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HELANE L. MORRISON (Cal. Bar No. 127752) Attorneys for Plaintiff UNITED STATES DISTRICT COURTNORTHERN DISTRICT OF CALIFORNIASAN JOSE DIVISION
Plaintiff Securities and Exchange Commission (the "Commission") alleges: SUMMARY OF THE ACTION1. Beginning as early as May 1999 and continuing through January 2000, Legato Systems, Inc. ("Legato" or the "Company"), a Silicon Valley software company, recorded millions of dollars in revenue and income from phony transactions arranged by its senior sales executives. The fraud perpetrated by Legato's senior sales executives was aided and abetted by Defendant Vince Steckler, while he was an executive of Legato's customer, Logicon, Inc. 2. Steckler caused Logicon to place a $7 million order with Legato, which Logicon had the right to cancel, knowing that the Legato sales executives fraudulently planned to submit the order as a sale of approximately $5.8 million in current revenue and $1.2 million in deferred revenue. In fact, under Generally Accepted Accounting Principles ("GAAP"), the cancellation provision prevented Legato from counting any part of the order as a current sale. Steckler knew that inclusion of the fraudulent order as a sale would cause Legato to record revenue in violation of GAAP, and to issue false and misleading financial statements in its quarterly report filed with the Commission (known as a Form 10-Q) and made available to the investing public. 3. Steckler also advised the Legato executives how to conceal the cancellation right from Legato's finance department, by including it only in a hidden "side letter" instead of in the order or contract between Logicon and Legato. 4. As a result of Steckler's conduct, Legato filed a report on Form 10-Q containing materially inflated revenue and net income for the third quarter ending September 30, 1999. JURISDICTION, VENUE AND INTRADISTRICT ASSIGNMENT5. The Commission brings this action pursuant to Section 21(d) of the Securities Exchange Act of 1934 (the "Exchange Act") [15 U.S.C. §§ 78u(d)]. This Court has jurisdiction over this action pursuant to Sections 21(e) and 27 of the Exchange Act [15 U.S.C. §§ 78u(e) and 78aa]. 6. Steckler, directly or indirectly, made use of the means and instrumentalities of interstate commerce, the mails, or the facilities of a national securities exchange, in connection with the acts, practices, and courses of business and transactions alleged herein. 7. This district is an appropriate venue for this action under Section 27 of the Exchange Act [15 U.S.C. §78aa]. Certain of the transactions, acts, practices and courses of business constituting the violations alleged herein occurred within the Northern District of California. 8. Assignment to the San Jose Division is appropriate pursuant to Civil Local Rule 3-2(e) because a substantial part of the events that give rise to the Commission's claims occurred in Santa Clara County, California, where Legato is headquartered. THE DEFENDANT AND OTHER PERSONS9. Vincent Steckler, age 43, of Great Falls, Virginia, is currently a vice president in charge of sales to government purchasers for a publicly traded software company. From July 1998 through August 2000, Steckler was a vice president in charge of sales to government purchasers for Logicon, Inc. ("Logicon"). In that position, Steckler was responsible for managing all sales operations relating to federal government sales and for closing large transactions with customers and suppliers. At Logicon, Steckler was eligible to receive a cash bonus if he met certain performance criteria. 10. Legato is a Delaware corporation, with its corporate headquarters located in Mountain View, California. Legato develops, markets and supports software for managing the data-storage functions of computer networks. At all times relevant to this action, Legato's common stock was quoted on the NASDAQ National Market System. 11. Logicon was, during 1999, a wholly owned subsidiary of Northrop Grumman Corporation, a public company whose common stock is traded on the New York Stock Exchange. Logicon provided information systems integration and various hardware and software solutions primarily to agencies of the federal government. Logicon currently operates as a division of Northrop Grumman Corporation, under the name Information Technology. DUE TO FRAUDULENT CONDUCT BY STECKLER AND OTHERS LEGATO MATERIALLY MISSTATED ITS RESULTS FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 199912. On November 10, 1999, Legato filed with the Commission its Form 10-Q for the third quarter ended September 30, 1999, setting forth its financial statements for that quarter and the results of its operations. In January 2000, Legato publicly announced that it would restate its third quarter 1999 financial statements, due to the transaction in which Steckler was involved. In May 2000, Legato restated its third quarter 1999 financial statements, reducing total revenue from $71,688,000 to $67,931,000 (an overstatement of 6 percent), and net income from $3,438,000 to $1,396,000 (an overstatement of 146 percent). 