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April 26, 2002


The opinion of the court was delivered by: William C. Conner, Senior U.S. District Judge.


Plaintiff Securities and Exchange Commission ("SEC") brings the instant action against defendants Solucorp Industries Ltd. ("Solucorp"), Joseph S. Kemprowski, Peter R. Mantia, James G. Spartz, Rober Kuhn, Victor Herman, Arle Pierro, W. Bryan Fair and Glenn R. Ohlhauser pursuant to § 10A of the Securities Exchange Act of 1934, 15 U.S.C. § 78j-1 (the "Exchange Act"). Plaintiff alleges, inter alia, that during the course of an audit of Solucorp's December 31, 1998 financial statements, Ohlhauser failed to comply with the requirements enumerated in § 10A(b). Ohlhauser now moves for summary judgment pursuant to FED. R. CIV. P. 56 and, in the alternative, for judgment on the pleadings pursuant to FED. R. CIV. P. 12(c). For the reasons stated hereinafter, the motion is denied.


Unless otherwise noted, the following facts are undisputed for the purposes of this motion.*fn1 Solucorp, a Canadian corporation headquartered in New York, engages in the treatment and disposal of contaminated soil and in the developing, marketing and licensing of products for use in environmental cleanups, including the "Molecular Bonding System" ("MBS"). (Pl. Rule 56.1 Stmt. ¶ 1.) Ohlhauser, a Chartered Accountant licensed in British Columbia, was a partner in the accounting and auditing firm of MacKay and Partners LLP ("MacKay") from late 1996 through 1999. (Id. ¶ 3.)

Ohlhauser was the partner in charge of auditing Solucorp's financial statements for several years, including the audit for the fiscal year ended June 30, 1997. (Id. ¶¶ 5, 7.) In December 1997, Ohlhauser was informed by Victor Herman, the chief financial officer of Solucorp's chief operating subsidiary, that Solucorp intended to file a registration statement with the SEC that would include the June 30, 1997 audited financial statements as well as unaudited financial statements for the quarter ended September 30, 1997. (Id. ¶ 20.) Because the September 30, 1997 statements were prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"), Herman asked Ohlhauser to reconcile the statements with United States GAAP for inclusion in the SEC filing. (Id. ¶ 21.)

Solucorp's financial statements for the quarter ended September 30, 1997 included $500,000 in accrued license fees payable by Smart International Ltd. ("Smart"). (Id. ¶ 23.) The license fees comprised 40% of total revenues for the quarter. (Id.) As of December 1997, the only document evidencing any agreement between Solucorp and Smart was a Licensing Agreement in Principle ("Agreement in Principle") dated June 4, 1997. (Id. ¶ 11; Finston Decl., Ex. 9.) The Agreement in Principle provided that Smart would obtain six-year licensing rights to use MBS to remediate contaminated soil in China in return for a $2 million licensing fee paid to Solucorp for the first year. (Pl. Rule 56.1 Stmt. ¶ 11.) If the initial fee could not be funded from commercial projects, payment could include the expected profits from Smart's exercise of an option to purchase 200,000 shares of Solucorp stock. (Id.) The fees for the remaining term of the license were to be negotiated by the parties on the basis of a "Market Survey" to be conducted by Smart. (Id.) The Agreement in Principle elaborated that "[t]his Agreement is subject to [Smart] completing a Market Survey within sixty (60) days of this date, and establishing viable operations and agreeing on-going (sic) financial arrangements with Solucorp within a further four (4) months." (Id.)

At least one member of Solucorp's Board of Directors was aware that more work was required to finalize the agreement. (Id. ¶ 11.) On September 25, 1997, Solucorp announced that the Market Survey would be completed in October, and on October 21, 1997, Solucorp received $150,000 in fees from Smart. (Id. ¶¶ 12, 13.) In a press release issued October 22, 1997, Solucorp announced the payment and stated that "Solucorp officials will arrive in China on November 9, 1997, to finalize terms of the agreement with Smart." (Id. ¶ 14.) The October 22 press release was included among the documents produced by MacKay during discovery in the instant action. (Id.) Solucorp did not recognize any license fees for the period ended June 30, 1997. (Id. ¶ 17.) However, a footnote to the June financial statements described the terms of the June 4, 1997 agreement, including the five-year term and the anticipated issuance to Smart of the 200,000 share option, stating that "[s]ubsequent to year end, the agreement was finalized." (Id. ¶ 18.)

