MANHATTAN (CN) - A federal judge refused to dismiss accounting fraud claims stemming from the $10 million purported sham sale of software to Verizon.
In a January 2013 complaint, the Securities Exchange Commission accused Jack Egan Jr. of having participated in a scheme to overstate revenue while serving as senior vice president and CFO of Volt Information Systems.
Verizon had been a top customer for a Volt subsidiary called Volt Delta Resources (VDR), which provides computer-based director assistance.
When VDR learned that Verizon was thinking about switching to a competitor, Volt offered to develop and lease customized directory assistance software in 2006.
It hoped to earn $70 million from the lease, but Verizon revealed that it "had an opportunity" to secure $10 million to buy a capital asset before the end of the year of 2006.
Though the VDR annual license would not qualify as a capital asset, a purchase of its software would.
Regulators say VDR organized a sham sale while continuing negotiations of a long-term lease of the same modules.
Verizon eventually transferred $10 million to Volt, and Egan authorized the transfer of that money to VDR.
After Verizon accepted two of the software modules in October 2007, VDR drafted a formal acceptance letter, releasing $7.5 million of the $10 million to itself.
VDR and Verizon's four-year lease of the same modules, executed in November 2007, was set to begin January 2008 at a cost of $70 million.
In its complaint, the SEC claimed that the "improper and fraudulent" recognition of $7.55 million as revenue resulted in an overstated, pre-tax net income of about $5.4 million for Volt's fourth quarter of 2007.
The SEC said Egan's involvement in the transaction amounted to a violation of generally accepted accounting practices.
Egan argued that accounting for software recognitions is "notoriously difficult," and that Volt had a history of accounting software revenue incorrectly.
U.S. District Judge William Pauley III called these arguments "irrelevant" in refusing to dismiss the complaint against him Friday.
"No specialized accounting knowledge is required to recognize that the same assets cannot be sold and then leased a few months later or that revenue is not earned from sham sales," he wrote.
Pauley also emphasized that "the complaint pleads more than recklessness."
"By alleging that Egan possessed accounting expertise and was confronted with multiple indicators of fraudulent activity, the SEC pleads 'strong circumstantial evidence of conscious misbehavior.' Egan is an accounting professional accused of an obvious GAAP violation."
Supporting the allegation of a "year-long pattern of activity contributing to the fraud," the decision also notes that Egan possessed accounting experience and "was responsible for revenue recognition policies" as Volt's CFO.
The "red flags" that Egan should have seen "could not have a non-fraudulent explanation," according to the ruling.
"Egan's arguments to the contrary miss the mark," Pauley added.
Pauley ruled that the complaint sufficiently provides enough "circumstantial evidence to survive with its allegations that Egan consciously misbehaved in withholding information from an auditor and making public statements despite knowing contradictory, non-public information."
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