TIFFANY & BOSCO, P.A. J. James Christian (#023614) Telephone:...
Transcript of TIFFANY & BOSCO, P.A. J. James Christian (#023614) Telephone:...
Case 2:09-cv-00406-FJM Document 58 Filed 09/25/09 Page 1 of 68
1 TIFFANY & BOSCO, P.A.Richard G. Himelrick (#004738)
2 J. James Christian (#023614)
3 Third Floor Camelback Esplanade II2525 East Camelback Road
4 Phoenix, Arizona 85016-4237Telephone: (602) 255-6000
5 Fax: (602) 255-01036 [email protected]
8 Liaison Counsel for Plaintiffs
9 THE ROSEN LAW FIRM P.A.10 Phillip Kim (pro hac vice)
Laurence Rosen (pro hac vice)11 Timothy Brown (pro hac vice)
12 350 Fifth Avenue, Suite 5508New York, NY 10118
13 Telephone: (212) 686-1060
14 Fax: (212) [email protected]
17 Lead Counsel for Plaintiffs
18 UNITED STATES DISTRICT COURTDISTRICT OF ARIZONA
19
20 JENNIFER BURRITT, ) No. CV-09-00406-PHX-FJMINDIVIDUALLY AND ON BEHALF ) ( Consolidated)
21 OF ALL OTHERS SIMILARLY )
22 SITUATED, ) CLASS ACTION
Plaintiff, )23 vs. ) FIRST AMENDED
24
) CONSOLIDATED CLASS ACTION
NUTRACEA, BRADLEY D. EDSON, ) COMPLAINT FOR VIOLATIONS25 TODD C. CROW, AND DAVID ) OF THE FEDERAL AND ARIZONA
BENSOL, ) SECURITIES LAWS26 Defendants. )27 ) JURY TRIAL DEMANDED
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1 Lead Plaintiff Harvey Pensack, and named plaintiffs Jennifer Burritt and
2 Jose Medrano, (collectively “Plaintiffs”), individually and on behalf of all other
3 persons similarly situated, by their undersigned attorneys, allege in this First
4 Amended Consolidated Class Action Complaint (“Complaint”) the following upon
5 knowledge with respect to their own acts, and upon facts obtained through an
6 investigation conducted by their counsel, which included, inter alia: (a) review
7 and analysis of relevant filings made by Nutracea Inc., (“Nutracea” or the
8 “Company”) with the United States Securities and Exchange Commission (the
9 “SEC”); (b) review and analysis of defendants’ public documents, conference calls
10 and press releases; (c) review and analysis of securities analysts’ reports and
11 advisories concerning the Company; (d) information readily obtainable on the
12 Internet; and (e) interviews with witnesses that have first-hand knowledge of the
13 fraud alleged herein.
14 Plaintiffs believe that further substantial evidentiary support will exist for
15 the allegations set forth herein after a reasonable opportunity for discovery. Most
16 of the facts supporting the allegations contained herein are known only to the
17 defendants or are exclusively within their control.
18 NATURE OF THE ACTION
19 1. This is a securities class action on behalf of all persons and entities
20 other than Defendants who purchased the common stock of Nutracea during the
21 period between April 2, 2007 and February 23, 2009, inclusive (the “Class
22 Period”), seeking to recover damages caused by Defendants’ violation of the
23 Sections 10(b) and 20(a), and Rule 10b-5 thereunder, of the Securities Exchange
24 Act of 1934 and for violation of A.R.S. §44-2003(A) and §44-1999 caused by
25 Defendants’ violation of A.R.S. § 44-1991(A)(3). Defendants are Nutracea, its
26 CEO, President and Director Bradley D. Edson (“Edson”); and former CFO Todd
27 C. Crow (“Crow”) (collectively “Defendants”).
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1 2. Defendant Nutracea is a small nutraceutical company engaged in the
2 research and development, manufacturing, sale, and distribution of rice bran
3 foodstuff and nutritional supplements. The Company’s products include rice bran
4 oil, human food additives, and animal food products. The Company sells its
5 products through a number of distribution channels, including infomercials
6 through ITV Global, Inc. (“ITV”) and EXI International d/b/a Famous Discoveries
7 (“Famous Discoveries”).
