Kenneth J. Guido, Cal. Bar No. 40020
UNITED STATES DISTRICT COURT
Plaintiff Securities and Exchange Commission ("SEC") alleges:
1. This is an action to obtain a civil penalty against a former officer of Aura Systems, Inc. ("Aura"). During its 1997 and 1998 fiscal years, Aura Systems, Inc., ("Aura"), currently a seller of an induction power system for mobile power applications, and formerly a seller of sound related and multi-media products, overstated its revenue by at least $26.5 million by fictitiously inserting itself into the distribution chain for Korea Data Systems Co., Ltd. ("KDS Korea") computer monitors that were sold to a major U.S. personal computer retailer and by recognizing revenue from nonexistent sales of computer monitors to two shell entities. Furthermore, in two quarterly reports filed in its 1997 fiscal year, Aura improperly recognized another $2.54 million in contract revenue that it had earned and booked in prior periods.
2. The SEC seeks the imposition of a civil monetary penalty pursuant to Section 20(d) of the Securities Act of 1933 [15 U.S.C. § 77t(d)] and Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u(d)(3)].
3. This Court has jurisdiction over this action 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. §78aa].
4. The defendant, directly or indirectly, made use of the means or instrumentalities of interstate commerce, or of the mails, in connection with the transactions, acts, practices, and courses of business alleged herein.
5. Gerald S. Papazian, age 46, was until February 28, 2002 Aura's President and Chief Operating Officer. Papazian resides in Palos Verdes, California.
OTHER RELEVANT PERSONS OR ENTITIES
6. Aura Systems, Inc. ("Aura"), a Delaware corporation headquartered in El Segundo, California, formerly sold sound related and multi-media products, and now sells an induction power system for mobile power applications. Aura's common stock is registered with the SEC pursuant to Section 12(g) of the Exchange Act and was quoted on the NASDAQ national market system until July 1999, when its stock was delisted. Aura's stock currently trades on the over-the-counter bulletin board under the symbol "AURA." Aura's fiscal year ends February 28.
7. Korea Data Systems USA, Inc. ("KDS"), a California corporation located in Garden Grove, California, was a U.S. affiliate of Korea Data Systems Co. Ltd. ("KDS Korea"), a Korean manufacturer of computer monitors.
Aura's Purported Monitor Resale Transactions
8. From at least 1996 to 1998, KDS Korea manufactured and sold two brands of computer monitors to a California computer monitor distributor then called Mag Innovision. Mag Innovision sold one brand to its own customers; the other brand belonged to a major U.S. personal computer retailer that had a contract with Mag Innovision.
9. Mag Innovision placed its monitor orders directly with KDS Korea, and KDS Korea shipped the monitors directly to Mag Innovision and/or the U.S. personal computer retailer. KDS, in Garden Grove, initially received some of Mag Innovision's payments for the monitors. Aura had nothing whatsoever to do with these monitor sales.
10. Nonetheless, Aura inserted itself into the monitor-sale transactions on paper so that it could record nonexistent revenue. To accomplish this, others at Aura booked sales and created and carried open accounts receivable from Aura's alleged monitor customers. Aura personnel also created or caused the creation of false documents to make it appear that Aura was a party to these computer monitor sales from KDS Korea to Mag Innovision and the U.S. retailer. These false documents included false Mag Innovision purchase orders, false Aura invoices to Mag Innovision, and false invoices from KDS to Aura.
11. In its fiscal 1997 annual report on Form 10-K filed with the SEC on June 13, 1997, Aura improperly reported $16.5 million in sales of KDS computer monitors to Mag Innovision.
12. KDS agreed to this purported insertion of Aura into the transactions for business reasons of its own.
13. Aura provided false documents to its independent auditors during its fiscal 1997 audit to support the sales.
14. To convince its auditors that the receivable from Mag Innovision was legitimate and to avoid a write-off at year-end, Aura made arrangements with KDS to record false "payments" from Mag Innovision. On at least six occasions in fiscal 1997 and 1998, KDS instructed Mag Innovision to pay a combined total of $13.4 million in funds Mag Innovision owed KDS directly to Aura. Aura booked these transfers as payments for computer monitors. KDS then credited Mag Innovision on its books for the payments.
15. After recording the payments from Mag Innovision, in several transfers from June 27, 1996 to November 3, 1997, Aura paid KDS back virtually all of the funds it had received from Mag Innovision.
16. In July, 1996, Aura falsely booked as payments from Mag Innovision another $1.9 million of funds Aura had received from a defunct shell company affiliated with KDS called Orchestra MultiSystems ("Orchestra"). Aura paid all $1.9 million back to KDS within several days of receiving the payments from Orchestra.
