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Thomas M. Melton (Bar No. # 4999)
UNITED STATES DISTRICT COURT
INTRODUCTION Plaintiff, Securities and Exhange Commission ("Commission") for its complaint against defendants ClearOne Communications, Inc. ("ClearOne"), Frances M. Flood ("Flood"), and Susie Strohm ("Strohm") alleges as follows: 1. ClearOne is a Utah corporation that files reports with the Commission pursuant to Section 12(g) of the Exchange Act. ClearOne's stock is quoted on the NASDAQ under the symbol CLRO. 2. Beginning with the fiscal quarter ended March 31, 2001, ClearOne in its Forms 10-Q and Forms 10-K for the fiscal years ended June 30, 2001 and June 30, 2002 overstated revenues, income and accounts receivable by recording certain transactions with its distributors and resellers as sales when in fact the transactions did not meet the requirements of Generally Accepted Accounting Principles ("GAAP") for sales. At the end of each quarter, ClearOne would "sweep the floor" of its inventory, stuff the distribution channels with ClearOne products, and force distributors to accept product that they did not want. ClearOne would then enter into undisclosed verbal agreements with its distributors and resellers whereby the distributors and resellers agreed to pay for the ClearOne merchandise as it was sold rather than in accordance with the written contracts ClearOne had with those entities. 3. ClearOne's improper accounting treatment of these transactions and revenue recognition policies resulted in material overstatements of revenue, accounts receivable and income in the company's financial statements that accompanied ClearOne's Forms 10-Q and 10-K that were filed with the Commission. The false and misleading financial statements were also incorporated by reference in a Form S-3 registration statement filed with the Commission. 4. Flood is the Chairman of the Board, President, and CEO of ClearOne. Flood designed, advocated and approved the transactions that resulted in ClearOne's material overstatement of revenue, accounts receivable and income. Flood directed manufacturing and sales personnel to dump ClearOne products into the distribution channel and onto distributors and resellers. Flood then promised distributors that they need not pay for the merchandise until it was sold to customers. Flood devised the channel stuffing scheme and entered into these arrangements with distributors and resellers of ClearOne products in order for ClearOne to meet its quarterly and annual revenue and sales projections. 5. Strohm, ClearOne's CFO, knew that ClearOne dumped products into the distribution channel at the end of each quarter and fiscal in order to meet revenue targets. Strohm also knew that the distributors and resellers took that inventory with an undisclosed verbal agreement that they would not be required to pay ClearOne for that inventory until they sold it to their customers. Strohm allowed ClearOne to materially overstate revenue, income and accounts receivable on the company's financial statements filed with the Commission. STATUTES AND RULES ALLEGED TO HAVE BEEN VIOLATED 6. Defendants ClearOne, Flood and Strohm have engaged and, unless enjoined, will continue to engage, directly or indirectly, in transactions, acts, practices, and courses of business which constitute violations of Section 17(a) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. § 77q(a)], Sections 10(b), 13(a) and 13(b) of the Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78j(b), 78m(a) and 78m(b)] and Rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2 thereunder [17 C.F.R. §§ 240.10b-5, 240.12b-20, 240.13a-1, 240.13a-13, 240.13b2-1 and 240.13b2-2]. 7. Defendants' conduct occurred in connection with the purchase and sale of ClearOne's securities. JURISDICTION AND VENUE 8. This Court has jurisdiction over this action pursuant to Sections 20(a), 20(d) and 22(a) of the Securities Act [15 U.S.C. §§ 77t(b), 77t(d) and 77v(a)] and Sections 21(d)(3), 21(e) and 27 of the Exchange Act [15 U.S.C. §§ 78u(d)(3), 78u(e) and 78aa]. 9. The defendants, directly or indirectly, have made use of the mails, means or instruments of transportation or communication in interstate commerce, or means or instrumentalities of interstate commerce in connection with the transactions, acts, practices and courses of business described in this Complaint. 10. Venue over this action is proper pursuant to Section 22(a) of the Securities Act [15 U.S.C. § 77v(a)] and Section 27 of the Exchange Act [15 U.S.C. §§ 77v(a) and 78aa]. 