiders (which included Beck and Clark) from trading during the first month of any calendar quarterwhen Critical Path's trading window was closed (which included January 2001). CRITICAL PATH MATERIALLY OVERSTATES RESULTS BUT STILL MISSES FOURTH QUARTER ESTIMATES 28. After the Nasdaq Stock Market closed on January 18, 2001, Critical Path announced unaudited condensed consolidated operating results for the fourth quarter and year 2000 "prepared and presented in accordance with generally accepted accounting principles." The results the company announced for the fourth quarter were materially overstated but still below consensus estimates for both revenue and earnings. Critical Path had forecast a one cent per share profit on revenue of $54 to $56 million. It now reported a net loss of $11.5 million for the quarter (excluding special charges), or sixteen cents per share, on revenue of $52 million. On news of the missed quarter, Critical Path's stock price plummeted. By the close of the first full day of trading after the announcement, it had dropped 55%, from $20 to $9. CRITICAL PATH FORCES OUT RINEHART AND ITS PRESIDENT, AND FIRES BECK; CLARK RESIGNS, AND CRITICAL PATH'S SHARE PRICE DROPS TO APPROXIMATELY $3 29. On February 2, 2001, before the Nasdaq Stock Market opened, Critical Path issued a press release disclosing that its board had formed a special committee to conduct an investigation into the company's revenue recognition practices, and that it now believed that the results the company announced on January 18 might have been materially misstated. It further stated that the board had placed the company's president and Rinehart on administrative leave. Nasdaq suspended trading in the stock pending the company's release of accurate financial results. 30. In February 2001, Rinehart and Critical Path's president were forced to resign, and several sales employees, including Beck, were fired. Clark preemptively resigned because he assumed that he too would be fired. 31. Trading in Critical Path's stock resumed on February 15 after the company announced, on a preliminary basis, that it would revise its fourth quarter revenue downward by between $6.5 and $8 million, and that approximately $4.2million of the revision would involve transactions that would never result in revenue. That day, Critical Path's share price closed at $3.06, a decline of approximately 70% from $10.06, the last Nasdaq price before the trading halt. On February 16, 2001, Critical Path's first full trading day since the Nasdaq Stock Market had suspended its trading, Critical Path's share price closed at $3. 32. Critical Path's February 2 and February 15, 2001 announcements-that its previously disclosed financial results might have been materially misstated and would be revised downward-caused the dramatic decline in Critical Path's stock price. Beck avoided losses of $586,368 by selling 27,348 Critical Path shares before that decline. Clark avoided losses of $343,140 by selling 16,325 shares of Critical Path stock before the decline. CRITICAL PATH RESTATES ITS RESULTS 33. Critical Path's report on Form 10-K for fiscal 2000-filed with the Commission on April 5, 2000-restated and revised the company's financial results as shown in the chart in paragraph 3 above. FIRST CLAIM Rinehart, Beck, and Clark Violated Section 10(b) of the Exchange Act [15 U.S.C.
34. Paragraphs 1 through 33 are realleged and incorporated herein by reference. 35. Rinehart, Beck, and Clark knowingly or recklessly participated in material misrepresentations and omissions of fact with the intent of inflating Critical Path's reported fourth quarter 2000 revenue and earnings. 36. By reason of the foregoing, Rinehart, Beck, and Clark violated Section 10(b) of the Exchange Act [15 U.S.C. Section 78j(b)] and Rule 10b-5 thereunder [17 C.F.R. Section 240.10b-5]. SECOND CLAIM Beck and Clark Violated Section 10(b) of the Exchange Act [15 U.S.C. Section 78j(b)] and Exchange Act Rule 10b-5 [17 C.F.R. Section 240.10b-5] [Insider Trading] 37. Paragraphs 1 through 36 are realleged and incorporated by reference herein. 38. Beck and Clark sold Critical Path stock on the basis of material nonpublic information concerning Critical Path's true financial condition, in breach of their fiduciary duties to Critical Path and its shareholders. 