JOHN B. BULGOZDY, Cal. Bar No. 219897
Attorneys for Plaintiff
UNITED STATES DISTRICT COURT
Securities and Exchange Commission,
PETER J. WEBB,
COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS
Plaintiff Securities and Exchange Commission ("Commission") alleges as follows:
1. This Court has jurisdiction over this action pursuant to Sections 21(d)(1), 21(d)(3)(A), 21(e) and 27 of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78u(d)(1), 78u(d)(3)(A), 78u(e), & 78aa. Webb has, directly or indirectly, made use of the means or instrumentalities of interstate commerce, of the mails, or of the facilities of a national securities exchange in connection with the transactions, acts, practices and courses of business alleged in this Complaint.
2. Venue is proper in this district pursuant to Section 27 of the Exchange Act, 15 U.S.C. § 78aa, because certain of the transactions, acts,
practices and courses of conduct constituting violations of the federal securities laws occurred within this district.
3. This action concerns a financial fraud arising out of the reporting of materially false information by a public company, Digital Lava, Inc. ("Digital Lava"), carried out by Defendant Peter J. Webb ("Webb"), Digital Lava's former Vice President of Sales. Webb caused Digital Lava to materially overstate its revenue in an October 26, 2000 press release and a November 14, 2000 Form 10-Q for the quarter ended September 30, 2000.
4. The fraudulent scheme involved improper recognition of revenues from the sale of a new product by Digital Lava called the "Firestream" system. Webb attempted to meet his quarterly sales quota by entering into contingent sales orders for the Firestream system with certain third parties, and then concealing the contingent nature of these sales from Digital Lava's senior management and its auditors. Webb knew, or was reckless in not knowing, that Digital Lava could not properly report revenue from the contingent Firestream sales under generally accepted accounting principles ("GAAP").
5. As a result of Webb's conduct, Digital Lava overstated its revenue by $598,000 in a press release and Form 10-Q reporting its third quarter 2000 results. On March 21, 2001, Digital Lava restated its Form 10-Q for the third quarter of 2000, eliminating the $598,000, and reducing its reported revenues to $1,100,000. The overstatement represented 54% of Digital Lava's restated revenues.
6. Defendant Peter J. Webb is a resident of Southlake, Texas. In or around October 1999, Webb became Digital Lava's Vice President of Sales, and he held this position until his mutually agreed-upon termination from Digital Lavaon or about March 20, 2001. As Vice President of Sales, Webb was responsible for the sales of Digital Lava's products and reported to Digital Lava's Chief Executive Officer ("CEO").
7. Digital Lava, Inc. was incorporated in Delaware in 1996, and had its principal place of business in Marina Del Rey, California. Digital Lava provided digital publishing services and software products that created on-demand, interactive presentations, training and communication services. At all relevant times, Digital Lava's common stock was registered with the Commission pursuant to Section 12 of the Exchange Act, 15 U.S.C. § 78l, and was traded on the Nasdaq Stock Market. Digital Lava was dissolved as a corporation on January 30, 2002. On March 7, 2003, Digital Lava filed a Form 15 terminating the registration of its securities under the Exchange Act.
8. In order to sell its common stock and other securities to members of the public and maintain public trading of its securities, Digital Lava was required to comply with statutes, rules, and regulations designed to ensure that its financial information was accurately recorded and disclosed to the investing public. Under these statutes, rules, and regulations, Digital Lava had a duty to, among other things: (a) make and keep books, records, and accounts which, in reasonable detail, accurately and fairly reflected its transactions and disposition of assets; (b) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP or any other criteria applicable to such statements and to maintain accountability for assets; and (c) file with the Commission quarterly reports on Form 10-Q for each of the first three quarters of each fiscal year, including financial statements that disclosed its financial condition and results of business operations for each three-month period. Digital Lava used a calendar year as its fiscal year.
9. Under GAAP, the Commission's rules and regulations, and Digital Lava's own publicly stated accounting policies, Digital Lava could recognize revenue from sales during a particular reporting period only if (a) persuasive evidence existed of a sales arrangement with a dealer; (b) delivery of the product had occurred; (c) the price for the product was fixed or determinable; and (d) collectibility of the sales price was reasonably assured.
10. During the third quarter of 2000, Digital Lava introduced a new product called the "Firestream" system. Firestream was a real-time encoding station that took video and audio and formatted it for distribution over the Internet. Webb was the primary individual responsible for Firestream sales. Digital Lava's standard sales process for Firestream was to sell the systems to dealers, who in turn sold the systems to end-users. Digital Lava required all terms and conditions of a sale to a dealer to be stated on the purchase order.
