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S.E.C. v. Espuelas

United States District Court, S.D. New York

October 26, 2012

Fernando J. ESPUELAS et al., Defendants.

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[Copyrighted Material Omitted]

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Charles Derrick Stodghill, James T. Coffman, Scott W. Friestad, Securities and Exchange Commission, Kenneth Wade Donnelly, U.S. Securities and Exchange Commission, Paul W. Sharratt, Washington, DC, for Plaintiff.

Brian J. Dunn, Securities and Exchange Commission, Treazure R. Johnson, George Kostolampros, Venable LLP, Washington, DC, Gregory W. Gilliam, Venable LLP, New York, NY, for Defendants.

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PAUL A. ENGELMAYER, District Judge:

In this lawsuit, the Securities Exchange Commission (" SEC" ) has sued various former executives of StarMedia Network, Inc. (" StarMedia" or the " Company" ) for accounting fraud. Pending here is defendant Peter Morales's motion for summary judgment as to the remaining claims against him: for aiding and abetting StarMedia's violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, and 13a-13; directly violating Exchange Act Rule 13b2-1; and directly violating Exchange Act Rule 13b2-2. For the reasons stated below, that motion is denied as to each claim. Also pending is Morales's motion to exclude expert testimony offered by the SEC. For the reasons stated below, that motion is denied, without prejudice to Morales's right to refile such a motion at the time that motions in limine are due.

I. Background and Undisputed Facts[1]

The SEC's allegations in this action are set forth in detail in the decisions of the Hon. Richard J. Holwell, who was previously assigned to this case. The Court assumes familiarity with those decisions. Here, the Court sets forth only those facts relevant to the resolution of this motion. Except as otherwise specified, the following facts are not in dispute.

A. Procedural History

On March 29, 2006, the SEC filed its initial complaint in this case against eight defendants, alleging violations of the Securities Act of 1933 (" Securities Act" ) and the Exchange Act of 1934 (" Exchange Act" ) (Dkt. 1). On September 30, 2008, Judge Holwell denied Morales's motion to dismiss all claims against him, but granted a motion to dismiss as to certain claims against other defendants. SEC v. Espuelas ( Espuelas I ), 579 F.Supp.2d 461 (S.D.N.Y.2008) (Dkt. 59).

On December 11, 2008, the SEC filed an amended complaint (Dkt. 66). Morales thereupon moved for judgment on the pleadings. On March 3, 2011, Judge Holwell denied that motion. SEC v. Espuelas (Espuelas IV), 767 F.Supp.2d 467, 476 (S.D.N.Y.2011) (Dkt. 129). On October 20, 2011, the case was reassigned to this Court. Two defendants remain in this case: Morales and Betsy Scolnik. Scolnik has also filed a motion for summary judgment, which is addressed in a separate opinion issued today.

B. Key Parties, Individuals, and Entities

StarMedia was an internet media company that targeted Spanish- and Portuguese-speaking

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markets. Sharratt Decl. Ex. 1; Ans. ¶ 24. It was incorporated in Delaware, maintained its headquarters in New York City, and its common stock was registered with the SEC and traded on NASDAQ. Sharratt Decl. Ex. 1; Ans. ¶ 24.

Peter Morales was employed by StarMedia from June 1998 until November 2001. Am. Compl. ¶ 22; Ans. ¶ 22. During that time, he served as the company's Vice President for Finance. Am. Compl. ¶ 22; Ans. ¶ 22. Morales reported to Steven Heller, the company's Chief Financial Officer (" CFO" ). Sharratt Decl. Ex. 24 (Investigative Testimony of Peter Morales, June 9, 2003) (" Morales Inv. Test." ) at 28-29; Grunberg Decl. Ex. A (Deposition of Peter Morales, February 2, 2011) (" Morales Dep." ) at 82. The parties dispute whether Morales served as the company's Controller between November 2000 and November 2001. Compare Pl.'s 56.1 ¶ 2, citing Ans. ¶ 22, with Def.'s 56.1 ¶ 2, citing Grunberg Decl. Exs. NN, SS, TT. As detailed below, the parties also dispute the nature of Morales's responsibilities, as well as his accounting expertise.

AdNet, S.A. de C.V. (" AdNet" ) was one of StarMedia's Mexican subsidiaries. Grunberg Decl. Ex. W at 2. StarMedia acquired AdNet in 2000 from two Mexican media companies— Grupo MVS S.A. de C.V. (" MVS" ) and HarryMoller Publicidad, S.A. (" HMP" ). Id. Walther Moller worked for AdNet before its acquisition, and, after the acquisition, was promoted to be its President; his family owned HMP. Def.'s 56.1 ¶ 15; Pl.'s Reply 56.1 ¶ 15. StarMedia de Mexico was another of StarMedia's Mexican subsidiaries. Grunberg Decl. Ex. L (Deposition of Steven Heller, January 25, 2011) (" Heller Dep." ) at 121.