39. By reason of the foregoing, defendant Beck and Clark violated Section 10(b) of the Exchange Act [15 U.S.C. Section 78j(b)] and Rule 10b-5 thereunder [17 C.F.R. Section 240.10b-5]. THIRD CLAIM Rinehart, Beck, and Clark Violated Section 13(b)(5) of the Exchange Act [15 U.S.C. Section 78m(b)(5)] and Exchange Act Rule 13b2-1[17 C.F.R. Section 240.13b2-1] and Aided and Abetted Violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act [15 U.S.C. Sections 78m(b)(2)(A) and 78m(b)(2)(B)] [Books-and-Records and Internal Controls Violations] 40. Paragraphs 1 through 39 are realleged and incorporated herein by reference. 41. Rinehart, Beck, and Clark deliberately circumvented existing internal accounting controls in order to falsify Critical Path's books and records. 42. Rinehart, Beck, and Clark, directly or indirectly, falsified or caused to be falsified, books, records, or accounts described in Section 13(b)(2) of the Exchange Act [15 U.S.C. Section 78m(b)(2)]. 43. Rinehart, Beck, and Clark knowingly and substantially participated in a scheme to cause false and misleading entries in Critical Path's books and records. By doing so, Rinehart, Beck, and Clark aided and abetted Critical Path's failure to make and keep books, records, and accounts which, in reasonable detail, accuratelyand fairly reflected the company's transactions and dispositions of its assets. 44. Rinehart, Beck, and Clark knowingly and substantially contributed to Critical Path's failure to maintain its internal accounting controls. By doing so, Rinehart, Clark and Beck aided and abetted the company's failure 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 conformity with GAAP. 45. By reason of the foregoing, Rinehart, Beck, and Clark violated Section 13(b)(5) of the Exchange Act [15 U.S.C. Section 78m(b)(5)] and Exchange Act Rule 13b2-1 [17 C.F.R. Section 240.13b2-1], and aided and abetted violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act [15 U.S.C. Sections 78m(b)(2)(A) and 78m(b)(2)(B)]. FOURTH CLAIM Rinehart Violated Exchange Act Rule 13b2-2 [17 C.F.R. Section 240.13b2-2] [Misleading the Auditors] 46. Paragraphs 1 through 45 are realleged and incorporated herein by reference. 47. Rinehart made materially false statements to accountants in connection with an audit of Critical Path's financial statements by issuing a materially false representation letter to Critical Path's auditors. 48. By reason of the foregoing, Rinehart violated Exchange Act Rule 13b2-2 [17 C.F.R. Section 240.13b2-2]. PRAYER FOR RELIEF WHEREFORE, the Commission respectfully requests that this Court: I. Permanently restrain and enjoin Rinehart, and his agents, servants, employees, attorneys, and assigns, and those persons in active concert or participation with him, andeach of them, from violating Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. Sections 78j(b) and 78m(b)(5)] and Exchange Act Rules 10b-5,13b2-1, and 13b2-2 [17 C.F.R. Sections 240.10b-5, 240.13b2-1 and 240.13b2-2], and from aiding and abetting violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act [15 U.S.C. Sections 78m(b)(2)(A) and 78m(b)(2)(B)]. II. Permanently restrain and enjoin Beck and Clark, and their agents, servants, employees, attorneys, and assigns, and those persons in active concert or participation with them, and each of them, from violating Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. Sections 78j(b) and 78m(b)(5)] and Exchange Act Rules 10b-5 and 13b2-1 [17 C.F.R. Sections 240.10b-5 and 240.13b2-1], and from aiding and abetting violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act [15 U.S.C. Sections 78m(b)(2)(A) and 78m(b)(2)(B)]. III. Order Rinehart, Beck, and Clark to pay civil monetary penalties under Section 21(d)(3) of the Exchange Act [15 U.S.C. Section 78u(d)(3)]. IV. Enter an order under Section 21(d)(2) of the Exchange Act [15 U.S.C. Section 78u(d)(2)] prohibiting Rinehart from acting as an officer or a director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act [15 U.S.C. Section 78l] or that is required to file reports pursuant to Section 15(d) of the Exchange Act [15 U.S.C. Section 78o(d)]. V. Order Beck and Clark to disgorge all losses avoided from their unlawful trading alleged in this complaint, with prejudgment interest. VI. Order Beck and Clark to pay civil monetary penalties under Section 21A of the Exchange Act [15 U.S.C. Section 78u-1]. VII. Grant such other relief as this Court may deem just and appropriate. Dated: August 22, 2002 Washington, DC
OF COUNSEL: William R. Baker III
LOCAL COUNSEL: James A. Howell (CA Bar No. 92721)
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http://www.sec.gov/litigation/complaints/comp17701.htm
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