8 3. During the Class Period a majority of the Company’s sales and
9 revenue were derived from a small number of customers. For fiscal year (“FY”)
10 ended December 31, 2006, five customers accounted for 67% of the Company’s
11 total sales revenue, with one customer, ITV, accounting for 45% of the
12 Company’s total sales. For FY ended December 31, 2007 six customers,
13 including ITV accounted for 59% of the Company’s total product sales revenue
14 (excluding license and royalty fees). Of these six customers, ITV accounted for
15 12% or approximately $2 million of the Company’s total product sales revenue
16 (excluding license and royalty fees) in FY 2007.
17 4. Defendants perpetuated an accounting fraud during the Class Period
18 by materially overstating revenue and net income and underreporting net loss in
19 the Company’s publicly filed financial statements and other public announcements
20 with the purpose and effect of artificially inflating the market price of Nutracea
21 common stock.
22 5. Defendants violated Generally Accepted Accounting Principles
23 (“GAAP”) which enabled the Company to misrepresent its financial performance
24 as follows:
25 a. Overstate its “record” revenue for the fourth quarter (“Q4”)
26 and fiscal year (“FY”) ended December 31, 2006 by $1,551,000, or 43%
27 and 9%, respectively. Net income before incomes taxes for FY 2006 was
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1 overstated by $1,283,000 or by 425% and in Q4 2006 previously reported
2 net income before income taxes of $778,000 was, in truth, a net loss before
3 income taxes of $505,000; 1
4 b. Overstate revenues for both the second quarter (“Q2”) and six
5 months ended June 30, 2007 by $7.6 million or 141% and 103%,
6 respectively. In truth, the originally reported net income before income
7 taxes for Q2 2007 of $2,087,000 was really a net loss before income taxes
8 of $4,714,000—a $6,801,000 or 144% understatement of loss; and the
9 originally reported net income before income taxes of $1,840,000 for the
10 six months ended Q2 2007 was in truth, a net loss of $4,961,000—a
11 $6,801,000 or 137% understatement of net loss; and
12 c. Overstate Q4 and FY 2007 revenue by $1,920,000, or 52%,
13 and $7,970,000, or 56%, respectively, and to under-report net loss before
14 income taxes for 2007 by $5,354,000 or 31%.
15 6. Nutracea has stated that additional restatement adjustments to its
16 previously reported financial statements – on top of those set forth above- will be
17 necessary as the Company is continuing its internal investigation by independent
18 outside counsel and forensic accounting consultants. The internal investigation
19 already has uncovered additional accounting improprieties and has been expanded.
20 7. Defendants perpetrated the accounting fraud by improperly
21 recording revenue on large transactions with affiliated parties near the end of
22 financial reporting periods that included: (a) a sham revenue transaction involving
23 an undisclosed related party where collectability was not reasonably assured; (b) a
24 previously undisclosed “bill and hold” arrangement with ITV that did not meet the
25 requirements for revenue recognition; (c) another sham transaction with an
26
27 1 Percentages used for comparison purposes herein were derived by dividing theamount overstated or understated by the originally reported amount.
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1 undisclosed affiliated joint venture partner, Famous Discoveries, where
2 collectability or payment was not reasonably assured; and (d) $5.0 million in
3 license revenue in separate “round-trip” sham transactions that should not have
4 been recognized because the separate transactions should have been considered a
5 single transaction with multiple deliverables under GAAP and there were various
6 obligations under the arrangement that would have precluded immediate
7 recognition of the revenue.
