U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19306 / July 18, 2005
Accounting and Auditing Enforcement
Release No. 2279 / July 18, 2005
Securities and Exchange Commission v. Gregory Brady, William M. Beecher, and Reagan L. Lancaster, Civil Action No. 3:05CV1416-M, United States District Court for the Northern District of Texas, Dallas Division.
On July 15, 2005, the Commission filed suit in Dallas federal court charging three former senior officers of Dallas-based technology company i2 Technologies, Inc., with securities fraud, insider trading and other federal securities law violations relating to alleged accounting improprieties involving materially misstated software license revenues. According to the complaint, for the four years ended December 31, 2001 and the first three quarters of 2002 (the "restatement period"), the defendants intentionally or recklessly participated in a scheme to misstate approximately $1 billion of software license revenues, including over $125 million of revenues that should never have been recognized; to conceal from investors the true nature of certain reciprocal, or "barter," transactions i2 entered into; and to hide grave customer problems i2 was experiencing. These matters were the subject of a settled enforcement action the Commission brought against i2 on June 9, 2004, in which i2 paid a $10 million civil penalty. See In the Matter of i2 Technologies, Inc., Lit. Rel. No. 18741 (June 9, 2004).
The individuals named in the Commission's suit are:
Gregory Brady, i2's former president and chief executive officer during critical parts of the restatement period.
William M. Beecher, i2's former chief financial officer during the restatement period.
Reagan L. Lancaster, i2's former executive vice president of worldwide sales, and later president of field operations, during critical parts of the restatement period.
In its complaint, the Commission alleges that each defendant knew or recklessly disregarded that certain i2 software products lacked functionality essential to the needs of i2's customers (which defendant Lancaster called "vaporware"), functionality that could only be provided through extensive customization and modification efforts by i2 consultants. The Commission also alleges that the defendants knew these functionality problems were causing serious customer relations problems, in contrast to the rosy customer relations story they were giving the public at the time.
According to the complaint, defendants also knew or recklessly disregarded that i2 was recording material software license revenues on transactions involving the non-functional software, in violation of generally accepted accounting principals ("GAAP"), notwithstanding i2's public representations (endorsed by defendants) that i2's accounting for software license revenues comported with GAAP. The complaint also describes defendants' involvement in a transaction between i2 and Enron Corporation, in which i2 purported to sell Enron a $10 million software license during the first quarter of 2000 while simultaneously agreeing to buy an identical amount of broadband services from an Enron subsidiary. As the complaint alleges, defendants knew or recklessly disregarded that i2 could not properly recognize this entire license revenue in the first quarter of 2000, but they nonetheless caused the company to do so, without any disclosure to the public about the true nature of the transaction.
The Commission alleges that the defendants concealed these matters from the public, as well as from i2's external auditors and the audit committee of i2's board of directors, for fear that disclosing them would cause i2's stock price to decline, thereby damaging defendants' ability to exercise lucrative stock options. As alleged in the complaint, the defendants, on the basis of the material non-public information described above, violated insider trading rules by reaping tens of millions of dollars profit exercising options on, and selling, i2's grossly inflated stock.
The Commission alleges in its complaint that defendants violated Section 17(a) of the Securities Act of 1933 and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 10b-5 and 13b2-1 thereunder; that defendants aided and abetted i2's violations of Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 13a-1 and 13a-13 thereunder; that Brady and Beecher violated Rule 13b2-2 under the Exchange Act; and that Beecher violated Rule 13a-14 under the Exchange Act. In its action, the Commission is seeking against each defendant a permanent injunction, disgorgement of ill-gotten gains plus prejudgment interest, an officer and director bar and a civil money penalty.