Vitesse Semiconductor Corporation, Louis R. Tomasetta, Eugene F. Hovanec, Yatin D. Mody, and Nicole R. Kaplan

U.S. Securities and Exchange Commission

Litigation Release No. 21769 / December 10, 2010

Accounting and Auditing Enforcement Release No. 3217 / December 10, 2010

Securities and Exchange Commission v. Vitesse Semiconductor Corporation, Louis R. Tomasetta, Eugene F. Hovanec, Yatin D. Mody, and Nicole R. Kaplan, Case No. 10 CIV 9239 (JSR). (S.D.N.Y, filed December 10, 2010)

SEC CHARGES VITESSE SEMICONDUCTOR CORPORATION AND FOUR FORMER VITESSE EXECUTIVES IN REVENUE RECOGNITION AND OPTIONS BACKDATING SCHEMES

The Securities and Exchange Commission today filed civil fraud charges in federal district court for the Southern District of New York against California-based integrated circuit maker Vitesse Semiconductor Corporation and four former senior executives of Vitesse ¢€" co-founder and former Chief Executive Officer Louis Tomasetta, former Chief Financial Officer and Executive Vice President Eugene Hovanec, former Controller and Chief Financial Officer Yatin Mody, and former Manager and Director of Finance Nicole Kaplan. The SEC alleges that Vitesse, through the former senior executives, perpetrated fraudulent and deceptive schemes during 1995 to April 2006 to inflate revenue from shipment of Vitesse's products and to backdate stock options to employees and officers by failing to record millions of dollars of compensation expense. The SEC alleges that all four former executives engaged in the revenue recognition fraud from 2001 to 2006 and that Tomasetta and Hovanec orchestrated the options backdating from 1995 to 2006. The four executives left Vitesse in 2006.

Vitesse has settled the matter by agreeing to be permanently enjoined and to pay a $3 million civil penalty. Mody and Kaplan have each agreed to a bifurcated settlement that provides they will be permanently enjoined and ordered to pay disgorgement, and that any civil penalty will be determined later by the district court. Mody has also agreed to be permanently barred from serving as an officer or director of a public company. The SEC's case against Tomasetta and Hovanec is contested.

The SEC's complaint alleges that during September 2001 through April 2006, Tomasetta, Hovanec, Mody, and Kaplan engaged in an elaborate channel stuffing scheme in order to improperly record revenue on product shipments. They caused Vitesse to immediately recognize revenue and record invalid accounts receivable for product shipped at period end to its largest distributor, even though the distributor had an unconditional right to return all of the product. The right of return was accomplished through undisclosed side letters and oral agreements. As a result, as alleged in the complaint, Vitesse materially inflated the revenue it reported in its financial statements in 14 quarters from September 2001 through early 2006.

The complaint further alleges that the defendants compounded their fraudulent revenue recognition practices by failing to timely record credits related to the invalid accounts receivable that were generated by the distributor's return of product. As further alleged, in order to conceal the true age of the accounts receivable from Vitesse's external auditor, Hovanec and Kaplan then directed that cash receipts received by Vitesse from the distributor and other customers be misapplied to these aged invalid receivables.

In addition, the SEC's complaint alleges that from 1995 to 2006, Tomasetta and Hovanec engaged in a scheme to backdate stock option grant dates for their personal benefit and the benefit of other Vitesse executives and employees. The complaint alleges that Tomasetta and Hovanec disregarded the dates on which Vitesse's Compensation Committee actually approved and granted the options. Instead, they intentionally selected grant dates in the past based on low points in the company's stock price in order to assign favorable exercise prices for the options. They also used hindsight to reprice option grants as Vitesse's stock price declined. In total, as alleged, Tomasetta and Hovanec backdated or repriced 40 option grants to employees and officers, representing over 60% of the total options that Vitesse awarded during the period.

As alleged in the complaint, Tomasetta and Hovanec collectively reaped millions of dollars in illicit profits from exercising backdated options. Despite representing in Vitesse's periodic filings made with the Commission that Vitesse did not grant in-the-money options and complied with applicable accounting rules, Tomasetta and Hovanec intentionally manipulated grant dates in order to award in-the-money options and failed to ensure that Vitesse properly recorded compensation expenses for the backdated grants. As a result of the backdating, Vitesse failed to record approximately $184 million in compensation expense, overstating its pretax income or understating its pretax loss by as much as 45% annually for its fiscal years 1996 through 2005.