17. In connection with the fiscal 1997 year end audit, Aura's independent auditors were provided a false "balance due" audit confirmation letter concerning the collectibility of the Mag Innovision receivable. This confirmation letter asked Mag Innovision to confirm that it owed Aura approximately $9 million as of February 28, 1997. The confirmation letter was purportedly signed by a Mag Innovision employee. However, the person who purportedly signed the letter was not a Mag Innovision employee, and the signature was not authentic.
18. By recording the fictitious sales, in its fiscal 1997 annual report on Form 10-K, Aura materially overstated revenue by $16.5 million and accounts receivable by approximately $9 million, or approximately 15% of gross receivables. Aura also falsely described itself as a computer monitor reseller in the text of its annual report.
The Fiscal 1998 Resale Transactions to MCDP
19. In Aura's 1998 fiscal year, Aura booked revenue from wholly fictitious monitor resales to MCDP. By 1998, MCDP was out of business and existed only as a defunct shell entity affiliated with KDS.
20. Aura used false purchase orders to Aura from MCDP and corresponding false invoices from Aura to MCDP and from KDS to Aura to make it appear that Aura was reselling KDS monitors to MCDP.
21. Between April 1997 and February 1998, Aura booked $5.9 million in nonexistent sales to MCDP. As with the Mag Innovision fraud, others at Aura made or caused entries in Aura's internal accounting system to reflect the fictitious sales, and provided false documents to Aura's independent auditors during the year-end audit.
22. A full year after the first purported sale to MCDP, Aura and KDS made circular wire transfers to MCDP to allow Aura to record "payments" from the fictitious sales and avoid a receivable write-off at year-end. In mid-1998, KDS wired approximately $2.4 million to MCDP in five separate transfers. Next, MCDP made five payments totaling $2.4 million to Aura. Aura falsely booked those transfers as payments for the computer monitors. Between April 30 and July 29, 1998, Aura repaid KDS all $2.4 million.
23. In connection with the fiscal 1998 year-end audit, Aura's independent auditors were provided a false accounts receivable confirmation letter. That confirmation letter purported to confirm that MCDP owed Aura a balance of $5.9 million as of February 28, 1998. However, the signature on the letter was not authentic. Several months later, on the last day of fiscal 1999, Aura wrote off over $5 million in receivables attributable to the MCDP sales.
24. During the fiscal 1999 year-end audit, Aura's auditors discovered the write-off and asked for further information about Aura's sales to MCDP and purchases from KDS. At that time, others at Aura falsely described the relationship between KDS and MCDP to the independent auditors.
25. As a result of this scheme, in its 1998 annual report on Form 10-K, Aura materially overstated revenue by $5.9 million attributable to the fictitious sales to MCDP. It also overstated accounts receivable by $5.9 million, or approximately 9% of gross receivables. Aura also falsely described itself as a computer monitor reseller in the text of its 1998 annual report.
The Fiscal 1998 Resale Transactions to FYE
26. Also in its 1998 fiscal year, Aura falsely reported revenue from fictitious computer monitor sales to FYE Trading ("FYE"), another defunct shell company affiliated with KDS. Aura recorded this revenue between March 1997 and February 1998.
27. As with the purported sales to Mag Innovision and MCDP, Aura used false documents, including false purchase orders from FYE to Aura, to support Aura's alleged sales to FYE. Others at Aura also made or caused accounting entries to reflect the purported sales in Aura's internal accounting system.
28. After the last of these sales was booked, Aura and KDS made circular wire transfers to create the appearance that FYE was paying Aura for the monitors. On five occasions between March 11 and August 25, 1998, FYE transferred a total of $2.25 million to Aura, which Aura recorded as payments for monitors. Within days of its payments to Aura, KDS transferred the $2.25 million to FYE. Between March and July 1998, Aura repaid KDS the $2.25 million it had received from FYE.
29. In June 1998, in connection with the fiscal 1998 year-end audit, Aura's independent auditors were provided a false accounts receivable confirmation letter, confirming that FYE Trading owed Aura approximately $4.1 million as of February 28, 1998. The signature on the letter was not authentic.
30. On the last day of the next fiscal year, Aura's fiscal year 1999, Aura wrote off over $3.5 million in receivables attributable to the FYE sales. When the independent auditors discovered the write-off and asked Aura for additional information, others at Aura made false representations about Aura's relationship with FYE.
31. In its fiscal 1998 annual report on Form 10-K, Aura materially overstated revenue by $4.1 million attributable to the fictitious sales to FYE Trading. It also overstated accounts receivable by $4.1 million, or approximately 6% of gross receivables for the year. The false sales to MCDP and FYE, totaling $10 million, accounted for 15% of Aura's total accounts receivable.
