United States Securities and Exchange Commission v. Brown

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
______________________________
SECURITIES AND EXCHANGE :
COMMISSION, :
:
Plaintiff, :
:
v. : Civil Action No. 09-1423 (GK)
:
GARY A. PRINCE, :
:
Defendant. :
______________________________:
MEMORANDUM OPINION
Plaintiff United States Securities and Exchange Commission
(“SEC” or “the Commission”) brings this civil action against
Defendant Gary A. Prince (“Prince”) alleging violations of the
Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77a et
seq., the Securities Exchange Act of 1934 (“Exchange Act”), 15
U.S.C. § 78a et seq., and various Rules promulgated under the
Exchange Act. On December 10, 2012 through January 4, 2013, the
Court held a bench trial in which fifteen witnesses testified.
Based on the testimony presented by those witnesses, the
voluminous number of exhibits admitted into evidence, the
parties’ representations of what facts were not in dispute, and
the applicable caselaw, the Court makes the following findings
of fact and conclusions of law.
TABLE OF CONTENTS
I. FINDINGS OF FACT .......................................... 5
A. Creation of Integral Systems, Inc. ....................... 5
B. Prince’s Duties and Activities Between 1982 and 1998 ..... 5
C. Prince’s Duties and Activities Between December 1998 and
August 2006 .................................................. 8
1. Prince Becomes a Full-Time Employee at Integral ........ 8
2. Mergers and Acquisitions Program ...................... 11
3. Prince’s Compensation ................................. 13
4. Prince’s Stock Options ................................ 13
5. Executive Management Salaries/Bonuses ................. 14
6. The “Gang of Six”/”Gang of Seven” ..................... 14
7. Advisor to Chamberlain ................................ 15
8. Prince’s Responsibility for the Contracts Department .. 17
9. Drafting the MD&A Section of Public Filings ........... 19
10. Reviewing and Commenting on Drafts of Public Filings .. 20
11. Prince’s Role During Brown’s Maternity Leave .......... 21
12. Financial Press Releases .............................. 23
13. Financial Forecasting ................................. 23
14. Financial Presentations ............................... 23
15. Attendance at Board of Directors Meetings ............. 24
16. Prince’s Involvement with the Accounting Department ... 24
D. Integral’s Knowledge and Actions from December 1998 to
August 2006 ................................................. 26
E. Role and Involvement of Counsel ......................... 28
1. Venable Becomes Corporate Counsel ..................... 28
2. The Relationship Between Venable and Integral ......... 29
3. Consultation with Venable Regarding Prince’s Hiring ... 30
4. Venable’s Knowledge of Prince’s Duties and Activities . 32
5. Integral’s Conversations with Venable about Prince’s
Possible Officer Status .................................... 34
a. Fall of 1999 ........................................ 34
b. January 2001 ........................................ 37
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c. Spring and Summer of 2002 ........................... 38
6. Venable’s Termination as Corporate Counsel ............ 39
7. Venable’s Rehiring by the Board of Directors Audit
Committee .................................................. 40
8. DLA Piper’s Resignation as Corporate Counsel and
Venable’s Rehire ........................................... 42
9. In December 2005, Venable Again Researched Whether Prince
Needed to Be Disclosed in Public Filings ................... 42
10. Integral’s Filing of a Form 8-K Disclosing Wachtel’s
Allegations ................................................ 44
11. NASDAQ and SEC Investigations ......................... 45
12. In August 2006, Prince Is Named an Executive Officer and
Disclosed to the SEC ....................................... 51
13. Advice from Venable to Integral ....................... 53
F. Post-2006 Activities and Procedural History ............. 54
II. CONCLUSIONS OF LAW ...................................... 56
A. Legal Framework ......................................... 56
B. Prince’s De Facto Officer Status ........................ 62
1. Prince’s Duties, Functions, and Responsibilities Did Not
Involve Performing Policy Making Functions ................. 66
C. Count VI: Liability under Section 16(a) and Rule 16a-3 of
the Exchange Act ............................................ 73
D. Count II: Liability Under Section 10(b) and Rule 10b-5 of
the Exchange Act ............................................ 74
1. Prince Did Not Act With Scienter When He Did Not File
Section 16(a) Reports ...................................... 76
a. Integral Requested and Received Venable’s Advice After
Making Complete Disclosure ............................... 77
b. Integral Relied on Venable’s Advice in Good Faith ... 81
c. In Subsequent Years, Venable Reiterated its Conclusion
That Prince Could Work at Integral Without Disclosure .... 82
2. The SEC Did Not Establish That a “Scheme to Defraud”
Existed .................................................... 91
E. Count III: Liability under Section 13(a) and Rules 13a-1
and 12b-20 of the Exchange Act .............................. 92
1. Scienter .............................................. 93
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F. Count V: Liability Under Section 14(a) and Rule 14a-9 of
the Exchange Act ............................................ 94
G. Count VII: Practicing Accounting Before the Commission .. 95
1. Prince Violated the Commission Rule 102(e) Order Barring
Him from Appearing or Practicing Before the Commission as an
Accountant ................................................. 95
2. Prince Did Not Obtain or Rely on Advice of Counsel
Regarding Practicing Accounting Before the Commission ..... 109
H. Relief ................................................. 112
III. CONCLUSION ............................................. 118
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I. FINDINGS OF FACT
A. Creation of Integral Systems, Inc.
1. Integral Systems, Inc. (“Integral”) is incorporated and
headquartered in Maryland. It makes and sells satellite ground
systems, including satellite communications systems and software
products for satellite command and control.
2. Integral was founded in 1982. One of the founders was
Steven R. Chamberlain, who served as Integral’s Chairman and
Chief Executive Officer (“CEO”) from 1982 until 2006.
3. Integral became a public company in 1988. At all times
relevant to this action, Integral was an issuer of securities
registered pursuant to Section 12 of the Securities Exchange Act
of 1934, 15 U.S.C. § 78l.
B. Prince’s Duties and Activities Between 1982 and 1998
4. In 1982, Prince was retained as a consultant by Integral to
help set up its financial books and record systems. He also
served as a Director on Integral’s Board.
5. In 1992, Prince became Vice President and Chief Financial
Officer (“CFO”) of Integral during which he had the “final call”
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on accounting matters. He was not a full-time employee and
performed his duties as a part-time consultant.
6. In June 1993, as a consequence of Prince’s conduct as CFO
of the public company Financial News Network, the SEC filed suit
against Prince for violation of the federal securities laws.
7. On July 9, 1993, Integral issued a Form 8-K (a filing that
a company is required to make disclosing any material event
important to shareholders or the SEC) disclosing that Prince had
been charged by the SEC.
8. On August 18, 1994, Judge Charles R. Richey of the U.S.
District Court for the District of Columbia entered an Order of
Final Judgment of Permanent Injunction against Prince. S.E.C. v.
Gary A. Prince, Civ. No. 93-1331 (D.D.C. 1994). That Judgment
prohibited Prince from violating the securities laws in the
future, including Section 10(b) and Rule 10b-5 of the Exchange
Act.
9. On March 31, 1995, Prince resigned as a Director and CFO of
Integral.
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10. On May 10, 1995, Integral filed a Form 10-Q (a quarterly
financial report filed with the SEC) disclosing that Prince had
resigned his Director and Officer positions at Integral and
noting that Integral would continue to use his services as a
consultant.
11. After Prince’s resignation, Prince continued to act as a
consultant to Integral from April 1995 until he joined the
company on a full-time basis in December 1998. In this capacity,
Prince reported directly to Chamberlain. His work included
performing financial analyses, evaluating companies for purposes
of acquisition and/or merger, drafting the “Management
Discussion and Analysis” (“MD&A”) section of the Form S-1 (a
registration statement filed with the SEC to register a
company’s securities), making revenue forecasts, drafting press
releases, offering bonus suggestions for members of executive
management, and helping to prepare public filings. Prince ceased
to be responsible for day-to-day accounting decisions and no
longer had the “final call” on accounting matters.
12. On September 5, 1995, Prince entered a plea of guilty to
two felony counts in the District Court for the Central District
of California charging him with conspiracy under 18 U.S.C. § 371–7–
and making a false statement to the SEC in violation of 18
U.S.C. § 1001. The charges also arose from Prince’s conduct as
CFO of Financial News Network. He was sentenced in late 1995 to
two months’ incarceration, two months of home detention, a
$50,000 fine, and three years of probation.
13. On June 24, 1997, the Commission issued an Order pursuant
to Commission Rule 102(e), 17 C.F.R. § 201.102(e), permanently
prohibiting Prince from exercising “the privilege of appearing
or practicing before the Commission as an accountant.”
(“Accounting Bar”). Pl.’s Ex. 2. The Commission provided no
further guidance to Prince on what the Accounting Bar permitted
him to do and not do.
C. Prince’s Duties and Activities Between December 1998
and August 2006
1. Prince Becomes a Full-Time Employee at Integral
14. In December 1998, Prince and Chamberlain began discussing
how to structure a role for Prince as a full-time employee at
Integral.
15. Chamberlain wanted to create a position for Prince that
would not require Integral to disclose Prince’s legal history in
its public filings. Since Chamberlain knew that officers had to
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be disclosed in a public company’s filings, Prince could not
serve as an officer. Chamberlain also wanted to create
procedures ensuring that Prince would not be involved with the
accounting department and the accounting data.
16. Moreover, Chamberlain was clear that he did not want Prince
to become an officer because the bylaws gave all officers the
ability to sign contracts and bind the company. Chamberlain did
not want Prince to have that sort of unchecked authority because
Chamberlain, though very appreciative of Prince's skills and
experience, also believed that Prince had an inflated sense of
his own worth and a propensity to meddle in areas beyond his
responsibilities.
17. A series of “carveouts” were created to “fence in” Prince’s
roles and duties. Prince was not allowed to sign contracts or
checks or bind the company in any way; he was not allowed to
hire or fire staff without permission; and he was not allowed to
hold himself out to be a vice president or officer of Integral.
18. Prince was not allowed to participate in accounting staff
meetings and was not allowed to work on preparation of
Integral’s financial statements. In general, he was also denied
“write” privileges to the network drives where the accounting
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numbers were stored, and at times he was denied “read” access to
the interim numbers.
19. Around the time Prince was hired as a full-time employee,
Chamberlain communicated these “carveouts” in person to Elaine
Brown, 1 the company’s Chief Financial Officer, and Thomas Gough,
the company’s President and Chief Operations Officer. Although
these “carveouts” were never put in writing, they were well-
known and understood throughout the company, and were monitored
by Chamberlain.
20. Prince’s primary responsibility was development of a
mergers and acquisitions program. Prince would also continue the
work he had been doing as a consultant including drafting the
MD&A, making revenue forecasts, drafting press releases,
offering bonus suggestions for members of executive management,
and helping to review and prepare public filings. Finally,
Prince would also function as a general advisor and staff member
to Chamberlain, as well as to other members of management.
21. As part of his general advisory role, Prince would
regularly share his opinion on a variety of subjects beyond
1
Elaine Brown is Elaine Parfitt’s married name. Test. of Elaine
Brown, Trial Tr. Dec. 14, 2012, A.M. Session 68. This opinion
will refer to her as “Brown,” which she used professionally.
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those directly related to his financial background and
experience. This activity was consistent with the broader
culture established by Chamberlain, who encouraged all employees
to share their opinions on any subject. Prince, a bit of a
gadfly, was particularly likely to share his opinions, except on
technical details to which he admitted total lack of knowledge.
His considerable business acumen and experience and his close
relationship to Chamberlain meant that he had a significant
amount of influence. However, the other employees regularly
disagreed with and disregarded his opinions, if and when they
thought necessary. Moreover, Chamberlain retained control over
all final decisions.
22. On December 30, 1998, Prince was hired as a full-time
employee and given the title “Director of Mergers and
Acquisitions.”
2. Mergers and Acquisitions Program
23. As the Director of Mergers and Acquisitions, Prince
investigated possible acquisitions of other companies for
Integral and reported his findings directly to Chamberlain.
Chamberlain would then negotiate the price and the contract
details based on Prince’s information.
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24. Once a subsidiary was acquired, Prince’s primary
responsibility was to assess the financial health of the
business and effectiveness of its existing management. After
acquisition or merger, Prince was in charge of overseeing the
operations of the subsidiaries. After acquisition, he also
supervised the activities of those companies who were acquired
and in some cases later shut down.
25. Prince served as Board Chairman and/or a Director for the
corporations created to acquire various subsidiaries.
26. Prince also played a role in assessing officer compensation
for the subsidiaries and recommended whether certain
subsidiaries' officers should be promoted, demoted, or
terminated. The ultimate decision on those issues, however,
remained with Chamberlain.
27. As part of his assessment of the financial health of newly-
acquired subsidiaries, Prince interacted with their accounting
staffs. He investigated their financial statements, made
suggestions on how they should record certain transactions, and
consulted with Integral’s accounting staff on how the
subsidiaries’ financial statements would be consolidated with
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Integral’s statements. Prince also consulted with outside
auditors about financial questions related to subsidiaries.
28. While Prince “wouldn’t hesitate to ask questions and review
[a subsidiary’s] financial results,” the accounting itself was
done by the subsidiary’s accountants, who were supervised by and
reported to Brown as Integral’s CFO. Test. of Elaine Brown,
Trial Tr. Dec. 14, 2012, P.M. Session 24-25.
29. Prince regularly made presentations to Integral’s Board of
Directors regarding potential acquisitions and issues regarding
subsidiaries.
3. Prince’s Compensation
30. Between December 1998 and August 2006, Prince was
consistently one of the five highest paid individuals at
Integral.
4. Prince’s Stock Options
31. Prince was granted Integral stock options in 2000, 2001,
2002, 2003, and 2004.
32. Prince did not file a Form 3 (an initial statement to the
SEC regarding beneficial ownership of securities), Form 4 (a
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statement to the SEC of changes in beneficial ownership of
securities), or Form 5 (an annual statement to the SEC of
changes in beneficial ownership of securities) between December
1998 and July 2006.
5. Executive Management Salaries/Bonuses
33. At various times, Prince proposed what bonus amounts
members of executive management should receive. This was done in
collaboration with others. The bonuses recommended by the group
would then go to Chamberlain for final approval. After he
approved, Brown or Gough would present the recommendations to
the independent Directors for approval.
34. Prince also collaborated with members of executive
management in recommending salary increases for Chamberlain.
6. The “Gang of Six”/”Gang of Seven”
35. Chamberlain, Gough, Brown, and Prince, as well as two or
three additional executive-level employees, were referred to as
the “Gang of Six” or “Gang of Seven,” or “G6” or “G7” (“G6/G7”).
36. The group was formed by Chamberlain in order to discuss
companywide policies on a variety of issues, including human
resource decisions, benefits, personnel, and mergers and
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acquisitions. Prince participated in G6/G7 meetings as an equal
member.
37. Brown, Gough, Peter Gaffney, 2 Prince, and Chamberlain all
testified 3 consistently and credibly that G6/G7 served as an
advisory vehicle to assist Chamberlain in making policy for the
company, and that Prince did not have authority to make policy
as a member of G6/G7.
7. Advisor to Chamberlain
38. In addition to advising Chamberlain in his capacity as a
member of G6/G7, Prince also served as a general advisor to
Chamberlain. His office was located immediately next to
Chamberlain’s office.
2
Gaffney held various positions in the company over the years.
When Prince started working at Integral as a full-time employee
in 1998, Gaffney was Vice President of the Commercial Division.
In 2000, he became Vice President of Product Development. In
2004, he became Vice President of the Government Division and
Chief Operating Officer. In the late spring of 2006, he became
Chief Executive Officer of Integral after Chamberlain stepped
down.
3
Although the Court refers to Chamberlain’s “testimony,” he died
before trial and thus was unavailable to testify in open court.
For ease, the Court refers to the contents of the two
investigative depositions taken by the SEC in 2007 and submitted
in Joint Exhibit 3 as Chamberlain’s “testimony."
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39. Prince could not and did not make policies or rules or
standards within the company. Until the summer of 2005, see
infra ¶¶ 41-49 (describing Prince’s authority over Contracts
Department), he did not have a Group 4 that reported to him and
therefore had no staff to direct, hire, or fire. Generally,
Prince would advise and make recommendations to Chamberlain, who
would then accept or reject them. Once Chamberlain made a
decision, Prince or the relevant Group head would then implement
it.
40. Prince’s influence with Chamberlain was well-recognized
throughout the company. For example, because of Prince’s
relationship with Chamberlain, people would often consult him to
get a sense of how Chamberlain might react to a particular idea
or suggestion. However, despite his significant influence, the
Integral employees testified consistently that they felt free to
disagree with Prince and regularly did disagree with him.
4
The Integral employees referred to the various divisions of the
company as "groups" or "operating groups."
