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Cady Bar the Door Insight & Commentary on SEC Enforcement Actions and Related Issues

SEC’s Secret Payments Brigade Marches On

Posted in Accounting Fraud, Whistleblowers

On Monday the SEC’s Miami Regional Office brought a settled enforcement action against Gilbert Fiorentino, a former director and officer of Systemax, Inc., a Long Island-based company that sells personal computers and other consumer electronics through its websites, retail stores, and direct mail catalogs.  The SEC’s complaint alleges that over the five years from 2006 through 2010, Fiorentino committed a number of violations that allowed him to be paid significantly in ways that were not disclosed to Systemax’s investors or even to Systemax itself.

As the chief executive of Systemax’s Technology Products Group, Fiorentino dealt directly with external service providers and manufacturer representatives that conducted business with Systemax.  In the five years at issue, Fiorentino received more than $400,000 in undisclosed compensation from these business partners.  The complaint curiously refers to “one or more” of these external service providers, but there were plainly more than one.  In one instance, Fiorentino shared one manufacturer representative’s monthly commissions generated from sales to Systemax’s subsidiary, Tiger Direct.  The rep was finally able to get free of this payment stream by agreeing to renovate Tiger Direct’s executive kitchen for $30,000.  Fiorentino also demanded $5,000 to $10,000 every month from an entity that supplied materials to Systemax’s subsidiaries for use in retail and mail order operations.  Fiorentino also misappropriated several hundred thousand dollars’ worth of Systemax merchandise.

Perhaps needless to say, Fiorentino failed to disclose these payments in a wide variety of contexts.  In his Sarbanes-Oxley Section 404 certifications, which required him to describe any conflicts of interest he had as a member of Systemax management, he falsely represented that he had none and that he had complied with the company’s internal controls.  He also routinely signed management representation letters to the company’s independent auditors that said he had no knowledge of fraud involving management or other employees.  Systemax was also required to disclose all of Fiorentino’s annual compensation, as one of the company’s highest paid executives, under Item 402 of Reg. S-K, as well as any transactions exceeding $120,000 in which it was a party and any director or executive officer had a material interest, under Item 404(a).  Fiorentino reviewed Systemax’s 10-Ks from 2006 through 2010, but allowed the annual statements to understate his compensation and omit his financial interests in the related party transactions described above.

The SEC charged Fiorentino with:

  • violating Section 10(b) of the Exchange Act and Rule 10b-5 (antifraud violations);
  • violating Section 13(b)(5) of the Exchange Act and Rule 13b2-1 (knowing record-keeping and internal control violations);
  • violating Rule 13b2-2 under the Exchange Act (lying to auditors);
  • violating Section 14(a) of the Exchange Act and Rules 14a-3 and 14a-9 (proxy violations);
  • aiding and abetting Systemax’s violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 (reporting violations); and
  • aiding and abetting Systemax’s violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act (books and records and internal control violations).

Three things about this case are interesting to me.

Illicit Payments

First, this Fiorentino matter is the latest in a long string of recent SEC matters involving people getting paid when they’re not supposed to.  Obviously the Commission’s wave of FCPA matters tops that list.  But it also includes pay-to-play cases in the public pension fund space, and even domestic commercial bribery, an area of misconduct that might have seemed beyond the SEC’s typical jurisdiction not so long ago.  In the same way, this case catches some pretty (allegedly!) thuggish behavior that one might have considered to be more akin to lunch money bullying than accounting fraud.  But if you’re going to engage in that sort of behavior as a senior officer of a Fortune 1000 company, the Exchange Act and the SEC’s reporting rules are going to apply to you, too.

Whistleblower Source

Second, this matter arose from an internal whistleblower complaint in January 2011 about Fiorentino’s actions at the company’s Miami office.  Systemax’s audit committee then launched an internal investigation, which the company disclosed in its 10-K filed in March of that year.  The complaint certainly did not have to mention the source of the investigation, but it did.  The complaint also noted that the initial tip was first reported internally, a dynamic the SEC wants to encourage both to bolster internal compliance programs and to refine the tips that eventually make their way to the Commission.  It may not be a matter that will lead to an award under the SEC’s whistleblower program, however.  While Fiorentino repaid his 2010 bonus of $480,000 and surrendered stock and stock options valued at up to $9.1 million in conjunction with his resignation from Systemax, he is paying a civil penalty of only $65,000 to settle this matter, well under the $1 million threshold necessary to trigger an award.

Aiding and Abetting

Finally, the SEC charged Fiorentino with aiding and abetting Systemax’s violations of a number of reporting, books and records, and internal controls provisions.  Systemax, though, is not a defendant in the matter, and as far as I can tell, never has been.  One of the elements of aiding and abetting liability is that a primary violation has taken place.  Here, the complaint assumes Systemax’s violations “based on the conduct alleged herein.”  I imagine the company is quite unhappy with the situation given that Fiorentino allegedly and repeatedly lied to Systemax and its auditors about his misconduct.  The complaint does not go deeply into the internal controls failures that might have sustained claims for primary violations that Fiorentino allegedly aided and abetted.  It is a bit odd, and not a situation I remember seeing before.