United States Securities & Exchange Commission v. DiMaria
Docket: 1:15-cv-7035-GHW
Court: District Court, S.D. New York; September 15, 2016; Federal District Court
The SEC has accused Edward DiMaria and Matthew Gamsey of manipulating Bankrate, Inc.'s financial statements to artificially inflate revenues and understate expenses for the second quarter of 2012, allowing the company to meet specific financial targets. Both defendants sought to dismiss the amended complaint, claiming the accounting entries were not material and that the SEC failed to establish scienter. The court denied their motions except for Gamsey, whose motion to dismiss a claim under 17(a)(2) of the Securities Act was granted.
Bankrate, through its website Bankrate.com, provides personal finance information and operates three main divisions: Bankrate Core, Bankrate Insurance, and Bankrate Credit Cards. DiMaria, the chief financial officer, and Gamsey, the vice president and director of accounting, were involved in fostering a corporate culture that accepted improper accounting practices to meet financial objectives. DiMaria allegedly used "over-accrued expense accounts," referred to as "Ed’s cushion," to manipulate financial results. For instance, he instructed a vice president to misclassify audit fees, disregarding potential complaints, and later misrepresented this action to the auditor.
Additionally, after reviewing the May 2012 financials, DiMaria directed employees to adjust revenues and reverse accruals to align with previously communicated financial targets. Following Bankrate's first quarter 2012 results, which fell slightly below analyst estimates, forecasts for the second quarter were lowered. By July 7, 2012, a preliminary version of the second quarter results indicated an Adjusted EBITDA of over $36 million, but by July 11, it was revealed that revenue was actually $286,000 lower due to a double-counting error in the Credit Cards division.
DiMaria instructed the vice president of finance to record an additional $300,000 in revenue for the Insurance division and $500,000 for the Credit Cards division, without providing a clear justification or identifying specific customers. The vice president’s email to the divisions included ambiguous details, raising concerns among the finance team regarding the validity of these entries. Gamsey, in communications with the vice president, expressed serious doubts about the revenue's legitimacy and warned about the need for a solid explanation in case of auditor inquiries.
The Insurance division recorded the additional $300,000 on July 11, 2012, linked to a dormant customer account. When questioned by auditors, Gamsey instructed the vice president to prepare a justification for this revenue. Subsequent drafts attempted to explain the $300,000 using various accounting issues, yet these did not comply with generally accepted accounting principles (GAAP). Moreover, the justifications were never submitted to the auditor. Instead, a misleading explanation was provided, which inaccurately affirmed that the revenue was related to the single customer account.
In contrast, the Credit Cards division refused to record the additional $500,000 revenue. DiMaria reacted by threatening to fire the accountants and insisted the revenue was due to "reporting issues," a claim Gamsey dismissed as implausible, suggesting that DiMaria's rationale was unfounded.
Credit Cards accountants anticipated an additional $176,000 in revenue for June, which was recorded for the second quarter. After this was communicated to Bankrate’s vice president of finance, an instruction was given to book $305,000 in additional revenue by inflating figures from two customers. This entry bypassed Bankrate’s accounting controls and was added directly to the revenue spreadsheet, avoiding scrutiny from auditors. The SEC alleges that these entries did not comply with GAAP, and both DiMaria and Gamsey were aware of or reckless regarding this noncompliance. All improper revenue entries were reversed in June 2015 during a restatement of Bankrate’s financial results.
On July 13, 2012, a revised financial statement was shared, showing an Adjusted EBITDA of $36,656,000. Shortly after, DiMaria directed a $400,000 reduction in a marketing accrual account, which increased quarterly earnings without support for the reduction. Gamsey questioned the rationale behind this reduction. This adjustment also was reversed in the 2015 restatement, with the SEC alleging DiMaria and Gamsey’s awareness of its impropriety.
Later on the same day, DiMaria directed a $450,000 reduction in the management incentive plan (MIP) accrual account, which he had previously manipulated to adjust Bankrate’s financial results. Following this, another revised financial statement showed an Adjusted EBITDA of $37.5 million. An analysis compared Bankrate’s results favorably against analyst estimates. On July 31, 2012, Bankrate released its second quarter financial results, which highlighted its Adjusted EBITDA and Adjusted EPS, aligning closely with analyst expectations.
