By: by Debra Gersh Earl Brian is among four named in a complaint that alleges they fraudulently inflated revenue and earnings figures at FNN
IN 1991, when United Press International filed for bankruptcy, there were a lot of unanswered questions about certain lease agreements with then-sister company Financial News Network. Now the Securities and Exchange Commission seems to have come up with what it believes is the answer ? they were bogus. Four former FNN executives ? including Earl W. Brian, former UPI chief executive officer and head of Infotechnology Inc. ? are the subject of a 60-page civil complaint filed by the SEC in Washington. Named in the complaint are C. Stephen Bolen, former executive vice president and chief financial officer for FNN, who was placed on leave of absence from the company in July 1990; Gary A. Prince, UPI chief financial officer until July 1990 when he succeeded Bolen at FNN; Mitchel H. Young, FNN controller who was placed on leave of absence in August 1990; and Brian, FNN chairman and chief executive officer; Infotech chairman, president and CEO; UPI chairman and CEO, and a director of Hadron. The complaint charges that the four engaged in the fraudulent inflation of revenues and earnings for fiscal 1989 and the first three quarters of 1990 as well as a scheme to cover up and perpetuate that fraud. The overstated revenues allegedly came from the false sale/leaseback of equipment to UPI and Institutional Research Network Inc., both FNN-related companies, and an elaborate plan to convince auditors that the equipment supposedly being leased actually existed. Essentially, the complaint says in part, FNN equipment was given to UPI and IRN, which then sold it to a leasing company through an intermediary vendor, Telecommunications Industries. The leasing company then leased the equipment to FNN or Data Broadcasting. So, in effect, FNN was leasing its own equipment. Then, the complaint charges, UPI and IRN would use the money from the lease company to enter into licensing agreements with FNN. FNN, in turn, would account for that money ? its own ? as revenue from UPI and IRN. Between December 1987 and September 1990, according to the complaint, Telecommunications Industries received about $54 million in sale proceeds from the leasing companies, with about $38 million going to UPI. Of the $38 million it received from the sale/leaseback agreement, UPI remitted $21.5 million to FNN as payments for this licensing agreement and used the rest for operations. ""In addition,"" according to the complaint, ""Brian and Prince attempted to conceal the fraudulent equipment sale/leaseback transactions from the auditors, by causing FNN and affiliated companies to purchase similar equipment during the 1990 audit and then attempting to pass off that equipment to the auditors as equipment that had either been acquired from UPI or possessed by FNN for some time."" According to the SEC complaint, for fiscal 1989, FNN total revenues were overstated by about 17%, pretax income from continuing operations by 96%, total current assets by 24.5% and total assets by 8%. Losses from discontinued operations were understated by about 46%. For the first quarter of 1990, the SEC alleges that FNN's revenues were overstated by about 42.5% and pretax income by 382%. In the second quarter 1990, revenues were overstated by about 40% and pretax income by 421%. For the third quarter 1990, revenues allegedly were overstated by 44% and pretax income by 483%. In addition, the complaint charges that Bolen authorized FNN to pay about $800,000 to a company he secretly controlled and that he engaged in insider trading by selling 20,000 FNN shares at $9 per share while withholding information about the true financial state of the company. When news of FNN's financial difficulties finally came out, its stock value plummeted. Disagreements about the fiscal 1990 figures led to the resignation in October 1990 of FNN's independent auditor, Deloitte & Touche, which also withdrew its opinions on FNN financial statements for the year ended June 30, 1989, as well as for Infotechnology for the same period and for UPI, for the period ended Dec. 31, 1989 (E&P, Oct. 20, 1990, P. 10). Bolen was fired and Brian was soon replaced as head of FNN and Infotech. By the end of November 1990, FNN reported that it anticipated a net loss of $72.5 million for 1990, a significant change from the ""positive trend in both revenues and earnings"" it had been reporting, according to the complaint. By March 1991, both FNN and Infotech filed for Chapter 11 bankruptcy protection, and UPI followed suit in August 1991 (E&P, Aug. 31, 1991, P. 14). In response to the complaint, Brian has ""agreed to consent, without admitting or denying the allegations in the complaint,"" to entry of a final judgment of permanent injunction enjoining him from future violations of SEC regulations. Prince's attorney, F. Joseph Warin of the Kutak Rock law firm in Washington, said his client plans to fight the charges and his response brief will be filed at the end of July or early August. ""We think the SEC overlooked and overreached,"" said Warin, adding that Prince was ""not a director or officer of FNN for 98% of the time"" covered in the complaint. Warin noted that Deloitte had approved the UPI audit but later withdrew because FNN had signed off on the financial statements. Attempts to reach Bolen and Young were unsuccessful. Bolen is listed in the SEC complaint as a resident of Los Angeles, but directory assistance showed no listing there. Young is listed as a resident of Marina del Rey, Calif., but the only listing was for an M. Young, whose name is Mark, not Mitchel, who said he had never worked for FNN. The first cause of action cited by the SEC involves a licensing and distribution agreement between Infotech and UPI, entered into soon after Infotech took control of the wire service in 1988. ""Pursuant to this agreement,"" according to the SEC, ""FNN, through its subsidiary, Data Broadcasting, leased to UPI a portion of its vertical blanking interval [VBI], which is that portion of a television signal that is not needed for visual images."" FNN recorded revenues from UPI for this VBI agreement totaling $27.3 million for the fiscal years 1988-1990, ""but UPI never actually used the VBI for its communications and little of the billed development work was ever performed,"" the complaint alleges. The SEC complaint continues: ""At the end of each fiscal period, after reviewing preliminary income statements that excluded related party revenues and consulting with Prince, Bolen told Young how much revenue, in round numbers, to record from UPI . . . . Young and a subordinate changed Bolen's round numbers to seemingly precise figures, often including cents, and then divided these figures approximately into thirds to derive 'monthly' amounts that they posted to FNN's general ledger."" These payments by UPI to FNN for the VBI ? ""as well as much of UPI's other cash needs"" ? were made possible by the allegedly fraudulent sale/ leaseback agreements. ""Without the funds that it received from FNN in this way, UPI would not have been able to pay the amounts that FNN recorded as VBI revenue,"" according to the SEC. ""In substance, FNN was making unsecured loans to UPI in order to enable UPI to pay the VBI charges, which FNN then recorded as revenue."" The complaint also details the allegedly fraudulent agreement between FNN and IRN over FNN:PRO, an on-line information service launched in July 1990 and suspended a few months later. During that time, however, FNN allegedly recorded revenues from IRN totaling more than $21 million, revenue that ""was not reasonably collectible. IRN's existing operations generated less than $3 million in total revenues during fiscal 1990, and FNN:PRO was not expected to generate any significant revenues until later years. ""The only possible source of payment in the near term was from financing provided by FNN itself, and in fact the only payments that FNN received from IRN ($5.5 million during the first quarter of fiscal 1991) consisted entirely of funds generated by FNN from sale/leaseback transactions,"" the complaint alleges. The SEC also charged that when FNN discontinued its ""Telshop"" home shopping service in 1989, it avoided writing off an additional $3 million of net book value of Telshop assets, maintaining that the equipment could be used by its other operations. Documents purporting to show that a leasing company had paid about $3 million for the equipment in a sale/ leaseback agreement were ""fabricated,"" according to the complaint. For fiscal 1989, FNN's net income was $3 million. Had it written off the full net book value of that Telshop equipment, ""it would have completely eliminated net income for the year."" The complaint alleges that the sale/leaseback agreements became an issue during the UPI audit for the year ended Dec. 31, 1989, when ""Bolen and Young obstructed Deloitte's efforts to perform the special support procedures for the UPI audit."" According to the SEC, Bolen convinced Deloitte auditors to postpone physical inspection of equipment until the FNN audit later in 1990. During the FNN audit, auditors from Deloitte ""immediately requested the equipment