8 8. On February 23, 2009 the Company issued an announcement stating
9 that its financial statements filed with the SEC and related public announcements
10 for the fiscal year ended December 31, 2007, including the associated second,
11 third, and fourth quarter periods for 2007, and all fiscal quarters in 2008 should
12 not be relied upon. The Company admitted that a restatement was required for
13 those periods as a result of accounting improprieties concerning two large
14 transactions. The Company stated in the announcement that the improprieties
15 were discovered by the Company’s previously undisclosed internal investigation
16 which was being conducted by independent outside counsel and forensic
17 accounting consultants.
18 9. The first improper transaction involved $2.6 million2 in revenue
19 recognized in the second quarter of 2007 in connection with the purported sale of
20 Dr. Vetz PetFlex product. The $2.6 million in question should not have been
21 recognized as revenue at all. While the Company received a $1 million down
22 payment on this transaction, the down payment the Company received was
23 provided to the purchaser through a loan from a consultant to, and former officer
24 of, the Company. The loan, and its related party nature, were concealed from the
25 Company’s auditors and never disclosed publicly by the Company. Moreover, the
26
27 2 The Company’s restatement announcements interchangeably use“$2,601,000” and “$2.6 million” in referring to this transaction.
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1 evidence relied upon by the Company to determine the purchaser’s ability to pay
2 the remaining $1.6 million receivable balance was inaccurate (i.e. false). The
3 Company had originally recorded a $800,000 reserve on this transaction in Q3
4 2007 and in Q4 2007. The Company has now admitted that the entire $2.6 million
5 should not have been recognized as revenue, will be reversed, and has
6 consequently created a $1 million liability for the down payment. These facts are
7 indicative of a sham transaction.
8 10. The second transaction involved a $2 million3 sale of the Company’s
9 RiceNShine product to ITV during December 2007—the end of Q4 and FY 2007.
10 The Company’s February 23, 2009 announcement revealed that the revenue
11 should not have been recognized in December 2007 but in later quarters because
12 the transaction occurred on a “bill and hold” basis and did not meet the
13 requirements for revenue recognition in December 2007. Prior to the February 23,
14 2009 announcement, the Company had not disclosed that it engaged in “bill and
15 hold” arrangement with this transaction—a separate violation of GAAP.
16 11. A “bill and hold” arrangement occurs when a seller charges a buyer
17 for products but retains possession of the goods until they are shipped at a later
18 date. Pursuant to GAAP, revenue is generally recognized under these
19 arrangements when goods are shipped to the buyer or to a designated location
20 selected by the buyer and the other elements of revenue recognition are satisfied,
21 including among other things, the risk of loss has passed to the buyer and
22 collectability is reasonably assured. Additionally, to record a “bill and hold”
23 transaction as revenue under GAAP, the buyer, not the seller, must request that the
24 transaction be on a “bill and hold” basis, and the buyer must have a substantial
25 business purpose for ordering the goods on a “bill and hold” basis. None of these
26
27 3 The Company’s announcements interchangeably use “$1,920,000” and“$2.0 million” in referring to this transaction.
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1 requirements were met. The Company fraudulently induced the customer to back-
2 date a letter to Nutracea’s co-packer requesting a bill and hold arrangement to
3 deceive its auditors, when none in fact existed, solely to inflate Nutracea’s Q4
4 2007 sales figures.
5 12. On April 23, 2009, the Company announced that the scope of the
6 internal investigation was expanded and disclosed that it had discovered more
7 accounting improprieties concerning two additional large transactions.
8 13. The third transaction involved the Company’s improper recognition
9 of $1.6 million4 in revenue on sales of Dr. Vetz PetFlex products in December
10 2006—near the end of the fourth quarter in 2006—to an undisclosed joint venture
11 partner, known as Famous Discoveries. In Q2 2007 the Company recorded an
12 $800,000 reserve for doubtful accounts on the receivable associated with the
13 December 2006 $1.6 million transaction.
14 14. Famous Discoveries entered into a joint venture with Nutracea to
15 sell Dr. Vetz PetFlex products through joint-ownership of Infomaxx LLC
16 (“Infomaxx”), a Delaware company created on December 13, 2006. At the
17 creation of the joint venture, Famous Discoveries owned the trademark Dr. Vetz.