11. Certain of the transactions, acts, practices and courses of business constituting violations alleged herein occurred within the state of Utah. ClearOne is a Utah corporation with its principal place of business in Salt Lake City, Utah. Flood and Strohm engaged and transacted business within the state of Utah during the time the financial statements of ClearOne were prepared and filed with the Commission. Moreover, all the defendants reside or may be found within the District of Utah. AUTHORITY FOR PROMULGATED RULES CITED HEREIN 12. Plaintiff Commission brings this action pursuant to Sections 20(b) and 20(d) of the Securities Act [15 U.S.C. §§ 77t(b) and 77t(d)] and Sections 21(d) and 21(e) of the Exchange Act [15 U.S.C. §§ 78u(d)(3) and 78u(e)], to restrain and enjoin the defendants from engaging in the transactions, acts, practices and courses of business described herein which violate the federal securities laws, and transactions, acts, practices and courses of business of similar purport and object, to order defendants Flood and Strohm to disgorge all ill-gotten gains received during the period of violative conduct, to impose civil money penalties pursuant to Section 20(d) of the Securities Act and Section 21(d)(3) of the Exchange Act against defendants Flood and Strohm, and to bar Flood and Strohm from serving as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act [15 U.S.C. § 78l] or that is required to file reports pursuant to Section 15(d) of the Exchange Act [15 U.S.C. § 78o(d)]. 13. Plaintiff Commission, pursuant to the authority granted to it by Section 10(b), 13(a) and 13(b) of the Exchange Act [15 U.S.C. §§ 78j(b) and 78m(a)], has promulgated Rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2. These rules were in effect at all times relevant hereto and are still in effect. DEFENDANTS 14. ClearOne is a Utah corporation with its principal place of business at 1825 Research Way, Salt Lake City, Utah, 84119. ClearOne is a provider of end-to-end video and audio conferencing services, including the manufacture and sale of video and audio conferencing products. 15. Frances M. Flood, age 46, is the Chairman of the Board, President, and CEO of ClearOne. Flood joined ClearOne in October 1996, as Vice President of Sales and Marketing. Flood became President of ClearOne in December 1997 and CEO in June 1998. Flood then became Chairman of the Board in November 2000. 16. Susie Strohm, age 42, joined ClearOne in February 1996, as company controller. Strohm was named Chief Financial Officer in 1998. Strohm stepped down briefly as CFO in August 2001. In the fall of 2002, Strohm again took the reins as CFO. Between August 2001 and September 2002, Strohm continued to serve as ClearOne's Vice President of Finance and Controller. BACKGROUND 17. From its inception as a manufacturer of audio and video conferencing equipment through 2001, ClearOne sold its products through a nationwide network of manufacturer's representatives. 18. Sometime in early 2001, ClearOne made the decision to alter its business model and instead of utilizing manufacturer's representatives, ClearOne began selling its products through a nationwide network of distributors complemented by a direct sales force. 19. Initially, ClearOne had two major distributors of its audio and video conferencing products, VSO Marketing based in Fairfield, New Jersey and Starin Marketing located in Chesterton, Indiana. Later, ClearOne added two other distributors, PT&T in California and NewComm Distributing located in Pennsylvania. 20. ClearOne also sold its products directly to resellers of video and audio conferencing products through a direct sales force. 21. The distributors had a written Distributor Agreement with ClearOne that provided specific payment terms for each distributor, usually requiring the distributor to pay ClearOne within 90 days of receiving ClearOne products. 22. The Distributor Agreement also required the individual distributors to take title to ClearOne products at the time those products left ClearOne's Utah warehouse. 23. The Distributor Agreement provided that the individual distributors had no right to return the ClearOne products that they received. 24. ClearOne recognized revenue from product sales and booked accounts receivable at the time the products were shipped from the company's warehouse. According to ClearOne, it transferred the risks and rewards, including title to its products at that time. THE FRAUD BEGINS 25. Through early 2001, ClearOne experienced robust growth and increased product sales every quarter. However, in early 2001 it became apparent to Flood that ClearOne would not meet its sales and revenue projections for the quarter ended March 31, 2001. 26. In order to meet sales projections, Flood devised a scheme for stuffing the distribution channel with ClearOne products. As soon as those products left ClearOne's warehouse, ClearOne would record sales on its books. 27. Thus, if ClearOne shipped enough product the last week of a quarter then it could meet revenue projections. 