U.S. Securities and Exchange Commission
Litigation Release No. 18628 / March 18, 2004
SEC Issues a Cease-and-Desist Order and Files Securities Fraud Case for Round-Trip Energy Trades Involving CMS Energy Corporation
Securities and Exchange Commission v. Preston Hopper and Tamela Pallas
Civil Action No. H-04-1054, U.S.D.C./Southern District of Texas (Houston Division)
In the Matter of CMS Energy Corp. and Terry Woolley, Securities Exchange Act of 1934 Release Number 49432
On March 18, 2004, the SEC announced that, yesterday, it issued a cease-and-desist order and filed a civil action relating to alleged fraudulent statements by CMS Energy Corporation ("CMS"), a Michigan-based energy company, in connection with over $5 billion in round-trip energy trades -- simultaneous, pre-arranged buy-sell trades of energy with the same counter-party, at the same price and volume, and over the same term, resulting in neither profit nor loss to either transacting party. The civil suit alleges that Preston D. Hopper, CMS's former controller, violated the antifraud provisions of the federal securities laws and aided and abetted CMS's violations of the antifraud, reporting, books-and-records and internal controls provisions, and Tamela C. Pallas, the former chief executive of CMS's Houston-based trading subsidiary, violated the antifraud provisions of the federal securities laws and for aided and abetted CMS's violations of the antifraud and reporting provisions. CMS and Terry Woolley, the former controller of CMS's energy-trading subsidiary, in a cease-and-desist order issued by the SEC on March 17, 2004 (the "Order"), have agreed to cease and desist from committing or causing violations and future violations of the above-referenced provisions. Woolley also agreed to pay a $25,000 penalty. CMS and Woolley consented to the cease-and-desist order without admitting or denying the findings.
In the civil action, the SEC alleges that Hopper improperly caused the revenue to be reported in CMS's SEC filings and earnings releases. According to the SEC's complaint, when CMS's outside auditors required CMS to reclassify the revenues and expenses from the 2001 trades in CMS's 2001 Form 10-K on a "net," rather than a "gross" basis, nullifying the impact of the trades on CMS's income statement, Hopper failed to ensure that material details about the reclassification were disclosed in the Form 10-K. The SEC further alleges that Pallas violated the antifraud provisions, and aided and abetted CMS's antifraud and reporting violations by orchestrating the trading without ensuring that the illusory volume and revenues associated with the trades were excluded from CMS's public disclosures and SEC filings. In its lawsuit, the SEC is seeking permanent injunctions, disgorgement with pre-judgment interest, and civil money penalties against Hopper for violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder, and for aiding and abetting CMS's violations of Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder, and against Pallas for violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and for aiding and abetting CMS's violations of Section 17(a) of the Securities Act and Sections 10(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.
The SEC finds in its Order that the round-trip trades conducted by CMS's trading subsidiary in 2000 and 2001, artificially increased CMS's revenues and trading volumes. Between the third quarter of 2000 and the third quarter of 2001, CMS cited its artificially inflated revenue and trading volume in its filings with the SEC, press releases, earnings conference calls and investor presentations. By reflecting the results of the trades, CMS overstated its revenue by a total of $5.2 billion over five quarters: $1.0 billion, or 10%, for the last two quarters of 2000; and $4.2 billion, or 36%, for the first three quarters of 2001. Woolley improperly recorded the revenues from the trades. CMS also overstated its trading subsidiary's reported energy-trading volume by 78% over the last two quarters of 2000 and 72% over the first three quarters of 2001. The settled Order requires that CMS cease and desist from committing or causing, and that Terry Woolley cease and desist from committing or causing violations and future violations of Section 17(a) of the Securities Act of 1933 ("Securities Act") and Sections 10(b), of the Exchange Act and Rule 10b-5 thereunder, and from causing any violation of Sections13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.