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Enforcement News: SEC Brings Enforcement Proceedings Against Branding Company and its Former Senior Executives to Redress Accounting Fraud

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  • Posted on: Dec 16 2019

A common fact pattern for accounting fraud involves a public company recognizing revenues before they are realized or realizable and earned. Senior executives who engage in such fraud often do so to meet or beat analysts’ revenue and earnings estimates. Case after case shows that the pressure to satisfy Wall Street (that is, meet or beat analysts’ estimates) is strong.

When a public company and its senior executives issue materially false and misleading statements about the company’s accounting practices and procedures, it usually draws the attention of the Securities and Exchange Commission (the “SEC”) and investors and shareholders, who file class action lawsuits to recover the damages caused from the decline in the price of the company’s stock resulting from the revelation of the truth about the company’s accounting practices. Sometimes, the conduct is egregious enough that criminal proceedings commence against the company and/or the responsible senior executives. Litigation involving Iconix Brand Group, Inc., the clothing and fashion brand-management company, and certain of its former senior executives, is a recent example of the foregoing.

On June 23, 2015, shareholders filed class action complaints against Iconix Brand Group, Inc. (“Iconix” or the “Company”) and, among others, Neil Cole (“Cole”), the Company’s former Chief Executive Officer, Seth Horowitz (“Horowitz”), the Company’s former Chief Operating Officer, and Warren Clamen (“Clamen”), the Company’s former Chief Financial Officer. Following the appointment of Lead Plaintiffs, and motion practice directed to the sufficiency of the allegations in the complaint, Lead Plaintiffs filed a second amended complaint alleging that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”) by issuing materially false and misleading statements regarding the Company’s accounting treatment for, inter alia, overseas joint ventures Iconix entered into to conceal its deteriorating financial condition. Specifically, Lead Plaintiffs alleged that Iconix formed overseas joint ventures, “sold” a 50% stake to local partners for millions of dollars, then immediately booked the entire purchase price – of which the joint venture partners paid only a fraction at closing, with the majority due in installments over a number of years – as profits for Iconix. Lead Plaintiffs alleged that, throughout the class period, defendants repeatedly assured the SEC and investors that the joint venture partners were obligated to pay their installments in full; that these partners were “well-capitalized” and “predetermined” to pay; and that if they did not pay, Iconix had “full recourse” and would sue to collect. Lead Plaintiffs alleged that these statements, made in direct response to an SEC inquiry into Iconix’s joint venture accounting that began in December of 2014 (the “SEC Inquiry”), were false.

In July 2019, the class action lawsuit was settled as to the Iconix defendants for $6 million.  On September 23, 2019, the court preliminarily approved the proposed settlement. Notice was disseminated and a final approval hearing date was scheduled for January 23, 2020. [The settlement website for the class action lawsuit can be found here.]

On December 5, 2019, the SEC announced (here) that it charged Iconix, Cole, Horowitz and Clamen with fraud. As discussed below, Horowtiz and Clamen agreed to settle the claims. Cole did not. Consequently, the SEC’s litigation against him remains ongoing.

[Ed Note: In 2003, the SEC charged Iconix’s predecessor, Candie’s, Inc., with violating the Section 10(b) of the Exchange Act for fraudulent recognition of revenue through the use of improper bill-and-holds and artificial inflation of revenue by entering into illusory sales transactions with a barter company. See Candie’s Inc., Securities Act Release No. 8228 (Apr. 30, 2003), available at https://www-test.sec.gov/litigation/admin/33-8228.htm. In 1996, the SEC charged Candie’s with violating Section 5 of the Securities Act of 1933 (the “Securities Act”) in connection with a scheme to evade the registration requirements with respect to four offerings. See Candie’s Inc., Securities Act Release No. 7263 (Feb. 21, 1996), available at https://www.sec.gov/litigation/admin/3436865.txt.]

In its complaint against Cole and Horowitz (here), the SEC alleged that these senior executives devised a fraudulent scheme to create fictitious revenue, allowing Iconix to meet or beat Wall Street analysts’ consensus estimates in the second and third quarters of 2014. According to the SEC, Cole and Horowitz realized substantial profits on Iconix stock sales as a result of the alleged fraud. In order to conceal the fraud, Cole and Horowitz allegedly deleted emails and caused Iconix to make false and misleading statements in response to the SEC Inquiry.

In its complaint against Iconix (here), the SEC charged the Company with fraud for recognizing false revenue and manipulating its reported earnings in 2014, entering into transactions to conceal distressed finances at two licensees who could not meet licensing royalty payments owed to Iconix, and failing to recognize over $239 million in impairment charges for three brands over a multi-year period.  Additionally, alleged the SEC, Iconix and Clamen failed to recognize losses from Iconix’s failing licensees, disclose that Iconix entered into transactions to secretly and temporarily bolster its licensees’ finances, and properly test for impairments.  As a result of these alleged accounting improprieties, Iconix overstated net income by hundreds of millions of dollars between 2013 and the third quarter of 2015.

“As the Commission alleges, Iconix and its top executives deceived investors by manipulating revenue and a key earnings metric, schemed to hide the lackluster results of its top brands and concealed growing losses,” said Anita B. Bandy, Associate Director of the SEC’s Division of Enforcement. “Today’s actions reflect our efforts to hold companies and executives accountable and obtain meaningful relief for investors.”

Without admitting or denying the allegations, Iconix agreed to injunctive relief and to pay a $5.5 million penalty, an amount that reflected the Company’s cooperation and remediation efforts, said the SEC. Horowitz consented to injunctive relief and a permanent officer and director bar, and agreed to disgorgement and prejudgment interest of over $147,000, and a penalty in an amount to be determined at a later date. The settlements are subject to court approval.

Clamen, without admitting or denying the SEC’s findings, agreed to cease and desist from future violations of the securities laws and pay disgorgement and prejudgment interest of nearly $50,000 and a $150,000 penalty. According to the SEC order (here), Clamen is suspended from appearing and practicing before the Commission as an accountant with the right to apply for reinstatement after three years. 

In its litigation against Cole, the SEC is seeking monetary and injunctive relief, including a permanent officer and director bar, and reimbursement to Iconix of certain incentive-based compensation pursuant to Section 304(a) of the Sarbanes-Oxley Act. 

In parallel actions, the U.S. Attorney’s Office for the Southern District of New York also announced on December 5, 2019, the filing of criminal charges against Cole and Horowitz (here). Horowitz pled guilty to the charges and is cooperating with the Government.  

Commenting on the charges, United States Attorney Geoffrey S. Berman said: “As alleged, Neil Cole entered into illegal secret agreements with joint venture partners to artificially inflate the value to his company.  Further, as alleged, Cole lied to outside auditors and to the SEC, and took steps to destroy evidence.  Now Neil Cole is in custody and facing serious criminal charges for his alleged conduct.  This is the third accounting fraud case brought by our Office in the last four months, which illustrates both the pervasiveness of this crime and my Office’s commitment to policing it.”

FBI Assistant Director William F. Sweeney Jr. added: “As alleged, Cole and Horowitz falsely represented the financial standing of Iconix’s revenue at the expense of its shareholders and the investing public.  To aggravate matters further, they allegedly destroyed and concealed evidence from the SEC during their inquiry into the company’s joint ventures.  This is not a crime to be taken lightly, and as our charges today prove, this type of alleged dishonorable behavior will not go unpunished.”  

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