The complaint further alleges that after the Wall Street Journal questioned Vitesse in November 2005 about the legitimacy of its option granting practices, Tomasetta and Hovanec engaged in a cover-up to hide some of their prior backdating. As alleged in the complaint, between November 2005 and April 2006, Tomasetta and Hovanec lied to Vitesse board members and to Vitesse's auditor by falsely telling them that past option grants were proper and correctly accounted for in the company's books.

The SEC alleges that in furtherance of their cover-up, Tomasetta and Hovanec fabricated minutes of two non-existent 2001 meetings during which Vitesse's Compensation Committee purportedly granted stock options. Tomasetta and Hovanec inserted these fabricated minutes into the stock option administrator's computer and turned back the clock on the computer thereby creating the false appearance that the minutes had been written at the same time as when the purported meetings occurred. Tomasetta also inserted the dates of these two phantom meetings into his Palm Pilot thereby creating the faĤade that these two meetings had actually happened. Also, as further alleged, on or about December 2005, Hovanec directed his assistant to create a third set of fabricated Compensation Committee meeting minutes to substantiate another backdated grant date from 2003.

Vitesse, Mody, and Kaplan have agreed to settle this matter, without admitting or denying the allegations in the complaint, on the following terms:

• Vitesse consented to entry of a judgment: (1) permanently enjoining it from violating Section 17(a) of the Securities Act of 1933 ("Securities Act"), Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Securities Exchange Act of 1934 ("Exchange Act"), and Exchange Act Rules 10b-5, 12b-20, 13a-1, 13a-13, and 14a-9; and (2) ordering Vitesse to pay a $3 million civil penalty.

• Mody consented to entry of a judgment: (1) permanently enjoining him from violating Section 17(a) of the Securities Act, Sections 10(b) and 13(b)(5) of the Exchange Act and Exchange Act Rules 10b-5, 13a-14, 13b2-1, and 13b2-2, and from aiding and abetting violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Exchange Act Rules 12b-20, 13a 1, and 13a 13; (2) permanently barring him from serving as an officer or director of any public company; (3) requiring him to disgorge ill-gotten gains of $105,604 plus prejudgment interest thereon of $56,716, for a total of $162,320; and (4) providing that, upon motion of the Commission, the court will determine whether a civil penalty is appropriate and the amount of any such penalty. Mody also consented to the issuance of an administrative order pursuant to Rule 102(e) of the Commission's Rules of Practice, permanently suspending him from appearing or practicing before the Commission as an accountant.

• Kaplan consented to entry of a judgment: (1) permanently enjoining her from violating Section 17(a) of the Securities Act, Sections 10(b) and 13(b)(5) of the Exchange Act and Exchange Act Rules 10b-5, 13b2-1, and 13b2-2, and from aiding and abetting violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Exchange Act Rules 12b-20, 13a 1, and 13a 13; (2) requiring her to disgorge ill-gotten gains of $31,050 plus prejudgment interest thereon of $16,445, for a total of $47,495; and (3) providing that, upon motion of the Commission, the court will determine whether a civil penalty is appropriate and the amount of any such penalty. Kaplan also consented to the issuance of an administrative order pursuant to Rule 102(e) of the Commission's Rules of Practice, permanently suspending her from appearing or practicing before the Commission as an accountant.

These settlements are subject to the approval of the United States District Court for the Southern District of New York. The settlement with Vitesse takes into account the company's cooperation in the SEC's investigation.

The complaint against Tomasetta and Hovanec alleges that each of them violated or aided and abetted violations of the antifraud, record-keeping, financial reporting, internal controls, lying to auditors, and equity transaction reporting provisions of the federal securities laws. Tomasetta is also charged with violating the proxy provisions of the Exchange Act. The complaint also alleges that Tomasetta and Hovanec violated Exchange Act Rule 13a-14 by signing certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 that were false and misleading. The SEC's complaint against Tomasetta and Hovanec seeks permanent injunctions, disgorgement with interest, civil monetary penalties, and officer and director bars.

Separately, the United States Attorney's Office for the Southern District of New York today filed criminal charges against Tomasetta and Hovanec, and announced that Mody and Kaplan have pleaded guilty to criminal charges.

See Also: SEC Complaint