11. For the third quarter of 2000, Webb's sales quota was approximately $1.8 million. Webb knew that Digital Lava's CEO had committed to analysts that Digital Lava would have a considerable increase in sales from the second quarter to the third quarter of 2000. Webb estimated that the only way to reach the projected sales figures was by offering flexible terms to dealers. However, during the third quarter of 2000, Digital Lava's Chief Financial Officer ("CFO") discussed revenue recognition with Webb, and specifically told Webb that there could not be any side agreements (i.e. agreements not reflected in a purchase order) with dealers. Webb knew that Digital Lava was a public company which had to disclose its financial information to the public accurately.
12. At the end of the third quarter, Webb appeared to have met his sales quota. In fact, Webb made contingent sales of Firestream systems to ten dealers,generating revenue of $598,000. In these transactions, Webb included the various contingent terms in verbal agreements or in "side letters" (i.e., documents that contained terms not included in the purchase orders). The contingent terms included not requiring dealers to pay for Firestream systems until they sold them to an end-user, or an absolute right of return.
13. Webb arranged for the contingent sale to one of Digital Lava's dealers of eight Firestream systems for approximately $319,000. This was the largest single Firestream sale in the quarter. The purchase order did not state any contingent terms. In fact, Webb agreed that the dealer did not have to pay Digital Lava for the eight Firestream systems until they were sold to an end-user. This contingent term was contained in a September 27, 2000 side letter from Webb to the dealer.
14. Also during the third quarter of 2000, Webb verbally approved a right of return for three Firestream systems which generated approximately $60,000 in revenue. Webb told his sales manager that the right of return could only be verbal, because Webb did not want the terms in writing.
15. Webb did not disclose the contingent terms of these sales to Digital Lava's management or to its finance department. As a result, Digital Lava recorded $598,000 in revenue from these and other Firestream transactions based on the purchase orders in violation of GAAP. The revenues were counted as sales for the purpose of Webb meeting his sales quota for the third quarter.
16. Digital Lava's auditors reviewed the Firestream revenue for the third quarter of 2000. The auditors discussed with Webb the Firestream revenue that Digital Lava recognized during the third quarter of 2000. Webb falsely told the auditors that there were no side agreements with any of Digital Lava's dealers to conceal from the auditors that revenue from contingent sales was included in Digital Lava's reported financial results.
17. Webb knew, or was reckless in not knowing, that his failure to informDigital Lava's management and finance department about the contingent terms and his false statements to Digital Lava's auditors that there were no side agreements with any of Digital Lava's dealers, would cause the Firestream transactions to be recorded improperly on Digital Lava's books and records, which in turn would cause material misrepresentations in Digital Lava's third quarter 2000 Form 10-Q.
18. On October 26, 2000, Digital Lava issued a press release falsely announcing record revenue of $1.74 million for the third quarter of 2000. In fact, this amount included $598,000 in Firestream revenue from the contingent sales. The false information concerning Digital Lava's revenues in this press release was a direct result of Webb's actions.
19. On November 14, 2000, Digital Lava filed its Form 10-Q for the third quarter of 2000. In the Form 10-Q, Digital Lava incorporated the revenue information in its previously issued press release.
20. On or about January 24, 2001, Digital Lava's CFO discovered one of the contingent Firestream sales entered into by Webb. Subsequently, the CFO contacted other dealers and discovered that several of Digital Lava's other dealers had also entered into contingent transactions to purchase Firestream systems.
21. On February 8, 2001, Digital Lava issued a press release announcing that it had identified a revenue recognition issue affecting the third quarter 2000 revenue, was performing an investigation of the matter, and had placed Webb on administrative leave.
22. On March 20, 2001, Digital Lava issued a press release that it had completed its investigation into revenue recognition issues and that it would revise its previously reported financial results for the third quarter of 2000. Specifically, Digital Lava expected that revenue from Firestream systems would decrease byapproximately $600,000.
23. On March 21, 2001, Digital Lava filed an amended Form 10-Q and restated its third quarter financial results to reduce its total revenues from $1,743,000 to $1,100,000. Total revenues in the original third quarter 2000 Form 10-Q were overstated by $643,000, or 58%, of which the $598,000 in Firestream revenue represented 93% of the restatement.