The SEC alleges that Bankrate's financial statements were materially inaccurate, specifically claiming that the company only achieved key analyst targets for Adjusted EBITDA and Adjusted EPS due to improper accounting entries. In its second quarter 2012 Form 10-Q, Bankrate reported a net income of approximately $16.3 million, which the SEC contends should have been reported as $15.5 million absent the alleged accounting discrepancies. DiMaria, as CFO, approved and signed the Form 10-Q and announced the financial results, while both he and Gamsey signed a management letter asserting compliance with GAAP, proper transaction recording, and a lack of knowledge regarding any fraud affecting the financial statements. Gamsey also orally assured the auditor of no improper accounting practices. Following the financial announcement, DiMaria sold 107,177 shares of Bankrate stock for about $2 million, with the SEC alleging that the stock price was artificially inflated due to the defendants' misrepresentations. The SEC filed a lawsuit against DiMaria and Gamsey on September 8, 2015, citing violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Both defendants moved to dismiss the case, prompting a series of filings and oppositions between January and March 2016. Under Federal Rule of Civil Procedure 8(a)(2), a complaint must include a clear statement of the claim, and to survive a motion to dismiss under Rule 12(b)(6), the complaint must present sufficient factual content to suggest a plausible claim for relief. Legal conclusions alone are insufficient, and allegations must move from mere possibility to plausibility.
Federal Rule of Civil Procedure 9(b) mandates that allegations of fraud or mistake must detail the specific circumstances involved. Plaintiffs must identify: (1) the false or misleading statements, (2) the reasons the statements are fraudulent, (3) the time and place of these statements, and (4) the individuals responsible for them, as established in Lundy v. Catholic Health Sys. and other cases. The SEC has charged DiMaria and Gamsey with violations of the Securities Act and the Exchange Act, focusing first on the securities fraud claims under Section 10(b) of the Exchange Act, which prohibits manipulative or deceptive practices in securities transactions. Rule 10b-5 outlines unlawful activities, including employing deceptive devices, making untrue statements of material facts, or omitting necessary material facts. To prove primary liability under Section 10(b) and Rule 10b-5, plaintiffs must demonstrate that the defendant made a material misrepresentation or used a fraudulent device with scienter. The Second Circuit notes that the elements to prove fraud under Section 17(a) of the Securities Act are similar to those under Section 10(b), though scienter is not required for certain injunctions. Defendants contend the accounting entries in question are immaterial and that the complaint lacks sufficient facts for a strong inference of scienter. Gamsey further argues that the SEC's failure to show he personally profited from the alleged fraud warrants dismissal of the 17(a)(2) claim against him. Materiality is defined as a statement or omission that a reasonable shareholder would consider significant in making decisions, implying that it substantially alters the total mix of available information.
A complaint cannot be dismissed on a motion unless misstatements are deemed obviously unimportant to a reasonable investor. The Second Circuit recognizes that the SEC's Staff Accounting Bulletin No. 99 (SAB 99) generally presumes that misstatements below 5% of a financial statement are immaterial, but this guideline is not definitive. Courts must also evaluate qualitative factors that could elevate the materiality of a quantitatively small misstatement. In this context, the amended complaint alleges that DiMaria intended to manage earnings to obscure Bankrate's failure to meet analysts' expectations, which is a qualitative factor that may render smaller misstatements material. The SEC argues that even small intentional misstatements should not be assumed to be immaterial. Defendants assert that Adjusted EBITDA and Adjusted EPS are minor non-GAAP metrics and not significant to reasonable investors, particularly given Bankrate's overall financial improvement. However, the Court finds these arguments unconvincing, noting that if the metrics were trivial, DiMaria's focus on them and their prominence in Bankrate's earnings release suggests otherwise. At this stage, the SEC is entitled to favorable inferences, leading to a reasonable conclusion that these metrics are significant to DiMaria, Gamsey, financial analysts, and investors.
Defendants may demonstrate later that the accounting entries in question involve estimates common to accrual accounting, but this does not weaken the Court's finding that the amended complaint alleges deliberate misstatements regarding the management of Bankrate's Adjusted EBITDA and EPS, as well as efforts to obscure its failure to meet analyst expectations. If proven, these misstatements could influence reasonable investors' decisions, thereby establishing materiality under SEC claims.
