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Securities and Exchange Commission v. Jacoby

United States District Court, D. Maryland

August 3, 2018

Securities and Exchange Commission,
v.
Phillip R. Jacoby, Jr.,

          MEMORANDUM

          CATHERINE C. BLAKE UNITED STATES DISTRICT JUDGE.

         The SEC has filed a complaint alleging that in 2014 and 2015 Lode B. Debrabandere, among others, participated in a fraud to artificially raise the revenue of Osiris Therapeutics, Inc. As a result, Debrabandere allegedly violated, or aided and abetted violations of, several anti-fraud provisions, and reporting and accounting requirements of the Securities and Exchange Acts. The SEC also alleges that Debrabandere violated the Sarbanes-Oxley Act by failing to reimburse Osiris for salary and bonuses he received as a result of his fraud. Debrabandere has moved to dismiss the SEC's amended complaint under Rule 12(b)(6). For the reasons stated below, his motion will be denied.[1]

         Background

         During all of 2014, and the first three quarters of 2015, Lode B. Debrabandere, Chief Executive Officer of Osiris Therapeutics, Inc., [2] a biotechnology company, allegedly participated, in fraud. (Am. Compl., ECF No. 38, at ¶¶ 1, 18). And he did so by improperly claiming revenue Osiris did not, or was not guaranteed to, receive. Here is how.

         A.

         Osiris sells its products in two ways: (1) it sells directly to consumers or distributors, through an in-house sales team; and (2) it sells through third-party distributors. (Id. at ¶ 20). When selling through a distributor, Osiris consigns its products, taking payment only when the distributor sells the product to an end-user or when the product is used in a surgical procedure. (Id. at ¶ 22). To account for its sales, through either of these means, in quarterly and annual filings with the SEC and in representations to auditors, Osiris is required to follow Generally Accepted Accounting Principles (GAAP): the company could account revenue when it was realized, realizable, or earned, which occurs when "(1) title and the risk of loss passes to the customer; (2) persuasive evidence of an arrangement exists; (3) sales amounts are fixed or determinable; and (4) collectability is reasonably assured." (Id. at ¶¶ 23-24). The complaint alleges that Debrabandere knew Osiris failed to abide by these accounting requirements, either as a result of his own conduct or the conduct of others, but nonetheless represented to auditors, investors, and the SEC that the company was fully compliant with respect to transactions with four distributors: Distributor A, Distributor B, Distributor C, and Distributor D.

         B.

         The first instance of Debrabandere's alleged misconduct is a cover-up. To reach a revenue goal set by Debrabandere in the fourth quarter of 2014, two co-defendants set out to convert consigned product in Distributor A's inventory to completed sales. (Id. at ¶¶ 36-39). They were successful-Distributor A agreed to buy $1.1 million worth of product with payments spread over a year-but the agreement was not reached until January 2015. Nevertheless, Osiris's books improperly recorded that sale as taking place on December 31, 2014, nearly a month before it actually occurred. (Id. at ¶¶ 40-43).

         Auditors requested information about this transaction in November 2015, which prompted Debrabandere allegedly to order a co-defendant to find documentation that would make the recorded revenue appear lawful. (Id. at ¶ 58). The co-defendant complied and sent Distributor A an email:

[A]ttached is something that I think you should find and send to me in an email saying you had this in your file from late last year and just came across it - and that it does memorialize our several phone conversations . .. call me if necessary, but write a wonderfully warm and convincing email, please - send it to my Osiris email

(Id.). The CEO of Distributor A replied with the requested back-dated letter, which was then forwarded to Debrabandere. (Id. at ¶ 60). The company then used this letter to convince its auditor that the revenue it recorded from Distributor A complied with GAAP. (Id.).

         C.

         More than just a participant in a cover-up, Debrabandere also allegedly directed fraudulent activity. Against a rush to meet a revenue target, Debrabandere was presented with a problem on March 27, 2015: Distributor B wanted Cartiform, one of Osiris's products, but the company did not have enough Cartiform to fill an order. (Id. at ¶¶ 64-65). Debrabandere devised a plan. The company would ship Distributor B "[G]rafix and later swap to [C]artiform when we have it," and it "would be great" if Distributor B could make a partial payment on the order. (Id. at ¶ 65). On March 31, 2015, the last day of the first quarter of 2015, Distributor B agreed to pay Osiris $100, 000 by the end of the day for Cartiform-not the Grafix Osiris planned to ship-and to purchase $650, 000 of Cartiform or Grafix by December 31, 2015. (Id. at ¶¶ 66-67). Osiris's ability to ship products to Distributor B, however, was conditioned on Distributor B obtaining certain "licenses, certificates, and permits." (Id. at ¶ 67). Thus, Debrabandere could not be sure the company would sell anything to Distributor B, and knew that Distributor B paid for products it did not order.

