Corporate Fraud : A Case Study of PowerLinx Inc

Introduction

Considerable concerns have been raised pertaining to the effectiveness of corporate governance following a wide spectrum of corporate financial frauds and scandals that have been symptomatic of, and subject to substantial deficiencies in corporate control. Fraud is considered to be an intentional act to gain an advantage through the employment of unlawful and unfair gains. Fraud encircles fraudulent financial reporting; assets misappropriation including payroll fraud, embezzlement, as well as theft; intentionally avoiding costs; costs of illicit purposes such as improper payment and public bribery; as well as the production of counterfeit products that contravenes intellectual property rights, among others.  Subsequently, such incidences have precipitated major reforms including the new regulations of Securities and Exchange Commission (SEC), the Sarbanes-Oxley Act, and the governance prerequisites adopted by the NASDAQ and NYSE (Doyle, 2013). Furthermore, associations such as Council for Institutional Investors, Institutional Shareholder Services, and The Corporate Library, have been actively involved in the promotion of significant reforms in a bid to strengthen the value of corporate governance when it comes to public corporations.

Fraud in financial reporting is attributable to a conscious intent to wrongfully presenting the reality by the company’s auditors, directors, and employees. The idea of ethics and honest financial reporting in business operations is very pertinent in today’s corporate world and invariably deals with ethical and moral actions of individuals and organizations. Issues arise when organizations have an obligation to comply with multiple legal and cultural requirements some of which tend to be in conflict. Corporate fraud falls under the broad category of the white collar crime. The white collar crimes are considered as the wrongdoings committed within the course and practice of one’s’ occupation by a person whose social status is relatively high (Robinson, 2008). There is a wide spectrum of areas in which corporate bearing may be in contravention with the law including company and security offenses, restrictive trade practices, consumer affairs, taxation, occupational safety and health, economic offenses against employees, discriminatory practices as well as prudential regulation. While in most scenarios corporate crimes are deliberate duplicitous practices, some arises from negligence, inattention to detail or recklessness (Doyle, 2013).

In a conventional setting, the objectives of criminal law are geared towards retribution, incarceration and rehabilitation as well as deterrence. When dealing with an artificial entity such as corporation, incapacitation and incarceration are rendered palpably irrelevant. In addition, imprisonment has been considered as a great stigma for corporate executives. Conversely, retribution in corporate wrongdoings comes with considerable challenges since it proves difficult to establish the moral blameworthiness of an organization. There is need therefore to treat corporations uniquely from other criminal actors and endeavor to formulate pragmatic punitive strategies when dealing with corporate fraud (Robinson, 2008).

Contextual Recapitulate of Corporate Fraud by Powerlinx Inc: Case Briefing

Case Title

Securities and Exchange Commission (Plaintiff) v. Powerlinx Inc., George Bernardich III, and James R. Cox (Defendants)

Civil Action No.: Case Number 1: 06CV01172

United States District Court for the District of Columbia

June 27, 2006

Case Introduction

The plaintiff, Security and Exchange Commission (SEC), alleged a pattern of fraudulent as well as other improper corporate conduct by the Defendant PowerLinx, Inc. over a period of four years. The allegation follows thus that the Defendant fraudulently recognized about ninety percent of its reported revenue during the initial three quarters of 2000 fiscal year through the initiation of consignment arrangement with numerous third-party dealers and proceeded to report the consignment order amounts under revenue in its financial statements prior to the manufacture, shipment, and sales of any cameras to customers. PowerLinx made public announcements of these of these artificially inflated revenues besides filing them in three consecutive reports with SEC. PowerLinx also issued numerous deceptive press releases that materially misrepresented the company’s operations and offered glowing, but unsubstantiated, revenue and earnings forecasts (U.S. District Court for District of Columbia, 2006).