C. The " Incremental Revenue" Transactions

The SEC refers to the transactions on which its claims are based as the " incremental revenue transactions." It alleges that, in November 2000, a group of StarMedia executives— not including Morales— devised a plan to exploit Moller's connections with HMP and MVS to inflate StarMedia's revenue. Am. Compl. ¶ 59. On November 29, 2000, Moller described these transactions to Heller in an email, which included a diagram. Sharratt Decl. Ex. 46.[2] Heller relayed this information to Jack Chen, StarMedia's President, and obtained Chen's approval to go ahead with the deal. Sharratt Decl. Ex. 27 (Investigative Testimony of Steven Heller, May 29, 2003) (" Heller Inv. Test." ) at 140. Heller then spoke with Fernando Espuelas, StarMedia's CEO, and Andriana Kampfner, another StarMedia executive, who were in Mexico. Id. at 164-65. Espuelas and Kampfner met with Moller, and after negotiation, agreed to the terms of the transactions. Id. at 136-39. The basic structure of those transactions is as follows:

StarMedia would send funds to AdNet, which it characterized as capital contributions. Heller Inv. Test. 141.[3] AdNet would then purchase pre-paid services from HMP and MVS. Id. at 108; Sharratt Decl. Exs. 46, 48, 51. In return, Moller would refer third-party clients of HMP and MVS to buy internet advertising from AdNet and StarMedia de Mexico. Heller

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Inv. Test. 108; Sharratt Decl. Exs. 46, 48, 51. These third parties would pay AdNet and StarMedia directly, ostensibly for the advertising. Heller Dep. 127. The revenue created from the third-party advertising sales would be recorded as delivered, but the expenses for AdNet's services would be expensed only later, at the time utilized. Id. at 126.

Although the parties agree on the basic framework of the transactions, they have two main disputes as to their substance.

First, the parties dispute whether services were actually purchased from HMP and MVS. Compare Pl.'s 56.1 ¶ 95, and Pl.'s Reply ¶¶ 34-35, with Def.'s 56.1 ¶¶ 34-35. Morales asserts that it was legitimate for AdNet to purchase prepaid services from HMP and MVS, because StarMedia, AdNet's parent, actually received and used services that HMP and MVS provided. Def.'s 56.1 ¶ 34, citing Grunberg Decl. Ex. F (Investigative Testimony of Cynthia Cueto, May 20, 2003) at 38, 46-48; Exs. OO, QQ; Heller Dep. 139. In return for the prepaid services, Morales asserts, StarMedia/AdNet made total payments of approximately $2.3 million to HMP and MVS during fourth quarter 2000 and the first two quarters of 2001. Def.'s 56.1 ¶ 25, citing Grunberg Decl. Exs. HH, II. The SEC disputes this amount, asserting that StarMedia's records reflect a series of payments to AdNet and HMP, as part of the incremental revenue transactions, totaling $2,617,500. Pl.'s 56.1 ¶ 87, citing Sharratt Decl. Ex. 92. The SEC also questions whether AdNet genuinely received value from the transactions, noting that the accounting firm KPMG could not verify the value of the services received from HMP. Pl.'s 56.1 ¶ 95, citing Sharratt Decl. Exs. 97-100.

Second, the parties dispute whether and how the third-party clients paid for their purchases of advertising from AdNet and StarMedia. The SEC asserts that the third-party clients either did not know of their advertising purchases, or were indifferent to them, because they were not paying for these purchases. Pl.'s 56.1 ¶ 40, citing Sharratt Decl. Exs. 33, 88-90. Rather, the SEC asserts, StarMedia funded its own revenue, in that the payments from AdNet to HMP and MVS were, in actuality, used to pay for the advertising services the third-party clients purchased. Am. Compl. ¶¶ 60-66. By contrast, Morales asserts that the parties never discussed or contemplated that HMP and MVS would send money to the third-party clients to purchase the advertising from StarMedia. Def.'s 56.1 ¶ 18, citing Heller Inv. Test. 158-59. Morales asserts that StarMedia provided legitimate advertising services to the third-party clients. Def.'s 56.1 ¶ 32-33. The SEC does not dispute that such services were provided, but notes that " [t]he delivery of products does not establish that the transactions were properly recorded in StarMedia's books and records or properly reported in the company's public disclosure." Pl.'s Reply 56.1 ¶ 33. During the fourth quarter of 2000, StarMedia booked revenues of $3.2 million from advertising that was placed at StarMedia de Mexico on behalf of clients of HMP and MVS. Sharratt Decl. Exs. 32-33; Am. Compl. ¶¶ 62-63. StarMedia booked revenues of $2.6 million from such advertising during the first quarter of 2001, and $2.675 million during the second quarter of 2001. Sharratt Decl. Exs. 32-33; Am. Compl. ¶¶ 87, 104. The parties do not dispute that these figures were booked as revenue. Def.'s 56.1 ¶¶ 23-24; Pl.'s Reply 56.1 ¶¶ 23-24.

The parties also dispute who at StarMedia was aware of the terms of the incremental revenue transactions. The SEC alleges that these terms were agreed upon orally, and never memorialized, Am.

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Compl. ¶ 67, and that, as a result, StarMedia's finance department and auditors were unaware of these transactions and therefore could not properly account for them. Am. Compl. ¶¶ 97, 99, 110. By contrast, Morales asserts that the finance department knew of the transactions because Heller, the CFO, helped to negotiate them and to determine the proper accounting treatment for them. Def.'s 56.1 ¶¶ 8, 27, 30, 37. Morales also asserts that the company's legal team was aware of ...

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