28. At the end of March 2001, Flood instructed ClearOne's Director of Manufacturing, William Olpin, to assemble enough products to ship to distributors so that it would appear that ClearOne actually met its sales projections. Flood instructed Olpin to "sweep the floor," meaning to send all the ClearOne inventory on-hand, as well as everything he could manufacture, to distributors to meet the quarterly sales projections. 29. Flood found a home for this inventory with one of ClearOne's distributors, Starin Marketing. Starin agreed to accept a large shipment of ClearOne products during the last week of March 2001. Flood had an secret agreement with Starin that he would not have to pay for that merchandise until he sold it. Flood told Starin that the transaction presented absolutely no risk to him. 30. Contrary to GAAP, ClearOne recognized revenue and booked an account receivable for that transaction. A PATTERN EMERGES 31. ClearOne's pattern of stuffing the distribution channel with its products and entering into secret agreements with its distributors continued each fiscal quarter thereafter. 32. At the end of each fiscal quarter, once ClearOne realized that it was not going to meet its revenue and sales projections, ClearOne would repeat the same pattern of stuffing the distribution channel and entering into secret agreements with resellers or distributors. 33. Flood instructed Olpin again each quarter to increase manufacturing during the last week of the quarter to produce enough products to meet projections. Flood, often through Timothy Morrison, Vice President of Product Sales or Misty Chalk, National Sales Manager, would communicate with ClearOne distributors and tell them how much product they needed to accept in order for ClearOne to meet projections. 34. Morrison or Chalk would reiterate the agreement that Flood originally made with the distributors that they did not have to pay for the ClearOne merchandise until it was sold to third parties. 35. Each quarter, Flood would also reassure the distributors directly that they would not have to pay for the inventory forced upon them by ClearOne. 36. The distributors then would send ClearOne a blank purchase order that ClearOne would fill with whatever inventory it had on hand and then ship that inventory to the distributors. Often these end-of-quarter shipments consisted of products that the distributors did not want and could not sell. 37. At the end of June 2001, Starin Marketing agreed to accept $750,000 worth of ClearOne products to assist ClearOne in making its year-end sales figures. Flood instructed James Starin to write a purchase order with the requirement that payment be made within 90 days. Flood also directed Starin to tell ClearOne's outside auditors that the product was shipped to Starin on those terms. 38. Flood, however, verbally assured Starin that he took the product without any risk and that he would not have to pay ClearOne until the product sold. Flood reminded Starin not to tell ClearOne's auditors about the pay as you sell agreement. 39. Again at the end of September 2001 (the end of ClearOne's first fiscal quarter for the year 2002), ClearOne again came up short of its projected sales and revenue figures. Flood instructed Morrison to ship $500,000 of product to VSO Marketing on the last day of the quarter. Starin Marketing received an equivalent shipment at that time. Neither Starin nor VSO was required to pay ClearOne until the products sold. 40. At the end of September 2001, Flood also contacted long-time friend Mike Peppel, CEO of MCSi, Inc. and requested that he assist ClearOne in meeting its quarterly projections. Peppel agreed to accept a last minute shipment of ClearOne products. Just like Starin Marketing and VSO, MCSi was not required to pay ClearOne until the product sold. 41. Despite knowing that the sales were merely sham transactions, ClearOne recognized revenue and booked an account receivable for that merchandise before the quarter's end. 42. In December 2001, ClearOne added two new distributors, NewComm Distribution and PT&T. 43. At the end of December 2001, ClearOne shipped an additional $500,000 of inventory to both NewComm and PT&T with the understanding that neither company was required to pay for the products until they sold them. 44. This pattern of behavior by ClearOne continued each quarter with ClearOne forcing inventory on all of its distributors, always on the pay as you sell plan and always to allow ClearOne to meet expectations. 45. By the end of June 2002, ClearOne fell short of meeting revenue and sales projections. 46. In order to meet the sales projections, Flood again contacted Peppel at MCSi and asked for another favor. 