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S.E.C. v. CASERTA

December 8, 1999

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
PETER CASERTA, SALVATORE MARINO, DANA C. VERRILL, DEFENDANTS.



The opinion of the court was delivered by: Block, District Judge.

      MEMORANDUM AND ORDER

Spectrum is a public corporation which holds technology patents allowing data transmissions to be made over cellular telephone networks. From 1991 through 1994, Peter Caserta ("Caserta") served as Spectrum's President, Chief Executive Officer ("CEO") and Vice Chairman of the Board of Directors, and Salvatore Marino ("Marino") was Spectrum's Treasurer and Chief Financial Officer ("CFO"). Dana Verrill ("Verrill") served as Chairman of the Board and President prior to Caserta's term in office.

The Securities and Exchange Commission ("SEC") has brought this action against Caserta, Marino and Verrill for violations of several federal securities anti-fraud statutes. It alleges that: (1) Caserta and Verrill participated in an illegal scheme to sell unregistered securities: (2) Caserta and Marino knowingly made material misrepresentations to the media and in Spectrum's financial reports to the SEC: and (3) Caserta and Marino engaged in insider trading when they sold more than ten million dollars of Spectrum stock while they possessed material, nonpublic information. Based on these alleged violations, the SEC seeks to enjoin each of the defendants from committing future securities laws violations and, in respect to Caserta and Marino, prohibiting them from acting as officers or directors of an issuer of securities or a company subject to SEC filing requirements. It also seeks to have Caserta and Marino disgorge all losses avoided in regard to their insider trading, and asks that civil penalties be assessed against all defendants.

Caserta and Marino move pursuant to Federal Rule of Civil Procedure ("FRCP") 56 for summary judgment to dismiss to the complaint in its entirety.*fn1 Caserta argues that the sale of unregistered securities claim is barred by the statute of limitations. Because this argument appears to only attack the sufficiency of the complaint, the Court will construe this branch of the motion as brought pursuant to FRCP 12(b)(6).*fn2 Together, Caserta and Marino argue that they should be granted summary judgment on the misrepresentation and insider trading claims because they complied with Generally Accepted Accounting Principles ("GAAP") and relied on the advice of Spectrum's accountants. In respect to the insider trading claims, they contend, in any event, that the information which the SEC alleges they traded upon was neither public nor material. In addition. they seek attorney fees under the Equal Access to Justice Act. The motion is denied in its entirety.

BACKGROUND

The following facts are drawn from the complaint. Defendants' Statement Pursuant to Local Rule 56.1 ("Def.Stmt."), Plaintiff SEC's Statement of Genuine Issues and Response to Defendants' Statement of Undisputed Facts ("Pl.Stmt."), and various exhibits. Except as otherwise noted, they are not in dispute.

I. Sale of Unregistered Securities

In its complaint, the SEC alleges that from early 1992 through December 1992, in order to raise $3,000,000 for Spectrum, Caserta and Verrill developed and implemented a program to sell unregistered Spectrum stock through the manipulation of an employee option plan. The complaint alleges that the underlying scheme began "in 1992," Complaint. ¶ 67. In conjunction therewith, "Caserta and Verrill solicited a newly-hired Spectrum employee to exercise options between September and December of 1992," and "Verrill arranged for a broker to fund the exercise of these options and sell the underlying stock." Id. ¶ 70.

II. Events Leading To Sale of Registered Stock

A. Licensing and Advertising Agreements

Between May and October 1993, Spectrum entered into agreements with, inter alia, Megahertz Corporation ("Megahertz"), Apex Data Corporation ("Apex Data") and U.S. Robotics, Inc. ("U.S.Robotics") to license Spectrum technology patents for use in modems. Each licensing agreement was executed contemporaneously with a separate advertising agreement between Spectrum and the respective licensee.

Caserta and Marino maintain that the licensing and advertising agreements were memorialized in separate contracts because they involved distinct legal obligations. The SEC contends, however, that the agreements were "companion paper transactions comprising part of a single agreement between Spectrum and each of the [l]icensees," Pl.Stmt. ¶ 3, but were kept separate, at Caserta and Marino's direction, "to create the illusion that [Spectrum] was obtaining a seven figure licensing fee from the licensees", whereas, in reality the licensing fees were essentially offset by advertising fees which Spectrum agreed to pay to the licensees under the advertising agreements "irrespective of whether or not any advertising had been done or any product developed." Id.

These licensing and advertising agreements were as follows:

1. Megahertz

2. Apex Data

In mid-July 1993, Spectrum entered into licensing and advertising agreements with Apex Data. In the licensing agreement, Apex Data obtained the right to use Spectrum technology at a royalty rate of $5.00 for each modern produced by Apex Data which used Spectrum's technology; the rate would be reduced if Apex Data included Spectrum's technology in all of its modem products. Additionally, Apex Data agreed to pay Spectrum a "sign-up" fee of $1.55 million, with $5,000 to be paid upon signing, $45,000 to be paid after Spectrum completed certain engineering, and 250,000 installments to be paid on each of six quarterly dates specified in the licensing agreement. In the advertising agreement, Spectrum agreed to pay Apex Data $1.5 million for using Spectrum's logo in the packaging and documentation for any Apex Data modems which used Spectrum technology. Payment was to be made in $250,000 installments on each of the dates on which Apex Data agreed to make its licensing installment payments. Once again, the agreements did not provide for the quarterly licensing and advertising payments to be correlated to modem productivity.

3. U.S. Robotics

On October 25, 1993, Spectrum signed licensing and advertising agreements with U.S. Robotics. In the licensing agreement, Spectrum granted U.S. Robotics the right to use Spectrum technology at a royalty rate of $2.50 for each modem produced by U.S. Robotics which employed that technology. U.S. Robotics agreed to pay Spectrum a "sign-up" fee of $1,500,000, with $100,000 to be paid upon signing, $150,000 to be paid upon the first sale or delivery by U.S. Robotics of modems using Spectrum's technology, and $250,000 to be paid on each of five quarterly dates specified in the licensing agreement. In the advertising agreement, Spectrum agreed to pay $1.25 million to U.S. Robotics to include Spectrum's logo on the packaging and documentation of any U.S. Robotics modems that used Spectrum technology. Payment was to be made in $250,000 installments on each of the same dates that U.S. Robotics agreed to make the licensing installment payments. As with the Megahertz and Apex Data agreements, the U.S. Robotics agreements did not provide for adjustments in the quarterly licensing and advertising payments based upon modem productivity.

B. SEC Filings

Spectrum's financial statements listed the cash received from Megahertz. Apex Data and U.S. Robotics, and treated the anticipated future installment payments from these licensees as accounts receivable. Although Spectrum recorded the corresponding offsetting future advertising fees as accounts payable, it amortized these payments over a three-year period. It also recognized the anticipated benefits of the advertising as assets.

According to Caserta and Marino, these accounting treatments met with the approval of Spectrum's accountant, the Arthur Andersen firm ("AA"). The SEC contends, however, that an AA partner, Jeffrey Steinberg, advised Marino that the Apex Data and U.S. Robotics transactions had to be recognized in the quarters when the agreements were actually executed. Furthermore, the SEC maintains that Marino, with Caserta's knowledge, proposed the basic accounting treatment to Steinberg, and sought to obtain Steinberg's approval of a 17-year amortization for the advertising expenses.

In October 1993, AA provided Marino with a memorandum as to questions and answers ("Q & A") that AA anticipated would be asked at Spectrum's annual shareholders' meeting that month. The Q & A stated that Spectrum's accounting treatment of the agreements was in accordance ...


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