18 Nutracea owned the trademark PetFlex. The purpose of Infomaxx, according to
19 the Company’s 2006 10-K was to “promote infomercials for the marketing of
20 Nutracea’s and [Famous Discoveries’] products.”
21 15. Nutracea and Famous Discoveries created Infomaxx
22 contemporaneous with the improper sale of $1.6 million of Dr. Vetz PetFlex
23 product to Famous Discoveries.
24
25
26 4 The Company’s announcements interchangeably use “$1,551,000” and
27 “$1.6 million” in referring to this transaction.
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1 16. In Q3 2007, the Company reversed the transaction with Famous
2 Discoveries by recording a sales return of $1.6 million. The sales return was a
3 condition of Nutracea’s purchase from Famous Discoveries of its remaining
4 interest in the Infomaxx joint venture.
5 17. The Company’s forensic investigation determined that it had
6 improperly recorded the $1.6 million sale to Famous Discoveries in Q4 2006
7 because at the time Nutracea recorded the sale, there was insufficient evidence that
8 Famous Discoveries had the ability to pay for the goods. Thus, under GAAP, no
9 sale had occurred and no revenue was recognizable.
10 18. According to Nutracea’s April 23, 2009 announcement, the $1.6
11 million sale of Dr. Vetz PetFlex products should have been reversed in 2006
12 instead of 2007 because the Company did not have adequate evidence to conclude
13 that Nutracea could collect the receivable relating to the sale to Famous
14 Discoveries in the quarter in which it was recognized; had insufficient experience
15 in the infomercial market to adequately understand the distribution channel, and
16 the fluctuating nature of sales into this channel or the potential for product return.
17 19. As explained below, this entire transaction with Famous Discoveries
18 was a sham because Nutracea never delivered $1.6 million of Dr. Vetz PetFlex
19 product to Famous Discoveries and the true terms of the transaction were akin to a
20 consignment sale in which no revenue may be recognized under GAAP. Edson
21 knowingly deceived Nutracea’s auditors to believe a true sale on credit, with the
22 buyer promising to pay--had occurred.
23 20. The fourth improper transaction involved the Company’s
24 recognition of $5 million in license fee revenue in June 2007—near the end of Q2
25 2007. In June 2007, the Company granted to Pacific Holdings Advisors Ltd
26 (“PAHL”) a perpetual and exclusive license and distribution rights for the
27 production and sale of stabilized rice bran and related products in Southeast Asia.
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1 The one-time fee was due and payable on the fifth anniversary of the
2 commencement of the rice bran production facility established by PAHL or a joint
3 venture of PAHL and the Company. At the time of the June 2007 grant, the
4 Company and PAHL formed Grain Enhancements, LLC.
5 21. In its April 23, 2009 announcement, the Company admitted that the
6 $5 million of license revenue recognized in June 2007 should never have been
7 recognized and its recognition violated GAAP because it should have been
8 considered as one arrangement with multiple deliverables instead of stand-alone
9 transactions, and because the arrangement had various obligations. As explained
10 herein, this transaction is indicative of a sham “round-trip” transaction because
11 when PAHL paid the Company the $5 million in March of 2008, Nutracea
12 immediately paid the $5 million right back to PAHL through an affiliated
13 company controlled by the same principal shareholder (FFOL) that controls
14 PAHL.
15 22. The Company’s violations of certain straightforward and
16 fundamental provisions of GAAP and violations of its own stated revenue
17 recognition polices had the effect of artificially inflating the Company’s stock
18 price during the Class Period.