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8. Prince’s Responsibility for the Contracts
Department
41. Prior to July 2005, Brown was head of the Contracts
Department at Integral. 5
42. In the first half of 2005, at least two contracts were
signed by Group heads containing significant errors which
injured Integral financially. Chamberlain concluded that further
review of contracts was needed before any contracts were
finalized.
43. On July 6, 2005, Brown emailed the staff of Integral,
telling them that only officers, including Prince, had the
authority to sign contracts. She testified that she did not mean
to suggest that Prince was an officer, and that after this email
was sent she spoke to Prince and confirmed he was not in fact an
officer and did not have authority to sign off on contracts. No
formal correction was ever disseminated.
5
When Brown began at Integral in 1983 as a
receptionist/administrative assistant, she did not have a
college degree. She was promoted quickly within Integral and
worked as a staff accountant while she pursued her college
degree. Eventually, she obtained her degree and then pursued and
obtained a Certified Public Accountant (C.P.A.) license, all
while working full-time as Integral’s CFO.
–17–
44. In the same email, Brown stated that Prince had been
“designated by [executive management] to review/approve
contracts and subcontracts” relating to specific business areas,
and that individuals must “obtain and retain proof that [Prince]
ha[d] reviewed/approved” a contract before it could be
finalized. Pl.’s Ex. 95. The contracts that Prince had to
approve were the “high value” or “primary” contracts.
45. Even after this email was sent, Prince did not execute or
sign any contracts on behalf of Integral.
46. On August 1, 2005, Chamberlain sent an email to Integral
managers stating that “effective immediately and until further
notice, no contract with our customers, nor any subcontract with
our teammates, is to be executed until approved by either Gary
Prince or myself.” Pl.’s Ex. 96; Def.’s Ex. 109. Thus, the
system that emerged was that all major contracts were reviewed
by Prince and required either Prince or Chamberlain’s approval.
47. Albert Alderete, a contracts administrator at Integral,
Gaffney, Brown, Gough, Chamberlain, and Prince all testified
consistently that, while Prince reviewed contracts, the final
decisions remained with the heads of the various Groups. Prince
was never given the authority to sign off on contracts. Rather,
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he performed a screening role to ensure that contracts were
properly drawn and, in particular, that all financial
calculations were correct.
48. On August 12, 2005, the Contracts Department was notified
that it was to be placed under Prince's direction. Prince began
to supervise the two employees in the Contracts Department,
including exercising hiring and firing power. He also made
salary decisions and did performance reviews.
49. In this time period, Prince was named “Managing Director of
Operations.”
9. Drafting the MD&A Section of Public Filings
50. One of Prince’s responsibilities included writing a first
draft of the MD&A section of Integral’s Form 10-Q and 10-K (an
annual financial report filed with the SEC) filings.
51. The MD&A is a business discussion which attempts to explain
the financial results for a particular period of time. It may
include comparisons to prior periods and/or forecasts or
projections for future periods. Before Prince took
responsibility for the MD&A, Chamberlain, Steve Carchedi,
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Gaffney, and Gough all contributed to writing it. None of these
individuals was an accountant.
52. Prince would update the prior filing’s MD&A only after the
accounting department had closed its books “for all intents and
purposes.” Test. of Elaine Brown, Trial Tr. Dec. 14, 2012, P.M.
Session 22-23. His narratives were edited, and ultimately, it
was Chamberlain who approved the final version of the MD&A that
was filed.
10. Reviewing and Commenting on Drafts of Public
Filings
53. When a reporting period ended, the accounting department
would close its books, and then, using the prior reporting
period’s filing as a template, would update the numbers and
language. Brown would then circulate this draft “among the
management team, among the outside directors, and just solicit
comments and feedback.” Test. of Elaine Brown, Trial Tr. Dec.
14, 2012, P.M. Session 18. Brown served as the “gatekeeper” of
the various comments she received from these individuals, and
would incorporate the comments she believed were appropriate and
ignore the ones she believed were not appropriate. Id. at 18-19.
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54. Prince regularly reviewed and commented on these draft
filings. Prince’s comments included asking questions, asking for
backup related to particular figures, pointing out internal
inconsistencies, suggesting additional language, deletions, or
rephrasings, adding information or correcting information
related to mergers and acquisitions, and changing numbers
related to future forecasts. In addition to reviewing and
commenting on the drafts themselves, he occasionally raised
questions about the accuracy of materials related to the public
filings and made suggestions in email exchanges with Brown and
others while the company was preparing its filing.
55. Prince’s comments were not always accepted, and even when
his suggestions were good ones, they were not always
incorporated verbatim. Brown testified credibly that she did not
feel any particular pressure to accept or reject suggestions
made by Prince.
11. Prince’s Role During Brown’s Maternity Leave
56. Brown was on maternity leave in the fall of 2004 and early
2005 when Integral prepared its Form 10-K for fiscal year 2004
and its Form 10-Q for the first quarter of fiscal year 2005.
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57. On October 27, 2004, Prince sent an email asking questions
about the fourth quarter of fiscal year 2004 to Pat Carey,
Integral’s Controller, and Al Smith, Integral’s Assistant
Controller. 6 Prince copied Brown on this email. The email began,
“Now that I’m running the Accounting Dept., :) . . .” Pl.’s Ex.
79. 7
58. Brown and Prince both testified that they understood this
phrase to be a joke. As Prince observed, “if I was making a coup
of the accounting department, I probably wouldn’t have copied
Ms. [Brown] on it.” Test. of Gary A. Prince, Trial Tr. Jan. 3,
2013, P.M. Session 83. Brown and Prince concurred, as did
Chamberlain, that Prince was not running the accounting
department during this period. Brown testified that she
continued to be involved from home, and delegated ultimate
responsibility to Carey, her second in command.
59. While Prince was more involved than usual in the
preparation of these filings, he testified, as did Chamberlain,
that his role was, primarily, to coordinate the gathering of all
6
This term was used in the company’s official documents, not the
more commonly used term “comptroller.”
7
As can be seen from a large number of exhibits in the record,
Prince not only had a very high opinion of himself, but also
liked to poke his views into everyone else’s work. He also had a
penchant for writing emails he would later come to regret.
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the required information from various subsidiaries for
preparation of the Form 10-K and Form 10-Q.
12. Financial Press Releases
60. Another of Prince’s responsibilities was drafting financial
press releases, particularly pre-earnings press releases. A pre-
earnings press release discusses a company’s financials before
the actual numbers are released. Press releases are incorporated
into Form 8-K filings.
61. Prince wrote the press releases after the numbers had been
finalized by the accounting department. He was not engaged in
the actual calculation of the numbers.
13. Financial Forecasting
62. Prince regularly engaged in financial forecasting, which
were projections of future earnings. Although Prince would
circulate internal emails which would predict earnings per
share, the official number released to the street was generated
by the operating Groups and the accounting department.
14. Financial Presentations
63. Prince gave two presentations to the Board of Directors
focusing on financial forecasts. He also gave a presentation to
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the Board of Directors on the “core business” at the request of
an independent Director. Def.’s Ex. 133.
64. Brown testified that it was her responsibility to make
reports to the Board of Directors on overall company financial
performance. She gave numerous such presentations.
65. Prince also gave financial presentations and tutorials to
fellow staff members.
15. Attendance at Board of Directors Meetings
66. Prince regularly attended Board meetings, even when he was
not making a presentation. Other non-Board members and non-
officers were periodically invited to and did attend Board
meetings.
16. Prince’s Involvement with the Accounting
Department
67. Prince occasionally interacted with the accounting
department in various ways. This included commenting on payroll
analyses, discussing incentives, comparing results to forecasts,
assessing Integral’s core profitability, analyzing general and
administrative costs, reviewing Defense Contract Audit Agency
(“DCAA”) submissions, evaluating legal costs, investigating how
capital losses had been booked, creating a software development
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amortization plan, assessing how the company should adopt new
financial accounting standards, proposing and evaluating segment
reporting structure, and assessing whether any particular
operating group was spending in an unusual or inappropriate
fashion.
68. All of these activities were part of Prince’s role as
Chamberlain’s “watchdog.” Test. of Peter Gaffney, Trial Tr. Dec.
10, 2012, P.M. Session 41-42; Test. of Gary A. Prince, Trial Tr.
Jan. 2, 2013, P.M. Session 13-14. Again, this was part of the
culture established by Chamberlain that encouraged everyone to
participate and voice their opinions in areas outside their
assigned duties and responsibilities. Prince, in particular, was
known for “not [being] shy about giving his opinions, or
thoughts, or ideas, or advice.” Test. of Elaine Brown, Trial Tr.
Dec. 14, 2012, A.M. Session 90.
69. Prince’s suggestions were not always followed, and the
final call on virtually all decisions was made by Chamberlain.
As Prince summarized, referring to Chamberlain’s ultimate
decisionmaking authority, “Integral was not a democracy; it was
a dictatorship.” Test. of Gary A. Prince, Trial Tr. Jan. 2,
2013, P.M. Session 16-17.
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D. Integral’s Knowledge and Actions from December 1998 to
August 2006
70. The fact that Prince was convicted of a felony in 1995 was
well-known among Integral staff members and the Board of
Directors.
71. The fact that Prince was barred from practicing accounting
before the Commission was also known by many individuals within
Integral.
72. The duties and activities discussed above, infra, ¶¶ 23-69,
were also widely known throughout Integral.
73. There was never any effort to keep Prince’s legal problems
or his actions, duties, or responsibilities from the Board of
Directors, the company’s lawyers, or the SEC.
74. Gaffney, Gough, Brown, and Prince all testified that Prince
was not named an officer because Chamberlain strongly preferred
not to disclose his biography and past legal troubles.
Chamberlain, however, testified that he was not concerned with
disclosure per se, noting that Integral had disclosed Prince’s
conviction in its public filings in 1995. 8 Chamberlain testified
8
The Form 8-K filing in 1995 predated Prince’s criminal
conviction for securities fraud and Prince’s Accounting Bar.
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that his primary concern regarding disclosure was the
possibility of shareholder lawsuits.
75. When Integral named its executive officers in February
2000, Prince was not named an executive officer.
76. Between December 1998 and August 2006, Integral filed six
Form 10-Ks with the SEC. None of these Form 10-Ks identified
Prince as an officer.
77. Between December 1998 and August 2006, Integral filed seven
proxy statements prior to annual meetings. These proxy
statements did not identify Prince as an executive officer.
78. John Flaherty, a member of the accounting department,
Gaffney, Brown, Gough, and Prince all testified credibly that
Brown was firmly in control of the accounting department and the
financial statements between December 1998 and August 2006. This
was also acknowledged by outside auditors in 2002.
However, the 1995 filing did note that Prince had been charged
with serious securities fraud violations.
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E. Role and Involvement of Counsel
1. Venable Becomes Corporate Counsel
79. In the spring of 1998, John Sullivan, a corporate partner
at the law firm of Venable LLP (“Venable”), and Wallace
Christner, a senior associate at Venable, “made a pitch” to
Integral to serve as corporate counsel in connection with a
securities offering. Test. of John Sullivan, Trial Tr. Dec. 17,
2012, A.M. Session 12-13.
80. After that discussion, Gough informed Sullivan and
Christner that Integral had a part-time consultant, namely
Prince, with a criminal background.
81. Chamberlain decided to hire Venable and the firm began
working on the Form S-1 filing in early June 1998.
82. At that point, Sullivan was the senior member of a four-
person team at Venable handling Integral's business, and served
as the relationship partner with Integral. Christner was the
“second-in-command.” Test. of Thomas Gough, Trial Tr. Dec. 20,
2012, A.M. Session 81. The third was an associate, Andrea
Kaufman, and the fourth was another associate, James Dvorak. W.
Craig Dubishar, a government contracts associate at Venable,
also worked on Integral issues in 1998.
–28–
83. Between December 1998 and August 2006, at least eight
additional Venable lawyers worked on Integral matters: Treazure
Johnson, a former SEC attorney; Anita Finkelstein, a partner in
the DC office who specialized in SEC matters; David Levenson, a
senior partner in the securities group; Brian Dunn, an associate
in the litigation group; Geoffrey Garinther, a partner; Ron Ben-
Menachem; Herbert Smith; and Philip Harvey, a litigator who
specialized in investigations.
84. When Sullivan left Venable in May 2001, Christner became
the relationship partner and served in that role until at least
October of 2006.
2. The Relationship Between Venable and Integral
85. To reduce legal costs, Chamberlain decided that Brown would
be the conduit between Integral and Venable, and that she would
contact Dvorak with any questions or problems Integral had.
Dvorak would then consult the more senior members of the Venable
team if needed.
86. Venable advised Integral on public filings, securities law
compliance, financing matters, mergers and acquisitions, and
government contracts.
–29–
87. The Venable attorneys understood themselves to be
Integral’s general corporate counsel, including on disclosure
issues, and Integral’s Board of Directors understood that
Venable was their general corporate counsel on those issues.
88. There was no formal or informal protocol in place by which
the Venable lawyers gathered information from Integral about its
activities or problems. There was also no system or protocol
whereby Venable lawyers who represented Integral later in time
became familiar with the work that had been performed for
Integral in the past by other Venable attorneys.
89. There was no evidence presented that any employee at
Integral ever failed to provide information requested by a
Venable lawyer.
3. Consultation with Venable Regarding Prince’s
Hiring
90. Chamberlain, who had no legal training, testified that he
spoke to Sullivan at some point before Prince was hired and
discussed Prince’s legal background and Accounting Bar.
Chamberlain insisted that he had given the SEC's Order
containing the Accounting Bar to Venable to review in an attempt
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to try to figure out what the meaning of “practicing accounting
before the Commission” was and what activities it covered.
91. Brown, Gough, and Prince all testified credibly that they
understood that Chamberlain had spoken to Venable about Prince’s
employment, and that, as a result of that conversation, the
“carveouts” and “fencing in” discussed above at ¶¶ 14-19 were
put in place.
92. Sullivan, however, testified that he never discussed hiring
Prince with Chamberlain, that Chamberlain never told him about
Prince’s criminal conviction or Accounting Bar, and that he
never provided advice about how to structure Prince’s role.
93. The Court finds that the consistent testimony of Brown,
Gough, and Prince was accurate, and that Sullivan, who admitted
to not having a clear memory of many of the events which
occurred over fourteen years ago, was not accurate.
94. Venable never prepared any written document describing what
Prince could or could not do. Any legal advice given by Venable
attorneys was generally transmitted informally to Brown, who
then transmitted it to other members of management.
–31–
4. Venable’s Knowledge of Prince’s Duties and
Activities
95. Venable was corporate counsel for Integral for several
months in 1998 before Prince became a full-time employee. During
that time, Venable lawyers knew that Prince was drafting the
MD&A portion of the fiscal year 1998 Form S-1, participating in
the preparation of the fiscal year 1998 Form 10-KSB (an
abbreviated version of the annual financial 10-K report for
small businesses), and that Prince was working on mergers and
acquisitions issues.
96. Between December 1998 and August 2006, Venable lawyers
regularly worked with Prince on issues related to mergers and
acquisitions. They knew that, in that capacity, Prince was
drafting offer letters, reviewing consulting agreements with
employees of subsidiaries, asking questions about financial
issues pertaining to the subsidiaries, serving as a Board
Chairman and/or Director for corporations created to acquire
subsidiaries, drafting press releases, and making presentations
to Integral’s Board of Directors.
97. Christner and Dvorak knew that Prince interacted with
outside auditors on behalf of Integral in his role as Director
of Mergers and Acquisitions.
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98. Christner knew that Prince worked on drafting the MD&A
section of public filings.
99. Sullivan, Christner, and Dvorak knew that Prince drafted
press releases.
100. Christner and Dvorak knew that Prince reviewed and
commented on drafts of public filings.
101. On April 12, 2000, reports by two financial analysts were
issued which contained lower projections for Integral’s revenues
than previously-issued reports. The price of Integral’s common
stock dropped significantly and Integral issued a press release
in response to the release of those reports. On November 1,
2000, the SEC wrote an inquiry letter to Integral asking for
information regarding the events that led up to the press
release.
102. On December 8, 2000, Venable sent a letter to the SEC on
behalf of Integral in response to its inquiry of November 1,
2000. The letter stated that Prince had interacted with outside
financial analysts on behalf of Integral, generated financial
projections, and drafted the press release in question.
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Sullivan, the relationship partner at the time, reviewed this
letter before it was sent to the SEC.
103. The SEC never responded to Venable’s December 8, 2000,
letter. Nor did anyone at the SEC ever contact anyone at
Integral or Venable to inform them that Prince’s activities, as
described in Venable’s letter, required him to be disclosed as
an executive officer or violated his Accounting Bar.
5. Integral’s Conversations with Venable About
Prince’s Possible Officer Status
104. Integral and Venable interacted on three separate occasions
between 1999 and 2002 regarding Prince’s desire to become an
Integral officer.
a. Fall of 1999
105. In October of 1999, Flaherty and Brown consulted Dvorak and
Sullivan about whether to include Prince’s compensation and
biographical information in the Form 10-KSB for fiscal year
1999. Brown faxed Dvorak various provisions from the Code of
Federal Regulations referencing “significant employee”
disclosure requirements and excerpts from Integral’s public
filings related to Prince. Dvorak did not recall following up on
this fax with Brown or with Sullivan.
–34–
106. A month later, Flaherty asked Brown “about the verdict from
[her] discussions with Venable regarding Gary Prince and whether
or not he [would] be included” as a highly-paid employee in the
executive compensation table in the Form 10-K for fiscal year
1999. Pl.’s Ex. 11. Brown responded to Flaherty and told him not
to include Prince in the table.
107. The next day, Dvorak and Flaherty spoke about “16(A)
disclosure issues.” Def.’s Ex. 46. Section 16(a) of the
Securities Exchange Act, 15 U.S.C. § 78p(a), requires certain
officers and directors to file beneficial ownership reports with
the SEC, including Forms 3, 4, and 5. See supra ¶ 32.
108. A few days later, on December 3, 1999, Brown faxed Dvorak
Prince’s biography and asked him how she could “avoid including”
the biography in the Form 10-KSB for fiscal year 1999, as this
was Chamberlain’s preference. She referenced a previous
discussion she had had with Dvorak where Dvorak suggested
removing the word “strategic” from Prince’s title and having
Chamberlain write a memorandum stating that Prince did not play
a key role in the decisionmaking of the company. In addition,
she stated in her fax that she did not “intend to include
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[Prince] in the Compensation Table since he is not an executive
officer.” Pl.’s Ex. 13; Def.’s Ex. 23.
109. Dvorak understood Brown’s fax to imply that she saw the
publication of Prince’s biography and his inclusion in the
compensation table as separate issues.
110. That same day, Brown sent Dvorak a draft of the Form 10-KSB
for fiscal year 1999, and asked to speak to him about the fax
she had sent him that morning. Again, there was no record of
how, when, and if Dvorak followed up with Brown.
111. When Chamberlain discovered that Brown and Flaherty had
been consulting Dvorak about disclosing Prince in the public
filings, he was upset that legal costs had been wasted on
something Chamberlain believed had been addressed the previous
year in his initial consultation with Sullivan. Brown apologized
to Chamberlain and Prince for the additional legal costs
incurred, and Prince responded, noting that he “believe[d] that
changing [his] title [would] do absolutely nothing in terms of
protecting the Company in the unlikely event of shareholder
litigation.” Pl.’s Ex. 15; Pl.’s Ex. 16.
–36–
112. Sullivan testified that at or around this time, he spoke
with Chamberlain and Gough about Prince’s role in the company
and Prince’s high level of compensation. Sullivan said that they
told him that Prince could not make policy and did not have
staff reporting to him. On the basis of this information,
Venable concluded that Prince did not need to be disclosed as an
executive officer.
b. January 2001
113. In early 2001, Prince raised the issue of becoming a named
executive officer. He set up a meeting with Sullivan and Dvorak,
noting that Chamberlain was “amenable to allow [sic] me to
reclaim my VP title provided I can do so without any adverse
public disclosures in our filings. I plan to present all of this
to Venable to ensure that this would be the case.” Def.’s Ex.
55.
114. On January 23, 2001, Chamberlain, Prince, Sullivan, and
Dvorak met to discuss this issue. At that point, Prince was
under the impression that, after five years had passed, he would
no longer need to disclose his legal background. Thus, the
question put to Venable was when the five years would expire.
–37–
115. Sullivan testified that he spoke with Chamberlain about why
the issue was being raised. He advised Chamberlain that giving
Prince the title of Vice President would indicate that he was an
executive officer.
116. Venable concluded that the five-year limit had not yet
expired, because the latest triggering event, the issuing of the
Accounting Bar, took place in June of 1997. Prince decided that
he would re-raise the issue when the five years expired in the
summer of 2002.
c. Spring and Summer of 2002
117. In March and April of 2002, Prince again raised the issue
of becoming a named officer.
118. At the end of April, Venable began researching the officer
disclosure question and discussing it with Brown and Prince.
Christner asked Anita Finkelstein, a partner who specialized in
SEC matters, to research the issue.
119. On April 30, 2002, Finkelstein emailed Christner,
suggesting that Prince’s conviction might require disclosure
beyond the five-year period.
–38–
120. On May 1, 2002, Finkelstein emailed Christner again,
concluding that Prince’s conviction and Accounting Bar would
have to be disclosed if he was named an executive officer. She
stated: “My bottom line is that if Prince is an executive
officer his history needs to be disclosed and will need to be
disclosed for the foreseeable future. If one wants to be really
compulsive, he or she should also keep in mind that the Rule 405
definition of ‘executive officer’ includes any folks who perform
‘policy making functions’ for the registrant. This means that
Integral is open to the complaint that, no matter what his
title, Integral should have made disclosure about Prince due to
the nature of his activities at Integral.” Def.’s Ex. 75. No one
at Integral received a copy of this email, nor was the second
sentence of this email ever conveyed to anyone at Integral.
121. On May 10, 2002, Christner emailed Prince informing him
that his conviction would have to be disclosed in the
foreseeable future.
6. Venable’s Termination as Corporate Counsel
122. Sometime between June 2003 and mid-2004, Chamberlain became
upset at the fee Venable charged in a particular matter and
–39–
decided to fire the firm as corporate counsel. Venable was
replaced by the law firm DLA Piper.
7. Venable’s Rehiring by the Board of Directors
Audit Committee
123. In October of 2005, Bonnie Wachtel, an independent
Director, raised various corporate governance concerns to the
other members of the Board’s Audit Committee, Doss McComas and
Dominic Laiti. In particular, Wachtel was deeply concerned about
Chamberlain’s failure to disclose to the Board a recent criminal
investigation into his alleged sexual misconduct with an
underage female.
124. On November 2, 2005, a Subcommittee, consisting of McComas
and Laiti, was created to conduct an internal review of the
allegations raised in Wachtel’s October 2005 letter. Laiti
proposed retaining Venable to conduct an investigation into
Chamberlain’s actions. Wachtel objected to hiring Venable,
alleging that the firm was not independent. Laiti responded by
stating that Venable would not risk its reputation by being
involved in a “cover-up.” Def.’s Ex. 116.
125. The motion to hire Venable was passed by the Board of
Directors, and Laiti stated that he would coordinate the review
–40–
with Garinther of Venable. The firm was given a $40,000 budget,
but no other restrictions were placed upon it.
126. Venable lawyers interviewed Prince and Gough. While the
focus of the investigation was on Chamberlain’s activities, the
lawyers obtained information regarding Prince’s duties and
activities. In particular, they discovered and/or confirmed that
Prince was a member of the G6/G7, that he worked on mergers and
acquisitions, and that he reviewed company press releases and
portions of SEC filings. See supra ¶¶ 95-100.
127. On November 30, 2005, the results of the independent
investigation were presented to the Board of Directors. 9 McComas
proposed implementing recommended changes and not pursuing any
further investigation. The Board adopted that proposal.
128. Despite having definitive evidence of the range of Prince's
responsibilities, including his participation in G6/G7, Venable
did not tell Integral at this time that Prince’s duties and
activities required him to be disclosed as an executive officer
or violated his Accounting Bar.
9
No evidence was presented about the specifics of the
recommendations.
–41–
8. DLA Piper’s Resignation as Corporate Counsel and
Venable’s Rehire
129. Sometime between November 2, 2005 and December 5, 2005, DLA
Piper resigned as Integral’s corporate counsel, at least in part
because of frustration over not receiving “full communication
about events that may be material to the Company and that
require disclosure considerations under the federal securities
laws,” presumably in reference to Chamberlain’s silence about
the criminal investigation and charges pending against him.
Def.’s Ex. 144. Venable was rehired as corporate counsel in late
November or December of 2005, either during the independent
investigation or shortly after it was completed.
9. In December 2005, Venable Again Researched
Whether Prince Needed to Be Disclosed in Public
Filings
130. On December 5, 2005, Wachtel sent Brown comments on the
draft Form 10-K for fiscal year 2005, and suggested that
Prince’s biography be included.
131. Executive management decided to confirm with Venable that
Prince’s biography did not need to be disclosed. Brown then
forwarded Wachtel’s email to Dvorak and asked him to “guide us
on how best to respond.” Pl.’s Ex. 112; Def.’s Ex. 136.
–42–
132. On December 7, 2005, Dvorak and Brown had a conversation in
which Dvorak asked Brown whether Prince had policy making
authority, what his title was, whether he could bind the
company, and whether his position had evolved or changed. Brown
described Prince as an advisor to Chamberlain.
133. On December 8, 2005, Brown emailed Dvorak “as a follow-up
to our conversation yesterday.” She noted that Prince could not
sign contracts and did not have check signing or wire transfer
authority. She described Prince as “a staff person reporting to
Steve and fill[ing] an advisory role, advising Steve, Tom, Pete
and me on company policy and PMs and division heads on
contracts.” Brown concluded that Prince did not need to be
disclosed, but asked to speak with Dvorak to “make sure Venable
agrees with our position” before she responded to Wachtel. Pl.’s
Ex. 112; Def.’s Ex. 140.
134. There is no evidence that Venable ever responded to Brown’s
concern.
135. On December 9, 2005, Brown emailed Wachtel, telling her
that Prince “is not a named executive officer and does not meet
the criteria to be a named exec. officer.” Def.’s Ex. 142;
Def.’s Ex. 144. Wachtel responded on December 12, 2005,
–43–
reiterating her “preference” that Prince be disclosed. Pl.’s Ex.
104.
136. Executive management forwarded the entire exchange between
Brown and Wachtel to McComas and Laiti, the independent
Directors. McComas responded, disagreeing with Wachtel’s
preference. He observed, “We have followed legal and accounting
advice on so many issues because of the complexity and need to
be up to date expertise [sic] that only they can provide in the
10K as a whole. The specific issues that Bonnie raises are her
personal preferences on issues which have previously been
covered with our advisors and the 10K has been approved by them
so I suggest we move forward with its release.” Pl.’s Ex. 104;
Def.’s Ex. 143. Laiti emailed the next day indicating that he
agreed with McComas. Def.’s Ex. 148.
137. Venable did not tell Integral at this time that Prince
should be disclosed, and Integral did not disclose Prince’s
employment or background in the Form 10-K for fiscal year 2005.
10. Integral’s Filing of a Form 8-K Disclosing
Wachtel’s Allegations
138. Wachtel declined to stand for reelection to the Integral
Board of Directors. A Form 8-K was filed with the SEC to
–44–
disclose this fact. See Hewlett-Packard Co., Exchange Act
Release No. 55,801, 90 S.E.C. Docket 1865 (May 23, 2007) (noting
that Exchange Act requires public companies to file a Form 8-K
when a director resigns because of a disagreement with the
company relating to its “operations, policies, or practices”).
139. Integral filed its Form 8-K on January 9, 2006, but did not
address Wachtel’s corporate governance concerns. Instead, at
Chamberlain’s request, the Form 8-K attached Wachtel’s
correspondence and summarily stated that Integral disagreed with
the content of her letters.
11. NASDAQ and SEC Investigations
140. Two days later, on January 11, 2006, officials from NASDAQ
contacted Gough seeking a meeting to discuss “issues raised in
the Company’s Form 8K.” Def.’s Ex. 152.
141. At some point in early 2006, the SEC contacted Integral
indicating that it also was going to investigate the events
surrounding the filing of the Form 8-K. Christner asked Treazure
Johnson, a Venable partner who had previously worked at the SEC,
to work on the case.
–45–
142. On February 15, 2006, Prince attended an interview with
NASDAQ, accompanied by Garinther of Venable.
143. NASDAQ requested any emails between Prince and the Audit
Committee. On March 29, 2006, Garinther responded to NASDAQ, on
behalf of Integral, noting that Venable had “not seen any
communications . . . between Mr. Prince and Integral’s outside
auditors.” Def.’s Ex. 175. The firm made this claim despite
knowing that such communications existed. See supra ¶¶ 97, 102.
144. On February 3, 2006, Integral staff emailed Venable lawyers
an organizational chart which showed Prince on the same level
with the other executive managers, identified him as the
“Managing Director of Operations,” and showed that he supervised
employees in the Contracts Department.
145. On April 7, 2006, Dunn of Venable prepared a memorandum
that was circulated internally within the firm addressing
whether Prince was a de facto officer of Integral. The
memorandum concluded that, “[g]iven Prince’s role at the
Company, the SEC could reasonably take the position that he was
a de facto officer and should have been disclosed as such in the
company’s SEC filings.” Def.’s Ex. 183; Def.’s Ex. 184.
–46–
146. Neither this conclusion nor this email was ever conveyed to
anyone at Integral.
147. Later in April, Chamberlain retired as CEO, at least in
part because of the criminal charges pending against him.
Gaffney eventually replaced him as CEO.
148. On April 23, 2006, McComas wrote to Christner on behalf of
the independent Directors, asking “some questions regarding the
NASDAQ/SEC discussions” about Prince.
149. Christner drafted, and Garinther and Johnson approved, a
response to the independent Directors noting that “whether or
not he has been acting as an officer seems to be in a gray
area,” and informing them that the best strategy was to
emphasize Prince’s “no-officer attributes” and “hope that in
light of the company’s current status,” the SEC would
“essentially lose interest in the matter.” In addition,
Christner noted that the firm “ha[d] not seen any evidence so
far that would lead us to believe he has practiced accounting
before SEC.” Def.’s Ex. 189; Def.’s Ex. 204.
150. Integral’s employees were never told directly that whether
Prince was an officer was “in a gray area.”
–47–
151. In June of 2006, Venable began to prepare a letter to the
SEC addressing Prince’s position in the company.
152. Venable directed Prince to put together a memorandum that
described his roles and functions in the company. Christner
wanted the memorandum to focus on what Prince was “not doing,
not signing contracts, not VP on bus. cards.” Def.’s Ex. 198
(emphasis in original); Test. of Elaine Brown, Dec. 14, 2012,
A.M. Session 52-55; Test. of Elaine Brown, Dec. 18, 2012, P.M.
Session 52-53.
153. Prince’s memorandum to Venable indicated that he
occasionally had individuals reporting to him directly,
participated in G6/G7, made proposals and suggestions related to
corporate organization and financial spending and controls, led
the Contracts Department, and had been given the added title
Managing Director of Operations.
154. On June 21, 2006, Smith, yet another Venable lawyer,
emailed Johnson a draft of the proposed letter to the SEC. In
his cover email, Smith made several observations. First, he
noted that he took an approach in drafting the letter that
highlighted “what Prince couldn’t/didn’t do at ISI.” Second, he
noted the similarities between Integral’s issues and a legal
–48–
case where a company had been held liable for not disclosing as
a de facto officer a significant management figure. Third, he
raised the possibility that Prince might be a “significant
employee” under item 401(c) of Regulation S-K. Def.’s Ex. 211.
155. No one at Venable ever shared any of these observations
with Integral.
156. On June 29, 2006, a special Board of Directors meeting was
held in which Christner participated by teleconference. Gough
suggested naming Prince an executive officer “in light of the
recent changes within the Company.” Def.’s Ex. 219. The Board
took the matter under consideration and decided to put it to
vote at a later date.
157. On July 25, 2006, McComas wrote to Christner on behalf of
the independent Directors, noting that they had sought advice
and a written statement from Venable regarding possible
liability, if any, as to the naming of new executive officers.
158. That same day, Christner asked Johnson to research whether
Prince’s Accounting Bar prevented him from being an officer.
Johnson responded, observing that she didn’t “see anything to
prevent Prince from serving as an officer,” noting that the
–49–
Accounting Bar was not an officer or director bar. Def.’s Ex.
229. She then noted that the “company will have to [sic] special
care, however, to ensure that he has nothing to do of an
accounting nature and particularly that he has no involvement in
the preparation of the company’s financial statements.” Id.
Johnson then sent another email, this time to both Garinther and
Christner, wherein she reiterated that she had told Christner
“that the company has to be very careful that he has no
responsibility at all for any accounting functions at Integral
and nothing to do with the preparation of the financials, other
than provide information when asked.” Def.’s Ex. 226.
159. No one at Venable ever sent either of these emails or
conveyed the substance of Johnson’s conclusions to Integral.