PowerLinx Fraud Issues

The complaint levels the claims that PowerLinx did contravene the antifraud regulations of the Federal Securities Laws in September 2004 through the issuance of significantly deceptive  press releases as well as filing misleading financial reports with SEC with regards to a alleged contract sales amounting to $ 23 million with a defense contractor, Universal General Corporation (UGC ), disregarding the fact that UGC had no assets, no revenue, as well as any means to grant any segment of the $ 23 million contractual obligations to PowerLinx. SEC highlights the fact that the PowerLinx failed in adhering to due diligence in establishing whether UGC was a legitimate entity and if it had the capacity to meet is contractual responsibilities. SEC identifies George Bernardich as being responsible for the failures in due diligence of PowerLinx besides drafting the materially misleading SEC filings and press releases.

Read also Reducing Risk of Fraud, Errors and Misstatements in Business through Implementing of Proper Internal Controls

Ensuing from change in management in April 2001, PowerLinx filed an annual report, dotted with misleading restatement of revenues as well as accounting errors, for 2000 financial year with the SEC. The plaintiff claims that the chief architect of PowerLinx’s fraudulent activities during 2000 was its now-deceased former chief executive officer, Richard L. McBride. However, as further alleged, Cox was responsible for certain of PowerLinx’s fraud and reporting violations and Bernardich, who had replaced McBride as chief executive officer in February 2001, aided and abetted PowerLinx’s reporting violations with respect to the company’s 2000 annual report (U.S. District Court for District of Columbia, 2006).

Individuals Involved in PowerLinx Fraudulent Acts

George Bernadich – President and Chief Executive Officer of PowerLinx (February 2001- April 2005)

Being the second Defendant in the case, Bernardich, was the president and the C.E.O, as well as the chairman of board of directors and also remained to be a director until March 2006. Bernardich took part in the drafting as well as signing of PowerLinx’s Form 10-K that was inaccurate and additionally he failed in establishing the accuracy of the accounts presented in the financial reports especially pertaining to the rationale for the restatement as well as the purported backlog orders worth $ 9 million in 2001. In the year 2004, in retorting to the inquiries of shareholders regarding the claim of shipments made to UGC, Bernardich organized the alleged shipment of products to UGC even with the knowledge that UGC had no capability as well as facilities to handle the goods and there was no anticipated use for the product at that period of time. Bernardich made arrangements for the manufacturer to append signature to the PowerLinx invoice as an acknowledgment for the receipt of the alleged shipment, and this was followed by a press release maing announcement on the same prior to filing Form 10-Q (U.S. District Court for District of Columbia, 2006).

James R. Cox – Secretary, Treasurer, and Director

Cox is alleged to have been directly conscientious for the fabricated revenue reporting during his tenure. Cox was responsible for the supervision of PowerLinx cameras production, while at the same time drafted and disseminated the falsified and misleading press releases. In addition, he was accountable for the knowledge, or reckless ignorance of the fact that PowerLinx was making reporting and filing sales on cameras that were not manufactured yet. In his authorized positions as the treasurer and director, Cox was charged with the mandate of signing Form 10-Q for a period of three quarters of the 2000 fiscal year with the knowledge that the reported financial statements were deceptive and false (U.S. District Court for District of Columbia, 2006).

Richard McBride – CEO and Chairman of Board of Directors

McBride was fundamentally responsible for generation of false content of the PowerLinx fabricated as well as deceptive press releases. He was accountable for the dissemination of the press releases through their inclusion in marketing materials besides having them posted on the PowerLinx’s website as well as on internet message boards. In 1998, McBride had also been convicted of fraud and during his tenure as the chief executive officer, chairman of board of directors and the president, in 2000, he was serving a six-year probation time, information he failed to disclose in the company’s annual report (U.S. District Court for District of Columbia, 2006).

Rules and Laws Violated in the PowerLinx Fraud Case

The Federal laws categorically provide that when officer or agent of a corporation acting within the apparent scope of their employment commits an offence, the bodily aspect of the offence ought to be attributed to the body corporate. In adopting the corporate culture approach, the American justice system has had a considerable impact on the scope of criminal liability (Turnill et al., 2012). This has been made so by the conceptual shift in the primary aspects of the liability which makes it easier to establish criminal liability on corporations.