19 23. Instead of coming clean about the Company’s accounting
20 improprieties, when asked during an investor conference discussing the
21 Company’s Q3 2007 results and the $800,000 reserve posted for the improper $2.6
22 million transaction, Defendant Crow provided a false reassurance to investors
23 claiming that the reserve was taken because the customer was a slow-paying
24 customer. The reality was that the entire $2.6 million of revenue should not have
25 been recognized from the beginning, as there was no evidence of collectability and
26 because of the related party nature of the transaction.
27
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1 24. By engaging in the accounting fraud, Defendants were able to report
2 “record” results and net income, when in fact the Company had suffered a net loss.
3 The fraudulent misrepresentations also enabled the Company to complete a $20
4 million April 2008 stock offering to raise much needed cash.
5 25. In the midst of the fraud, Defendant Edson received a rare cash
6 incentive bonus in April 2008 that exceeded his entire salary for 2007.
7 26. As a result of the accounting fraud, defendant CEO Edson and
8 defendant CFO Crow were replaced. In addition, the Company had difficulty
9 finding a replacement CFO as two other prior candidates inexplicably resigned or
10 refused to start.
11 27. The SEC initially commenced an informal investigation concerning
12 the specific transactions that are the subject of the restatement. The SEC has since
13 converted the informal investigation into a full-blown formal SEC investigation –
14 demonstrating the seriousness of Defendants’ accounting fraud.
15 28. As a result of the Company’s disclosure that its financial statements
16 cannot be relied on and must be restated, the NASDAQ has delisted the
17 Company’s stock from trading on the NASDAQ Bulletin Board.
18 29. The Company’s internal investigation, which has already been
19 expanded once after the discovery of additional accounting improprieties, is
20 ongoing. To date, the Company has cautioned that the internal investigation could
21 yield additional accounting errors and improprieties.
22 30. When the truth of Defendants’ accounting fraud began to enter the
23 market on February 23, 2009, the price of Nutracea’s securities fell over 29%
24 damaging Plaintiffs and the Class.
25 JURISDICTION AND VENUE
26 31. The federal claims herein arise under Section 10(b) and 20(a) of the
27 Exchange Act (15 U.S.C. §78j(b) and §78t(a)) and Rule 10-b5 promulgated
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1 thereunder (17 C.F.R. §240.10b-5). The Arizona securities claims arise under
2 A.R.S. § 44-1991(A)(3), §44-2003(A) and §44-1999.
3 32. This Court has jurisdiction over the subject matter of the federal
4 claims pursuant to §27 of Exchange Act (15 U.S.C. §78aa) and 28 U.S.C. § 1331
5 as a substantial part of the conduct complained of herein occurred in this District.
6 33. The Court has jurisdiction over the subject matter of the Arizona
7 claims pursuant to 28 U.S.C. § 1332(d) because the matters in controversy in this
8 civil class action exceed $5 million exclusive of interest and costs, at least one
9 class member is a citizen of a state different than any of the Defendants, and it is
10 believed there are hundreds if not thousands of potential class members.
11 34. The Court also has supplemental jurisdiction over the Arizona
12 claims pursuant to 28 U.S.C. § 1367(a) because the Court has original jurisdiction
13 over the federal claims under 28 U.S.C. § 1331 and the Arizona and federal claims
14 arise from a common nucleus such that the claims would ordinarily be tried
15 together.
16 35. In connection with the acts, conduct and other wrongs alleged
17 herein, Defendants either directly or indirectly used the means and
18 instrumentalities of interstate commerce, including but not limited to, the United
19 States mails, interstate telephone communications and the facilities of the national
20 securities exchange.
21 PARTIES
22 36. Court-appointed Lead Plaintiff Harvey Pensack, a resident of
23 University Park, Florida purchased Nutracea securities during the Class Period and
24 has suffered damages as a result. Lead Plaintiff’s certification, previously filed
25 with the Court, is incorporated herein.
26 37. Named plaintiff Jennifer Burritt, a resident of Long Meadow,
27 Massachusetts, purchased Nutracea securities during the Class Period and has
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1 suffered damages as a result. Her certification, previously filed with the Court, is
2 incorporated herein.