47. ClearOne shipped $1.2 million in inventory to MCSi at the end of June 2002. ClearOne, booked revenue of $1.2 million. MCSi was not required to pay for the inventory until it sold through to its customers. 48. At the same time, in June of 2002, Flood invented yet another way to dispose of inventory. She simply found someone who was willing to hide inventory in his garage. ClearOne shipped 100 V-There video conferencing units to a non-distributor. Those units were stored at the non-distributor's home and he was not required to pay ClearOne unless he sold the units. 49. ClearOne invoiced the non-distributor $5,000 each for the V-There units, recognizing an aggregate of $500,000 in revenue. This $5,000 unit price was much higher than the usual price charged to distributors of V-There units. Ultimately, the non-distributor attempted to return all the V-There units to ClearOne. 50. At the end of June 2002, ClearOne also invoiced each of its distributors, NewComm, PT&T, VSO Marketing and Starin Marketing, for at least $200,000 of V-Labs starter kits. As was typical, Flood told each distributor it was not required to pay for the starter kits until the inventory sold to one of their customers. The distributors never even received the V-Labs starter kits. Instead, the starter kits were purportedly stored in a Minneapolis warehouse. 51. Before the end of the quarter and the fiscal year ended June 30, 2002, ClearOne recognized revenue of at least $800,000 from hiding the V-Lab starter kits in that Minneapolis warehouse. 52. By the end of June 2002, approximately 50% of the revenue claimed by ClearOne in that quarter resulted from inventory stuffed in the distribution channels or sitting in a warehouse or garage. 53. In addition to receiving inventory that they did not want, distributors also received inventory that was outdated or obsolete. 54. For example, the V-There video conferencing units had poor picture quality and did not sell well. At the end of at least one quarter, ClearOne dumped a large quantity of V-There units on each of its distributors, again agreeing that the distributors did not have to pay for the product until it sold to customers. 55. ClearOne also invoiced distributors for products at a price higher than agreed upon. For example, ClearOne sent Kodak video conferencing units to its distributors and invoiced them at dealer cost rather than the discounted price typically charged to a distributor. ClearOne then recorded revenue at the dealer cost. 56. ClearOne's channel stuffing was not limited to the United States. On at least one occasion, in June 2002, ClearOne delivered over $1 million of inventory to an Australian reseller of ClearOne video and audio conferencing products. 57. The Australian company refused to retrieve the ClearOne products from a bonded warehouse in Australia. Ultimately, ClearOne was forced to look for other ways to rid itself of the inventory shipped to Australia. 58. However, ClearOne recorded revenue and booked an account receivable at the time the ClearOne products left its warehouse. FLOOD AND STROHM MISLEAD AUDITORS, ANALYSTS AND INVESTORS 59. ClearOne was concerned about maintaining the historical growth in sales and revenue and its stock price. ClearOne also needed to maintain its stock price during its important private offering that closed December 11, 2001. That private placement raised $25.5 million for the company. 60. Flood expressed her concern to Morrison and other ClearOne employees that ClearOne's stock price remain high in order for ClearOne to close on important acquisitions or to close the private placement. 61. In order to maintain the façade of a healthy company with robust sales and revenues, Flood instructed ClearOne employees, including among others, Morrison, Chalk and Strohm to mislead analysts or investors. 62. Specifically, Flood told ClearOne employees not to discuss the channel stuffing that took place at the end of every quarter. In addition, Flood instructed individuals at ClearOne not to talk about the secret agreements with distributors. If asked, employees were not to tell anyone that distributors could wait and pay for products when the products sold rather that to pay ClearOne in accordance with the Distribution Agreements. 63. Flood also communicated the same message to the distributors. The distributors were told that if they received a call from an investor or analyst, they should simply confirm the payment terms set forth in the Distribution Agreement and under no circumstance should they mention that the distributors could wait and pay ClearOne for its products at the time the products sold. 64. Flood and Strohm also instructed ClearOne employees, including, among others, Tim Morrison, to mislead ClearOne's independent auditor Ernst & Young LLP. 65. Flood told Morrison that he should not tell Ernst & Young about the secret agreements that Flood had made with the distributors or resellers. Morrison was also told that he should remain silent about the channel stuffing the occurred at the end of every quarter. 