Securities Regulation Daily Execs hid scheme to meet revenue targets, lied to auditors
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Thursday, September 15, 2016

Execs hid scheme to meet revenue targets, lied to auditors

By Rodney F. Tonkovic, J.D.

Two former Bankrate, Inc. executives behind a scheme to artificially inflate the company’s revenue were unsuccessful in their attempt to get the SEC's complaint against them dismissed.

According to the Commission, Bankrate's former CFO and director of accounting schemed to artificially inflate the company's revenues and to understate its expenses to meet financial targets. The court denied the executives' motion with the exception of one Securities Act claim against the former director of accounting (SEC v. DiMaria, September 15, 2016, Woods, G.).

In 2015, the Commission charged Bankrate and three executives with using improper accounting methods to artificially inflate the company’s revenues and to understate its expenses to meet financial targets. According to the Commission, the CFO, Edward DiMaria "fostered a corporate culture that condoned using improper accounting techniques to achieve financial targets." Bankrate, the Commission said, carried over-accrued expense accounts on its books, and DiMaria used these accounts to "tune" Bankrate’s numbers to meet financial targets.

Bankrate’s second quarter 2012 earnings release exceeded analyst estimates. The Commission alleged that Bankrate’s financial results were materially misstated and that it only met key analyst targets because of the improper accounting entries. The Commission alleged further that Bankrate's Form 10-Q for that period overstated its net income by approximately $1 million. This suit against DiMaria and Matthew Gamsey, the director of accounting, followed. The Commission instituted administrative proceedings against Bankrate and its former vice president of finance, which were settled after the payments of penalties in the amounts of $15 million and $150,000, respectively.

Entries were material. Both DiMaria and Gamsey argued that the accounting entries at issue were not material. The court noted that the Second Circuit has acknowledged SEC Staff Accounting Bulletin No. 99, which provides that a misstatement related to less than five percent of a financial statement carries a preliminary assumption of immateriality. DiMaria and Gamsey accordingly provided calculations yielding an alleged misstatement of between 4.8 and 4.9 percent of net income, but the court observed that these numbers "are only the starting point." The Commission alleged that DiMaria intended to manage earnings to conceal Bankrate’s failure to meet the analysts' expectations. "Managing" earnings and hiding the failure to meet expectations are specifically mentioned in SAB No. 99 as factors that could render a small misstatement material. Drawing all reasonable inferences in the Commission's favor, the court concluded that the allegations sufficiently pleaded deliberate misstatements about the measures taken to hide Bankrate's failure to meet analyst expectations.

Scienter alleged. The court then found that the complaint adequately alleged that both DiMaria and Gamsey acted with scienter. Regarding DiMaria, the court found that the allegations, including that DiMaria directed multiple unjustified accounting entries until the financial statements reflected the numbers he wanted and that he had a history of "tuning" Bankrate’s numbers to meet targets, combined to support a strong inference that he acted with the requisite scienter. DiMaria's alleged conduct, the court added, crossed the line from taking affirmative action to meet targets to consciously creating a false appearance that the targets were met in spite of his knowing that this was not the case.

The court then found that, with respect to Gamsey, the Commission adequately pleaded scienter through allegations of conscious misbehavior or recklessness. According to the court, the allegations showed that Gamsey was not only aware of the improper accounting entries, but also helped to conceal them from Bankrate's auditor.

A claim against Gamsey under Securities Act Section 17(a)(2), however, was dismissed because the complaint failed to show that he obtained money or property by means of the alleged misstatements. The complaint failed to allege any chain of events that concluded with Gamsey receiving money or property as a result of the alleged scheme, the court said.

Section 13 claims. Finally, the court found that Gamsey violated Section 13(b)(5) by causing the improper entries to be recorded in Bankrate's financial statements. Gamsey, the Commission adequately alleged, made affirmative misrepresentations to Bankrate's auditors that he was unaware of any fraud, which ensured that the improper entries would be reflected in the financial statements. In addition, both DiMaria and Gamsey signed a management representation letter falsely assuring the auditors that Bankrate's financial statements had been prepared in conformity with GAAP and that all frauds had been reported.

The case is No. 1:15-cv-7035.

Attorneys: Stephen C. McKenna for the SEC. Barry H. Berke (Kramer Levin Naftalis & Frankel LLP) for Edward Dimaria.

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