U.S. Securities and Exchange Commission
Litigation Release No. 18340 / September 11, 2003
Accounting and Auditing Enforcement Release No. 1858
Securities and Exchange Commission v. Brightpoint, Inc., American International Group, Inc., Phillip Bounsall, John Delaney and Timothy Harcharik (S.D.N.Y. Civ. 03 CV 7045 (HB)
SEC Sues AIG, Brightpoint and Three Individuals in Accounting Fraud Case
AIG Settles Action and Agrees to Pay $10 Million Penalty
Washington The Securities and Exchange Commission announced today that it filed a civil accounting fraud action in federal district court in the Southern District of New York against American International Group, Inc. (AIG), Brightpoint, Inc. (Brightpoint) and two former officers and a former employee of Brightpoint, respectively, Phillip Bounsall (Bounsall), John Delaney (Delaney) and Timothy Harcharik (Harcharik). All of the defendants except Harcharik have consented to the entry of final judgments in settlement of this matter. The Commission also announced today that it instituted separate settled cease-and-desist proceedings against Brightpoint, AIG, Bounsall and an AIG employee.
The civil and administrative actions involve the role played by AIG, one of the world's largest insurance underwriters, in enabling Brightpoint, a public reporting company, to commit securities fraud. As a sophisticated financial services provider, AIG played an indispensable part in the fraudulent transaction by selling Brightpoint a new "insurance" product that AIG had developed and marketed for the specific purpose of helping issuers to report false financial information to the public.
Beginning in 1997, AIG developed and marketed a so-called "non-traditional" insurance product for the stated purpose of "income statement smoothing," i.e., enabling a public reporting company to spread the recognition of known and quantified one-time losses over several future reporting periods. The key to achieving the desired accounting result was to create the appearance of "insurance," i.e., that the "insured" (Brightpoint) was paying premiums in return for an assumption of risk by AIG, when, in fact, Brightpoint was merely depositing cash with AIG that AIG refunded to Brightpoint.
In this case, AIG issued such a purported insurance policy to Brightpoint for the purpose of assisting Brightpoint to conceal $11.9 million in losses that Brightpoint sustained in 1998. Brightpoint's chief accounting officer, Delaney, and its director of risk management, Harcharik, negotiated the purported policy with an AIG assistant vice president. Brightpoint's chief financial officer, Bounsall, approved the insurance transaction without adequately reviewing it. As a result of the transaction, Brightpoint's 1998 financial statements, as reported in the 1998 Form 10-K, overstated Brightpoint's actual net income before taxes by 61 percent. The misrepresentation was subsequently republished in a registration statement filed in September 1999 and in Forms 10-K for 1999 and 2000.
Specifically, the Commission alleged in the civil action that:
Based on the facts alleged, in the civil action the Commission charged:
- In October 1998, Brightpoint publicly announced that in the fourth quarter ending December 31, it would recognize a one-time charge, ranging from $13 million to $18 million, arising out of losses sustained by one of its divisions in the United Kingdom (UK). However, by December 1998, the UK losses had mushroomed to about $29 million, and Brightpoint's corporate controller, defendant Delaney, and its director of risk management, defendant Harcharik, devised a scheme to cover-up these additional, unanticipated losses, rather than disclose them.
- In December 1998, Delaney and Harcharik turned to the Loss Mitigation Unit (LMU) of National Union Fire Insurance Company of Pittsburgh, Pa., one of defendant AIG's principal general insurance company subsidiaries. LMU offered "insurance" products specifically designed to "smooth" the financial statement impact of losses sustained by AIG clients. Brightpoint and AIG negotiated the terms of a $15 million "retroactive" insurance policy that covered all of the extra UK losses. The parties agreed to combine this "retroactive coverage" with prospective fidelity coverage (together, the Policy) in an effort to avoid scrutiny from Brightpoint's Auditors (the Auditors). The "cost" of the $15 million "retroactive coverage" to Brightpoint was about $15 million, which Brightpoint was to pay in monthly "premiums" over the prospective three-year term of the policy. The Policy, finalized in January 1999, enabled Brightpoint to record in 1998 an insurance receivable of $11.9 million, which Brightpoint netted against the total UK losses of about $29 million, bringing the net loss to within the previously disclosed $13 million to $18 million range.
- In fact, the "retroactive coverage" should not have been accounted for as insurance. It was merely a "round-trip" of cash a mechanism for Brightpoint to deposit money with AIG, in the form of monthly "premiums," which AIG was then to refund to Brightpoint as purported "insurance claim payments." In drafting the Policy, Delaney and Harcharik took pains to ensure that the "retroactive coverage" raised no "red flags" for the Auditors: They created a blended fidelity coverage and retroactive policy that was designed to look like traditional, non-retroactive indemnity insurance and they gave the policy an effective date of August 1998.
