U.S. Securities and Exchange Commission
Litigation Release No. 18896 / September 24, 2004
Accounting and Auditing Enforcement Release No. 2109 / September 24, 2004
September 23, 2004
SEC v. James T. Dooley and James E. Lorenz, III, Case No. CV 04-1352 HA (D. Ore.)
SEC v. John E. Isselmann, Jr., Case No. CV 04-1350 MO (D. Ore.)
SEC CHARGES FORMER EXECUTIVES OF ELECTRO SCIENTIFIC INDUSTRIES, INC. WITH FINANCIAL REPORTING FRAUD
SEC Also Brings Enforcement Action Against Former General Counsel of ESI
The Securities and Exchange Commission announced the filing of financial fraud charges against James T. Dooley, who served as Chief Financial Officer and Chief Operating Officer and then Chief Executive Officer of Electro Scientific Industries, Inc. (ESI), and James E. Lorenz, III, the company's former Corporate Controller. ESI, which makes manufacturing equipment for electronics and other high-technology manufacturers, is one of Portland, Oregon's largest public companies. According to the Commission's complaint, Mr. Dooley and Mr. Lorenz engaged in a scheme to improperly inflate ESI's financial results, reporting a false profit rather than a loss for ESI's quarter ended August 31, 2002, and a substantially reduced loss for the quarter ended November 30, 2002. After the fraud was discovered in 2003, ESI was later forced to correct the results for both quarters in a restatement of its financial results.
In a separate action, the Commission also charged that John E. Isselmann, Jr., ESI's former General Counsel, failed to provide important information to ESI's Audit Committee, Board of Directors, and independent auditors regarding the key accounting transaction that enabled ESI to report a profit rather than a loss in the quarter ended August 31, 2002. Without admitting or denying the Commission's allegations, Mr. Isselmann agreed to settle the enforcement action by paying a $50,000 civil penalty and consenting to an order prohibiting certain securities law violations.
According to the complaint against them, beginning in at least the fall of 2002, Mr. Dooley, 50, of Cape Coral, Florida, and Mr. Lorenz, 41, of Portland, Oregon, conspired to falsely inflate ESI's declining financial results by covering up significant expenses through various accounting devices. The fraud reached its climax during a late-night meeting on September 12, 2002 when Mr. Dooley and Mr. Lorenz secretly and unilaterally decided to eliminate all retirement and severance benefits for ESI's employees in Asia in order to increase ESI's bottom line for the quarter by $1 million. The accounting fraud caused ESI to issue press releases and file quarterly reports with the Commission containing materially false financial statements that understated expenses and overstated net income. In certifications required by the recently enacted Sarbanes- Oxley Act, Mr. Dooley also falsely stated that ESI's quarterly reports filed with the Commission were truthful. As a result of the restatement, ESI's net income for the quarter ended August 31, 2002, was restated from a profit of $158,000 to a net loss of $3,394,000, and ESI's net loss for the quarter ended November 30, 2002, was restated from $9,548,000 to $12,908,000.
With respect to the former General Counsel Isselmann, the Commission alleged that, although not involved in Mr. Dooley and Mr. Lorenz's late-night activities on September 12, 2002, Mr. Isselmann failed to provide important information to the Audit Committee, Board of Directors, and outside auditors relating to one of the restated accounting transactions. Isselmann attended a meeting with ESI's Audit Committee and independent auditors to review the financial results for the quarter ended August 31, 2002, where he did not question a false statement by Dooley that the decision to eliminate the retirement benefits for employees in Asia had been reviewed by legal counsel. Isselmann also was provided a document written for ESI's independent auditors stating that ESI was under no legal obligation to provide retirement benefits to its Japanese employees. Isselmann later received written legal advice that contradicted what the Audit Committee and outside auditors had been told. The advice stated that the law prohibited the unilateral elimination of such benefits. Despite having opportunities to convey the advice to ESI's Audit Committee, Board, and independent auditors, Isselmann failed to do so. Isselmann's failure allowed Dooley and Lorenz to hide an ongoing fraud. Moreover, while in possession of the written legal advice stating that the law prohibited the unilateral elimination of the benefits, Isselmann was involved in the review process for ESI's quarterly report filed with the Commission describing the elimination of the benefits and the resulting impact on ESI's income. Isselmann's conduct was a cause of the Company reporting materially false financial results for ESI's first quarter ended August 31, 2002, and violated a Commission rule prohibiting officers of public companies from omitting to state material facts to independent auditors.
The Commission's civil complaint against Mr. Dooley and Mr. Lorenz, filed in federal district court in Portland, alleges that they violated or aided and abetted violations of the antifraud, internal controls, and books-and-records provisions of the federal securities laws (Section 17(a) of the Securities Act of 1933, Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act"), and Rules 10b-5, 12b-20, 13a-13, and 13b2-1 thereunder). The complaint also charges that Dooley and Lorenz lied to ESI's outside auditors in violation of Exchange Act Rule 13b2-2, and that Dooley falsely certified that ESI's Commission filings were truthful in violation of Exchange Act Rule 13b-14. The complaint seeks an injunction, civil monetary penalties, disgorgement, and an order barring Mr. Dooley and Mr. Lorenz from serving as an officer or director of a public company.
The Commission's lawsuit against Isselmann charges that he omitted to state necessary material facts to ESI's independent auditors in violation of Exchange Act Rule 13b2-2. Under the settlement, without admitting or denying the Commission's allegations, Mr. Isselmann agreed to pay a $50,000 civil penalty and consented to an injunction against similar securities law violations, and a Commission order directing that he cease and desist from causing violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13.
The Commission also announced today that it would not bring any enforcement action against ESI because of its swift, extensive, and extraordinary cooperation in the Commission's investigation. This cooperation included reporting its discovery of possible misconduct to the Commission immediately upon the Audit Committee's learning of it, conducting a thorough and independent internal investigation, sharing the results of that investigation with the government (including not asserting any applicable privileges and protections with respect to written materials furnished to the Commission staff), terminating responsible wrongdoers, facilitating the Commission staff's investigation overseas, and implementing remedial actions designed to prevent the recurrence of fraudulent conduct. These actions, among others, significantly facilitated the Commission's expeditious investigation of this matter.
In a separate action, the United States Attorney's Office for the District of Oregon announced the filing of criminal securities fraud charges against Dooley and Lorenz. The Commission acknowledges the assistance of the United States Attorney's Office, the Portland Division of the Federal Bureau of Investigation, and the Seattle Division of the U.S. Postal Inspection Service.
SEC Complaint in this matter (James T. Dooley and James E. Lorenz, III)
SEC Complaint in this matter (John E. Isselmann, Jr.)