32. Papazian knew, or was reckless in not knowing, that Aura should not have recorded the alleged monitor sales to Mag Innovision, MCDP and FYE, and that recording and carrying them on Aura's books rendered materially false and misleading Aura's financial statements contained in its 1997 and 1998 annual reports on Form 10-K. Papazian signed these annual reports that he knew or was reckless in not knowing contained the materially false monitor resale transactions.
33. In fiscal years 1997 and 1998, Papazian signed management representation letters that he knew or was reckless in not knowing contained false representations that Aura's sales were legitimate. Papazian caused those representation letters to be provided to Aura's independent auditors.
Aura Fraudulently Recognized an Additional $2.54 Million
34. In quarterly reports filed during its 1997 fiscal year, Papazian and others at Aura caused Aura to make two incorrect revenue recognition entries relating to contracts Aura had to install its electric valve actuators in engines. The entries resulted in material revenue overstatements of $1.04 million in the second quarter and $1.5 million in the third quarter.
35. An Aura accounting executive made or caused the entries to be made. Papazian, as President, had oversight responsibilities for Aura's contracts and assisted that executive in preparing the entries by providing information about the amount of work performed under the contracts.
36. By virtue of these entries, Aura's fiscal 1997 second and third quarter reports on Form 10-Q were false and misleading. The entries were material to Aura's financial results: The second quarter entry had the effect of overstating revenue by $1.04 million. Without that entry, Aura would have reported a loss of approximately ($515,000), rather than net income of $525,000. Similarly, the third quarter entry had the effect of overstating revenue by $1.5 million. Without that entry, Aura would have reported a loss of approximately ($631,000), rather than net income of $868,246.
37. At its 1997 year-end, Aura reversed the $1.04 and $1.5 million Aura had recognized in the second and third quarters. Aura reversed the $1.5 million entry by netting it against an unrelated $3.5 million license fee receivable, and directly reversed the $1.04 million entry at year-end.
Violations of Section 17(a) of the Securities Act [15 U.S.C. § 77q(a)]
38. Paragraphs 1 through 37 are realleged and incorporated by reference.
39. On December 4, 1997, Aura filed a registration statement on Form S-3 with the SEC. That registration statement incorporated by reference Aura's materially false annual report for fiscal year 1997. Papazian signed the registration statement while knowing or being reckless in not knowing that the 1997 annual report incorporated therein by reference contained materially false financial statements due to the purported computer monitor transactions.
40. On June 25, 1998, Aura filed a registration statement on Form S-3 with the SEC. That registration statement incorporated by reference Aura's materially false annual report for fiscal year 1998. Papazian signed the registration statement while knowing or being reckless in not knowing that the 1998 annual report incorporated therein by reference contained materially false financial statements due to the purported monitor transactions.
41. By reason of the foregoing, Papazian violated Section 17(a) of the Securities Act [15 U.S.C. § 77q(a)].
Violations of Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)]
42. Paragraphs 1 through 41 are realleged and incorporated by reference.
43. By reason of the foregoing, Papazian violated 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].
Violations of Section 13(b)(5) of the Exchange Act [15 U.S.C. § 78m(b)(5)]
44. Paragraphs 1 through 43 are realleged and incorporated by reference.
45. By reason of the foregoing, Papazian violated Section 13(b)(5) of the Exchange Act [15 U.S.C. §78m(b)(5)].
Violations of Exchange Act Rule 13b2-1 [17 C.F.R. § 240.13b2-1]
46. Paragraphs 1 through 45 are realleged and incorporated by reference.
47. Papazian, directly or indirectly, falsified or caused to be falsified, Aura's books, records or accounts subject to Section 13(b)(2)(A) of the Exchange Act. By reason of the foregoing, Papazian violated Exchange Act Rule 13b2-1 [17 C.F.R. §240.13b2-1].
Violations of Exchange Act Rule 13b2-2 [17 C.F.R. § 240.13b2-2]
48. Paragraphs 1 through 47 are realleged and incorporated by reference.
49. Papazian, as an officer and director of Aura, directly or indirectly, made materially false or misleading statements, or omitted to state, or caused another person to omit to state material facts necessary in order to make statements made, in light of the circumstances under which they were made, not misleading to Aura's accountants in connection with their audits of Aura's financial statements for fiscal years 1997 and 1998. By reason of the foregoing, Papazian violated Exchange Act Rule 13b2-2 [17 C.F.R. §240.13b2-2].
PRAYER FOR RELIEF
WHEREFORE, the SEC respectfully requests that this Court enter a judgment:
(a) ordering Papazian to pay civil monetary penalties pursuant to Section 20(d) of the Securities Act [15 U.S.C. § 77t(d)] and Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)] in respect of his violations; and
(b) granting such other relief as this Court may deem just and appropriate.
Dated: June 10, 2002
* Plaintiff's Trial Attorney