- In October 2001, following an inquiry by the Commission's staff, the Auditors began looking more closely at the Policy and determined that it was not traditional insurance. Although the Auditors questioned whether the policy was insurance at all, they decided at the very least that the policy provided retroactive coverage and, therefore, that all premium expense associated with it should have been recorded in 1998. On November 13, 2001, Brightpoint announced a restatement, which treated the Policy as real, but retroactive, insurance (the First Restatement). The First Restatement expensed the full policy "premium" in the fourth quarter of 1998, amounting to $15.3 million.
- On January 31, 2002, Brightpoint announced that it would further restate its financial statements to reflect that the "premiums" for the "retroactive coverage" under the Policy were only deposits with AIG. This second restatement came about when the Auditors learned that, one day before Brightpoint announced the First Restatement, it had "cancelled" the "retroactive coverage" and obtained from AIG a refund in the full amount of premiums Brightpoint had paid over and above the "insurance claim payments" made to it by AIG under the "retroactive coverage." The cancellation transaction left no doubt that the "retroactive coverage" was not insurance.
- Brightpoint with securities fraud in violation of Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 (Exchange Act) and with violating the reporting, books-and-records, and internal controls provisions of Exchange Act Sections 13(a) and 13(b)(2) and Exchange Act Rules 12b-20, 13a-1 and 13b2-1.
- AIG with securities fraud in violation of Section 10(b) of the Exchange Act and Rules 10b-5 and aiding and abetting violations of Exchange Act Rule 13b2-2 for making materially false statements to the Auditors.
- Delaney with securities fraud in violation of Section 17(a) of the Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act, with violating the reporting, books-and-records, and internal controls provisions of Exchange Act Section 13(b)(5) and Exchange Act Rule 13b2-1 and with violating Exchange Act Rule 13b2-2 for making materially false statements to the Auditors; Delaney was also alleged to be liable as a control person of Brightpoint, pursuant to Section 20(a) of the Exchange Act, for Brightpoint's books-and-records violations under Exchange Act Section 13(a) and Exchange Act Rules 12b-20 and 13a-1.
- Harcharik with securities fraud in violation of Section 10(b) of the Exchange Act and Rules 10b-5 and with aiding and abetting violations of Exchange Act Section 13(b)(5) (internal controls and books-and-records provision) and Exchange Act Rules 13b2-1 (books-and-records provision) and 13b2-2 (making materially false statements to the Auditors).
- Bounsall with violating the books-and-records provisions of Rule 13b2-1 of the Exchange Act.
Without admitting or denying the allegations in the Commission's complaint, all of the defendants except Harcharik have agreed to settle the Commission's charges. In connection with the settlements, AIG agreed to pay a civil penalty of $10 million, Brightpoint agreed to pay a civil penalty of $450,000, Delaney agreed to pay a civil penalty of $100,000 and consented to the entry of a Final Judgment that permanently enjoins him from future violations of the federal securities laws and permanently bars him from serving as an officer or director of any public company, and Bounsall agreed to pay a civil penalty of $45,000.
With regard to Harcharik, the Commission's complaint seeks the entry of a final judgment permanently enjoining him from future violations of the federal securities laws and ordering him to pay civil penalties.
Without admitting or denying the facts set forth in their respective administrative orders, AIG, Brightpoint and Bounsall also consented to the issuance of separate cease-and-desist orders. Specifically, AIG and Brightpoint consented to the issuance of separate orders (i) finding that each violated the antifraud provisions of the Exchange Act and, in the case of Brightpoint, the antifraud provisions of the Securities Act and the reporting provisions of the Exchange Act, and (ii) directing that AIG and Brightpoint, respectively, cease and desist from further violating those provisions. In addition, AIG consented to pay $100,000 in disgorgement and to retain an independent consultant to make recommendations to ensure that AIG's insurance products will not be used in the future to violate the securities laws. Bounsall consented to the issuance of a separate order (i) finding that he was a cause of Brightpoint's violation of the books-and-records provisions of Rule 13b2-1 of the Exchange Act and (ii) directing him to cease and desist from further violating that provision.
Brightpoint is a Delaware corporation headquartered in Plainfield, Indiana that provides outsourced services such as distribution, fulfillment, customized packaging, prepaid and e-business solutions, and inventory management in the wireless telecommunications and data industry. AIG is a Delaware corporation with its principal corporate offices located in New York, New York and is a holding company that, through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States and abroad.
SEC Complaint in this matter