66. Strohm attended the meetings between Morrison and Ernst & Young to ensure that Morrison did not disclose the channel stuffing or secret agreements. 67. During all this time, Flood led investors, the public and the market to believe that ClearOne continued to experience revenue growth and increased sales. 68. On July 18, 2001, ClearOne issued a press release with financial guidance for the fiscal year ended June 30, 2001. In that press release Flood indicated that "regular checks with [ClearOne's] distribution channels indicate . . . orders continue at a healthy rate." Flood, however, knew that statement was false because she ordered ClearOne to stuff product in the distribution channel and allowed distributors to pay as items sold. 69. On April 23, 2002, ClearOne announced its financial results for the third quarter of fiscal year 2002 in a press release. Flood touted ClearOne's increased product sales, noting a 46 percent increase. Of course, Flood failed to disclose that much of that increase was attributable to products stuffed into distribution channels and unsold inventory located in distributors' warehouses. 70. Also in the April 23, 2002 press release, Flood noted the "significant increase" in ClearOne's accounts receivable balance. Flood attributed the significant increase in part to the addition of 15 new dealers. That statement was false. The addition of new dealers did not cause the astronomical increase in accounts receivable, rather ClearOne's channel stuffing quarter after quarter and the side agreements with distributors was the true source of the increase. 71. On August 13, 2002, ClearOne issued another press release in which it reported its financial results for the fourth quarter and the fiscal year ended June 30, 2002. In that press release, ClearOne indicated, "[P]roduct sales for the fourth quarter were up 52 percent to $10.9 million." That statement was false. A large portion of the increase in sales simply reflected ClearOne's recognition of revenue on shipments of products stuffed into the distribution channel and sent to distributors or resellers who had no obligation to pay for the product until it was sold. 72. That August 13 press release also stated that product sales grew 32 percent in fiscal year 2002. That statement was false. By that time, approximately $11.5 million of inventory had been stuffed into the distribution channel. In fact, ClearOne had experienced essentially no growth in sales. CLEARONE'S FINANCIAL STATEMENTS CONTAIN MATERIAL OVERSTATEMENTS 73. In addition to the false press releases touting the company's success, the company's financial statements contained materially overstated revenue, income and accounts receivable figures. 74. As a result of its improper revenue recognition policies, including channel stuffing and secret agreements with resellers and distributors, ClearOne's accounts receivable balance grew exponentially. ClearOne knew that this balance was not collectible because the distributors were not obligated to pay. Many of ClearOne's products were not selling and millions in inventory simply sat in warehouses and garages around the country. 75. Despite knowing that the ballooning accounts receivable balance was the result of the channel stuffing and pay-as-you-go agreements with distributors and resellers, Flood and Strohm fabricated an explanation for the huge increase in accounts receivable. They attributed the ballooning accounts receivable balance to the addition of new distributors or to late shipments. 76. Both as CFO and as Vice President of Finance, Strohm had responsibility for preparing ClearOne's financial statements. 77. Flood told Strohm about the pay-as-you-go arrangements she had entered into with the distributors. In fact, in June 2001, when Strohm first learned about the channel stuffing and secret agreements with distributors, Strohm requested to step down as CFO and accepted a demotion to Controller. Strohm stepped down so that she would not be required to sign ClearOne's annual and quarterly reports filed with the Commission. 78. Despite knowledge of the pay-as-you-go arrangements with distributors and the channel stuffing Strohm continued to allow ClearOne to book revenue and record accounts receivable for ClearOne products as the were shipped from ClearOne's warehouse. 79. Strohm knew that the risks and rewards associated with much of the inventory did not transfer at that time because the distributors receiving the products did not have to pay for them until the products sold through to their customers. 