13. As described below, during the third quarter of 1999, Steckler aided and abetted Legato's sales executives' fraudulent conduct, causing Legato fraudulently to recognize revenue on one transaction that accounted for a significant portion of the falsely reported revenue and income. Steckler knew that his actions in this transaction would cause the financial statements in Legato's original Form 10-Q for the third quarter ended September 30, 1999 to be materially false and misleading. A. Steckler Materially Assisted Huetteman and Malmstedt in Causing Legato to Fraudulently Recognize Revenue on a $7 Million Order from Logicon.14. During the summer of 1999, Legato's sales executives approached Logicon with a proposal to sell a large quantity of software to the U.S. Air Force. Because Logicon had a relationship with the Air Force but Legato did not, Logicon was a necessary intermediary for a sale of Legato's products under government procurement regulations. 15. In mid-September 1999, Mark Huetteman, Legato's then Vice President in charge of North American sales, sent a proposal to Logicon to sell $7 million worth of Legato's software and services. Under the terms of the proposal, Logicon would place the $7 million order for Legato software and services by September 30, 1999, the last day of Legato's quarter. In return, Logicon would receive a sizeable commission and become the exclusive reseller of Legato products for the Air Force. 16. In order to effectuate the transaction, Legato needed to enter into a "reseller agreement" with Logicon; however, it soon became apparent that Logicon would be unable to obtain the necessary corporate approvals to sign a reseller agreement prior to September 30, 1999. Accordingly, under the proposal negotiated between Steckler and Legato's sales executives, Logicon's order was to be contained in an "order letter" and followed by a purchase order and the reseller agreement. 17. In September, the deal hit a stumbling block when a Logicon contract specialist refused to sign the order letter unless Legato granted Logicon the right to cancel its obligation to pay Legato the $7 million if Legato and Logicon did not negotiate a mutually acceptable reseller agreement within 30 days. 18. Logicon's requested right to cancel the order presented problems for Legato entering into and recording revenue from the transaction. GAAP does not permit companies to recognize revenue for a contingent sale, including a sale to a reseller who does not in fact have a binding obligation to pay for the software purchased because the reseller is assured that it has the right to cancel the purchase before any payment is made. 19. Legato's sales executives, Huetteman and David Malmstedt (Huetteman's superior in charge of world wide sales), knew that the Logicon transaction would be jeopardized if the order letter contained any contingencies. Legato's general counsel had previously rejected an amendment to a draft order letter on the grounds that it contained a contingency, and the general counsel had informed the Logicon contract specialist that the order letter could not contain this term. 20. To get around this problem, Steckler suggested that Huetteman provide Logicon with a right to cancel the transaction if the parties were unable to negotiate a more definitive agreement. The cancellation right was to be reflected in a letter separate from the order letter. 21. Steckler knew that by placing the right to cancel in a separate "side letter," Legato's finance department would not learn of Logicon's right to cancel the order when determining whether to record revenue for the transaction. Steckler told Huetteman that Legato would thus recognize current revenue and income from the transaction. 22. In late September, Steckler dictated to Huetteman during a telephone call portions of the proposed side letter in an effort to ensure that the side letter contained terms that were agreeable to Steckler and to the Legato sales executives. On September 29, 1999, Huetteman sent a draft of the side letter that he composed with Steckler's aid by e-mail to Steckler, Malmstedt, and another Legato salesperson. 23. The draft side letter that Huetteman e-mailed stated, in relevant part:
24. On September 29, 1999, Steckler forwarded the e-mail containing the side letter to the contract specialist at Logicon with the comment, "Let's go with this." 25. On September 29, 1999, Huetteman placed the side letter he had e-mailed to Steckler on Legato letterhead, signed it, and then sent it by email and facsimile to Steckler. Huetteman and Malmstedt did not forward the side letter to Legato's legal or finance departments. 26. On September 30, 1999, the Logicon contract specialist signed and transmitted an order letter from Logicon to Legato to purchase $7 million worth of software and support services. The side letter containing the right to cancel was not, however, attached to, referenced in, or included with Logicon's order letter. 27. Upon receipt of Logicon's $7 million order letter, Legato recognized $5.8 million as current revenue in the third quarter of 1999. The order letter stated that the $5.8 million was for product that Legato had shipped. (The remaining $1.2 million was to be separately invoiced for updates and technical support services and was therefore not recorded as current revenue by Legato.) 28. GAAP does not permit companies to recognize revenue for a contingent sale. A contingent sale may arise where - as here - the reseller does not in fact have a binding obligation to pay for the software purchased because the reseller is assured that it has the right to cancel the purchase before any payment is made. Under GAAP, contingent sales may not be recognized as revenue by the seller because collectibility of the sales price is not probable. 29. Because Logicon's order reflected in the order letter was subject to the 30-day cancellation clause contained in the side letter, it was improper for Legato to recognize revenue on Logicon's order during the third quarter of 1999. 30. In January 2000, the $5.8 million in revenue was reversed - that is, Legato's income and expenses were reduced to reflect that the transaction had not occurred. The reversal was done when Legato's outside auditors determined that Legato should not have recognized revenue on the Logicon transaction. 31. On January 19, 2000, Legato publicly announced that it would be restating the results of the quarter ended September 30, 1999 due to "an adjustment concerning one contract," referring to the reversal of revenue from the Logicon transaction. However, Legato also stated that it believed "the revenue [from the Logicon transaction] will be recorded in the first and second quarters of 2000." Then, following discovery of the side letter in March 2000, the Logicon transaction was ultimately cancelled by mutual agreement of the parties. 32. Malmstedt and Huetteman knew, or were reckless in not knowing, that Logicon's order was subject to a 30-day cancellation clause that made revenue recognition in the third quarter improper. Malmstedt and Huetteman both also knew, or were reckless in not knowing, that their failure to inform Legato's finance department about the 30-day cancellation provision would cause the Logicon transaction to be recorded improperly on Legato's books and records, which in turn would cause material misrepresentations in the company's Form 10-Q for the quarter ended September 30, 1999. 33. Steckler knew that Logicon's order was subject to a 30-day cancellation clause that made revenue recognition by Legato in the third quarter improper. Steckler also knew that the purpose for including the cancellation clause in a separate side letter, which was not attached to, referenced in, or included with the order letter, was to conceal the 30-day cancellation provision from Legato's finance department. Steckler knew, as he told Huetteman, that Legato would recognize current revenue from the Logicon transaction and that Legato would report income from the transaction. 34. Steckler also knew that Legato was a public company. Steckler knew from his experience working for and with public companies that the transaction with Logicon would be ultimately reflected as part of the sales and income reported in Legato's Form 10-Q for the quarter ended September 30, 1999. 35. By arranging for the cancellation provision to be concealed in a separate side letter, Steckler and Legato's sales executives all knew that Legato would keep records of a significant transaction, including records recording most of the transaction as current revenue and income, that did not accurately and fairly reflect the terms of the transaction. Steckler and Legato's sales executives further knew that by concealing the cancellation provision in a separate side letter, they were circumventing Legato's accounting controls, including Legato's prohibition against including contingencies such as cancellation provisions in sales orders. 36. During the second half of 1999, Legato's stock price rose from under $30 to nearly $80 per share on an historic (pre-split) basis. In April 2000, once the fraud was finally revealed to the public, the stock price plunged to under $20 per share on an historic (pre-split) basis. 37. The Commission seeks to enjoin Steckler from future violations of the federal securities laws and to obtain civil monetary penalties related to the violations. FIRST CLAIM FOR RELIEFAiding and Abetting Violations of Section 10(b) 38. The Commission realleges and incorporates by reference Paragraphs 1 through 37 above. 39. By engaging in the conduct described in Paragraphs 1 through 37 above, Huetteman and Malmstedt, directly or indirectly, in connection with the purchase or sale of securities, by the use of the means or instrumentalities of interstate commerce, or of the mails, with scienter:
40. Steckler knowingly provided substantial assistance to Huetteman's, Malmstedt's and/or Legato's violations of Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 [17 C.F.R. § 240.10b-5]. 41. Steckler aided and abetted, and unless enjoined will continue to violate Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 [17 C.F.R. § 240.10b-5]. SECOND CLAIM FOR RELIEFAiding and Abetting Violations of Section 13(b)(5) 42. The Commission realleges and incorporates by reference Paragraphs 1 through 37 above. 43. Huetteman and Malmstedt knowingly circumvented Legato's internal accounting controls and directly or indirectly falsified, or caused to be falsified, Legato's books, records or accounts of transactions subject to Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A)], in violation of Section 13(b)(5) of the Exchange Act [15 U.S.C. § 78m(b)(5)] and Rule 13b2-1 [17 C.F.R. § 240.13b2-1]. 44. Steckler knowingly provided substantial assistance to Huetteman's and Malmstedt's circumvention of Legato's system of internal accounting controls and direct or indirect falsification of Legato's books, records and accounts subject to Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A)], in violation of Section 13(b)(5) of the Exchange Act [15 U.S.C. § 78m(b)(5)] and Rule 13b2-1 [17 C.F.R. § 240.13b2-1]. 45. Steckler aided and abetted, and unless enjoined will continue to violate Section 13(b)(5) of the Exchange Act [15 U.S.C. § 78m(b)(5)] and Rule 13b2-1 [17 C.F.R. § 240.13b2-1]. THIRD CLAIM FOR RELIEFAiding and Abetting Violations of Section 13(a) of the Exchange Act 46. The Commission realleges and incorporates by reference Paragraphs 1 through 37 above. 47. Legato, aided and abetted by and through the acts of its employees and officers, filed with the Commission a quarterly report on Form 10-Q for the third quarter ended September 30, 1999 that contained untrue statements of material fact and omitted to state material information required to be stated therein or necessary in order to make the required statements made, in the light of the circumstances under which they were made, not misleading, in violation of Section 13(a) of the Exchange Act [15 U.S.C. § 78m(a)] and Rules 12b-20 and 13a-13 [17 C.F.R. §§ 240.12b-20 and 240.13a-13]. 48. Steckler knowingly provided substantial assistance to Legato's violation of Section 13(a) of the Exchange Act [15 U.S.C. § 78m(a)] and Rules 12b-20 and 13a-13 [17 C.F.R. §§ 240.12b-20 and 240.13a-13]. 49. Steckler aided and abetted and unless 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 [17 C.F.R. §§ 240.12b-20 and 240.13a-13]. FOURTH CLAIM FOR RELIEFAiding and Abetting Violations of 50. The Commission realleges and incorporates by reference Paragraphs 1 through 37 above. 51. Legato, aided and abetted by and through the acts of its employees and officers, failed to make and keep books, records, and accounts which, in reasonable detail, accurately and fairly reflected the transactions and dispositions of the assets of the company, in violation of Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A)]. 52. Steckler knowingly provided substantial assistance to Legato's violation of Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A)]. 53. Steckler aided and abetted and unless 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)]. PRAYER FOR RELIEFWHEREFORE, the Commission respectfully requests that this Court: I.Permanently enjoin and restrain Steckler from violating, directly or indirectly, Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. §§ 78j(b) & 78m(b)(5)] and Rules 10b-5 and 13b2-1 thereunder [17 C.F.R. §§ 240.10b-5, and 240.13b2-1], and from aiding and abetting violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act [15 U.S.C. §§ 78m(a) & 78m(b)(2)(A)] and Rules 12b-20 and 13a-13 thereunder [17 C.F.R. §§ 240.12b-20 & 240.13a-13]. II.Order Steckler to pay a civil penalty, pursuant to Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)]. III.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. IV.Grant such other and further relief as this Court may determine to be just and necessary.
http://www.sec.gov/litigation/complaints/comp18327.htm
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