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Biotech Company And Former Executives Settle Charges Of Securities And Accounting Fraud

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  • Posted on: Nov 13 2017

On November 2, 2017, the Securities and Exchange Commission (“SEC” or the “Commission”) announced (here) that it had charged Osiris Therapeutics, Inc. (“Osiris” or the “Company”), a Maryland-based biotech company, and four former senior executives with inflating reported revenue growth, improperly recognizing revenue and misleading investors.

In its complaint (here), the SEC alleged that Osiris routinely overstated Company performance and issued fraudulent financial statements for a period of nearly two years.  According to the SEC, Osiris and its former senior officers artificially inflated the Company’s reported revenue and results of operation, entered into undisclosed side agreements with distributors, improperly recognized revenue in direct contravention of the Company’s accounting policies, lied to Osiris’ independent public accounting firm, and backdated and falsified documents.

As alleged, the fraudulent actions complained of were carried out by former Company officers, including Phillip R. Jacoby, Jr. who served as Osiris’ chief financial officer and, subsequently, vice president of finance and principal accounting officer; Gregory I. Law who served as Osiris’ vice president of finance and principal accounting officer and, subsequently, chief financial officer; Lode B. Debrabandere who served as Osiris’ chief executive officer; and Bobby Dwayne Montgomery, who served as Osiris’ general manager of orthopedics and sports medicine and, subsequently, its chief business officer.

According to the SEC, throughout 2014 and the first three quarters of 2015, the defendants repeatedly mislead the investing public about Osiris’ financial condition and results of operations. Osiris did so by: (i) prematurely recognizing revenue in periods before sales had been made and critical agreement terms were finalized; (ii) recognizing revenue using higher, inaccurate prices, while disregarding data explicitly showing lower, actual revenue numbers; (iii) recognizing revenue on consignment inventory, directly contradicting Osiris’ disclosed accounting policies; and (iv) prematurely recognizing revenue involving transactions with distributors despite the fact that the Company already had significant accounts receivable with them. As alleged, these accounting practices led to misstatements about Osiris’ revenue, a key financial metric for the Company, which was reported in Osiris’ periodic filings, current reports, and earnings calls.

According to the SEC, the fraudulent misstatements and omissions were driven by Osiris’ corporate culture, which was set and communicated by Debrabandere and embraced by Jacoby, Law, and Montgomery. During at least 2014 and the first three quarters of 2015, Osiris was focused on recognizing gross revenue, which Osiris executives and employees often referred to as “top line” revenue. In particular, Debrabandere was focused on demonstrating consistent revenue growth quarter over quarter. When the defendants realized that Osiris’ actual sales were not meeting Debrabandere’s aggressive targets, they engaged in a variety of improper accounting practices to artificially inflate reported revenue.

“As alleged in our complaint, Osiris Therapeutics falsely portrayed to investors that its revenue was growing so rapidly that its performance was consistently exceeding expectations,” said Julie Lutz, Director of the SEC’s Denver Regional Office.  “Corporate cultures cannot be so fixated on higher revenues that they use illegal accounting gimmicks to meet the financial numbers they desire.”

Osiris agreed to settle the charges without admitting or denying the allegations by consenting to the entry of a final judgment, subject to court approval, that permanently restrains and enjoins the Company from violating certain provisions of the federal securities laws, and by agreeing to pay a $1.5 million civil penalty.

“We are very pleased to have reached the resolution announced today, which relates to activities that occurred during the tenure of the Company’s former management team,” said Peter Friedli, Chairman of the Board of the Company. (Here.) “We have instituted broad remedial measures designed to detect and prevent the issues that led to the matter being resolved, and this resolution allows us to continue moving forward with the Company’s critical mission of making advances in the area of cellular and regenerative medicine.”

Although the Company settled the charges with the SEC, the litigation continues against Debrabandere, Jacoby, Law, and Montgomery.  The SEC is seeking disgorgement of ill-gotten gains plus interest and penalties along with officer-and-director bars.

In addition to the SEC action, there is an ongoing investigation by the U.S. Attorney’s Office for the Southern District of New York relating to matters that were also investigated by the SEC.

Finally, there are multiple shareholder actions involving the matters resolved by the Company and the SEC:

  • a securities class action pending in the United States District Court for the District of Maryland (Kiran Kumar Nallagonda v. Osiris Therapeutics, Inc., Case No.: 1:15-cv-03562-JFM), alleging violations of the federal securities laws; and
  • a shareholder derivative action pending in the Circuit Court for Howard County in the State of Maryland (Kevin Connelley v. Lode Debrabandere et al ., Case No. 13C16106811), alleging that, in connection with the matters subject to the class action, each of the individual directors and officers named as defendants: (i) violated their fiduciary duties to the Company’s shareholders; (ii) abused their ability to control and influence the Company; (iii) engaged in gross mismanagement of the assets and business of the Company; and (iv) was unjustly enriched at the expense of, and to the detriment of, the Company.

This Blog previously wrote about derivative actions here.

Takeaway

The SEC’s stated mission is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” (Here.) Although each mission should be a priority, the SEC’s focus is often based on its chair and commissioners and the politics of the day. Former Chair Mary Jo White and Enforcement Division Director Andrew Ceresney viewed enforcement and investor protection to be the agency’s top priority. Based upon his background and pro-business disposition, Jay Clayton, the new chair of the agency and a mergers & acquisitions attorney, is more likely to focus on capital formation as the Commission’s priority. Notwithstanding, there is little reason to believe that the Enforcement Division will stop investigating violations of the federal securities laws. (Here.)

The federal securities laws are, after all, intended to protect investors.  To that end, they are based on the principle that all investors, whether institutions or individuals, should have access to full and complete material information about a company before they buy its securities, as well as during the period of time in which they hold them. Public company reporting requirements are, therefore, designed to ensure that such information is publicly disseminated so that investors can make an informed decision as to whether to buy, sell or hold a particular security. The SEC charged Osiris and its former executives for failing to provide the transparency required under the federal securities laws.

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