160. Later that day, Christner emailed McComas, informing him
that Venable “[c]oncluded that while the order does prohibit
Gary from practicing accounting before the SEC, it does not
prohibit him from becoming a director or officer of a registrant
such as Integral System [sic]. If Gary does become an executive
officer, however, Integral should take appropriate actions to
insure that his work for the company does not constitute
practicing accounting before the SEC.” Def.’s Ex. 232.
–50–
161. On July 31, 2006, McComas responded to Christner’s email,
asking him for a definition of “practicing accounting before the
SEC” that the Board could use as guidance to “make sure that the
appropriate action is taken to not allow this to occur.” Def.’s
Ex. 235.
162. The same day, Christner responded to McComas’s email,
noting that “there is not a clear and useful definition” of
practicing accounting before the Commission. He forwarded his
response to Johnson and asked for “any further insight.” Again,
Johnson reiterated that if Prince “stays away from the
financials he should be fine.” Def.’s Ex. 235. There was no
evidence presented that Venable ever passed that information on
to Integral management or in any other way provided more
guidance to the independent Directors after their email request
for a clear and useful definition of practicing accounting
before the Commission.
12. In August 2006, Prince Is Named an Executive
Officer and Disclosed to the SEC
163. On August 2, 2006, the Board of Directors named Prince an
executive officer, after agreeing that his “duties and role in
the Company” did not include practicing accounting before the
–51–
SEC. Def.’s Ex. 237. Venable began preparing a Form 8-K to
disclose this fact.
164. On August 4, 2006, Prince filed a Form 3 with the SEC,
reporting his ownership of Integral stock options. On August 16,
2006, Prince filed another Form 3 with the SEC, reporting
additional Integral stock options.
165. On August 8, 2006, Integral filed a Form 8-K with the SEC
identifying Prince as “Executive Vice President and Managing
Director of Operations” and disclosing his legal history.
166. On August 14, 2006, Venable sent a letter to the SEC in
response to the SEC's inquiry about the January 9, 2006, Form 8-
K, stating that it “strongly believe[d]” that Prince was not an
executive officer between December 1998 and March 17, 2006.
Pl.’s Ex. 129; Def.’s Ex. 241.
167. In September of 2006, SEC lawyers called Johnson and said
they had reviewed Venable’s submission and were still of the
opinion that Prince’s employment should have been disclosed. The
SEC indicated that they were going to recommend filing an
enforcement action. They also told Johnson to let them know if
–52–
there were any additional facts they should consider before they
made their recommendation.
168. Johnson spoke with Brown to assess whether there were any
additional relevant facts to disclose to the SEC.
169. On October 2, 2006, Johnson faxed another letter to the
SEC, stating that she had no additional facts to report.
13. Advice from Venable to Integral
170. At no point between December 1998 and August 2006 did
anyone at Venable ever advise anyone at Integral that Prince
needed to be disclosed to the SEC regardless of his title.
171. At no point between December 1998 and August 2006 did
anyone at Venable advise anyone at Integral that any of the
activities that Prince was engaging in were activities that
might trigger a disclosure obligation.
172. At no point between December 1998 and August 2006 did
anyone at Venable advise anyone at Integral that any of the
activities that Prince was engaging in were activities that
might violate his Accounting Bar.
–53–
F. Post-2006 Activities and Procedural History
173. On March 28, 2007, Prince filed a Form 4 with the SEC
disclosing changes in his beneficial ownership of Integral
securities.
174. On March 30, 2007, Integral terminated Prince’s employment.
175. Since his termination, Prince has worked for two private
companies and served as executor of Chamberlain’s estate. He has
also done some consulting work for non-public companies. Brown
and Gough testified credibly that they knew of nothing that
Prince was currently doing or intended to do which would violate
his Accounting Bar now or in the future.
176. On July 30, 2009, the SEC issued an Order Instituting
Cease-and-Desist Proceedings, Making Findings, and Imposing a
Cease-and-Desist Order in In the Matter of Integral Systems,
Inc., Respondent (Admin. Proceeding File No. 3-13566).
177. On the same day, the SEC filed its Complaint in this Court
against Chamberlain, Brown, and Prince. [Dkt. No. 1]
178. On February 18, 2010, Chamberlain was dismissed as a party
because of his death. [Dkt. No. 28]
–54–
179. On November 26, 2012, Final Judgment as to Brown was
entered in this case. Without admitting or denying any
allegations against her, Brown paid a civil penalty of $25,000
to the SEC pursuant to Section 21(d)(3) of the Exchange Act of
1934, 15 U.S.C. § 78u(d)(3), in resolution of the claims
asserted against her in this civil proceeding. [Dkt. No. 130]
–55–
II. CONCLUSIONS OF LAW
A. Legal Framework
The SEC brought several claims against Prince under the
securities laws, four of which are still pending. All of those
claims are based on the allegation that Prince was a de facto
officer of Integral, and that Integral and Prince violated their
obligations under the securities laws to disclose his officer
status, as well as his troubled legal history.
The Securities Act of 1933 and Securities Exchange Act of
1934 impose a number of obligations on public companies and the
individuals who serve as officers and directors of those
companies. One of those obligations requires companies such as
Integral 10 to file annual reports with the SEC that contain
information that would be relevant to the investing public. See
Exchange Act Rule 13(a)(2), 15 U.S.C. § 78m(a)(2). In addition,
such companies must ensure that their proxy statements contain
similar information. See Exchange Act Rule 14(a), 15 U.S.C.
§ 78n(a).
The Regulations establish what must be included in annual
reports and proxy statements to ensure that they are accurate
10
It is undisputed that Integral issued securities registered
under Section 12 of the Exchange Act, 15 U.S.C. § 78l, and was
thus subject to the Exchange Act’s disclosure obligations. See
Findings of Fact ¶ 3.
–56–
and not misleading. 17 C.F.R. § 229.10(a)(2) (setting out the
“requirements applicable to the content of the non-financial
statement portions” of certain documents, including annual
reports and proxy statements). Among other things, companies
must identify all “executive officers” and describe their
business experience. Id. § 229.401(b), (e)(1). They must also
disclose certain legal proceedings that are “material to an
evaluation of the ability or integrity” of any executive
officer. Id. § 229.401(f).
The securities laws also require that officers identified
in a company’s filings make disclosures to the SEC. Among other
things, officers are required under Section 16 of the Exchange
Act to periodically report any ownership of or transactions in
the equity securities of their company. 15 U.S.C. § 78p(a)(1),
(3).
In this case, the SEC’s claims under the securities laws
allege that Integral and Prince failed to comply with their
disclosure obligations. Count VI focuses on Prince’s failure to
file stock ownership disclosure statements and alleges that that
failure violated Section 16(a) and Rule 16a-3. See 15 U.S.C.
§ 78p(a); 17 C.F.R. § 240.16a-3(a) (setting out various forms
for use in fulfilling Section 16(a) reporting requirements).
–57–
To establish this claim, the SEC need only show that Prince
was a de facto officer, that he owned Integral securities during
the relevant time period, and that he failed to file Section
16(a) disclosure reports. See infra n.14 (noting that the SEC
has consistently held that no scienter need be established to
prove a violation of Section 16(a)).
Count II builds on that claim by alleging that Prince’s
failure to file Section 16(a) reports with the SEC was part of a
“scheme to defraud” the public in violation of Section 10(b) of
the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R.
§ 240.10b-5. The SEC argues that the purpose of the scheme was
to conceal Prince’s role as a de facto executive officer at
Integral, and thus conceal from the public Prince’s legal
history.
Section 10(b) of the Exchange Act forbids anyone to use a
“manipulative or deceptive device or contrivance in
contravention” of the SEC’s rules and regulations. 15 U.S.C.
§ 78j(b). The primary rule that implements Section 10(b) is Rule
10b-5, which makes it unlawful “to employ any device, scheme or
artifice to defraud, . . . or to engage in any act, practice, or
course of business which operates or would operate as a fraud or
deceit upon any person, in connection with the purchase or sale
of any security.” Exchange Act Rule 10b-5(a), (c); 17 C.F.R.
–58–
§ 240.10b-5(a), (c). Violations of Rule 10b-5(a) and/or (c) are
referred to as “scheme liability.” See Pacific Inv. Mgmt. Co.
LLC v. Mayer Brown LLP, 603 F.3d 144, 158 (2d Cir. 2010).
In order to establish Count II, the SEC must begin by
proving what it must prove to establish Count VI: that Prince
was a de facto executive officer of Integral, was therefore
obligated to file Section 16(a) disclosure reports, and failed
to do so.
To establish scheme liability under Section 10(b), the SEC
must also prove by a preponderance of the evidence that:
1) Prince did not file Section 16(a) reports in order to
perpetuate a “scheme to defraud” that had the principal purpose
and effect of not disclosing his history of securities fraud
violations to the public; 2) his legal history was a material
fact; 3) the scheme was made in connection with the purchase or
sale of securities; and 4) Prince had the requisite scienter.
See S.E.C. v. Goble, 682 F.3d 934, 942-43 (11th Cir. 2012)
(citation omitted) (noting that in an SEC civil enforcement
action, the SEC must establish that a misrepresentation or
omission was material, made with scienter, and made “in
connection with the purchase or sale of securities”) (citation
omitted); S.E.C. v. Brown, 740 F. Supp. 2d 148 (D.D.C. 2010)
(noting that an individual’s participation in a scheme to
–59–
defraud may result in primary liability only if the individual
“engaged in conduct that had the principal purpose and effect of
creating a false appearance of fact in furtherance of the
scheme”) (quotation and citation omitted).
The SEC also brings two claims against Prince for aiding
and abetting Integral’s alleged failure to fulfill its
disclosure obligations. Section 20(e) of the Exchange Act
creates aiding-and-abetting liability for “any person that
knowingly or recklessly provides substantial assistance to
another person” in violation of the securities laws and the
rules and regulations issued under those laws. 15 U.S.C.
§ 78t(e).
Count III alleges that Prince aided and abetted Integral’s
failure to file accurate and non-misleading annual reports with
the SEC. The SEC argues that Integral failed to identify Prince
as a de facto officer in its annual reports, making such reports
materially false or misleading in violation of Section 13(a) of
the Exchange Act and Rules 13a-1 and Rule 12b-29. See 15 U.S.C.
§ 78m(a); 17 C.F.R. §§ 240.13a-1 and 240.12b-20. The SEC also
alleges that Prince provided “knowing and substantial
assistance” to Integral’s violation by participating in
Integral’s decision not to disclose him or his violations in
those reports. See Graham v. S.E.C., 222 F.3d 994, 1000 (D.C.
–60–
Cir. 2000) (noting that to establish aiding and abetting claim
under Section 20(e) SEC must show that a principal has committed
a primary violation, the aider and abettor provided substantial
assistance to the primary violator, and the aider and abettor
acted with the requisite scienter).
Thus, to establish Count III, the SEC must show that:
1) Prince was a de facto officer of Integral; 2) Prince’s
officer status made his legal history material information that
Integral was required to disclose in its annual reports; 3)
Integral failed to disclose Prince’s history, and thus failed to
submit complete and accurate annual reports; 4) Prince provided
substantial assistance to Integral in its violation; and 5)
Prince acted with the requisite scienter.
Similarly, Count V alleges that Prince aided and abetted
Integral’s distribution of false and misleading proxy
statements. The SEC argues that Integral failed to identify
Prince as a de facto officer in its proxy solicitations, making
those solicitations false or misleading in violation of Section
14(a) of the Exchange Act and Rule 14a-9. See 15 U.S.C.
§ 78n(a); 17 C.F.R. § 240.14a-9. It alleges that Prince aided
and abetted that violation by participating in the decision not
to disclose his officer status and legal history in those
solicitations.
–61–
Therefore, to establish Count V, the SEC must show that:
1) Prince was a de facto officer of Integral; 2) Prince’s
officer status made his legal history material information that
Integral was required to disclose in its proxy statements; 3)
Integral failed to disclose Prince’s history, and thus
distributed false and misleading proxy statements; 4) Prince
provided substantial assistance to Integral in its violation;
and 5) Prince acted with the requisite scienter.
Because all four of these counts require the SEC to
establish by a preponderance of the evidence that Prince was a
de facto officer of Integral, the Court addresses that issue
first.
B. Prince’s De Facto Officer Status
Counts II and VI allege that Prince was an officer under
Section 16 of the Exchange Act and therefore was required to
file beneficial ownership reports, which he failed to do. Counts
III and V allege that, because Prince was an officer, Integral
was required to disclose him and his legal history in its annual
reports and proxy statements, which it failed to do. Thus, the
SEC must establish by a preponderance of the evidence that
Prince was a de facto officer of Integral as a necessary
prerequisite to prove any of these claims.
–62–
Exchange Act Rule 3b-7 defines an “executive officer” to
include a company’s “president, any vice president . . . in
charge of a principal business unit, division or function (such
as sales, administration or finance), any other officer who
performs a policy making function or any other person who
performs similar policy making functions for the registrant.” 17
C.F.R. § 240.3b-7.
Exchange Act Rule 16a-1 defines an “officer” to include a
company’s “president, principal financial officer, principal
accounting officer (or, if there is no such accounting officer,
the controller), any vice-president of the issuer in charge of a
principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a
policy-making function, or any other person who performs similar
policy-making functions for the issuer.” Id. § 240.16a-1(f).
Neither the Regulations nor caselaw provide any additional
description or definition of “policy-making functions.”
The Second Circuit has interpreted the broad language of
the Regulations to require a court to reject reliance on an
employee’s title and instead to perform a fact-intensive
analysis of the employee’s duties and responsibilities to
determine if they are a de facto officer. See Colby v. Klune,
178 F.2d 872, 873 (2d Cir. 1949) (addressing whether an
–63–
individual is an officer under Section 16(b) of the Exchange
Act, which prevents officers from using private information for
short-swing profits).
Versions of this functional approach, mentioned favorably
by the Supreme Court, 11 have been adopted by the Fourth, Sixth,
and Ninth Circuits. See Winston v. Fed. Exp. Corp., 853 F.2d
455, 456-57 (6th Cir. 1988) (evaluating whether individual who
had been vice-president still had access to confidential
information after his resignation); Merrill Lynch, Pierce,
Fenner & Smith, Inc. v. Livingston, 566 F.2d 1119, 1122 (9th
Cir. 1978) (noting that “court must look behind the title . . .
to ascertain [a] person’s real duties”); Gold v. Sloan, 486 F.2d
340, 351 (4th Cir. 1973) (rejecting “objective test” and
evaluating facts to determine if particular officer actually
received insider information).
This mode of analysis has also been applied outside of the
Section 16(b) context. See S.E.C. v. Solucorp Industries, Ltd.,
274 F. Supp. 2d 379, 382-87 (S.D.N.Y. 2003) (using functional
approach to determine liability under Section 10(b) and rule
11
Wolf v. Weinstein, 372 U.S. 633, 652 n.19 (1963) (citing
Colby, 178 F.2d at 875) (observing that in the context of
Section 16(b), “it is clear that a determination of who is a
corporate ‘officer’ within the meaning of the statute requires a
flexible assessment of particular powers and responsibilities
rather than a rigid rule of thumb”).
–64–
10b-5); S.E.C. v. Enterprises Solutions, Inc., 142 F. Supp. 2d
561, 574 (S.D.N.Y. 2001) (using functional approach to determine
if individual was an “officer” for Section 16(a) purposes).
The rationale relied upon in these cases focuses on
ensuring that a company not be allowed to “hide a significant
figure in the management of a company” behind a vague title,
such as “consultant.” See Enterprises Solutions, Inc., 142 F.
Supp. 2d at 574; see also US Diagnostic Inc., S.E.C. Release No.
7928, 2000 WL 1920604, at *4 (Dec. 20, 2000) (citing C.R.A.
Realty Corp. v. Crotty, 878 F.2d 562, 563 (2d Cir. 1989)(noting
that company “cannot avoid liability by characterizing
[defendant] as a ‘consultant’ while allowing him to function as
an officer”). 12
While our Court of Appeals has not addressed this issue,
the functional, fact-intensive analysis of an alleged officer’s
duties and responsibilities, adopted by the Second, Fourth,
Sixth, and Ninth Circuits, is a fair and reasonable approach
which is consistent with the SEC’s overriding obligation to
protect the investing public. See Ernst & Ernst v. Hochfelder,
425 U.S. 185, 194 (1976) (noting that investor protection was a
primary purpose behind passage of the Securities Act of 1933 and
12
Although no court seems to have definitely addressed this
issue, no court has developed an alternative approach.
–65–
Securities Exchange Act of 1934). Therefore, this Court will
apply the functional analysis to evaluate whether Prince was a
de facto officer at Integral.
1. Prince’s Activities Did Not Include Performing
Policy Making Functions
As discussed above, the Regulations set out several
categories of individuals who qualify as “officers,” including
any person who performs “similar policy making functions” to a
“president,” a “vice president . . . in charge of a principal
business unit, division or function,” or “any other officer who
performs a policy making function.” 17 C.F.R. §§ 240.3b-7;
240.16a-1(f).
