Steven V. Cotton

U.S. SECURITIES AND EXCHANGE COMMISSION

Litigation Release No. 19850 / September 28, 2006

Accounting and Auditing Enforcement Release No. 2487 / September 28, 2006

SEC v. Steven V. Cotton, Civil Action No. SA CV-06-905 AG (ANx) (C.D.Cal.)

SEC Charges Former CFO of Lantronix, Inc. With Fraudulently Inflating Revenues and Earnings

Lantronix Agrees to Cease and Desist From Future Securities Law Violations

The Securities and Exchange Commission today filed securities fraud charges against Steven V. Cotton, the former chief financial officer and chief operating officer of Lantronix, Inc., an Irvine, Calif. technology company, for perpetrating a scheme to defraud the investing public by falsely inflating Lantronix's financial results in its fiscal 2002 and 2001 years.

Separately, Lantronix agreed to the issuance of an order that it cease and desist from future violations of the antifraud provisions of the federal securities laws.

The Commission's complaint, filed in U.S. District Court in Los Angeles, California, alleges that Cotton, age 43, of Huntington Beach, California, orchestrated a scheme to inflate the company's revenues and earnings by deliberately sending excessive product to distributors and granting them undisclosed expanded return rights and unusual extended payment terms (a fraudulent practice known as "channel stuffing"). The complaint further alleges that, as part of the channel stuffing scheme and to prevent imminent product returns, Cotton caused Lantronix to loan funds to a third party to purchase Lantronix product from one of its distributors. According to the complaint, Lantronix, through Cotton, also engaged in other improper revenue recognition practices, including shipping product that had not been ordered and recognizing revenue on a contingent sale.

The complaint alleges that as a result of Cotton's scheme, Lantronix overstated its revenues by up to 21 percent and understated pre-tax losses by up to 98 percent for its second and third quarters of fiscal year 2001, its fiscal year 2001, and the first quarter of fiscal 2002. Lantronix publicly reported its false financials in periodic reports on Form 10-Q and 10-K and in a registration statement for a public offering of stock in July 2001. Lantronix subsequently restated its financial results for the relevant periods.

The complaint further alleges that Cotton made substantial profits from his scheme through bonuses and through the sale of Lantronix stock at artificially inflated prices.

The Commission charged Cotton with violating the antifraud provisions, Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; the record-keeping and internal controls provisions, Section 13(b)(5) of the Exchange Act and Rule 13b2-1; and the false statements to auditors provision, Rule 13b2-2 of the Exchange Act. Cotton was also charged with aiding and abetting Lantronix's violations of the reporting provisions, Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder; the record-keeping provision, Section 13(b)(2)(A) of the Exchange Act; and the internal controls provision, Section 13(b)(2)(B) of the Exchange Act.

The Commission seeks a permanent injunction against Cotton, an order that he repay his ill-gotten gains, civil monetary penalties, and an order barring him from serving as an officer or director of a publicly-traded company.
 
The Commission also issued a cease-and-desist order against Lantronix requiring it to cease and desist from committing or causing any violations and any future violations of the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; the reporting provisions of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder; the record-keeping provision, Section 13(b)(2)(A) of the Exchange Act; and the internal controls provision, Section 13(b)(2)(B) of the Exchange Act. Lantronix consented to the issuance of the cease-and-desist order.

SEC Complaint in this matter