Judge rejects most charges in SEC’s Cabletron case

The Securities and Exchange Commission still has a securities fraud civil case against six former executives of Cabletron Systems and its spinoffs, it’s just not much of one.

U.S. District Court Judge Steven J. McAuliffe last week dismissed more than half of the SEC’s charges against the executives — mainly for not being specific enough — and substantially narrowed the charges left standing.

Of the case, Lucy Karl, an attorney representing David Kirkpatrick, Cabletron’s former chief financial officer, said, “Basically, it was gutted.”

But that’s a step up for the SEC, which was at risk of having the whole case thrown out entirely. (SEC attorneys could not be reached for comment at NHBR deadline.)

The SEC charged that the 10 defendants were all engaged in a scheme to inflate revenue at Cabletron and its spinoffs — Enterasys Networks and Aprisma Technologies — during seven quarters starting in 2002 when the then Rochester-based Cabletron was one of the state’s largest companies.

The defendants — led by former Cabletron chief executive Piyush Patel, along with Kirkpatrick and Eric Jaeger, the former executive vice president of corporate affairs — used a number of accounting tricks to boost sales and hid those methods from auditors, the SEC and investors, the SEC alleged.

Similar, but more narrow, charges led to the criminal conviction of four former Enterasys executives named in the civil suit, all of whom defaulted or settled with the SEC.

The six remaining civil defendants have contested the charges. They include Lawrence Collins, former Enterasys comptroller, Michael Skubisz, former chief executive of Aprisma, and Jerry A. Shanahan, former executive vice president of Cabletron and chief operating officer of Enterasys.

(Shanahan was a defendant in a criminal trial, but the jury acquitted him on one charge and could not reach a decision on the others. An attempt to retry him was dropped because it would have constituted double jeopardy, in light of a U.S. Supreme Court decision.)

Judge McAuliffe had originally dismissed the first SEC complaint against the former Cabletron executives as too vague, and gave the government a chance to restate its case. The SEC’s amended complaint however, was no better, McAuliffe said, so he asked the agency’s lawyers to spell it out again.

That too failed, McAuliffe said.

On Sept. 30, in a 162-page opinion — which lambasted the SEC as not being clear enough — McAuliffe said he had to go on “scavenger hunt” and “trudge through the repetitive and verbose” complaint to find out which defendant is accused of what. Generally dismissing the idea of a conspiracy, McAuliffe wanted to see more specifics about individual conduct.

“The SEC is laboring mightily to pound a number of square pegs into round holes of individual liability,” McAuliffe wrote. Noting that the SEC had plenty of time to make its case, and plenty of evidence with the preceding criminal case, the agency is “required a modest degree of clarity — who did what, said what, to whom, and when? At this stage, inference, innuendo, resort to the passive voice, group pleading, and vague conclusory language all tend to suggest that the SEC does not have, and has little hope of finding, evidence necessary to support its claims.”

In addition to vagueness, McAuliffe said that some of the revenue allegedly enhanced by fraud was too small to matter, limiting at least two counts to what occurred to a single quarter during the spinoff, not seven.

Much of McAuliffe’s opinion focused on Patel, the lead defendant who engineered the Cabletron spinoff. Patel was the handpicked successor of Cabletron co-founder Craig Benson, who later went on to serve a term as New Hampshire’s governor. Benson — a board member and the company’s largest stockholder at the time — was never named in any federal allegation.

The SEC amended its complaint to paint Patel as one of the prime movers of fraudulent activities, attempting to link him with numerous transactions. But McAuliffe only let stand one deal in which Cabletron invested $2 million in a company — Cellit — to allow it to buy Aprisma’s products, even though it didn’t need them. In such a third-party deal, Cabletron was in essence buying its own product and recording it as revenue, the SEC has charged.

In the end, the SEC was left with only three of its eight counts against Patel, all of which were much more limited than the original charges.

In the case of Kirkpatrick, McAuliffe only dismissed three charges, though he did severely limit four of the five counts remaining. But that’s because his position as CFO made him more liable to certain charges, his attorney, Karl, said.

However, she added: “If you consider that 400 paragraphs have been reduced to a mere couple of paragraphs, and if you consider that these allegations were considered in a light most favorable to the plaintiff, I think this radically limits the scope of their case, to say the least.”

Jaeger now has to face two charges, both limited; Collins faces five, four of which are limited; Skubisz’ case consists of four charges, all of which are limited; and Shanahan now face three, all of which are limited.

The SEC should have narrowed the charges to begin with, wrote McAuliffe, who characterized the federal agency’s approach as “shotgun,”

“The SEC’s effort to maintain all claims against all defendants under every stretched legal theory imaginable was doomed in large part from the start,” he wrote. “Perhaps with some focus, the SEC will find the case manageable.”

Shanahan’s attorney, Andrew Good, however, didn’t think the decision helped the SEC out at all.

“This is just a further step in the ultimate exoneration of Mr. Shanahan. We won on six criminal charges, and we will win on these three civil charges as well,” Good said. — BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW