Risk & Compliance

SEC Nails Down Backdating, Fraud Cases

Allegations are settled that Quest Software wrongly granted millions of stock options, and that MedQuist boosted results with billing tricks that i...
Stephen TaubMarch 13, 2009

Stock-option backdating is back in the news, with Quest Software, a midcap provider of point-of-sale systems, settling civil charges by the Securities and Exchange Commission. The SEC also settled a fraud case against MedQuist Inc., a small-cap medical-transcription company.

The SEC charged that Quest, executive chairman Vincent Smith, former CFO John Laskey, and former controller and principal accounting officer Kevin Brooks improperly granted undisclosed in-the-money stock options to executives and employees by backdating millions of options from 1999 through 2002.

The software firm restated $113.6 million of its operating income in September 2007 as a result of the alleged misconduct. The company and the three individuals settled the SEC allegations without admitting or denying them. The executives also agreed to pay more than $300,000 combined.

“Today’s action reinforces that the commission will hold companies and executives accountable for engaging in misconduct that deceives investors,” said Rosalind Tyson, director of the SEC’s Los Angeles office.

According to the complaint, Quest failed to accurately describe its stock-option practices in its public filings and failed to properly account for the backdated options in its financial statements. This resulted in false and misleading disclosures in regulatory filings from 1999 through 2005.

Quest also was accused of backdating 28 separate grants involving more than 11 million shares of common stock. The company’s failure to properly record compensation expenses in connection with the backdated options caused operating income to be overstated by 4 percent to 963.1 percent and its operating loss to be understated by 26.12 percent to 154 percent from 1999 through 2005, according to the regulator.

The SEC also alleged that Smith and Laskey approved a policy by which Quest would pool stock-option grants each month and backdate the grants to coincide with the lowest stock price of the month. According to the complaint, although he knew about the use of hindsight to date option grants, Brooks failed to ensure the accuracy of Quest’s financial statements and disclosures.

Smith, Laskey, and Brooks also took steps to prevent Quest’s independent auditors from discovering the backdating, including the use of false written consents from Quest’s board of directors, the SEC claimed.

Smith, Brooks, and Laskey will pay civil penalties of $150,000, $60,000, and $50,000, respectively. Brooks also agreed to disgorge $34,775, representing half of the in-the-money value of backdated options he had exercised — he already paid back the other half to the company — and prejudgment interest of $5,808.29. He is suspended for five years from appearing or practicing as an accountant before the SEC.

In the other case, the SEC settled a civil injunctive action against MedQuist and a former company executive over alleged securities fraud and other violations.

The commission’s complaint alleged that, from 1999 to 2004, MedQuist claimed in SEC filings, press releases, and earnings calls that its strong financial performance was due to its disciplined and conservative business practices. Yet at the same time, it systematically and secretly inflated customer bills to increase revenues and profit margins, according to the charges.

Without admitting or denying the allegations, MedQuist agreed to be permanently enjoined from violating federal securities laws. Company president and chief operating officer John Donohoe, also without an admittance or denial, agreed to a $75,000 civil penalty and a five-year officer and director bar.

The commission alleged that Donohoe, among other things, knew the company was increasing its bills to meet revenue and margin targets, and that he and others misled shareholders and other public investors about the source of MedQuist’s success.

In a separate complaint, the SEC charged MedQuist’s ex-CFO Brian Kearns and ex-controller Bruce Van Fossen with participating in the fraudulent scheme.

The two allegedly knew company offices were not calculating bills in accordance with customer contracts, but rather were secretly manipulating the number of transcribed lines charged to customers in order to increase revenues and profit margins. Neither Kearns nor Van Fossen took steps to stop the scheme, the SEC asserted.

“Both knew that customers and employees complained of billing fraud, but neither investigated the accuracy of the company’s line counts,” the commission claimed.

The complaint further alleged that Kearns and Van Fossen made false statements to auditors designed to conceal the billing complaints and the scheme itself.


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