An SEC enforcement action
alleged that senior corporate
officials misled the company’s
outside audit firm as part of a
fraudulent accounting scheme to
inflate revenues. The SEC
alleged that the company
overstated its sales revenues by
booking false sales and engaging
in improper revenue recognition
practices. The Commission
charged the company’s former CEO
and CFO and corporate secretary
for their roles in the
fraudulent accounting scheme.
The SEC also charged the former
controller and the former
director of financial services
for improper accounting. SEC
v. NutraCea, DC Ariz.
CV-11-0092-PHX-DGC, AAER No.
3324.
Without
admitting or denying the SEC's
allegations, the former CEO,
corporate secretary, controller
and financial services director
agreed to settle the action and
to the entry of permanent
injunctions. The CEO was
permanently barred from serving
as an officer or director and
the secretary agreed to a five
year bar. The accounting
professionals agreed to be
barred for at least one year
from SEC practice. The action
continues against the former
CFO, alleging that he violated
and aided and abetted violations
of the antifraud, books and
records, financial reporting,
internal controls, and lying to
auditors provisions of the
federal securities laws.
The SEC said
that in the second quarter of
fiscal year 2007 the company
improperly recorded a $2.6
million sale of four different
products to a purported
customer. The company had
attempted to book revenue from
the sale of these same products
to three different customers in
the previous quarter, but the
outside auditors disagreed with
the company’s assessment that
revenues from the sales were
appropriately recognized. The
CEO fought hard to convince the
outside auditors that the
revenue from these first quarter
sales should be booked. However,
the outside audit firm refused
to change its position and made
the company reverse the revenue,
causing a shortfall in revenues
by 47% from the same period one
year before.
In the next
quarter, the CEO was determined
to recognize revenue from the
sale of these same products.
Specifically, he approached the
customer’s president and asked
him to issue purchase orders for
$2.6 million of product.
According to the SEC, this
transaction was a complete sham
since the customer had no
intention of purchasing and
selling these products.
Under SEC
SAB No. 104, collectability must
be reasonably assured before
revenue can be recognized. In
this instance, reasoned the SEC,
collection of the receivable
could not be reasonably assured
because of the customer’s
precarious financial condition
and the dubious nature of the
sales arrangement. To further
substantiate this sham sale and
to support recognizing the
entire sale in the second
quarter, the CEO worked out a $1
million loan from the company’s
former COO to the customer to
enable the customer to make a
down payment on the $2.6 million
purchase
Despite
their knowledge that the $1
million down payment on the $2.6
million sale was from the
company’s former COO’s loan, the
CEO, CFO and the two accounting
professionals failed to disclose
this information to the outside
auditors. Instead, they
affirmatively misled the
auditors when they all signed a
management representation letter
related to the auditors’ review
of the interim financial
information of the second
quarter Form 10-Q falsely
representing that the interim
financial information was
presented in accordance with
GAAP. All financial records and
related data were made available
to the auditors, and they had no
knowledge of any fraud or
suspected fraud affecting the
company involving management,
employees who had significant
roles in the internal control,
or others where fraud could have
a material effect on the interim
financial information.