The SEC obtained a $62,630,434.56 judgment against Tomo Razmilovic, the former CEO of Symbol Technologies, Inc. in its long running financial fraud action arising out of the fraud at the company. SEC v. Razmilovic, Case No. CV 04-2276 (E.D.N.Y.). The amount is one of the largest obtained by the Commission against an individual in a financial fraud action.
Mr. Razmilovic and his co-defendants are alleged to have engaged in a wide spread fraudulent scheme to inflate the revenue, earnings and other measures of financial performance so that Symbol would meet or exceed its financial projections. From 1998 through the fourth quarter of 2002 the defendants are alleged to have engaged in a variety of fraudulent accounting practices which included improper topside adjustments, a number of revenue recognition schemes and the manipulation of reserves, all of which distorted the financial results of the company.
Symbol restated its financial results for 1998 through 2001 following an internal investigation that was impeded by certain former employees. In that restatement the company reversed cumulative net revenue of $234,220,000 and cumulative net earnings of $325,536,000 that had been previously recognized through the period ended September 30, 2002. As of that date Symbol’s restated Stockholders’ Equity was $946,261,000 compared with $1,171,393,000 originally reported. According to the disclosures made in conjunction with the restatement, the adjustments were necessary because of “widespread errors and irregularities primarily involving the timing and amount of product and service revenues recognized and the timing an amounts recognized with respect to certain reserves, restructurings, certain option programs and several categories of cost of revenue and operating expenses.”
Mr. Razmilovic became president and COO of Symbol in 1995. In 2000 he was promoted to CEO. He resigned from that position in 2002. During the term of his employment he received a salary, incentive based compensation tied to the performance of the company as well as stock options. At the time of his resignation he was awarded a severance package.
The SEC brought a civil fraud action alleging a wide ranging financial fraud over the period of the restatement orchestrated by Mr. Razmilovic. Parallel criminal charges were also brought. Mr. Razmilovic fled the country although he defended the SEC case. The court entered a default judgment on the question of liability following his failure to appear for a deposition. At the hearing on remedies the Commission sought an injunction, disgorgement, prejudgment interest, civil penalties and an officer and director bar. Mr. Razmilovic appeared through counsel. Each side offered expert testimony to support its claims on the monetary issues.
The court began with the request for disgorgement. The question here, according to the court, is the amount of money acquired through wrongdoing. Generally, the amount should be a reasonable approximation of the profits which are causally connected to the violation. Where the fraud is pervasive the court concluded that it is reasonable to order the disgorgement of all ill-gotten gains realized during the course of the wrongful scheme rather than calculate the amount tied to each wrongful act. The focus of this calculation is the ill-gotten gains aside from what the defendant would have otherwise obtained. In making this calculation the costs incurred by the defendant are not deducted. The court then applied these principles to the types of compensation paid to Mr. Razmilovic:
Base salary: During the term of his employment Mr. Razmilovic received a base salary which was increased at the time of his promotion. The SEC sought as disgorgement the entire amount paid arguing that under his employment agreement his wrongful conduct was grounds for termination. Thus his fraudulent conduct would have precluded him from receiving payments from 1998 through 2002 when he resigned.
The court concluded however that the Commission did not establish a causal link between the base salary and the fraud. Rather, the evidence demonstrates that under Symbol’s policies the base salary was not tied to the financial performance of the company. Since Symbol remained a viable company throughout the fraud it is reasonable to infer that Mr. Razmilovic rendered some functions and service that were of value to the company despite the fraud. This contrasts with situations where the company only continued because of the fraud which might make it appropriate to disgorge all of the base salary.
The court concluded however that it is reasonable to assume that Mr. Razmilovic was promoted from COO to CEO based on the fraudulent metrics. Accordingly, he was directed to disgorge the increased amount of compensation he received. This totaled $932,247.84.