24. Without the contingent Firestream sales of $598,000, Digital Lava would have only reported $1,145,000 in total revenues, far short of Webb's sales quota of $1.8 million.
25. The Commission realleges and incorporates by reference ¶¶ 1 through 24 above.
26. Webb, by engaging in the conduct described above, directly or indirectly, in connection with the purchase or sale of a security, by the use of means or instrumentalities of interstate commerce, of the mails, or of the facilities of a national securities exchange, with scienter:
a. employed devices, schemes, or artifices to defraud;
b. made untrue statements of a material fact or omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or
c. engaged in acts, practices, or courses of business which operated or would operate as a fraud or deceit upon otherpersons.
27. By engaging in the conduct described above, Webb violated, and unless restrained and enjoined will continue to violate, Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5.
28. The Commission realleges and incorporates by reference ¶¶ 1 through 24 above.
29. Digital Lava violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder by filing with the Commission a materially false and misleading quarterly report on Form 10-Q for the third quarter of 2000.
30. Webb knowingly provided substantial assistance to Digital Lava's violation of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
31. By engaging in the conduct described above and pursuant to Section 20(e) of the Exchange Act, 15 U.S.C. §78t(e), Webb aided and abetted Digital Lava's violations, and unless restrained and enjoined will continue to aid and abet violations, of Section 13(a) of the Exchange Act, 15 U.S.C. § 78m(a), and Rules 12b-20 and 13a-13 thereunder, 17 C.F.R. §§ 240.12b-20 and 240.13a-13.
32. The Commission realleges and incorporates by reference ¶¶ 1 through 24 above.
33. Digital Lava violated Section 13(b)(2)(A) of the Exchange Act by failing to make or keep books, records and accounts that in reasonable detail accurately and fairly reflected its transactions and disposition of its assets.
34. Webb knowingly provided substantial assistance to Digital Lava's violation of Section 13(b)(2)(A) of the Exchange Act.
35. By engaging in the conduct described above and pursuant to Section 20(e) of the Exchange Act, 15 U.S.C. §78t(e), Webb aided and abetted Digital Lava's violations, and unless restrained and enjoined will continue to aid and abet violations, of Section 13(b)(2)(A) of the Exchange Act, 15 U.S.C. § 78m(b)(2)(A).
36. By engaging in the conduct described above, Webb violated Exchange Act Rule 13b2-1 by, directly or indirectly, falsifying or causing to be falsified Digital Lava's books, records, and accounts subject to Section 13(b)(2)(A) of the Exchange Act. Unless restrained and enjoined, Webb will continue to violate Rule 13b2-1, 17 C.F.R. § 240.13b2-1.
37. The Commission realleges and incorporates by reference ¶¶ 1 through 24 above.
38. By engaging in the conduct described above, Webb violated Section 13(b)(5) of the Exchange Act, by circumventing or failing to implement a system of internal accounting controls, or by knowingly falsifying any book, record oraccount described in Section 13(b)(2) of the Exchange Act. Unless restrained and enjoined, Webb will continue to violate Section 13(b)(5) of the Exchange Act, 15 U.S.C. § 78m(b)(5).
39. The Commission realleges and incorporates by reference ¶¶ 1 through 24 above.
40. By engaging in the conduct described above, and in connection with audits or examinations of the financial statements of Digital Lava and the preparation and filing of statements and reports required to be filed with the Commission, Webb, directly or indirectly, made or caused to be made materially false or misleading statements to accountants and omitted to state, or caused another person to omit to state to accountants, material facts necessary in order to make statements made to the accountants, in light of the circumstances under which such statements were made, not misleading.
41. By reason of the foregoing, Webb violated, and unless restrained and enjoined will continue to violate, Exchange Act Rule 13b2-2, 17 C.F.R. § 240.13b2-2.
WHEREFORE, the Commission respectfully requests that the Court:
Issue findings of fact and conclusions of law that Webb committed the alleged violations.
Issue a judgment, in a form consistent with Fed. R. Civ. P. 65(d), permanently enjoining Webb and his officers, agents, servants, employees and attorneys, and those persons in active concert or participation with any of them,who receive actual notice of the order by personal service or otherwise, and each of them, from violating Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and from aiding and abetting violations of Section 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
Retain jurisdiction of this action in accordance with the principles of equity and the Federal Rules of Civil Procedure in order to implement and carry out the terms of all orders and decrees that may be entered, or to entertain any suitable application or motion for additional relief within the jurisdiction of this Court.
Dated: June 25, 2003
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