After reviewing the Agreement in Principle, Ohlhauser concluded that recognition of revenue was improper for the quarter ended September 30, 1997 because the Agreement in Principle was contingent upon the Market Survey and was insufficiently definite as to Smart's obligation to pay a license fee. (Id. ¶ 24.) Ohlhauser informed Herman of his concerns in a memorandum dated December 18, 1997. (Id.) In a subsequent phone conversation, Herman responded that revenue recognition was appropriate because Solucorp and Smart had been negotiating a final agreement for several months, and that Solucorp management had traveled to China in the fall for that purpose. (Id. ¶ 25.) Herman further explained that the final agreement, which had yet to be memorialized, would address Ohlhauser's concerns and that Smart had already paid $200,000 and was expected to pay the additional $300,000. (Id.) Unconvinced, Ohlhauser sent Solucorp's outside counsel a copy of his December 18 memorandum. (Id. ¶ 26.) During a conversation with Herman and outside counsel on December 19, 1997, outside counsel reiterated that Herman did not agree with Ohlhauser's assessment. Herman also requested that MacKay cease all work with respect to the September 30, 1997 financials with the exception of completing the reconciliation to United States GAAP. (Id.)

Solucorp filed its form 10-KSB registration statement with the SEC on December 22, 1997. (Id. ¶ 32.) Pursuant to 17 C.F.R. § 228.601 (b)(10), Solucorp was required to attach copies of all material contracts. With respect to Smart, the Agreement in Principle was attached. (Id.) The only mention of the parties finalizing the terms of the agreement was contained in the aforementioned footnote to the June financials. (Id.)

In late 1997, Solucorp changed its fiscal year-end from June 30 to December 31. (Id. ¶ 33.) In its financial statements for the six-month transition period ended December 31, 1997 (the "December financials"), Solucorp recognized $1,090,000 in Smart license fees comprising approximately 50% of total revenues. (Id. ¶ 35.) In early 1998, Ohlhauser audited the December financials for inclusion in a Form 10-K to be filed with the SEC. (Id. ¶ 34.)

Still concerned about revenue recognition, Ohlhauser wrote to Herman on February 27, 1998 that revenue "should be recognized when reasonable assurance exists regarding measurement and collectibility." (Id. ¶ 36.) Accordingly, Ohlhauser requested information relating to Smart's ability to pay and requested to see a copy of the final license agreement negotiated by the parties. (Id.) Solucorp provided Ohlhauser with a copy of the final license agreement (the "License Agreement") that superseded the Agreement in Principle. (Id. ¶ 37.) The License Agreement had a commencement date of June 1, 1997 and was "dated as of' September 15, 1997. (Finston Decl., Ex. 25.) Although the License Agreement was executed on or about December 30, 1997, the signers of the agreement both cited September 15, 1997 as their signature date. (Pl. Rule 56.1 Stmt. ¶ 28.)

After reviewing the License Agreement, Ohlhauser wrote to Herman on March 10, 1998 that:

I am still concerned with accounting for license agreement with Smart. This agreement is dated September 15, 1997, however it was not referred to on the 10-KSB [filed with the Commission on December 22, 1997]. . . It appears that this agreement has been `backdated' and I don't know exactly how you reconcile this with information contained in the first 10-KSB. I don't know what SEC may say if these new `facts' aren't consistent with items previously filed.

(Id. ΒΆ 37.) Herman responded, in apparent contrast to his prior representations, that he believed Solucorp had negotiated the contract during a visit to China on September 15, 1997. On March 22, 1998, Ohlhauser also drafted a memorandum addressed to Rick Day, a partner of McGladrey Pullen LLP, an accounting ...

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