Calif. Execs Beat SEC Fraud Claims Amid Trial Fumbles
The Securities and Exchange Commission has come up short again in at trial, this time in a case against two executives at a now-defunct California start-up. A federal judge in Los Angeles tossed all seven causes of action against the execs on Dec. 10, capping a bench trial in which two SEC witnesses contradicted themselves and a third was found to be unreliable.
The SEC filed the suit in 2011 against Peter Jensen and Thomas Tekulve Jr., the former chair and CFO, respectively, of Basin Water Inc. The agency alleged that the pair improperly and fraudulently booked revenues related to six sales transactions in 2006–07, right after the company, which produced a novel water filtration technology, went public. The SEC also accused Jensen of insider trading. The 57-page complaint sought $250,000 in fines apiece, disgorgement and a permanent injunction.
Jensen turned to David Scheper at Scheper Kim & Harris, and Tekulve tapped Carolyn Kubota of O'Melveny & Myers. Kubota said the defendants fought the allegations from the start as misguided. The agency's regional office "really just misassessed the nature of the conduct," she said. "We felt the SEC didn't listen."
That appears to be an understatement. In Tuesday's 44-page ruling, U.S. District Judge Manuel Real found that three of the six key SEC witnesses had zero credibility, and that the SEC had no evidence to show that any fraud had been committed.
One government witness, former Basin Water CEO Michael Stark, contradicted earlier testimony and emails indicating that he was close to a businessman with whom the defendants negotiated one of the red-flagged transactions. A second SEC witness, a lawyer-intermediary for the counterparty in another disputed transaction, admitted on cross that he was suspended for 11 months from the practice of law by the Texas bar for ethical violations only two months earlier, and that he had been fined $600,000 by two state authorities for providing illegal debt relief services.
The testimony of a third SEC witness who had negotiated still another disputed transaction was likewise tossed after he admitted a past felony conviction that he denied during depositions. "Assessing these facts, along with [the witness's] demeanor and attitude during his testimony, the court places little weight on the substance of his testimony," the judge wrote.
Meanwhile, the SEC's accounting expert, the judge went on, was unpersuasive because her observations "relied excessively on hindsight in evaluating the accounting issues …. rather than viewing the facts as they existed at the time." And the SEC didn't call to the stand the company's outside auditor, even though the auditor had vetted all the allegedly fraudulent revenue booking transactions.
Kubota and Scheper argued that the accounting irregularities were simple mistakes, and in any case, the transactions and financial information were reviewed by the outside auditor, the company's audit committee, and an outside lawyer at Latham & Watkins. "We said, look, not every mistake is negligent, and not every mistake is a securities fraud," said Kubota.
In the end, the judge agreed. The SEC "has not presented any direct evidence that Jensen or Tekulve knowingly or intentionally misled anybody … there is no evidence of recklessness," Real wrote.
The loss couldn't come at a much worse time for the SEC. Just two months ago, a Texas jury cleared Dallas Mavericks owner Mark Cuban of SEC insider trading charges, and last week a Kansas jury cleared website contractor NIC Inc. of accounting fraud charges in another SEC trial.
Read more from our colleagues at The National Law Journal.
Correction: An earlier version of this story misidentified Basin Water as Basic Water. We regret the error.