80. Strohm knowingly employed accounting methods that violated GAAP and resulted in ClearOne's financial statements materially overstating revenue, income and accounts receivable. 81. For the fiscal year ended June 30, 2002, ClearOne's improper revenue recognition policies, channel stuffing and secret agreements with distributors and resellers resulted in at least a 23% overstatement of ClearOne's net income. 82. Those materially misstated financial statements were included in the Forms 10-Q filed with the Commission for the quarters ended March 31, 2002, September 30, 2001, December 31, 2001, March 31, 2002, and September 30, 2002 and in the Forms 10-K for the fiscal years ended June 30, 2001 and June 30, 2002. The materially misstated financial statements were also incorporated by reference in a Form S-3 registration statement filed with the Commission. FIRST CAUSE OF ACTION EMPLOYMENT OF A DEVICE, SCHEME OR ARTIFICE TO DEFRAUD Violation of Section 17(a)(1) of the Securities Act [15 U.S.C. § 77q(a)] 83. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 84. Defendants ClearOne, Flood, and Strohm, and each of them, by engaging in the conduct described in paragraphs 1 through 82 above, directly or indirectly in the offer or sale of securities, by the use of the means or instruments of transportation or communication in interstate commerce or of the mails, with scienter, employed devices, schemes, or artifices to defraud. 85. By reason of the foregoing, defendants ClearOne, Flood, and Strohm, directly or indirectly, violated, and unless restrained and enjoined will continue to violate Section 17(a)(1) of the Securities Act [15 U.S.C. § 77q(a)]. SECOND CAUSE OF ACTION FRAUD IN THE OFFER AND SALE OF SECURITIES Violations of Sections 17(a)(2) and (3) of the Securities Act [15 U.S.C. § 77q(a)] 86. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 87. Defendants ClearOne, Flood, and Strohm, and each of them, by engaging in the conduct described in paragraphs 1 through 82, directly and indirectly, in the offer and sale of securities of ClearOne, by the use of the means or instruments of transportation or communication in interstate commerce or of the mails, obtained money or property by means of untrue statements of material fact or by omitting to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, and engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon purchasers of such securities. 88. By reason of the foregoing, defendants ClearOne, Flood, and Strohm, directly or indirectly, violated, and unless restrained and enjoined will continue to violate, Sections 17(a)(2) and (3) of the Securities Act [15 U.S.C. §§ 77q(a)(2) and (3)]. THIRD CAUSE OF ACTION FRAUD IN CONNECTION WITH THE PURCHASE AND SALE OF SECURITIES Violations of 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] 89. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 90. Defendants ClearOne, Flood, and Strohm by engaging in the conduct described in paragraphs 1 through 82 above, directly or indirectly, in connection with the purchase and sale of securities, by the use of means or instrumentalities of interstate commerce or of the mails, with scienter: (1) employed devices, schemes or artifices to defraud; (2) made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (3) engaged in acts, practices or courses of business which operated or would operate as a fraud or deceit upon other persons. 91. By reason of the foregoing, defendants ClearOne, Flood, and Strohm, directly or indirectly, 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]. FOURTH CAUSE OF ACTION FALSE FILINGS WITH THE COMMISSION Violations of Section 13(a) of the Exchange Act [15 U.S.C. § 78m(a)] and Rules 12b-20, 13a-1 and 13a-13 [17 C.F.R. 240.13a-1 and 240.13a-13] 92. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 93. Section 13(a) and Rules 12b-20, 13a-1 and 13a-13 require companies filing periodic reports with the Commission to file truthful reports that do no omit information and would otherwise make the information in the filings not misleading. 94. ClearOne violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 by filing materially misleading Forms 10-Q for the quarters ended March 31, 2002, September 30, 2001, December 31, 2001, March 31, 2002, and September 30, 2002 and Forms 10-K for the fiscal years ended June 30, 2001 and June 30, 2002. The materially misleading financial statements were also included in the Form S-3 registration statement that was filed with the Commission. 