The few cases that have found an employee to be a de facto
officer because of their ability to make policy involved alleged
“consultants” who were actually in total control of a company.
Solucorp, 274 F. Supp. 2d at 383 (noting testimony that no one
could do anything that alleged “consultant” did not “direct or
approve”); Enterprises Solutions, 142 F. Supp. 2d at 568(finding that alleged officer was “running the company,” and
that company had been created as “a corporate shell with no
employees, no facilities and no chief executive”); Weeks, S.E.C.
Release No. 8313, 2004 WL 828 (Oct. 23, 2003) (determining that
named officers “exercised neither authority nor influence in the
–66–
management and operations of DACO” and that Weeks was actually
running company). The SEC has never alleged that Prince was
“running the company” and thus none of these cases involve
factual situations similar to the present one.
Instead, the SEC argues that, because of his membership in
G6/G7, Prince “proposed and formulated policy” for Integral. See
SEC’s Post-Trial Mem. 5. It is undisputed that G6/G7 was a body
that met to discuss important policy decisions and make
recommendations to Chamberlain and that Prince participated
fully as an equal member of that group. See Findings of Fact
¶ 36. Indeed, Gaffney testified that Prince was a particularly
influential member of G6/G7, second only to Chamberlain. Test.
of Peter Gaffney, Trial Tr. Dec. 10, 2012, P.M. Session 52.
However, as this Court has found in its Findings of Fact,
G6/G7 members gave their opinions and advice to Chamberlain
because he requested them to and because he fostered an office
culture in which all employees were encouraged to share their
opinions. See ¶¶ 21, 36, 68.
However, at the end of the day, Chamberlain was the only
person who had authority to make company policy for Integral.
See id. ¶¶ 37, 69; Test. of Elaine Brown, Trial Tr. Dec. 18,
2012, P.M. Session 49 (“ . . . Steve Chamberlain is the one that
set policy in the company.”); Test. of Thomas Gough, Trial Tr.
–67–
Dec. 20, 2012, P.M. Session 93 (“I don’t think any decisions
were made unless Chamberlain was present.”); Test. of Gary A.
Prince, Trial Tr. Jan. 2, 2013, P.M Session 16-17 (“The people
[Chamberlain] chose for membership in G-6 were the people he
thought had the overall interests of the company at heart, and
that’s why he was interested in our recommendations and advice.
But certainly the decisions and policies were set and made by
Mr. Chamberlain.”). Thus, Prince’s participation in G6/G7 does
not, in and of itself, establish that he performed a “policy
making function” at Integral.
Moreover, the testimony was consistent that Prince did not
and could not make policy for Integral in any capacity. See
Findings of Fact ¶¶ 37, 39. Each of the former Integral
employees testified that Prince did not have the authority to
make policy. See Test. of Peter Gaffney, Trial Tr. Dec. 10,
2012, P.M. Session 55 (specifying that there was no policy
Prince could have instituted on his own without the approval of
G6/G7); Test. of Thomas Gough, Trial Tr. Dec. 20, 2012, A.M.
Session 80 (testifying that Prince “did not have authority to
make decisions”); Test. of Elaine Brown, Trial Tr. Dec. 18,
2012, P.M. Session 49 (“ . . . Steve Chamberlain is the one that
set policy in the company.”); Joint Ex. 3, SEC Dep. of Steven R.
–68–
Chamberlain 83, Aug. 8, 2007 (noting that Prince could not make
or implement policy).
The testimony of Gaffney and Gough that Prince did not have
any authority to make policy is particularly significant. No
evidence was presented that either of them had any continuing
relationship of any kind with Integral or Prince, or had any
particular reason to protect Integral, Chamberlain, or Prince.
There was nothing in their testimony that suggested in word or
tone that they had anything other than professional respect for
Prince. Their testimony, which supports the testimony of Prince,
Brown, and Chamberlain, and which the Court credits, compels the
finding that Prince did not and could not make policy at
Integral.
The SEC also argues that various other facts indicate that
Prince had policy-making authority. See SEC’s Post-Trial Mem. 6-
7. The Court finds that none of these facts, independently or
taken together, establish that Prince performed a policy making
function at Integral.
The strongest argument proffered by the SEC points to
Prince’s influence over the Mergers and Acquisitions program
which he headed at Integral. The SEC established that Prince
supervised all day-to-day details regarding the potential
acquisition of subsidiaries as well as the operations of those
–69–
which had been acquired. See Findings of Fact ¶¶ 24, 26-27.
However, as the Court has already found, the ultimate decision
on all significant mergers and acquisitions issues remained with
Chamberlain. Id. ¶ 26. Thus, while Prince had substantial
influence and involvement with regard to mergers and
acquisitions issues, he did not have final, policy making
authority over that program. 13
Prince also did not have policy making authority over the
Contracts Department, which he began to supervise in August
2005. Id. ¶ 48. At that time, Chamberlain changed the company
protocol to require that all significant contracts be reviewed
and approved by either Prince or Chamberlain before they could
be signed off on by the head of the particular Group involved.
Id. ¶ 46. The testimony of the Integral employees was consistent
that this new level of review was not a substantive one, but
merely an opportunity to screen for major errors, especially
those that might affect Integral's finances. Id. ¶ 47. Moreover,
the restriction placed on Prince when he was hired that
13
The Court notes that the SEC could have argued that the
“policy making functions” of a “vice president . . . in charge
of a principal business unit, division or function (such as
sales, administration or finance),” 17 C.F.R. §§ 240.3b-7;
240.16a-1(f), encompass the type of influence and authority that
Prince had over the mergers and acquisitions program, even if he
did not have the final say over particular issues. Because the
parties did not raise or address this argument and no court has
addressed this issue, the Court will not consider it.
–70–
prevented him from signing off on contracts remained in place,
and no evidence was presented that Prince ever signed any
contract. Id. ¶¶ 17, 43, 45.
Although Prince supervised a few employees, including
exercising hiring and firing power, see id. ¶ 48, the SEC did
not present any evidence indicating that such supervision of
employees constituted an ability to make policy.
The other arguments proffered by the SEC are also
insufficient to establish that Prince was a de facto officer.
The SEC points to the fact that Prince was one of the most
highly paid employees at Integral, see id. ¶ 30, and that his
office was next to Chamberlain’s office, see id. ¶ 38. Such
facts indicate nothing more than the fact that Prince was a
highly valued employee who worked closely with Chamberlain. See
id. ¶¶ 38, 40.
The SEC also argues that Prince’s involvement in
recommending compensation and bonuses for members of executive
management is relevant. See id. ¶¶ 33-34. However, the
significance of that fact is minimized by the consistent
testimony offered by the Integral employees that a number of
people were involved in the recommendation process. See id.
¶ 33; Test. of Thomas Gough, Dec. 20, 2012, A.M. Session 74.
Again, this was part of the general office culture established
–71–
by Chamberlain that encouraged everyone to participate and share
their opinions. See Findings of Fact ¶¶ 21, 68. In sum, these
facts, without more, do not support a finding that Prince had
policy-making authority.
The record is clear that, while Prince exercised
significant influence at Integral and was very close to
Chamberlain, he did not have the authority to make or implement
any policy decisions. Such authority lay with Chamberlain and
the heads of the various Groups. To decide that the Regulations
reach individuals involved in discussing company strategy and
policy, but who do not have the authority to actually implement
such policy, would expand the scope of de facto officer status
far beyond what any court has to date recognized as policy
making authority.
Thus, the Court concludes that the SEC did not prove by a
preponderance of the evidence that Prince’s responsibilities
were such that he was a de facto officer under 17 C.F.R.
§ 240.3b-7 or 17 C.F.R. § 240.16a-1(f). The SEC has therefore
failed to establish an essential element of Claims II, III, V,
and VI. The Court will now briefly address the other elements of
the various counts.
–72–
C. Count VI: Liability Under Section 16(a) and Rule 16a-3
of the Exchange Act
Count VI alleges that Prince is liable under Section 16(a)
of the Exchange Act, 15 U.S.C. § 78p(a), and Rule 16a-3
thereunder, 17 C.F.R. § 240.16a-3, for his failure to file
disclosure statements identifying his ownership of Integral
stock and changes in such ownership during the period from 1998
until 2006. Section 16(a) requires anyone “who is a director or
an officer of the issuer of [any equity] security” to file a
statement concerning any holdings and transactions of the
issuer's securities. 15 U.S.C. § 78p(a); 17 C.F.R. § 240.16a-
3(a) (establishing various forms for use in fulfilling Section
16(a) reporting requirements). As discussed above, the Court
finds that Prince was not a director or an officer, and was thus
not required to file Section 16(a) reports. Therefore, Prince is
not liable under Section 16(a) of the Exchange Act and Rule 16a-
3 thereunder. 14
14
Our Court of Appeals has not addressed the issue of whether
scienter is required to establish a violation of Section 16(a),
but the SEC has consistently held that no scienter is required.
Lexington Resources, Inc., S.E.C. Release No. 379, 2009 WL
1684743, at *18 (June 5, 2009) (citations omitted); Weeks, 2002
WL 169185, at *50; cf. S.E.C. v. Savoy Indus., 587 F.2d 1149,
1167 (D.C. Cir. 1978) (holding that Section 13(d)(1) of the
Exchange Act was a reporting provision as compared to an
antifraud provision, and, therefore, no intentional conduct need
be proven).
–73–
D. Count II: Liability Under Section 10(b) and Rule 10b-5
of the Exchange Act
Count II alleges that Prince violated Section 10(b) of the
Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R.
§ 240.10b-5, by participating in a “scheme to defraud.”
The SEC argues that Prince participated in a scheme to
defraud, established by Chamberlain, where Prince would function
as an officer for Integral, but his officer status would not be
disclosed to the public in order to avoid disclosing his
negative regulatory and criminal history. SEC’s Post-Trial Mem.
9-10. The SEC asserts that Prince understood his obligation to
file Section 16 ownership reports, but that such filings “would
be tantamount to an admission that he was, in fact, an officer”
and therefore that Prince chose not to file them to avoid
disclosing his background. Id. at 10-11.
The Court has already concluded that the SEC failed to
establish that Prince was acting as a de facto officer. Thus,
Prince was not required to file beneficial stock ownership
reports under Section 16(a). See supra II.B-C. However, the
Court finds that, even if Prince was a de facto officer required
to file Section 16(a) reports, the SEC has not established
important other elements of its “scheme to defraud” claim.
–74–
As discussed above, see supra II.A., to establish its claim
under Section 10(b) and Rule 10b-5, the SEC would have to prove
by a preponderance of the evidence that (1) Prince was a de
facto executive officer at Integral; (2) Prince was thus
required to file Section 16(a) reports with the SEC; (3) Prince
did not file such reports in order to perpetuate a “scheme to
defraud” that had the principal purpose and effect of not
disclosing his history of securities fraud violations to the
public; (4) Prince's legal history was a material fact; (5) the
scheme was made in connection with the purchase and sale of
securities; and (6) Prince had the requisite scienter. The Court
now addresses the two elements disputed by the parties – whether
or not the SEC has proven by a preponderance of the evidence
scienter and a “scheme to defraud.” 15
15
This Court has already observed that if Prince was a de facto
officer and had to disclose his past legal troubles, an omission
of those facts might be material because it “could have affected
the total mix of information in Integral’s filings, rendering
them misleading . . . .” Brown, 740 F. Supp. 2d at 160 (citation
omitted); Dolphin & Bradbury, Inc. v. S.E.C., 512 F.3d 634, 638-
39 (D.C. Cir. 2008) (noting that omitted fact is material “if a
reasonable investor would have viewed it as significantly
altering the total mix of information made available”).
Neither party raised or addressed the issue of materiality
or the issue of whether an alleged “scheme to defraud” involving
Prince’s failure to file Section 16(a) reports would be a fraud
made “in connection with the purchase or sale of securities.”
Goble, 682 F.3d at 943. Thus, the Court assumes without deciding
–75–
1. Prince Did Not Act With Scienter When He Did Not
File Section 16(a) Reports
The SEC must establish scienter to prove a violation of
Section 10(b) and Rule 10b-5. See Aaron v. S.E.C., 446 U.S. 680,
691 (1980). To act with scienter means to act with “an intent to
deceive, manipulate, or defraud.” Dolphin & Bradbury, 512 F.3d
at 639. Extreme recklessness may satisfy this intent
requirement. Id. (citing S.E.C. v. Steadman, 967 F.2d 636, 641
(D.C. Cir. 1992)). Such recklessness is not merely a heightened
form of negligence, but is an “extreme departure from the
standards of ordinary care.” Id. (citing Steadman, 967 F.2d at
641-42). Moreover, whether a defendant “acted with scienter . .
. is a factual determination.” Id. (citing Steadman, 967 F.2d at
641).
Prince argues that he reasonably relied on the advice
provided by attorneys at Venable, Integral’s corporate counsel,
that he was not an officer at Integral who needed to be
disclosed in Integral’s public filings. It is an open question
in this Circuit “whether reliance on the advice of counsel is a
good defense to a securities violation.” Zacharias v S.E.C., 569
F.3d 458, 467 (D.C. Cir. 2009). Generally, in a civil securities
action, reliance on the advice of counsel “does not operate as
that the SEC has met is burden with respect to those elements of
its claim.
–76–
an automatic defense, but is only one factor to be considered.”
S.E.C. v. Savoy Industries, 665 F.2d 1310, 1314 n.28 (D.C. Cir.
1981). However, reliance on the advice of counsel “need not be a
formal defense; it is simply evidence of good faith, a relevant
consideration in evaluating a defendant’s scienter.” Howard v.
S.E.C., 376 F.3d 1136, 1147 (D.C. Cir. 2004).
For the reasons discussed below, the Court finds that the
SEC has not established Prince's scienter by a preponderance of
the evidence. Because proof of such scienter is necessary to
establish a violation under Section 10(b) and Rule 10b-5, the
Court does not need to resolve the open question of whether
advice-of-counsel is an independent defense to such a violation.
a. Integral Requested and Received Venable’s
Advice After Making Complete Disclosure
The advice-of-counsel defense requires the defendant to
establish four elements: he must have “(1) made complete
disclosure to counsel; (2) requested counsel’s advice as to the
legality of the contemplated action; (3) received advice that it
was legal; and (4) relied in good faith on that advice.”
Zacharias, 569 F.3d at 467. While the Court does not need to
address whether Prince established an advice-of-counsel defense
per se, all of its elements are directly relevant to Prince’s
scienter. Thus, the Court addresses each in turn.
–77–
The first relevant factor as to whether Prince relied on
counsel is whether he requested counsel’s advice as to the
legality of the contemplated action. Id. Chamberlain approached
Venable in 1998 regarding Prince’s possible employment. 16 See
Findings of Fact ¶¶ 90-93. At this point, Venable was Integral’s
general corporate counsel and advised Integral on public
filings, securities law compliance, financing matters, mergers
and acquisitions, and government contracts. See id. ¶¶ 81, 86-
87.
Chamberlain spoke with John Sullivan, the senior partner in
charge of Venable’s account, and asked Sullivan how he could
structure Prince’s role so that Integral would not have to
disclose Prince’s legal history in its public filings. Id.
¶¶ 15, 74, 90-91; Joint Ex. 3, SEC Dep. of Steven R. Chamberlain
83, July 11, 2007, p. 47. As our Court of Appeals has observed,
it is a “common attorney-client interaction” for a client to
“come[] to his lawyer with a plan and ask[] him to find a way to
implement it in a legal manner.” United States v. DeFries, 129
F.3d 1293, 1309 (D.C. Cir. 1997).
16
To the extent that the SEC argues that Prince himself did not
request the advice of counsel, that argument has been rejected
by our Court of Appeals. See Howard, 376 F.3d at 1148-49 (noting
that it “would be impractical and highly inefficient” if lower-
level employees were not allowed to rely on the communications
of their superiors with outside counsel).
–78–
Thus, it is clear that Chamberlain “actively sought”
advice on the very question at issue in this case – whether
Prince could legally perform certain functions at Integral
without being disclosed to the SEC in Integral’s public filings.
Thus, this case is not one in which the defendant did not
actively seek the opinion of counsel or did not present the
entire question to counsel for consideration. See Zacharias, 569
F.3d at 467 (noting that “lawyer must opine on the legality of
the entire issue” in question); S.E.C. v. Scott, 565 F. Supp.
1513, 1535 (S.D.N.Y. 1983) (noting that defendant’s “complacent
attitude” and failure to “actively” seek the advice of counsel
was insufficient to establish the defense). In sum, Prince has
established that Integral “requested counsel’s advice as to the
legality of the contemplated action.” See Zacharias, 569 F.3d at
467.
