This is an update of a Street Sweeper article that originally ran on December 20, 2010.
On December 20, 2010, the Securities and Exchange Commission ("SEC") filed a Complaint in the U.S. District Court for the Northern District of Georgia charging Joseph M. Elles ("Elles"), a former Executive Vice President of Atlanta-based children's clothing marketer Carter's Inc., with engaging in financial fraud and insider trading. The SEC alleges that Elles's misconduct caused an understatement of Carter's expenses and a material overstatement of its net income in several financial reporting periods.
NOTE: DEFENDANT ELLES IS PRESUMED INNOCENT UNLESS AND UNTIL PROVEN GUILTY. ALL CHARGES ARE MERELY ALLEGATIONS AT THIS TIME.
The SEC Complaint charges that from 2004 to 2009, Elles fraudulently manipulated the dollar amount of discounts that Carter's granted to its largest wholesale customer - Kohl's Corporation ("Kohl's"), a large national department store - in order to induce Kohl's to purchase greater quantities of Carter's clothing for resale.
In the clothing industry, such discounts are referred to as "accomodations," and are used to defray costs related to inventory clearance and sales promotions. Ultimately, the accomodations arranged by Ellles allowed Kohl's to achieve a target profit margin on its purchases from Carter's.
Cast of Characters
According to the Complaint:
Joseph M. Elles, 55 and a resident of Las Vegas, Nevada, was hired by Carter's in 1996 as Vice President of Regional Accounts and, thereafter, promoted in 1997 to Executive Vice President of Sales-a position he held until his termination from Carter's in March 2009. As Executive Vice President of Sales, Elles supervised all of the individual Vice Presidents who managed Carter's retail and mass channel customer accounts, and reported directly to Carter's President. Elles was terminated from the Company as of March 2009.
Carter's, Inc. is an Atlanta-based public issuer and the self proclaimed "largest branded marketer in the U.S. of apparel exclusively for babies and young children." The Company sells clothing under the Carter's brand names, as well as private label apparel, through its own stores and oth-er retailers. In fiscal 2009, the Company generated net income of $116 million on sales of$1.59 billion. Since October 2003, Carter's common stock has been registered with the Commission under Section 12(b) ofthe Exchange Act and listed on the NYSE.
Kohl's Corporation is a public issuer and retailer based in Wisconsin. Kohl's operates over a thousand department stores in 49 states. At the time of Elles' misconduct, Kohl's was Carter's largest wholesale customer in terms ofvolume of purchases
See, Kohl's webpage promoting Carter's products
See, Carter's homepage
According to the Complaint, Elles concealed his misconduct by persuading Kohl's to defer subtracting the discounts from payments until later financial quarters. In furtherance of this alleged scheme, Elles is charged with creating and signing false documents that misrepresented to Carter's accounting personnel the timing and amount of those discounts.
The SEC contends that accounting rules require that "accomodations" be recorded as an expense in the period when the related sale is recognized. When properly implemented, an accommodation essentially functions as an expense that reduces the revenue otherwise realized by Carter's from the sale to which the accommodation relates.
In contrast, Elles' alleged scheme misrepresented that the expense occurred in a later fiscal quarter when Kohl's deducted the payments from Carter's, rather than in the earlier quarter when the sale was recognized. Consequently, it is alleged that Elles caused the understating of expenses in some quarters and the subsequent overstatement of income in the corresponding quarters.
Paragraph 36 of the Complaint sets forth the value of the secretly deferred "accomodations" from the immediately prior fiscal year into the year noted:
Not only is Elles charged with the financial manipulations cited above, but between May 2005 and March 2009, he exercised options and sold 200,814 shares of Carter's stock, realizing a pre-tax profit of $4,739,862. Each of these stock sales occurred prior to Oct. 27, 2009, when Carter's initially disclosed the fraud, after which the company's common stock share price dropped 23.8 percent. After discovering Elles's actions and conducting its own internal investigation, Carter's was required to issue restated financial results for the affected periods
Summing It Up
The Complaint alleges that Elles violated Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5 and 13b2-1, and aided and abetted violations of Sections 13(a) and 13(b)(2)(A) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1, 13a-11 and 13a-13. The SEC is seeking permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, financial penalties, and an officer and director bar against Elles.
The SEC also announced that it has entered a non-prosecution agreementwith Carter's under which the company will not be charged with any violations of the federal securities laws relating to Elles's unlawful conduct. In agreeing to the the non-prosecution agreement, the SEC noted that the considerations compelling that undertaking reflected
the relatively isolated nature of the unlawful conduct,
Carter's prompt and complete self-reporting of the misconduct to the SEC,
Carter's exemplary and extensive cooperation in the investigation, including undertaking a thorough and comprehensive internal investigation, and
Carter's extensive and substantial remedial actions.
The Carter's non-prosecution agreement represents the first such agreement entered into by the SEC since the announcement of the SEC's new cooperation initiative earlier this year. Under the terms of the agreement, Carter's agreed to cooperate fully and truthfully in any further investigation conducted by the SEC, as well as in the enforcement action filed against Elles.Among the notable restrictions imposed upon Carter's by the agreement is that the company: