Former Cabletron CEO responds to SEC complaint

Charges that former Cabletron Systems Chief Executive Officer Piyush Patel engaged in securities fraud while splitting up the former Rochester-based company are not specific enough and should be dismissed, according to Patel’s attorneys in a motion filed Friday in U.S. District Court in Concord.

The filing was the first major response to a civil complaint filed by the Securities and Exchange Commission against Patel and nine others — including four former executives of Enterasys Networks who were recently sentenced to serve from three to 11 years in prison for fraudulently inflating revenue to jack up the stock price.

The civil charges are similar to the criminal charges filed against the former Enterasys executives, but they involved different deals and date back before Aug. 6, when Cabletron – once the state’s largest employer — spun off Enterasys. While the criminal trial narrowed in on four transactions, the SEC complaint lists some 64 transaction over a 22-month period involving nearly $66 million in revenue.

However, Patel was no longer in charge of the company after Aug. 6 when Cabletron ceased to exist, and couldn’t have been responsible for most of the deals, which closed after that time by their subsidiaries, according to his filing.

Patel did go on to chair another Cabletron spin-off, Riverstone Networks, some of whose former executives also are charged by the SEC with inflating revenue, but Patel was not named in that case. There also is an ongoing criminal investigation into Riverstone, which – at least at one point – had targeted Patel.)

The Cabletron/Enterasys complaint alleges that Patel, along with Cabletron’s then-chief financial officer, David Kirkpatrick, and Robert Barber detailed the structure of “three-corner” deals in March 2001 in a conference call to the investment team. In these deals, Enterasys would invest in shaky companies that would then buy Enterasys products through a distributor in order to increase sales.

Barber, as a member of the Enterasys investment team, was sentenced to eight years in federal prison because of his involvement in such deals.

Despite auditors urging that such deals should be “collapsed” when Cabletron was spinning off Enterasys in August, former Enterasys CEO Enrique “Henry” Fiallo and former Enterasys CFO Robert Gagalis allegedly went to Patel and Eric Jaeger – Cabletron’s former senior vice president of corporate affairs — saying that they would not meet sales projections in that crucial quarter.

Patel and Jaeger then directed the Enterasys officials to force more product through the channel “in the absence of legitimate revenue opportunities,” according to the SEC complaint.

However, noted Patel’s response, three-corner deals are not fraudulent if the transactions had no economic substance, and there was no evidence that Patel – who wasn’t an accountant – knew this. “Therefore ‘presenting the concept’ is not enough to plead fraud,” said the response.

As for the August meeting, Patel was either out of power then or a “lame duck,” and “it is thus highly unlikely that he was ‘directing’ anyone to do anything,” according to Patel’s response.

Specific deals

The complaint named Patel in conjunction with two particular deals:

• He allegedly knew that Enterasys had entered into a financing arrangement with Cellit, in which Enterasys agreed to invest $2 million in Cellit in return for two $1 million promissory notes, an equity interest in Cellit and Cellit’s agreement to purchase $1 million of product made by Aprisma, another Cabletron subsidiary that was later spun off into a private company.

• He also allegedly participated in improperly recognizing approximately $701,000 in revenue from sales to TrustWave Corp.

According to his response, Patel’s attorneys argue that each deal wasn’t large enough to be significant, and the complaint doesn’t detail how Patel knew there was anything improper about either deal.

Patel “appears to be named as a defendant solely because of his position as CEO of Cabletron,” his attorneys wrote.

Jaeger’s attorneys echoed Patel’s response, arguing that Jaeger was not an accountant and didn’t actually sign any financial statements.

They had a different spin on Jaeger sending an e-mail entitled “Deal Cleanup,” which encouraged former CFO Gagalis to “crack the whip” before presenting finances to auditors. While the SEC said the e-mail demonstrated a cover-up, Jaeger’s attorney interpreted it as a suggestion “that businesspersons be fully prepared before meeting with the Company’s outside auditors.”

While the complaint alleges Jaeger negotiated a $250,000 reciprocal purchase agreement between Enterasys and Everest Broadband Networks, even though neither needed the other’s product, Jaeger’s attorney wrote that there was no allegation that his client was “in any way involved in whatever accounting judgment was made.”

Attorneys for Enterasys’ former chief operating officer, Jerry Shanahan, also contended that the complaint wasn’t specific enough, but his attorney instead asked for a more “definite statement of facts,” as opposed to a dismissal.

The SEC named Shanahan in four specific deals, including one with Tech Data Canada that included a secret side e-mail that included terms that would have prevented auditors from recognizing revenue from it. It was on the basis of this deal that Shanahan was charged with criminal fraud along with the Gagalis, Barber and two other defendants. But the others were convicted last December, the jury could not reach a decision on Shanahan, who is scheduled to be retried on criminal charges in September.

The first pretrial hearing conference in the civil case isn’t scheduled until October. – BOB SANDERS