The second relevant factor as to whether Prince relied on
counsel is whether, after requesting the advice of counsel as to
the legality of a particular action, he received advice from
counsel that such action was legal. Zacharias, 569 F.3d at 467.
Sullivan and Chamberlain agreed that Prince could be hired as a
full-time employee so long as certain “carveouts” were put in
place to ensure that he would not function as an officer at
Integral. See Findings of Fact ¶¶ 90-91, 93. Chamberlain
–79–
understood that hiring Prince, provided those “carveouts” were
in place, meant that Prince would not have to be disclosed in
Integral’s public filings. Id. ¶¶ 15, 17, 90-91. In other words,
Chamberlain received advice that Prince could be hired as a
full-time employee under certain conditions and that, so long as
those conditions were satisfied, it would be legal not to
disclose his employment to the SEC. Therefore, Prince has
established that Integral “received advice that [the
contemplated action] was legal.” See Zacharias, 569 F.3d at 467.
The third relevant factor as to whether Prince reasonably
relied on counsel is whether he disclosed to counsel all
relevant information that would bear on the legality of the
proposed action. See id. The SEC does not identify any relevant
information that Chamberlain failed to disclose to Sullivan in
their initial meeting. Chamberlain indicated that Prince would
be working on mergers and acquisitions issues as well as
continuing the work he had been doing as a consultant, which
included drafting press releases, making bonus suggestions for
members of executive management, and functioning as a general
advisor to Chamberlain and other members of senior management.
See Findings of Fact ¶ 20.
Moreover, Venable had served as corporate counsel for
Integral for several months before this conversation and Venable
–80–
lawyers knew that Prince had been participating in the
preparation of financial statements and working on mergers and
acquisitions issues. Id. ¶ 95. Thus, Venable lawyers were aware
of the major responsibilities that Prince would have as a full-
time employee at Integral.
Because Chamberlain and Integral disclosed all relevant
facts to Venable, they “made complete disclosure to counsel,”
which is relevant to whether they reasonably relied on the
advice of counsel. See Zacharias, 569 F.3d at 467; see also
Dolphin & Bradbury, 512 F.3d at 642 (determining that defendant
cannot establish reliance on advice of counsel unless all
relevant facts are disclosed to attorney).
b. Integral Relied on Venable’s Advice in Good
Faith
The fourth factor relevant to whether Prince reasonably
relied on advice of counsel is whether, after receiving advice
that the proposed action was legal, he relied on that advice in
good faith. See Zacharias, 569 F.3d at 467. There was absolutely
no evidence proffered by the SEC to suggest that Prince or
anyone at Integral did not believe that Venable’s advice was
accurate or legal. See Steadman, 967 F. 2d at 638 (noting that
evidence did not support finding that anyone knew advice of
counsel was wrong or recklessly relied on it).
–81–
The evidence demonstrates that Chamberlain relied on
Venable’s advice when he hired Prince and structured his role at
Integral to reflect the “carveouts” discussed with Sullivan. See
Findings of Fact ¶¶ 17, 91; Joint Ex. 3, SEC Dep. of Steven R.
Chamberlain 83, July 11, 2007, p. 47. These “carveouts” were
communicated to Integral’s senior management, and were
recognized and complied with throughout Prince’s tenure. See
Findings of Fact ¶¶ 17, 19, 91. Not only were these “carveouts”
communicated internally, the evidence showed that there was
never any effort to keep Prince’s regulatory and criminal
history or his actions, duties or responsibilities from anyone,
inside or outside of Integral. 17 See id. ¶¶ 70-73. Thus, Prince
has successfully established that Integral requested and
received advice from Venable after disclosing all relevant
information and then relied on that advice in good faith when
concluding that there was no need to file various reports with
the SEC, including Section 16(a) reports.
c. In Subsequent Years, Venable Reiterated its
Conclusion That Prince Could Work at
Integral Without Disclosure
Integral and Venable had a number of discussions regarding
Prince’s officer status in subsequent years, and at no point did
17
The Court notes that Integral issued a Form 8K in 1993
disclosing the charges of securities fraud filed by the SEC
against Prince. See id. ¶ 7.
–82–
anyone at Venable ever advise anyone at Integral that Prince’s
employment needed to be disclosed to the SEC in public filings.
See Findings of Fact ¶¶ 170-71.
In 1999, Integral employees asked Venable lawyers whether
Prince’s compensation required that he be disclosed in the Form
10-KSB for fiscal year 1999. Id. ¶¶ 105-10. Sullivan spoke with
Chamberlain and Gough about Prince’s roles in the company and
level of compensation, and concluded that, because Prince did
not make policy and did not have staff reporting to him, he did
not have to be disclosed. Id. ¶ 112. Based on that advice,
Integral did not disclose Prince as a highly-paid employee in
the executive compensation table in its Form 10-KSB for fiscal
year 1999. Id.
In 2001, Prince set up a meeting with Venable attorneys,
including Sullivan and Dvorak, to discuss whether or not he
could become a named executive officer without being disclosed
in Integral’s public filings. Id. ¶ 113. The attorneys and
Prince were under the (mistaken) impression that, after five
years had passed, Prince’s earlier legal troubles would no
longer need to be disclosed. Id. ¶¶ 114, 116. Venable attorneys
informed Prince that the five-year limit would not expire until
the summer of 2002 and they decided to revisit the issue at that
time. Id. ¶ 116.
–83–
In the spring of 2002, Prince again raised the question of
his officer status and the firm researched the issue. Id.
¶¶ 117-118. It concluded that, if Prince was named an executive
officer, his legal history would have to be disclosed for the
foreseeable future. Id. ¶ 121. Venable partner Anita Finkelstein
explicitly noted in an email to Wallace Christner, who was the
relationship partner at that time, that, “Integral is open to
the complaint that, no matter what his title, Integral should
have made disclosure about Prince due to the nature of his
activities at Integral.” Def.’s Ex. 75. No one at Integral
received a copy of this email, nor was this information ever
conveyed to anyone at Integral. See Findings of Fact ¶¶ 120-21. 18
Finally, in December 2005, Bonnie Wachtel, a member of the
Integral Board of Directors, suggested that Integral include
Prince’s biography and legal history in its Form 10-K for fiscal
year 2005, regardless of his title. Id. ¶¶ 130, 135. Integral
18
The SEC argues that Integral’s investigation into whether
Prince would have to be disclosed if he was named an executive
officer was irrelevant because that is a distinct question from
the question at issue here, which is whether Prince’s
compensation and roles required his disclosure regardless of his
title. SEC’s Post-Trial Mem. 17-18. The SEC fails to realize
that the latter question is a logical antecedent of the first
question. The question of whether providing Prince with an
additional title would require disclosure is based on an
assumption that Prince’s current job functions did not require
disclosure. Finkelstein’s memorandum underscores that Venable
lawyers understood the relationship between these two inquiries.
See Def.’s Ex. 75.
–84–
employees consulted with Venable lawyers and decided not to
disclose Prince in that filing. Id. ¶¶ 131-34, 137.
Over the years, Venable lawyers worked intimately with
Prince on a number of issues. They worked with Prince on mergers
and acquisitions issues, and were well aware that he was
drafting offer letters, Def.’s Ex. 40, reviewing consulting
agreements with employees of subsidiaries, Def.’s Ex. 46,
drafting press releases, Def.’s Exs. 82, 85, serving on the
Board of Directors for corporations created to acquire
subsidiaries, Def.’s Exs. 64, 69, 87, and interacting with
outside auditors in his capacity as Director of Mergers and
Acquisitions, Def.’s Exs. 80, 82. See Findings of Fact ¶¶ 96-97.
They also knew that Prince was interacting with outside
financial analysts, drafting press releases, and participating
in the preparation of Integral’s public filings. See id. ¶¶ 98-
100, 102. The evidence shows that Venable understood the breadth
of Prince’s duties, activities, and responsibilities at
Integral.
Thus, with full awareness of Prince’s activities at
Integral, Integral employees and Venable attorneys discussed
Prince’s officer status five times between December 1998, when
Prince became a full-time employee at Integral, and August 2006,
when Prince was named an executive officer. At no point in this
–85–
period did anyone at Venable ever advise anyone at Integral that
Prince needed to be disclosed to the SEC. Id. ¶¶ 170-71.
The SEC argues that during this time, Prince “affirmatively
misrepresented his role as a member” of G6/G7 to Venable. SEC’s
Post-Trial Mem. 17-18, 22. However, there was no evidence
produced at trial indicating that Prince or anyone at Integral
actively hid Prince’s membership on that committee from Venable.
The SEC then argues that Prince's and Integral's failure to
disclose Prince’s “involvement and influence” on G6/G7 was an
omission of a material fact that would have affected the advice
Venable provided. SEC’s Post-Trial Mem. 17, 22. While there was
no evidence that Venable lawyers knew about G6/G7 or Prince’s
participation in the group until 2005, see Findings of Fact
¶ 126, the fact is, as discussed supra, Prince did not have
policy-making authority at Integral, even though he was a member
of G6/G7. See supra II.B.1. Moreover, Venable lawyers were fully
apprised of the scope of Prince’s duties and responsibilities.
And even after Venable lawyers definitely knew of Prince's
participation in G6/G7, they continued to advise Integral that
Prince was not an executive officer. See Findings of Fact
¶¶ 137, 149.
Moreover, there was no evidence that at any time any
employee of Integral failed to provide information requested by
–86–
a Venable lawyer. See id. ¶ 89. Our Court of Appeals has
cautioned against finding that a defendant, particularly a non-
lawyer defendant, did not rely on counsel because they did not
disclose all possibly relevant facts. In DeFries, the Court of
Appeals observed:
No client ever tells his or her lawyer every single
fact that a good lawyer probes before giving advice.
Indeed, clients do not typically even know which facts
a lawyer might think relevant. (That is, in part, why
they consult lawyers.) So long as the primary facts
which a lawyer would think pertinent are disclosed, or
the client knows the lawyer is aware of them, the
predicate for an advice-of-counsel defense is laid.
129 F.3d at 1308-09. The record shows that Integral’s employees
asked for Venable's advice, believed they had disclosed the
relevant facts to Venable, and that the Venable lawyers were
aware of those facts.
The Court also notes that the firm put no formal or
informal protocol in place by which its many lawyers (at least
twelve different ones worked on the Integral account) could
gather and compile information from Integral, nor did it have
any system by which it could track earlier work that had been
done by Venable lawyers on Integral issues. 19 See Findings of
19
At least one Court of Appeals has observed that “part and
parcel of effectively protecting a client, and thus discharging
the attorney’s duty of care, is to protect the client from the
liability which may flow from promulgating a false or misleading
offering to investors.” F.D.I.C. v. O’Melveny & Myers, 969 F.2d
–87–
Fact ¶ 88. This systemic failure had consequences. For example,
a Venable lawyer wrote to NASDAQ officials asserting that
Venable knew of no communications between Prince and outside
auditors despite the fact that Venable lawyers had been copied
on such communications and represented to the SEC in 2000 that
Prince had had such communications. Id. ¶ 143. Although the
issue of Prince’s disclosure was raised multiple times by
Venable over the years, Venable attorneys never prepared any
written document setting out what Prince could or could not do.
Id. ¶ 94.
This is particularly troubling in light of several exhibits
which show that Venable lawyers repeatedly raised concerns
amongst themselves regarding the inherent risk involved in
Integral’s choice to not disclose Prince. See Def.’s Ex. 75
(internal email noting that “Integral is open to the complaint
that, no matter what his title, Integral should have made
disclosure about Prince due to the nature of his activities at
Integral”); Def.’s Exs. 183-84 (memorandum prepared by Venable
744, 749 (9th Cir. 1992), rev’d on other grounds O’Melveny &
Myers v. F.D.I.C., 512 U.S. 79 (1994). The Ninth Circuit
concluded that “attorneys, in rendering opinions relating to the
securities laws, are not justified in assuming facts as
represented to them by the client and in basing their opinion on
the assumption that such facts are correct. Rather . . . the
attorney must make a reasonable effort to independently verify
the facts on which the opinion is based.” Id. (quotation
omitted).
–88–
attorney Brian Dunn concluding that, “[g]iven Prince’s role at
the Company, the SEC could reasonably take the position that he
was a de facto officer and should have been disclosed as such in
the company’s SEC filings”); Def.’s Ex. 211 (internal email
noting troubling similarities between Integral’s issues and a
legal case where a company had been held liable for not
disclosing as a de facto officer a significant management
figure). Venable lawyers never shared these documents or the
concerns they raised with anyone at Integral. See Findings of
Fact ¶¶ 121, 146, 155.
The record shows that the Integral employees repeatedly
sought Venable’s advice and did everything they were asked to do
to assist their attorneys in formulating such advice. See, e.g.,
Def.’s Ex. 21 (fax from Brown to Dvorak with portions of the
Code of Federal Register asking questions about “significant
employee” disclosure requirements); Def.’s Ex. 24 (email from
Brown to Dvorak asking him to follow-up regarding her earlier
fax); Test. of James Dvorak, Trial Tr. Dec. 21, 2012, P.M.
Session 15-17 (testimony of Dvorak that he does not remember
ever following up as requested).
Based on these facts, the Court concludes that Integral’s
employees, including Prince, acted in an entirely reasonable and
transparent fashion when they repeatedly sought advice from
–89–
their attorneys about Prince’s officer status and relied on that
advice accordingly. Moreover, this factual scenario demonstrates
the good faith of Integral employees in attempting to get legal
advice from their lawyers to avoid problems with the SEC.
The record shows that Integral requested and received
nothing but “green flags” from Venable regarding its choice to
hire Prince as a full-time employee and structure his position
in a way that was supposed to avoid disclosure of his legal
history. See Howard, 376 F.3d at 1147 (noting that court found
no scienter existed when Howard relied on counsel and only
encountered “green flags” not “red flags”). As our Court of
Appeals has observed, such approval of its actions by counsel
“constitutes powerful evidence that [the] actions did not amount
to an extreme departure from the standards of ordinary care so
obvious that the actor must have been aware of it.” Id. at 1148(internal quotation marks omitted) (citation omitted).
Thus, the Court concludes that, even if Prince had been a
de facto officer required to file Section 16(a) reports, he did
not fail to file such reports with the requisite scienter
because, in reasonable and good faith reliance on Venable’s
advice, he believed he was not required to file them. Because
such scienter is required to establish the SEC’s claim that
Prince participated in a scheme to defraud that violated Section
–90–
10(b) and Rule 10b-5 of the Exchange Act, the SEC has failed to
establish an essential element of that claim.
2. The SEC Did Not Establish That a “Scheme to
Defraud” Existed
Even if Prince had acted with scienter in failing to file
Section 16(a) reports, the SEC failed to show that he did so as
part of a “scheme to defraud.” The SEC argued that Chamberlain
“was the chief architect of the scheme to defraud and Prince was
a willing and active participant.” SEC’s Post-Trial Mem. 9.
However, the evidence shows that Chamberlain intended to
and believed he could legally employ Prince without disclosing
him to the SEC. See supra II.D.1. Prince understood that
Chamberlain had received legal approval for this action, and
reasonably relied on that advice. Id. Prince did not believe he
was obligated to file Section 16(a) reports, and there was no
indication that he, Chamberlain, Brown, or anyone else decided
he should not file such reports in order to defraud the public
or the SEC. Thus, even if Prince was extremely reckless in
relying on counsel’s advice that he did not need to file Section
16(a) reports, the Court finds there was no “scheme to defraud”
at Integral.
The SEC has failed to establish by a preponderance of the
evidence several elements of its claim that Prince participated
–91–
in a “scheme to defraud” that violated Section 10(b) and Rule
10b-5 of the Exchange Act and, thus, has failed to establish
liability under Claim II of the Complaint.
E. Count III: Liability Under Section 13(a) and Rules
13a-1 and 12b-20 of the Exchange Act
Count III alleges that Integral violated Section 13(a) and
Rules 13a-1 and 12b-20 of the Exchange Act when it failed to
identify Prince as an executive officer in its annual reports,
making such reports materially false or misleading. See 15
U.S.C. § 78m(a); 17 C.F.R. §§ 240.13a-1, 240.12b-20; see also
SEC’s Proposed Findings of Fact & Conclusions of Law 27 [Dkt.