The justice system recognizes the various levels of intent which range from direct intent to negligence. However, the American justice system tends to reduce the level of intention prerequisite to a crime to a single fault element which narrows down to permitting or authorizing the offence.  It should be noted that the corporate culture operates in a rather complex setting. The culture is only relevant at the stage of establishing liability but do not have a proportionate legally codified role in determining the sentences (Robinson, 2008). Further, the challenges of the American Justice system stems from the lack of prosecutorial powers by some of the corporate regulatory agencies. It should be noted that the penalties provided by the corporate crimes laws tend to be significantly unassertive while those that are imposed in the event of sanction and conviction do not get anywhere close to the maximum. Most of the penalties imposed on corporate crimes are nominal fines and prison terms are only imposed in very rare occasions most of which are those involving fraudulent conduct.  The antifraud provision of the American law is prescribed by the Exchange Act of 1934, more particularly under the Rule 10b-5.

PowerLinx and the other defendants in carrying out corporate fraud were liable to the violation of Section 10(b) which defines the act of fraud as any conduct that either directly or indirectly, and through the employment of transportation and communication tools, to make use of schemes, devices and artifices to commit fraudulent acts. In addition, this section of the law outlaws making of falsified statements of material facts, or the omission of material facts with an aim of making misleading statements. Pursuant to section 15(d) of the Exchange Act, under rules 15d-1, 15d-11, 15d-13, and 12b-20, PowerLinx acted in contravention of the requirement to file current and accurate SEC annual reports. Under the same rules, it is established that both Cox and Bernardich aided and abetted violations of the law through provision of considerable assistance in disregarding the lawful requirement of periodic reporting as prescribed by the Act. Furthermore, subject to Section 13(b)(2)(A) of the Exchange Act, PowerLinx, failed to keep correct books of records, as well as accounts which, in plausible aspects, truthfully and reasonably mirrors its business transactions and the nature of the corporation’s assets (U.S. District Court for District of Columbia, 2006).

Impact on Affected Stakeholders

The corporate culture provisions may pave the way for challenges to the corporate veil. This is draws from the concept that they emphasis more on the actual process of decision-making and track of authority as opposed to the legal structure of corporate entities.  It would be plausible if the corporate culture approach could give result in establishment of the bodily component of crimes, give provision for the physical elements to be credited to organizations that effectually well-organized them to be committed. It would be sufficient for the justice system to look into the sanctions in more realistic approaches in a bid to attain deterrent effects and in rewarding the victims of corporate misconduct (Robinson, 2008). These victims include shareholders, creditors and the corporation. In current circumstances the quest for retribution has tended to overlook the perspective of such sufferers. The need to integrate the role of victims is vital if the justice process is to be well-adjusted and not subject to ideology (Doyle, 2013)..

The cost of corporate fraudulent acts is not only borne by the members of the general public but honest business firms and individuals suffer economically the disadvantage subject to their competitors engaging in corporate wrongdoings (Freiberg, 2000). To this regard, the nature of a corporate wrongdoing involves both criminal and civil liability. For instance, the Corporation law provides both civil and criminal actions to be leveled against the same conduct. This indistinctness can be attributed to the seemingly poorly developed legal concepts of corporate crime and owing to the fact that the current criminal laws and statutes are as a result of composite of provisions that have advanced over time from models that were meant to deal more specifically with individuals than with corporate organizations (Braithwaite, 2010). Consequently, a company need not only seek to make profits and expand its niche in the market but also ensure it avoids dealing in actions that might result in adverse economical and ethical costs as well as fraudulent activities that will invariably affect its staff, consumers, and general public (Robinson, 2008).

Essential Actions for Prevention of Fraud

The issue of corporate fraud is a multi-faceted and there are no simple solutions to the problem. The debate on whether corporate liability should be criminal in essence or whether the unique circumstances of punishing a corporate entity should merit different approaches cannot be ignored. It is apparent that action should be taken in dealing with corporate criminal liability in America, and it should be noted that a singular methodology cannot be adequately sufficient to address either the conviction of corporations, or the sanctioning of corporations. The utter volume of corporations committing fraudulent acts makes any consistent approach to the use of prosecution very difficult certainly. In addition, the complexity of the corporate crime analysis in America has always resulted in a superficial portrayal of its statistics. This draws from the fact that detection and prevention of fraudulent acts poses considerable challenges since most of the offenses are usually hidden from the public gaze (Wagner, 1999).

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