         Osiris recorded $750, 000 in revenue from Distributor B for the first quarter of 2015 notwithstanding that it only had received $100, 000 conditioned on the shipment of a product Osiris did not, and could not, ship. (Id. at ¶¶ 69-70). Debrabandere represented that Osiris really did receive $750, 000 in revenue from Distributor B anyway, confirming for the company's auditors that: (1) the company's financial statements were prepared in accordance with GAAP; (2) the financial statement did not omit material transactions; and (3) that Debrabandere did not know of "any fraud or suspected fraud involving management, employees who have significant roles in internal control, or which could have a material effect on the financial statements." (Id. at ¶ 76).

         D.

         Debrabandere similarly is alleged to have manipulated transactions with Distributor C to meet revenue goals during the first, second, and third quarters of 2015. Under its agreement with Osiris, Distributor C was "the exclusive marketer and promoter of BIO," one of Osiris's products. (Id. at ¶¶ 91, 93). Osiris would ship product to Distributor C on consignment: Distributor C would hold the inventory, but Osiris could not register sales until the inventory was sold to an end-user. (Id. at ¶ 109). When customers purchased BIO from Distributor C, Distributor C would then transfer the payment, less its commission, to Osiris. (Id. at ¶ 93).

         Despite this arrangement, Debrabandere urged employees to register some consignment inventory as sales, stating that "[w]e cannot wait until we receive [purchase orders] to book these as a sale .... Goal is to get to $1 million" in BIO sold this quarter. (Id. at ¶ 110). His employees listened. (Id. at ¶ 113). Like its transactions with Distributor B, Debrabandere then misrepresented Osiris's business with Distributor C to auditors. (Id. at ¶¶ 123-24).

         E.

         Finally, Debrabandere allegedly participated in the fraudulent accounting of Osiris's business with Distributor D. Distributor D received product from Distributor E, a commissioned distributor of Osiris's products Ovation and Grafix, during 2014 and the first three quarters of 2015. (Id. at ¶ 129). As part of this arrangement, Distributor D was to make payment on the Osiris products it purchased within 30 days, but Osiris allowed Distributor D to withhold payment until after the product was sold to an end-user, which often occurred much later than 30 days after it purchased the Osiris product. (Id. at ¶¶ 130-31). Debrabandere allegedly knew about, and agreed to, this practice. (Id. at ¶ 131). Despite outstanding payments as a result of Distributor D's late payments-in January 2015, Osiris employees acknowledged that Distributor D owed the company $7 million, (id. at ¶ 132)-Osiris recognized $14 million in revenue from Distributor D during 2014, and $4 million during the first three quarters of 2015, in violation of GAAP, (id. at ¶ 135). Eventually, Distributor E notified Osiris that it was taking over Distributor D's account in an email that was forwarded to Debrabandere. (Id. at ¶ 134).

         Debrabandere then misrepresented the company's sales with Distributor D by failing to disclose that Distributor D's account was deficient, or that Distributor E took over Distributor D's payments, (id. at ¶ 146). Indeed, he represented the opposite: (1) the company's financial statements were prepared in accordance with GAAP; (2) the financial statement did not omit material transactions; and (3) that he did not know of "any fraud or suspected fraud involving management, employees who have significant roles in internal control, or which could have a material effect on the financial statements." (Id. at ¶¶ 140-42, 146).

         G.

         Because these fraudulent transactions artificially raised Osiris's revenue, Debrabandere also allegedly made materially false and misleading statements to investors regarding Osiris's finances during 2014 and the first three quarters of 2015, and participated in false filings to the SEC during the first three quarters of 2015. (Id. at 148).

I. First Quarter of 2014
• Debrabandere stated on an earnings call that he was "pleased with the quarter-over-quarter growth rate of 25%, or revenue of $10 million." (Id. at ¶149).
• As CEO, "Debrabandere reviewed, approved, and was ultimately responsible for the accuracy of Osiris's" Form 10-Q and Form 8-K filings, which contained misstatements during the first quarter of 2014. (Id. at ¶150).
II. Second Quarter of 2014
• On an earnings call, Debrabandere claimed Osiris "continued to experience very healthy growth and reported sales of $13.3 million." (Id. at ¶ 151).
• Osiris's Form 10-Q contained misstatements because of the company's transactions with Distributor D. Its form 8-K similarly contained errors. (Id.)
III. Third Quarter of 2014
• Debrabandere touted "another record quarter for Osiris" to investors and stated the company continues "to experience very healthy growth and reported sales of $17.2 million for the quarter."(Id. at ¶ 153).
• Osiris's Form 10-Q contained misstatements because of the company's transactions with Distributor D. Its form 8-K ...

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