In terms of scienter, a securities fraud complaint must comply with Rule 9(b) of the Federal Rules of Civil Procedure, which requires particularity in alleging fraudulent intent. General allegations of GAAP or SEC violations without fraudulent intent are insufficient. While the SEC must meet Rule 9(b)'s specificity, it is not bound by the stricter pleading standards of the Private Securities Litigation Reform Act (PSLRA). Courts must consider plausible alternative explanations when assessing if facts present a strong inference of scienter. While Rule 9(b) allows for general allegations of intent, plaintiffs must provide sufficient facts indicating a strong inference of fraudulent intent, either by demonstrating motive and opportunity or through strong circumstantial evidence of conscious misbehavior or recklessness.
Specifically regarding DiMaria, he contends that the SEC has not sufficiently alleged improper motives, which typically involve corporate profitability and stock price maintenance—common to corporate officers and thus not sufficient for this analysis. The SEC counters that it asserts scienter through conscious misbehavior. When motive is unclear, heightened circumstantial evidence is necessary to indicate conscious misconduct. Under this theory, the SEC must show conduct that is exceedingly unreasonable and significantly deviates from ordinary care, implying that the risks were either known to DiMaria or so evident that he should have recognized them.
An express allegation of deliberate misconduct may establish the requirement of scienter, as indicated in SEC v. Collins. Aikman Corp. The determination hinges on whether the collective facts presented create a strong inference of scienter, rather than assessing each allegation in isolation. In this case, the SEC alleges that DiMaria orchestrated an accounting scheme to meet analysts' expectations for Bankrate's Q2 2012 performance. Specific actions attributed to DiMaria include ordering the booking of an additional $800,000 in revenue without justification and later reducing a marketing accrual by $400,000. He allegedly provided misleading explanations to auditors regarding these entries and reacted aggressively to resistance from his team, threatening to fire those who opposed his directives. Furthermore, DiMaria is accused of instructing the Core division to book $305,000 in unsubstantiated revenue after the Credit Cards division refused to comply. Although DiMaria asserts that his communications reflect frustration rather than misconduct and claims the booked revenue was GAAP-compliant, the SEC's allegations, if taken as true, suggest a fraudulent scheme. The court concludes that the facts presented indicate DiMaria either knew the accounting was erroneous or was reckless in not knowing, thereby supporting an inference of scienter under Rule 9(b).
DiMaria's assertion that he could rely on the accountants' explanations for questionable accounting entries is undermined by allegations in the amended complaint, which state that he instructed the accountants to record additional revenue, threatened them for non-compliance, and only ceased directing these dubious entries once Bankrate's financial results aligned with analyst expectations. His actions suggest a deliberate effort to create a false narrative of financial performance rather than a standard practice among corporate officers.
Regarding Gamsey, the SEC sufficiently alleges scienter, claiming that his extensive experience as a CPA and his involvement in concealing improper accounting entries support a strong inference of conscious misbehavior or recklessness. Despite expressing concerns over DiMaria’s directives to book additional revenue, Gamsey allegedly aided in obscuring these entries from the auditor. He prompted the vice president of finance to prepare explanations for the questionable revenues and ultimately signed a management representation letter affirming the compliance of Bankrate's financial statements with GAAP, denying any knowledge of fraud. Gamsey's professional background, his reactions to the accounting practices at issue, and his misleading statements to auditors contribute to the inference of scienter, although he may later present evidence of his diligence in defending against these claims.
The amended complaint's fifth claim alleges that both defendants violated Section 17(a) of the Securities Act. The SEC has sufficiently pleaded violations of Sections 17(a)(1) and (3), but Gamsey contends that the SEC did not adequately allege a violation of Section 17(a)(2) since he purportedly "obtained money or property for Bankrate, but not for himself." Section 17(a)(2) prohibits obtaining money or property through untrue statements in securities offerings. Courts in the district are divided on whether a defendant must personally benefit from the fraud or if it suffices that they obtain money or property for an employer. The ruling in SEC v. Syron stipulates that personal gain is necessary, while SEC v. Stoker allows for the possibility of benefiting an employer. The current court aligns with Judge Sullivan's interpretation in Syron, asserting that the term "obtain" implies personal gain. The SEC's complaint against Gamsey lacks allegations of him receiving any benefit from the misconduct, leading to the dismissal of the Section 17(a)(2) claim without prejudice.