95. ClearOne's filings were materially inaccurate and contained misstatements and omissions in that, among other things: a. The financial statements accompanying ClearOne's filings improperly recorded transactions with resellers and distributors as sales when ClearOne products were shipped to the distributors and resellers. b. ClearOne's filings with the Commission falsely indicated that ClearOne transferred the risks and rewards associated with its products to its distributors and resellers and the time of shipment. c. ClearOne's filings with the Commission did not disclose the secret agreements made by Flood with various ClearOne distributors and resellers allowing those distributors and resellers to pay for ClearOne merchandise after it sold to their customers. d. ClearOne's filings with the Commission did not disclose that the financial statements contained therein were not prepared in accordance with GAAP. 96. As a result of the conduct set forth in paragraphs 1 through 82 above, ClearOne directly or indirectly, violated Section 13(a) of the Exchange Act [15 U.S.C. § 78m(a)] and Rules 12b-20, 13a-1, and 13a-13] promulgated thereunder. FIFTH CAUSE OF ACTION FALSE BOOKS AND RECORDS Violations of Sections 13(b)(2)(A) and (B) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A) and (b)] and Rule 13b2-1 [17 C.F.R. 240.13b2-1] thereunder 97. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 98. Section 13(b)(2)(A) of the Exchange Act requires companies to keep accurate books, records and accounts which reflect the transactions entered into by a company and the disposition of its assets. Rule 13b2-1 also requires that a company's books and records not be falsified by any person. 99. Section 13(b)(2)(B) requires companies to 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 generally accepted accounting principles or any other criteria applicable to such statements and to maintain accountability for such assets. 100. ClearOne failed to make and keep books, records and accounts that provided reasonable assurances that transactions it had entered into with its distributors and resellers had been accounted for and not falsified. ClearOne did not devise or maintain a system of internal accounting controls that assured that sales were being properly recorded on its financial statements. 101. As a result of the conduct set forth in paragraphs 1 through 82 above, ClearOne, directly and indirectly, violated Section 13(b)(2)(A) and (B) of the Exchange Act and Rule 13b2-1 thereunder and Flood and Strohm violated Rule 13b2-1 under the Exchange Act. SIXTH CAUSE OF ACTION AIDING AND ABETTING FALSE BOOKS AND RECORDS VIOLATIONS AND FALSE FILINGS 102. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 103. Aiding and abetting liability arises when there is: (1) a violation of the securities laws by some other party; (2) a general awareness by the aider and abettor that his role is part of an overall activity that was improper; and (3) substantial assistance by the aider and abettor in the achievement of the primary violation. Either willfulness or a reckless indifference to a known obligation or set of facts will satisfy the scienter requirement to be held liable as an aider and abettor. 104. Flood and Strohm aided and abetted ClearOne in violating Section 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder in that they were aware that ClearOne was recognizing revenue improperly since Flood had designed and implemented the channel stuffing scheme and secret agreements with the distributors and resellers of ClearOne products. 105. Strohm was aware of the channel stuffing and the secret agreements because Flood told her about them. Strohm was also present during discussions with other ClearOne employees, including but not limited to Tim Morrison and Misty Chalk, during which the channel stuffing and secret agreements with distributors were discussed. 106. Flood and Strohm knew or were reckless in not knowing that ClearOne's distributors and resellers were not obligated to pay ClearOne for many of the products shipped to them until those products were sold to customers. 107. Flood and Strohm aided and abetted ClearOne's violations by causing its books and records to improperly reflect transactions with ClearOne's resellers and distributors as sales on the company's financial statements that were included with for the quarters ended March 31, 2002, September 30, 2001, December 31, 2001, March 31, 2002, and September 30, 2002 and in the Forms 10-K for the fiscal years ended June 30, 2001 and June 30, 2002. Flood and Strohm also allowed the falsified financial statements to be included in a From S-3 registration statement filed with the Commission. 108. By reason of the foregoing, Flood and Strohm, directly or indirectly, aided and abetted ClearOne, and unless restrained and enjoined will continue to aid and abet ClearOne, to violate section 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder. SEVENTH CAUSE OF ACTION PROVIDING FALSE AND MISLEADING INFORMATION TO ACCOUNTANTS Violations of Rule13b2-2 under the Exchange Act [17 C.F.R. § 240.13b2-2] 109. Plaintiff Commission repeats and realleges Paragraphs 1 through 82 above as though fully set forth herein. 