schedules from the sale/leaseback transactions."" The audit senior noticed that ""many of the schedules, from unrelated transactions with various leasing companies, were identical except for the equipment serial numbers, which often differed by only one or two digits. He also noted that on some of the similar schedules, the sequential serial numbers for quantities of equipment overlapped."" The Deloitte auditor also was told by a ""subordinate of Bolen and Young that multiple sales and leasebacks of the same equipment had occurred."" Bolen and Young allegedly were able to stall the auditors, and used that delay ""to fabricate"" a list of full serial numbers, the SEC alleges. Deloitte auditors took that list and prepared another list of equipment chosen for physical inspection. It was some two months before auditors were allowed to inspect any of the equipment. ""In fact, during this time Bolen and Young caused FNN staff members to order new inventory tags with the Micro Research Industries [one of the leasing companies] logo, type in serial numbers from the list of selected equipment prepared by Deloitte and apply them to similar equipment at FNN's Los Angeles facility."" The complaint further charges that in order to conceal the allegedly fraudulent sale/leaseback deals, Brian and Young caused FNN to purchase television equipment that closely matched items subject to multiple financing and then tried to convince the auditors that the equipment had been acquired from UPI. These purchases were allegedly paid for by IRN and UPI accounts controlled by Prince, using proceeds from the FNN sale/leaseback deals. Deloitte inspectors were able to locate less than half the equipment slated for observation, but Brian and Prince allegedly ""caused FNN and related companies to continue the purchases, having large quantities of equipment shipped to an FNN facility in New York and to UPI facilities in Washington, D.C., and Warwick, R.I., among other destinations."" Brian and Prince allegedly blamed the auditor's findings on ""shoddy clerical work"" and claimed there were a number of ""subsequent finds,"" which the SEC charges were actually purchased during the audit. In addition to charging a coverup of the source of the sale/leaseback equipment and subsequent false revenue accounting, the SEC complaint also pointed out that in 1989, FNN entered into a $50 million loan agreement with Security Pacific Bank and Toronto-Dominion Bank that prohibited FNN from incurring lease-operating expenses for fiscal 1990 that exceeded fiscal 1989 by more than $3 million. To hide these agreements from the auditors, Bolen directed a corporation to be chartered in the British Virgin Islands, called MicroResearch Industries Ltd., to specifically resemble the division of Telecommunications Industries with the same name. Starting in March 1990, about $17 million in proceeds from sale/leaseback deals were deposited in bank accounts for the British Virgin Islands corporation, although none of those transactions were disclosed to Deloitte auditors. To further cover up the lease agreement violations of the Security Pacific loan covenant, the complaint alleges that Bolen directed Young to alter the FNN general ledger to reclassify payments to three companies. The changes reportedly were made at night and on weekends to avoid detection and even went so far as to fabricate a letterhead for one leasing company, creating phony invoices, and allegedly deleted another from the books completely. The SEC complaint lists in far greater detail the specifics of each complaint as well as the particular SEC and general accounting violations allegedly committed by Bolen, Brian, Prince and Young. The SEC is seeking permanent injunctions against all the defendants. It also is seeking to force Bolen to ""disgorge all of his illicit profits and losses avoided"" and pay penalties under provisions of the Insider Trading Sanctions Act of 1984. It also seeks a court order prohibiting him from serving as a director or officer of any publicly traded company.nE&P
* The overstated revenues allegedly came from the false sale/leaseback of equipment to UPI and Institutional Research Network Inc., both FNN-related companies. * Earl Brian * ""In addition,"" according to the complaint,""Brian and Prince attempted to conceal the fraudulent equipment sale/leaseback transactions from the auditors."" * In response to the complaint, Brian has ""agreed to consent, without admitting or denying the allegations in the complaint,"" to entry of a final judgment of permanent injunction enjoining him from future violations of SEC regulations.