Bonuses: Under Symbol’s Executive Bonus Plan Mr. Razmilovic was paid in 1999 and 2000 based on the fraudulently reported numbers. Accordingly, he was directed to disgorge the total amounts which equaled $1,691,400.00.
Severance payment: Under the terms of his severance agreement Mr. Razmilovic was paid $5 million. Mr. Razmilovic argued that the SEC failed to establish a causal link between this payment and the fraud. The agreement however stipulated that the amount was paid in consideration of his relinquishment of certain stock options awarded in February 2001. Since that award is tied to the fraud, the payment must be disgorged the court concluded.
Stock transactions: The SEC also sought the disgorgement of all profits obtained from Symbol stock transactions by Mr. Razmilovic during the period. This includes his options and open market transactions.
Here the court concluded that disgorgement should be the amount of the ill-gotten gains which is the difference between the inflated value of the proceeds realized on the date the options were exercised and the value of the proceeds that otherwise would have been obtained absent the fraud. The court concluded that the SEC met its initial burden by establishing the amounts reported to the IRS by Mr. Razmilovic on his W-2s. At the same time “Razmilovic’s reliance on private securities fraud cases addressing the issue of inflation, but in the context of loss causation, is not misplaced. Although the SEC is not required to prove the element of loss causation in order to establish liability . . . it is required to prove a causal connection between the fraud and Razmilovic’s ill-gotten gains for the purpose of disgorgement.” Here the key question is when there was a corrective disclosure or the fraud materialized and caused the value of the securities to decline. Where the fraud has been concealed “a corrective disclosure is not necessary to establish causation . . . [and] a risk allegedly concealed by the defendants which subsequently materialized, caused the value of the securities to decline.” In this case, expert testimony offered by the SEC from an economist based on an event study demonstrated that the risk materialized over a period of time. The court discounted the defense expert who ignored key facts. Based on this methodology the court directed the disgorgement of $33,869,975.20 from the stock transactions.
Credits: Mr. Razmilovic claimed he is entitled to “credits” for the amounts paid in the settlement of parallel civil litigation and taxes. He also argued that he should not have to pay prejudgment interest in view of the amounts frozen during the case. The court rejected Mr. Razmilovic’s claim that he is entitled to a $2,250,000 credit for amounts paid in the private damage actions because the relief sought there differs from the disgorgement here. Nevertheless the court chose to exercised its direction and allow a credit if the amount is paid within 20 days.
The claim for a tax credit was rejected, concluding that there is no authority supporting a credit for taxes paid. While there is authority for not imposing prejudgment interest where the assets were frozen during the case, the principle applies where all of the ill-gotten funds were frozen. In this case it is clear that only a portion of those assets were frozen. The court thus imposed prejudgment interest.
The court also considered the question of penalties. Here the court concluded that “civil penalties authorized by the securities laws serve a dual purpose, i.e., to both punish the individual violator for his past violations and deter future violations . . . “ In assessing a penalty courts typically consider a series of factors keyed to the nature of the conduct, the scienter of the defendant, the risk of loss, acceptance of responsibility and the financial condition of the company. In this regard the court rejected Mr. Razmilovic’s claim that his penalty should be proportional to others in the case since those individual settled. In contrast, he is a fugitive. Nevertheless, the court declined to impose a penalty equal to the statutory amount which would equal the pecuniary gain in view of the sum involved. Accordingly, the court imposed a penalty equal to one half of the pecuniary gains or $20,876,811.32.
The court concluded by entering an order permanently enjoining Mr. Razmilovic from future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2) and 13(b)(5) and directing that he pay disgorgement of $41,753,623.04 plus prejudgment interest in addition to a civil penalty of $20,876,811.32. The court also barred Mr. Razmilovic from serving as an offer or director of a public company.
Program: The Impact of the Supreme Court’s Decision in Morrison v. National Bank of Australia on securities litigation and SEC enforcement actions. Presented by Celequ Legal Education in conjunction with West Thomson. Webcast on October 12, 2011 from 12:00 to 1:00 EST. For furtrher information please click here