No. 138-9]. The SEC also argues that Prince aided and abetted
that violation by “engaging in conduct the purpose and effect of
which was to conceal his status as an officer from investors,”
which constituted “knowing and substantial assistance” to
Integral’s violations. Id.Because the Court has concluded that Prince was not a de
facto executive officer who Integral was required to disclose in
its annual reports, there was no primary violation for Prince to
aid and abet. However, even if Prince was a de facto officer,
the SEC has failed to prove by a preponderance of the evidence
–92–
that Prince had the requisite scienter to establish its aiding
and abetting claim under Section 20(e) of the Exchange Act. 20
1. Scienter
Section 20(e) was amended recently to specifically cover
anyone who “knowingly or recklessly” (emphasis added) provides
substantial assistance to a securities fraud violator. See
S.E.C. v. Apuzzo, 689 F.3d 204, 211 n.6 (noting that Dodd-Frank
Act of 2010 amended Section 20(e) to include recklessness).
Thus, the level of scienter that the SEC must prove for its
aiding and abetting claims is the same as for its claims under
Section 10(b) and Rule 10b-5 of the Exchange Act. For the
reasons discussed above, Prince and Integral’s reasonable
reliance on counsel compels this Court to conclude that Prince
did not act with “extreme recklessness” in participating in
Integral’s decision to not disclose Prince in its public
filings. See supra II.D.1.
Therefore, the SEC has failed to prove by a preponderance
of the evidence that, even if Integral violated Section 13(a) or
Rules 13a-1 or 12b-20 by not disclosing Prince in its annual
reports as an officer, Prince aided and abetted that violation
20
The Court notes that the SEC failed to address this claim in
its Post-Trial Brief. Because the only issue raised by Prince in
his Post-Trial Brief as to this claim specifically was the issue
of scienter, that is the only element of this claim the Court
will address.
–93–
with the requisite scienter. See Howard, 376 F.3d at 1143(quoting Graham, 222 F.3d at 1004) (finding that Howard was not
extremely reckless in aiding and abetting violation of
securities laws when he did not encounter “‘red flags’ or
‘suspicious events creating reason for doubt’ that should have
alerted him to the improper conduct of the primary violator”).
Thus, the SEC has failed to establish an essential element of
this claim.
F. Count V: Liability Under Section 14(a) and Rule 14a-9
of the Exchange Act
Count V alleges that Integral violated Section 14(a) and
Rule 14a-9 of the Exchange Act when it failed to identify Prince
as an executive officer in its proxy statements, making such
statements false or misleading. See 15 U.S.C. § 79n(a); 17
C.F.R. § 240.14a-9; see also SEC’s Proposed Findings of Fact &
Conclusions of Law 28. The SEC also argues that Prince aided and
abetted that violation by concealing his status as an officer,
which constituted “knowing and substantial assistance” to
Integral’s violations. Id.Because the Court has concluded that Prince was not a de
facto executive officer who Integral was required to disclose in
its proxy statements, there was no primary violation for Prince
to aid and abet. However, even if Prince was a de facto officer,
–94–
the SEC has failed to prove by a preponderance of the evidence
that Prince aided and abetted any violation by Integral of
Section 14(a) or Rule 14a-9 with the requisite scienter. For the
same reasons discussed above, see supra II.D.1, II.E.1, the SEC
has thus failed to prove an essential element of this claim. 21
G. Count VII: Practicing Accounting Before the Commission
1. Prince Violated the Commission Rule 102(e) Order
Barring Him from Appearing or Practicing Before
the Commission as an Accountant
SEC Rule 102(e) allows the Commission to “deny, temporarily
or permanently, the privilege of appearing or practicing before
[the Commission] in any way to any person who is found by the
Commission . . . to have engaged in unethical or improper
professional conduct.” 17 C.F.R. § 201.102(e). This rule is
“directed at protecting the integrity of the Commission's own
processes, as well as the confidence of the investing public in
the integrity of the financial reporting process.” Marrie v.
S.E.C., 374 F.3d 1196, 1200 (D.C. Cir. 2004).
The Commission issued a Rule 102(e) Order against Prince in
1997. See Findings of Fact ¶ 13; Pl.’s Ex. 2. This Order
permanently prohibits Prince from exercising “the privilege of
21
The SEC failed to address this claim in its Post-Trial Brief.
Again, because the only issue raised by Prince in his Post-Trial
Brief as to this count was the issue of scienter, that is the
only element of the claim the Court addresses.
–95–
appearing or practicing before the Commission as an accountant.”
See id. For purposes of analysis, violation of this prohibition
requires two elements. First, an individual must “appear[] or
practice[] . . . as an accountant.” Second, such action must
have occurred “before the Commission.”
The Court addresses the second prong regarding actions
taken “before the Commission” first. Rule 102(f) defines
“practicing before the Commission” to include “[t]he preparation
of any statement, opinion, or other paper” filed with the
Commission. 17 C.F.R. § 201.102(f). As discussed above, the
securities laws require a public company to file various
documents with the SEC. See supra II.A. Primarily, companies are
obligated to file annual and quarterly reports. See 15 U.S.C.
§ 78m(a) (requiring every issuer of registered securities to
file annual and quarterly reports with the SEC). These are filed
on Form 10-Ks and 10-Qs. 17 C.F.R. §§ 240.13a-1, 240.13a-13
(requiring that annual and quarterly reports be filed on Form
10-Ks and Form 10-Qs, respectively).
In addition, when a public company acquires a significant
subsidiary, the financial statements of that subsidiary must be
filed with the SEC. See 17 C.F.R. § 210.3-05; Test. of Lynn
Turner, Trial Tr. Dec. 12, 2012, A.M. Session 48. Thereafter,
the company has to file financial statements that consolidate
–96–
their balance sheets and statements of income and cash flow with
those of the subsidiary. See 17 C.F.R. §§ 210.3-01; 210.3-02;
see also 17 C.F.R. § 210.3A-02 (discussing how to present
consolidated financial statements of a registrant and its
subsidiaries).
The evidence was undisputed that Prince reviewed and
commented on drafts of Integral’s public filings, including Form
10-Ks and Form 10-Qs. See Findings of Fact ¶ 54. Prince also
wrote the first draft of the MD&A section included in those
filings. See id. ¶¶ 50-52. In addition, Prince engaged in
discussions with members of the Integral accounting staff and
the accounting staff at Integral subsidiaries regarding the
financial statements. See id. ¶¶ 27, 67. These activities
clearly meet the second prong, in that they involve work done on
various types of statements and documents “filed with the
Commission.” 17 C.F.R. § 201.102(f)(2). 22 Thus, the question is
whether these activities constitute “practicing accounting”
before the Commission.
22
Several of the SEC’s allegations do not constitute filings
with the Commission. The fact that Prince occasionally attended
meetings of the Board of Directors and gave presentations and
tutorials on financial issues to Directors and members of the
Integral staff has no relationship to public filings. See
Findings of Fact ¶¶ 63, 65-66. In addition, neither the
financial forecasts that Prince prepared for internal analysis
nor Defense Contract Auditing Agency submissions were filed with
the Commission. See id. ¶¶ 62, 67.
–97–
Rule 102(f) defines “practicing before the Commission” to
include “[t]he preparation of any statement, opinion, or other
paper by any . . . accountant” if that document is filed with
the Commission. 17 C.F.R. § 201.102(f) (emphasis added). The
crux of this dispute turns on what the word “preparation”
encompasses.
In the leading decision addressing this issue, Robert W.
Armstrong III, S.E.C. Release No. 34-51920, 2005 WL 1498425(June 24, 2005), Armstrong, a vice president and controller of a
subsidiary of a public company, prepared financial data and
submitted it to the parent company, which included that data in
its filings with the SEC. Id. at *2, *4, *11. The SEC
administrative law judge found that Armstrong did not “appear or
practice” before the Commission because he did not prepare the
actual reports filed by the public company with the SEC. Id. at
*11.
The Commission disagreed, stating that “[t]he text of the
Rule does not specify that a person must sign a document filed
with the Commission. Moreover, the term ‘preparation’ of a
document is, we believe, sufficiently broad to encompass the
preparation of data to be included in a document filed with the
Commission, at least where, as here, the data was prepared for
the express purpose of being included in such a document.” Id.–98–
Thus, participation in the preparation of data for inclusion in
a financial statement filed with the Commission is sufficient.
This Court has already observed that Armstrong “established
that an individual may . . . be found to have practiced before
the Commission if he or she participated in the preparation of
financial statements filed with the Commission by, for example,
creating, compiling or editing information or data incorporated
into [filings with the Commission] and consenting to their
incorporation.” S.E.C. v. Brown, 878 F. Supp. 2d 109, 125
(D.D.C. 2012) (emphasis added) (internal quotation marks
omitted) (citing Armstrong, 2005 WL 1498425 at *11). 23
The language in Armstrong rejects the theory put forth by
Prince’s expert witness, Jonathan Macey, that only accounting
department personnel and the executives who have final authority
for financial disclosures are “practicing accounting.” Macey
originally defined “practicing accounting” as “calculating or
computing specific numbers for inclusion in public filings;
making substantive accounting determinations in connection with
23
The Court also noted that Armstrong’s interpretation of
“practicing before the Commission” was consistent with the
language of Rule 102(f) and noted that Prince could identify no
past practices or rulings that were inconsistent with its
interpretation. See Brown, 878 F. Supp. 2d at 125. Thus, the
Commission’s interpretation of Rule 102(f) in Armstrong was
reasonable and entitled to deference. Id. (citing Bowles v.
Seminole Rock & Sand Co., 325 U.S. 410, 414 (1945) and Drake v.
F.A.A., 291 F.3d 59, 67 (D.C. Cir. 2002)).
–99–
the preparation of public filings; or making determinations
regarding the accuracy or appropriateness of public filings.”
Def. Gary A. Prince’s Post-Trial Br. 43; see also Dkt. No. 110-
1, Reply Aff. of Professor Jonathan R. Macey in Further Support
of Def. Gary A. Prince’s Mot. for Partial Summ. J. 3; Test. of
Jonathan Macey, Trial Tr. Dec. 18, 2012, A.M. Session 48-49.
However, Macey’s testimony at trial made clear that his
definition was far more limited. After extensive cross-
examination, it became clear that Macey’s definition was really
limited to two groups; low-level accounting personnel and
individuals who have final authority over exactly what numbers
are included in a public filing. See Test. of Jonathan Macey,
Trial Tr. Dec. 18, 2012, A.M. Session 43, 46-47, 51, 58-59;
Test. of Jonathan Macey, Trial Tr. Dec. 17, 2012, P.M. Session
15, 39-40, 51.
Macey’s definition would exclude from legal liability
people who review and decide on accounting treatments, even if
those actions affect the data included in a financial statement,
unless those people have final authority to implement their
suggestions. Test. of Jonathan Macey, Trial Tr. Dec. 18, 2012,
A.M. Session 52, 58-59, Test. of Jonathan Macey, Trial Tr. Dec.
17, 2012, P.M. Session 46, 51-52.
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This cramped definition ignores the language and spirit of
Armstrong, which rejected the premise that only those who were
“responsible for signing or filing the financial statements”
were practicing accounting. Armstrong, 2005 WL 1498425 at *11.
Armstrong himself did not make the ultimate determination as to
whether the information that he contributed would be included in
the filings. Id. at *4. In fact, he “voiced concerns” regarding
the substance of the subsidiary’s statements, but they were
submitted despite his disagreement. Id. at *5. Thus, the fact
that Prince did not have final authority over what information
was included in Integral’s filings with the SEC, see Findings of
Fact ¶ 53, is not dispositive.
Macey’s definition ignores the fact that accounting is not
a mechanistic, quantitative endeavor, but instead requires many
non-quantitative decisions on which people can reasonably
disagree. See Test. of Lynn Turner, Trial Tr. Dec. 12, 2012,
A.M. Session 37, 70 (discussing how preparation of financial
disclosures involves quantitative decisions, but also involves
numerous non-quantitative decisions about how various accounting
principles and treatments should be applied to underlying
data). 24 Because these non-quantitative decisions may greatly
24
Lynn Turner, the SEC’s expert witness, was extremely qualified
to opine on what constitutes accounting. He is a certified
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affect what final numbers are included in the financial
statements, those who participate in making those decisions are
“creating” and “compiling” the relevant information, even if
they do not have final authority over the exact numbers that are
included. 25
public accountant who practiced at one of the country’s largest
accounting firms for twenty years, served as chief financial
officer of a major technology company, served as Chief
Accountant of the Commission from July 1998 to August 2001, and
served on the Board of Directors of several major companies.
Pl.’s Ex. 132, Ex. 8. Macey, on the other hand, is not now nor
ever has been an accountant, C.P.A., or corporate officer. Test.
of Jonathan Macey, Trial Tr. Dec. 18, 2012, A.M. Session 32.
Moreover, Macey has never been involved in a Rule 102(e)
proceeding nor has he ever written about Rule 102 as an
academic. See Def.’s Ex. 266, ex. 1 (Macey’s resume).
25
The SEC argues that the definition of “practicing accounting”
goes beyond when someone is “creating, compiling, or editing”
data or information that is incorporated into financial
statements, and includes any editorial review of the statements.
For example, it argues that Prince was practicing as an
accountant when he suggested using rounded numbers, Pl’s Ex. 36
p. 15; Pl.’s Ex. 37 p. 16; Pl.’s Ex. 55 p. 8, noted that a
particular sentence was illogical, Pl.’s Ex. 37 p. 43, and
suggested consolidating two sentences into one, Pl.’s Ex. 53 p.
9. It also alleges that the various times that Prince pointed
out inconsistencies within or among financial filings
constituted practicing accounting. Pl.’s Ex. 29, pp. 2, 12;
Pl.’s Ex. 30, p. 7; Pl.’s Ex. 37, p. 24; Pl.’s Ex. 53, p. 12;
Test. of Gary A. Prince, Trial Tr. Jan. 2, P.M. Session, 56-57,
59-60, 62-63, 69, 71.
The SEC’s position is vulnerable to the criticism that it
is far too broad because it could arguably encompass anyone,
including non-accountant executive officers and directors, who
identified typographical errors or engaged in editorial review
of public filings. However, the Court need not delve into this
challenging question on which the Circuit has not ruled, because
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The record contains evidence showing that Prince engaged in
such decisionmaking. For example, Prince sent an email to Brown
and Pat Carey, Integral’s controller, regarding the accrual of
bonuses given to employees at SAT, one of Integral’s
subsidiaries. Pl.'s Ex. 134. He wrote, “I have instructed Paul
[SAT’s controller] to accrue the bonuses in FY00 and to reverse
the FY01 entries. Please make sure the consolidated numbers
reflect this change also.” Id.; Test. of Gary A. Prince, Trial
Tr. Jan. 3, 2013, A.M. Session 53-54. Clearly, Prince was making
an accounting determination for SAT, and then directing the
Integral accounting staff to make sure that this number was
reflected in the consolidated financial statements. Those
financial statements were then filed with the SEC. See 17 C.F.R.
§ 210.3A-02 (discussing how to present consolidated financial
statements of a registrant and its subsidiaries).
Prince's actions are similar to the work the SEC deemed
“practicing accounting” in Armstrong. Armstrong, 2005 WL
1498425, at *11 (determining that Armstrong “appeared and
practiced before the Commission” when he computed the income
that needed to be held in reserve, directed that determination
be included in the subsidiary’s reports, and then reviewed and
there is substantial evidence in the record of Prince
“practicing accounting” under the narrower “creating, compiling
or editing” standard set forth in Armstrong.
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approved its inclusion in the parent company’s financial
filings).
Similarly, Prince wrote to the controller of another
Integral subsidiary, RT Logic, and opined on how the subsidiary
should book certain journal entries in its closing financial
statements. Pl.’s Ex. 54. He made specific recommendations as to
how certain items should be recorded. For example, he stated
that a particular credit should be booked to additional paid-in
capital rather than retained earnings and noted that a debit
should flow through a particular expense. Id.; Test. of Lynn
Turner, Trial Tr. Dec. 12, 2012, A.M. Session 45-46. The closing
financial statements were then included in a Form 8-K that
Integral filed with the SEC. Id. at 45, 48. 26
26
Although Prince argues that he was merely making a
recommendation in this email, Test. of Gary A. Prince, Trial Tr.
Jan. 2, 2013, P.M. Session 81, Brown’s response indicates that
Prince had final review over the financial statement before it
was filed. She wrote, “I’m assuming we’ll receive the revised
financial either today or tomorrow. I’ll await your review
before paying out the excess purchase price to former RT
shareholders. If you review/approve them while at RT, please let
me know so I can start processing the payments.” Pl.’s Ex. 54.
The last sentence indicates that Prince had the authority to
review and approve the financial statement containing the
disputed transactions without Brown’s review or approval. Thus,
although Integral’s general procedure gave Brown the final say
on accounting issues, see Findings of Fact ¶ 53, in this
instance Brown is giving Prince the authority and responsibility
to be the last Integral employee to review a financial statement
eventually filed with the SEC.
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Other documents similarly show Prince participating in
determining the proper treatment of Integral’s financial data.