For aiding and abetting securities fraud, the SEC must prove: 1) a primary violation of securities law, 2) the aider's knowledge of the violation, and 3) substantial assistance by the aider. "Substantial assistance" requires that the aider associate with and participate in the venture, intending to help it succeed.
Gamsey argues for the dismissal of the SEC's third claim in the amended complaint, which alleges he aided and abetted a Rule 10b-5 violation. He contends that mere awareness and approval do not equate to substantial assistance. However, the complaint alleges that Gamsey possessed knowledge that DiMaria's directives contradicted accounting principles and would necessitate reversals. Specifically, he questioned the implications of booking an additional $800,000 in revenue and later participated in efforts to cover up the fraudulent accounting by communicating with the vice president of finance regarding misleading explanations for auditors. Gamsey also signed a management representation letter and misled auditors about his awareness of improper practices. The SEC argues that while DiMaria initiated the fraudulent scheme, Gamsey actively contributed to its success, establishing a case for aiding and abetting liability.
Furthermore, the SEC has asserted control person liability against DiMaria, requiring evidence of (1) a primary violation by DiMaria, (2) Gamsey's control over him, and (3) Gamsey’s culpable participation in the fraud. DiMaria’s assertion that he lacked the necessary scienter for control person liability is countered by the SEC's allegations meeting the higher standard for primary securities fraud.
Additionally, regarding violations of Section 13 of the Exchange Act, specifically Section 13(b)(5) and Rule 13b2-1, the SEC accuses both DiMaria and Gamsey of failing to implement internal accounting controls and falsifying records. Gamsey disputes the sufficiency of the complaint's factual allegations related to his violations, despite the SEC asserting that he expressed concerns regarding improper accounting entries.
Gamsey made false statements to Bankrate's auditor, claiming ignorance of any fraud, which allowed improper financial entries to appear in the company's second-quarter statements. He advised the vice president of finance to record additional revenue in a manner that would evade scrutiny, indicating a need for caution regarding potential future discoveries of these adjustments. These actions suggest violations of SEC Rule 13(b)(5) and contribute to claims that he aided and abetted Bankrate's breaches of Sections 13(a) and 13(b)(2) of the Exchange Act. The eighth claim asserts that both he and DiMaria violated Rule 13b2-2 by making materially false statements to auditors, as they signed a management representation letter asserting compliance with GAAP and lack of knowledge of fraud. Misstatements in such letters, including assurances that all frauds had been reported, are sufficient for claims under Rule 13b2-2. Gamsey's argument regarding the resolution of his concerns was rejected, as the court cannot draw inferences in his favor at this stage. The court partially granted and denied the defendants' motions to dismiss, directing the Clerk of Court to terminate the pending motions. All facts are accepted as true for this motion's context, although legal conclusions are not afforded the same assumption.
In *Ashcroft v. Iqbal*, the SEC alleges misconduct involving the vice president of finance, who reportedly deferred $99,000 in second-quarter accounting fees to the third quarter after being instructed by DiMaria to achieve an Adjusted EBITDA of $37 million. Although Gamsey was made aware of this decision, neither he nor DiMaria directly participated in it. The SEC's case does not rely on a $450,000 reduction in the management incentive plan accrual account, which it does not contest as improper. However, allegations that Gamsey knew about improper booking of audit fees in Q1 2012 and later misrepresented this entry to the auditor bolster claims of his scienter.
The SEC references *De Sole v. Knoedler Gallery* to support the notion that substantial assistance can occur through active involvement or negligence in preventing a breach. However, the court finds this case inapplicable, noting that both *De Sole* and *Calandra* addressed fraud under New York state law, not federal securities law, and the cited standards differ. Moreover, the referenced passage from *Lerner* was unrelated to fraud, focusing instead on aiding and abetting breaches of fiduciary duty.
The SEC also makes claims against DiMaria, asserting he aided and abetted violations. DiMaria's sole defense is a lack of scienter, which the SEC effectively counters. Additionally, the SEC alleges that Gamsey knowingly failed to implement adequate internal accounting controls to ensure compliance with GAAP, a claim that holds due to the factual basis provided, despite being described as a bare legal conclusion.
