The Securities and Exchange Commission today announced accounting fraud charges against two former top executives of a now-bankrupt online video management company, accusing them of falsifying financial statements to make the company appear more profitable than it was in reality.

The SEC alleges that then-CEO Kaleil Isaza-Tuzman and then-CFO Robin Smyth employed a variety of schemes to manipulate KIT Digital’s books and mislead investors, including an off-the-books slush fund used to generate payments back to the company and create the false appearance that KIT Digital was being paid for its products. 

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Isaza-Tuzman and Smyth.

“We allege that Isaza-Tuzman and Smyth brazenly falsified the financial condition of a public company and misled investors and auditors about the company’s revenues and ability to deliver the products it was touting,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.

According to the SEC’s complaint filed in federal court in Manhattan:

• In one scheme, Isaza-Tuzman and Smyth used KIT Digital’s own money to make it look like customer receivables were being paid.  They added $7.85 million in cash consideration to an acquisition transaction with the secret understanding that the seller would not receive any of that money.  Smyth instead had the money wired to third parties so at least $4.3 million was returned to KIT Digital as purported payments from customers.
• Isaza-Tuzman and Smyth caused KIT Digital to improperly recognize nearly $1.34 million in sales revenue for the quarter ended June 30, 2010, even though they knew or recklessly disregarded that the company had not delivered the required product to the purchaser and thus was not entitled to recognize revenue on the sale.  They worked to obtain a false confirmation of delivery from their customer, altered purchase order language to hide a product deployment schedule, and misled the company’s auditors into thinking that the purchaser’s website was being run on the software that KIT Digital had promised, when it was not.
• Isaza-Tuzman fraudulently failed to disclose that he had arranged with a hedge fund manager to use KIT Digital’s own money to trade the company’s stock to increase the volume or support the price at opportune moments.  Isaza-Tuzman hid the fact that $2 million in offshore investments were inappropriately being characterized as cash or cash equivalents when the company had no chance at readily getting its money back.

The SEC’s complaint charges Isaza-Tuzman and Smyth with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 as well as Rule 10b-5, and Section 13(b)(5) of the Exchange Act as well as Rules 13b2-1, 13b2-2, and 13a-14.  They’re charged with aiding and abetting violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13.  The SEC is seeking disgorgement of ill-gotten gains plus prejudgment interest and penalties as well as permanent injunctive relief and officer-and-director bars.

The SEC’s investigation has been conducted by Kristine Zaleskas, Kenneth Gottlieb, Adam Grace, Stephen Johnson, and Daphne Downes of the New York office and the litigation will be handled by Alexander Janghorbani and Ms. Zaleskas.  The case is being supervised by Sanjay Wadhwa.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Southern District of New York, the Federal Bureau of Investigation, the U.S. Postal Service, and the Public Company Accounting Oversight Board.