Governance: directors sued for "wilful blindness"over accounting fraud

The SEC alleges that "Pompano Beach, Florida.-based DHB Industries (now known as Point Blank Solutions) engaged in pervasive accounting and disclosure fraud through its senior officers and misappropriated company assets to personally benefit the former CEO. This resulted in the filing of materially false and misleading periodic reports to investors. The SEC further alleges that outside directors Jerome Krantz, Cary Chasin, and Gary Nadelman were wilfully blind to numerous warning signs signalling the accounting fraud, reporting violations and misappropriation at DHB."

These are not the first allegations: former DHB CEO David Brooks and two other former senior officers have been the subject of previous proceedings.

"We will not second-guess the good-faith efforts of directors. But in stark contrast, Krantz, Chasin and Nadelman were directors and audit committee members who repeatedly turned a blind eye to warning signs of fraud and other misconduct by company officers," said Robert Khuzami, Director of the SEC's Division of Enforcement.

The SEC filed two separate complaints in U.S. District Court for the Southern District of Florida against DHB and the former outside directors. According to the SEC’s complaint against Krantz, Chasin, and Nadelman, their wilful blindness to red flags allowed senior management to manipulate the company’s reported gross profit, net income and other key figures in its earnings releases and public filings between 2003 and 2005. The company overstated inventory values, failed to include appropriate charges for obsolete inventory, and falsified journal entries. By ignoring warning signs, the three outside directors also facilitated the misconduct by Brooks, who diverted at least USD10 million out of the company through fraudulent transactions with a related entity that he controlled. Their failure additionally facilitated DHB’s improper payment of millions of dollars in personal expenses for Brooks, including luxury cars, jewellery, art, real estate, extravagant vacations and prostitution services. Despite the signs indicating fraud, Krantz, Chasin, and Nadelman approved or signed DHB’s false and misleading filings.

The SEC’s complaints against DHB, Krantz, Chasin, and Nadelman charge them with breaching or aiding and abetting the breach of antifraud, reporting, books and records and other provisions of the federal securities laws. DHB has agreed to settle with the SEC and agreed to a permanent injunction from future violations. The proposed settlement took into account the remedial measures already taken by the company. The company is currently in bankruptcy and its settlement with the SEC is pending the approval of the bankruptcy court. The SEC seeks injunctive relief, surrender of ill-gotten gains, monetary penalties and officer and director bars against Krantz, Chasin, and Nadelman.

The U.S. Attorney’s Office for the Eastern District of New York previously filed criminal charges against Brooks, Hatfield, and Schlegel based on the same misconduct. On 14 Sept., 2010, a jury convicted Brooks and Hatfield of, among other things, multiple counts of securities fraud, insider trading and obstruction of justice, including obstructing the SEC’s investigation. Brooks and Hatfield are awaiting sentencing. Schlegel previously pleaded guilty to criminal charges pursuant to a plea agreement.

The SEC’s civil actions against Brooks, Hatfield, and Schlegel are stayed pending the full resolution of the criminal actions.