110. Flood and Strohm, directly and indirectly, made and caused to be made materially false and misleading statements, and omitted to state and caused other persons to omit to state, material facts necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading to accountants in connection with Ernst & Young LLP's audits of ClearOne's financial statements for the fiscal years ended June 30, 2001 and June 30, 2002. 111. Specifically, Flood and Strohm told ClearOne distributors, resellers and employees, including but not limited to Tim Morrison, not to disclose to Ernst & Young LLP the channel stuffing engaged in by ClearOne. 112. Flood and Strohm also told ClearOne distributors that they should tell Ernst & Young LLP that title passed to them on all ClearOne merchandise at the time the merchandise left ClearOne's warehouse. 113. The distributors were instructed by Flood and Strohm not to tell Ernst & Young LLP about the under the table payment terms agreed to by ClearOne and the distributors. Instead Flood and Strohm told ClearOne distributors to tell Ernst & Young LLP that the distributors intended to pay ClearOne for the stuffed inventory according to the terms of the Distribution Agreements. 114. By their conduct, Flood and Strohm caused ClearOne's books and records to improperly reflect transactions with ClearOne's resellers and distributors as sales on the company's financial statements that were included with for the quarters ended March 31, 2002, September 30, 2001, December 31, 2001, March 31, 2002, and September 30, 2002 and in the Forms 10-K for the fiscal years ended June 30, 2001 and June 30, 2002. Flood and Strohm also allowed the falsified financial statements to be included in a From S-3 registration statement filed with the Commission. 115. By reason of the foregoing, Flood and Strohm, directly or indirectly, and unless restrained and enjoined will continue to violate Rule 13b2-2 under the Exchange Act. PRAYER FOR RELIEF WHEREFORE, the Commission respectfully requests that this Court: I. Issue findings of fact and conclusions of law that the defendants committed the violations charged herein. II. Issue in a form consistent with Rule 65(d) of the Federal Rules of Civil Procedure, orders temporarily restraining and preliminarily and permanently enjoining defendants ClearOne, Flood, and Strohm, and their officers, agents, servants, employees, attorneys, and accountants, 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 engaging in the transactions, acts, practices and courses of business described herein, and from engaging in conduct of similar purport and object in violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. III. Issue in a form consistent with Rule 65(d) of the Federal Rules of Civil Procedure, orders temporarily restraining and preliminarily and permanently enjoining defendants ClearOne, Flood, and Strohm, and their officers, agents, servants, employees, attorneys, and accountants, 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 engaging in the transactions, acts, practices and courses of business described herein, and from engaging in conduct of similar purport and object in violation of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2 thereunder. IV. Issue in a form consistent with Rule 65(d) of the Federal Rules of Civil Procedure, orders temporarily restraining and preliminarily and permanently enjoining defendants Flood and Strohm, and their officers, agents, servants, employees, attorneys, and accountants, 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 engaging in the transactions, acts, practices and courses of business described herein, and from engaging in conduct of similar purport and object in aiding and abetting ClearOne's violation of Section 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2 thereunder. V. Permanently bar the defendants Flood and Strohm from serving as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act, as amended [15 U.S.C. § 78l] or that is required to file reports pursuant to Section 15(d) of the Exchange Act [15 U.S.C. § 78o(d)]. VI. Enter an order directing defendants Flood and Strohm to disgorge all ill-gotten gains received during the period of violative conduct. VII. Enter an order directing defendants Flood and Strohm to pay civil money penalties pursuant to Section 20(d) of the Securities Act and Section 21(d)(3) of the Exchange Act. VIII. 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 this ____ day of January 2003. _____________________
http://www.sec.gov/litigation/complaints/comp17934.htm
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