Prince prepared spreadsheets that calculated various scenarios
regarding what percentage of total revenue a particular contract
would represent. Pl.’s Ex. 135. Brown then evaluated the
scenarios and chose one for use in the Form 10-KSB for fiscal
year 1999. Id. Prince made a similar calculation for Brown
regarding the Form 10-K for fiscal year 2001, and created a
spreadsheet with the “back-up for this calculation.” 27 Pl.’s Ex.
35. The subject lines and substance of the emails show that
Prince was fully aware that these calculations were going to be
used in SEC filings.
Prince was also actively involved with the implementation
of Financial Accounting Standard 123 for fiscal year 2006. Pl.’s
Ex. 93; Test. of Lynn Turner, Trial Tr. Dec. 12, 2012, A.M.
Session 63. He sent a long email to Integral’s senior management
and accounting staff explaining what he called “my plan,” which
attempted to address “the prospect of [an] adverse [profit and
loss] effect].” Pl.’s Ex. 93. The profit and loss statements are
financial statements that are included in Integral’s filings.
27
While the evidence and testimony was generally consistent that
Prince did not have “write” privileges with respect to
accounting data, see Findings of Fact ¶ 18, this exhibit shows
that, at least at one point, he had such privileges.
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Test. of Lynn Turner, Trial Tr. Dec. 12, 2012, A.M. Session 64-
67. Thus, Prince's “plan” directly affected the way that stock
options were reported to the SEC in Integral’s financial
statements.
In general, the implementation of Generally Accepted
Accounting Principles (“GAAP”) and the rules of the Financial
Accounting Standards Board (“FASB”) require complex decisions
involving the exercise of accounting judgment. Test. of Elaine
Brown, Dec. 18, 2012, P.M. Session 13; Test. of Lynn Turner,
Dec. 12, 2012, A.M. Session 36-37. Thus, part of functioning as
an accountant, and “creating, compiling, or editing” the
information or data incorporated in a financial statement, is
making such decisions. The foregoing exhibits show that Prince
was actively engaged in this process.
The SEC also emphasizes the significance of an email Prince
sent claiming to be “running the Accounting Dept” while Brown
was on maternity leave. See Pl.’s Ex. 79; SEC’s Proposed
Findings of Fact and Conclusions of Law 66; Test. of Lynn
Turner, Dec. 13, 2012, P.M. Session 11-15, 50. The testimony was
consistent, and this Court finds, that Prince’s statement was
intended as a joke and that Brown and her second in command, Pat
Carey, remained in control of the Accounting Department during
her absence. See Findings of Fact ¶ 58; Test. of Gary A. Prince,
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Trial Tr. Jan. 3, 2013, P.M. Session 83 (“[I]f I was making a
coup of the accounting department, I probably wouldn’t have
copied Ms. [Brown] on it.”).
Throughout the course of his employment at Integral, Prince
reviewed and commented on draft filings and made a variety of
editorial suggestions. See Findings of Fact ¶ 54. His comments,
however, were not generally substantive recommendations about
how to book particular entries or how to treat financial data.
Pl.’s Exs. 18, 29, 30, 36, 37, 52, 53, 61, 64, 69, 119. While
Brown was on maternity leave, however, Prince did make
accounting judgments that affected the actual numbers that went
into the financial statements.
The Court finds that Prince did take on additional
responsibilities regarding Integral's filings with the SEC
during this time period. See id. ¶ 59. Prince admitted that he
assisted the accounting staff in gathering and compiling
information while Brown was on maternity leave. Test. of Gary A.
Prince, Trial Tr. Jan. 2, 2013, P.M. Session 36, 38; Test. of
Gary A. Prince, Trial Tr. Jan. 3, 2013, A.M. Session 42.
Two exhibits demonstrate the type of recommendations Prince
was making during Brown’s absence. First, he suggested that a
particular reserve be taken and noted in the Form 10-K for
fiscal year 2004. Pl.’s Ex. 79 (“I’d say take the remaining
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license revenue on ATNAGE but set up a reserve for a similar
amt.”) In response, Al Smith, the assistant controller, informed
Prince that “[t]his change would ripple through the sheets.” Id.Second, Prince, in conjunction with others in the accounting
department, determined how a particular contract dispute should
be booked. Pl.’s Ex. 80 (“The Boys, Stuart and I have discussed
the matter and . . . [i]t is our collective judgment that we
should reserve $260K of the $460K leaving us with a $200K
“exposed” receivable for this job.”) These were substantive
financial judgments that affected Integral’s financial
statements and, eventually, its Form 10-K for fiscal year 2004.
The emails demonstrate Prince “practicing accounting” by
determining how particular data should be treated in the
financial statements of Integral and its subsidiaries. Those
statements were then incorporated in filings before the
Commission. While there is no need to address the SEC’s broader
definition of accounting, the Court finds that these particular
incidents fall well within Armstrong’s definition of
“preparation” as “encompass[ing] the preparation of data to be
included in a document filed with the Commission, at least
where, as here, the data was prepared for the express purpose of
being included in such a document.” See Armstrong, 2005 WL
1498425, at *11. Thus, since Prince was practicing accounting by
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preparing financial data that was filed with the Commission, he
violated the terms of his Accounting Bar.
2. Prince Did Not Obtain or Rely on Advice of
Counsel Regarding Practicing Accounting Before
the Commission
Prince notes in his Post-Trial Brief that if he did
practice accounting before the Commission, he “did so in good
faith reliance upon the advice of counsel.” Def. Gary A.
Prince's Post-Trial Br. 47. However, Prince did not identify any
caselaw requiring scienter to establish a violation of a Rule
102(e) Order. Even if an advice-of-counsel defense was
available, Prince has failed to establish the elements of such a
defense on this issue.
As discussed above, the elements of an advice-of-counsel
defense require the defendant to establish that he: “(1) made
complete disclosure to counsel; (2) requested counsel’s advice
as to the legality of the contemplated action; (3) received
advice that it was legal; and (4) relied in good faith on that
advice.” Zacharias, 569 F.3d at 467.
There was some indication that Chamberlain and Sullivan
discussed Prince’s Accounting Bar at their initial meeting in
1998, and that the “carveouts” put in place were intended to
prevent Prince from violating that Bar. See Findings of Fact
¶¶ 18, 90. For that reason, Prince was not allowed to
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participate in accounting staff meetings and was denied access
to accounting data. Id. ¶ 18.
However, there is no evidence in the record that
Chamberlain indicated to Sullivan that he intended to have
Prince participate in the preparation of financial data to the
extent that Prince did. In fact, it is unclear that Chamberlain
ever knew that Prince engaged in recommending particular
financial determinations as discussed above. See supra II.G.1.
Thus, the evidence does not support a finding that Chamberlain
and Integral fully disclosed the relevant information and
requested the type of specific advice on the issue that would
support an advice-of-counsel defense. 28
Moreover, Prince’s testimony contradicts his argument that
he relied on the advice of counsel. He testified that, in 1997,
he spoke with his then-attorney, Roger Spaeder of Zuckerman
Spaeder, regarding the Accounting Bar. Test. of Gary A. Prince,
Trial Tr. Jan. 2, 2013, P.M. Session 11. He related that Spaeder
28
The Court notes that Venable did know that Prince interacted
with accounting personnel and outside auditors on financial
issues, helped draft the MD&A section of public filings,
reviewed and commented on drafts of public filings, and
generated financial projections as part of his employment at
Integral. Id. ¶¶ 96-98, 100, 102. However, because there is such
scant evidence to support whether Chamberlain actually asked and
received approval for Prince to engage in such actions,
Venable’s tacit awareness of these tasks is insufficient to
allow such a defense.
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told him to “stay away from the preparation or participation in
the preparation of financial statements that would be filed with
the SEC.” Id. Prince clearly did not “stay away” from such
financial statements, but participated in drafting and reviewing
portions of Integral’s statements as well as the preparation of
the underlying data. See supra II.G.1; see also Findings of Fact
¶¶ 50, 54, 59, 67. He did not ask for any more specific advice
from Spaeder or from Venable at any time. 29 Thus, even if our
Court of Appeals recognized an advice-of counsel defense as a
29
In the spring of 2006, Christner of Venable advised Integral’s
independent Directors that the firm had “not seen any evidence”
that would lead it to believe Prince had practiced accounting
before the Commission. See Findings of Fact ¶ 149. This is the
first evidence that this issue was discussed between Integral
and Venable after Chamberlain’s initial meeting with Sullivan.
The advice was given approximately two years after the latest
incidents that the Court found were practicing accounting before
the Commission. See supra II.G.1.
However, the Court notes that in the spring of 2006,
Christner asked Treasure Johnson to research the Accounting Bar,
and she concluded that the company should take “special care . .
. to ensure that [Prince] has nothing to do of an accounting
nature and particularly that he has no involvement in the
preparation of the company’s financial statements,” Def.’s Ex.
229, and that Integral “has to be very careful that he has no
responsibility at all for any accounting functions at Integral
and nothing to do with the preparation of the financials, other
than provide information when asked,” Def.’s Ex. 226. In
addition, a week later, Johnson again advised Christner that
Prince should “stay[] away from the financials.” Def.’s Ex. 235.
Despite the fact that Integral’s Directors had clearly asked for
guidance on this issue, no one at Venable sent these emails or
conveyed the substance of them to anyone at Integral. See
Findings of Fact ¶¶ 159, 162.
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complete defense to securities violations, Prince did not adduce
enough evidence to establish that he would be entitled to such a
defense.
H. Relief
The SEC has prevailed only on Count VII of its Complaint,
which alleged that Prince practiced accounting before the
Commission in violation of his Accounting Bar. The requested
relief for this claim is a permanent injunction “restrain[ing]
and enjoin[ing]” Prince from violating the Accounting Bar by
appearing or practicing before the Commission as an accountant.
Compl. 20; SEC’s Proposed Findings of Fact & Conclusions of Law
43.
In Savoy Industries, 587 F.2d at 1168, our Court of Appeals
stated that “where the SEC seeks an injunction regarding future
conduct (rather than to halt an ongoing violation) [which is the
situation in this case], its ultimate test is whether the
defendant's past conduct indicates . . . there is a reasonable
likelihood of further violation(s) in the future.” The Court set
forth the following factors for assessing whether an injunction
is warranted: (1) whether the violation was “an isolated
incident;” (2) whether the defendant has “demonstrated that he
understands his conduct to have been wrongful;” (3) whether he
gives “sufficient assurances against future violations;” and (4)
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whether his “business activities may present him further
temptations to violate the law.” Id.; see also S.E.C. v.
Bilzerian, 29 F.3d 689, 695 (D.C. Cir. 1994) (quoting S.E.C. v.
First City Fin. Corp., 890 F.2d 1215, 1228 (D.C. Cir. 1989)).
While it is true that the issuance of a permanent
injunction against future securities violations is a “drastic
remedy and not a mild prophylactic,” S.E.C. v. Yun, 148 F. Supp.
2d 1287, 1293 (M.D. Fla. 2001), vacated on other grounds, 327
F.3d 1263 (11th Cir. 2003), the Court concludes that the SEC has
proven, by a preponderance of the evidence, that imposition of
an injunction is warranted.
As to the first Savoy factor, there is simply no question
that Prince's violation of his Bar against appearing or
practicing as an accountant before the Commission was not “an
isolated incident.” As the Court's lengthy Findings of Fact
indicate, from December 1998 when he became a full-time employee
at Integral, to 2007 when his employment was terminated, Prince
was deeply involved in the preparation of financial statements,
in the writing of the MD&A section of Integral's Form 10-Q and
10-K filings with the Commission, in reviewing and commenting in
detail on drafts of the financial statements, in questioning the
accuracy of data, in adding and/or correcting information, and
making suggestions about internal inconsistencies and specific
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language. See Findings of Fact ¶¶ 50, 52, 54, 59, 67. The Court
did not specifically conclude that each element of Prince's
participation in the preparation of the financial statements was
inappropriate in light of his Accounting Bar. However, the Court
identified seven specific examples, spanning several years,
where Prince clearly violated the Bar. Thus, Prince cannot argue
that his violations were “isolated incident(s).”
As to the second Savoy factor, it is unclear from the
testimony whether Prince “has demonstrated that he understands
his conduct to have been wrongful.” While he has given
assurances that he will not do any accounting work for any
public company, see Test. of Gary A. Prince, Trial Tr. Jan. 3,
2013, P.M. Session 23-24, he has certainly not shown that he
considers his past conduct to be a violation of the existing Bar
against his practicing accounting before the Commission. The
Court understands full well that he is entitled to present a
vigorous defense, as his counsel have done, but that does not
preclude consideration of Savoy's ruling that the defendant's
understanding that his conduct was wrong is a legitimate factor
to be considered.
As to the third and fourth factors, Prince has failed to
give “sufficient assurances against future violations,” and has
not demonstrated that his future business activities will not
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“present him with future temptations to violate the law.” See
Savoy, 587 F.2d at 1168. While Prince testified that he would
never commit the kind of conduct he is guilty of in this case,
his “assurance” rings hollow.
At this time, Prince holds himself out on the internet as
the Founder and CEO of Fiscal Management Associates, LLC. Pl.’s
Ex. 187. His website is both instructive and troubling.
In it he emphasizes that he has over thirty years of
experience in financial management, that he has been the Chief
Financial Officer for at least four public companies which he
names, that he has been the Chief Financial Officer for
“numerous” private companies, naming four of them, that he has
“been involved in the preparation of financial statements for
more than 100 companies,” and that he has an MBA from the
University of Maryland and is a non-practicing C.P.A. To any
member of the public reading this material, it would be apparent
that Prince is extremely experienced in handling accounting
matters for both public and private companies.
Prince testified that Fiscal Management Associates is
currently “inactive” and that it existed for the purpose of
soliciting business and explaining his areas of expertise. Test.
of Gary Prince, Trial Tr. Jan. 3, 2013, P.M. Session 18-20. He
also testified that it was now used to buy and sell classic
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cars, but that he would consider taking on work for a public
company if the opportunity arose. Id. at 20-23.
There is nothing to indicate that Fiscal Management
Associates does not still exist for the activities and financial
management consulting that it was originally created for. The
fact that the contact number is currently “inactive,” as Prince
testified, id. at 18, would certainly not be apparent to a
member of the public scanning the internet for the kinds of
financial management services Prince advertised. The bottom line
is that whether this company is active or not, Prince has never
taken down this advertisement, it does not say a word about
trading of classic cars, and no member of the public would know
those facts. The fact that this company is now used for
purchasing and selling classic cars in no way gives “sufficient
assurance against future violations,” and certainly does not
reassure the Court that no business activities may present him
with temptation to violate the law.
In addition to the analysis of Savoy factors justifying
imposition of an injunction, the Court takes into consideration
-- even though it is not dispositive -- Prince's prior violation
of the securities law. As the Findings of Fact indicate, he
violated the securities laws before joining Integral as a full
time employee in 1998 and served a short jail term. See Findings
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of Fact ¶¶ 8, 12. Three years after being released from
incarceration, he began violating the Rule 102(e) Order. See
Pl.'s Ex. 135 (creating spreadsheets for use in public filings
in 1999).
Finally, in 1997, shortly before joining Integral as a full
time employee, Prince spoke with his then-attorney, Roger
Spaeder of Zuckerman Spaeder, regarding the limitations under
the Accounting Bar. He testified that Spaeder told him to “stay
away from the preparation or participation in the preparation of
financial statements that would be filed with the SEC.” Test. of
Gary A. Prince, Trial Tr. Jan. 2, 2013, P.M. Session 11.
However, Prince did no such thing. Again, as set forth in
detail in the Findings of Fact, Prince participated extensively
in the preparation of financial statements, the reviewing of the
underlying data supporting those financial statements, and in
suggesting how certain accounting decisions should be made. The
fact that he failed to follow the explicit advice of his own
counsel, the fact that he maintains a website which could
mislead the investing public, the fact that analysis of the
Savoy factors does not suggest that there will be no future
conduct in violation of his Bar Order, and the fact of his prior
violation of the Securities Act, convinces the Court that there
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is a “reasonable likelihood” of future violations by the
Defendant. Savoy, 587 F.2d at 1168.
Therefore, the Court concludes that the SEC has proven by a
preponderance of the evidence that an injunction against
violating Prince's Bar on practicing accounting before the
Commission is necessary in order to protect the investing
public.
III. CONCLUSION
For the foregoing reasons, the Court grants judgment in
favor of the SEC on its claim that Prince practiced accounting
before the Commission in violation of his Accounting Bar and
grants the SEC's request for injunctive relief. The Court grants
judgment in favor of Prince on all other claims. An Order will
accompany this Memorandum Opinion.
/s/________________________
May 2, 2013 Gladys Kessler
United States District Judge
Copies to: attorneys on record via ECF
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