The SEC prevailed in an appeal of a financial fraud action. SEC v. Monterosso, Nos. 13-10341, 13-10342, 13-10464 (11thCir. Opinion June 30, 2014) [an enhanced version of this opinion is available to lexis.com subscribers]. A key issue in the case is the application of the Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2296 (2011) [enhanced version].
The action centers on a financial fraud at GlobeTel Communications Corporation, a telecom company. In 2007 the Commission brought an action against Joseph Monterosso and Luis Vargas. Mr. Monterosso manged GlobeTel’s wholesale telecom business beginning in September 2006. He also served as president of one if its subsidiaries and as COO from July 2006 through May 2007. Mr. Vargas was vice president of subsidiary Centerline Communications and owned Carrier Services, Inc., another telecom company. The Commission’s complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 13(b)(2)(A). Shortly after filing that action the agency filed a second complaint based on the same financial fraud. That action named as defendants the company and three additional officers, two of whom settled.
The Commission’s complaint alleged a fraudulent scheme to inflate revenue. Between 2004 and 2006 GlobeTel bought and sold large blocks of calling minutes with particular origination and termination points. The firm generated revenue by connecting individual callers with locations they called. The calls were routed through GlobeTel’s switch. Firms such as GlobeTel pay by the minute for the right to route calls through the switches to the network of another company. GlobeTel’s revenue depended on the traffic routed through its switch.
In 2004 the “off-net” program was implemented to enhance reported revenue. The program referred to telecom traffic run on a switch that was not owned GlobeTel or its subsidiaries, Volta, Lonestar and Centerline. In essence the program created false invoices to reflect transactions between GlobeTel’s subsidiaries and other companies. For example, invoices were created showing Volt sales. Yet the subsidiary never sold anything. Other invoices showed that Centerline engaged in transactions with a company called CSI. Centerline never bought or sold anything to or from CSI. The defendants participated in the scheme.
In 2004 and 2005 the fraudulent off-net revenue accounted for about 58% and 87.4% of GlobeTel’s revenue, respectively. For the first quarter of 2006 it accounted for about 92% of the revenue.
The District Court granted summary judgment in favor of the Commission and against Messrs. Monterosso and Vargas. Both were found liable for violations of the antifraud provisions and for aiding and abetting violations of the books and record sections cited in the complaint. The Court entered a permanent injunction against each man, prohibiting future violations of the Sections cited in the complaint. The Court also held the two defendants jointly and severally liable for disgorgement of $675,000, along with prejudgment interest, and imposed penalties of $300,000 and $150,000 against, respectively, Mr. Monterosso and Mr. Vargas. An officer and director bar was imposed as to each defendant.
On appeal a key issue argued by the two defendants hinged on the application of Janus. Each defendant contended that they could not be held liable under the antifraud provisions in view of the Supreme Court’s decision.
Janus addressed the scope of liability under Section 10(b) and Rule 10b-5. In its decision the Court focused on the provision in the rule which states that it is unlawful to “make any untrue statement of a material fact in connection with the purchase or sale of securities,” the Circuit Court noted. The Janus Court held that the maker of a statement is the person or entity with the ultimate authority over it, including the content and how to communicate it. In that case participating in preparing a prospectus was not sufficient to impose liability.
The defendants in this case contend that while they may have participated in the “off-net” program, they did not make any statement and therefore cannot be held liable. The Court rejected this contention. Janus only addressed Rule 10b-5(b), it does not concern Rule 10b-5(a) and (c) or Securities Act Section 17(a). Indeed, the language of Section 17(a) does not require a defendant to “make” a statement to be liable. Likewise, subsections (a) and (c) of Rule 10b-5 do not incorporate that requirement. And, in any event, the case here does not hinge on making a false statement. Rather, the action is concerned with the commission by the defendants of deceptive acts as part of a scheme to generate fictitious revenue for GlobeTel. Thus Janus is not relevant. The Court affirmed the grant of summary judgment.
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