3 38. Named plaintiff Jose Medrano, a resident of La Feria, Texas,
4 purchased Nutracea securities during the Class Period and has suffered damages as
5 a result. His certification, previously filed with the Court, is incorporated herein.
6 39. Defendant Nutracea is a California corporation with its principal
7 executive offices located at 5090 N. 40th Street, Suite 400, Phoenix, Arizona.
8 40. Nutracea, through wholly owned subsidiaries, engages in the
9 manufacture, development and marketing of nutraceuticals and related food
10 products.
11 41. Nutracea claims to preserve naturally, through its proprietary
12 stabilizations processes, the nutritional content of rice bran that otherwise would
13 be lost through the rice milling process or the passage of time. Nutracea’s rice
14 bran is used in a variety of products including nutritional supplements, baked
15 goods, energy bars, animal feed and pet food.
16 42. During the Class Period the Company’s common stock was actively
17 traded on the NASDAQ Bulletin Board under ticket “NTRZ.OB.” The
18 Company’s stock was delisted from the Bulletin Board on May 5, 2009.
19 43. Defendant Bradley D. Edson (“Edson”) during the Class Period was
20 the Company’s Chief Executive Officer, President and a member of the board of
21 directors. As a result of his misconduct in connection with the restatement of the
22 financial statements, Edson was forced to resign from his positions with the
23 Company on March 10, 2009.
24 44. Defendant Todd C. Crow (“Crow”) at all relevant times herein was
25 the Company’s Chief Financial Officer. While Crow attempted to resign as the
26 Company’s CFO in March 2008 following the filing of the Company’s 10-K for
27 2007, and again on April 23, 2008, his proposed replacements refused to assume
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1 the CFO role or left the Company. Eventually, on November 6, 2008, the
2 Company was able to find a willing replacement for Crow in Olga Hernandez-
3 Longan. Ms. Hernandez-Longan, however, inexplicably resigned in July 2009.
4 45. Edson and Crow are collectively referred to hereinafter as the
5 “Individual Defendants.”
6 46. It is appropriate to treat the Individual Defendants as a group for
7 pleading purposes and to presume that dissemination of the false, misleading and
8 incomplete information conveyed in the Company’s public filings, press releases
9 and other publications as alleged herein is the result of collective actions of the
10 narrowly defined group of defendants identified above. Each of the above officers
11 and directors of Nutracea and its subsidiaries and affiliates, by virtue of his
12 position with the Company, directly participated in the management of the
13 Company, were directly involved in the day-to-day operations of the Company at
14 the highest levels, and were privy to confidential proprietary information
15 concerning the Company and its business, operations, growth, financial
16 statements, and financial condition, as alleged herein. Said Defendants were
17 involved in drafting, producing, reviewing and/or disseminating the false and
18 misleading statements and information alleged herein, were aware, or recklessly
19 disregarded, that the false and misleading statements regarding the Company were
20 being issued, and approved or ratified these statements, in violation of the federal
21 securities laws.
22 CONFIDENTIAL WITNESSES
23 47. Confidential Witness No. 1 (“CW1”) is a founder and CEO of
24 Famous Discoveries. CW 1 on behalf of Famous Discoveries primarily negotiated
25 on behalf of Famous Discoveries with defendant Edson about the terms of the
26 purported $1.6 million dollar sale of Dr. Vetz PetFlex products to Famous
27 Discoveries that was made in December of 2006.
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1 48. Confidential Witness No. 2 (“CW2”) is a founder and President of
2 Famous Discoveries. CW2 was also involved in negotiations on behalf of Famous
3 Discoveries with defendant Edson concerning the $1.6 million sale and other
4 transactions solicited by Edson.
5 49. Confidential Witness No. 3 (“CW3” ), is a third-party percipient
6 witness, that personally spoke to Robert Maihos, an officer, director and 50%
7 owner of ITV Direct, Inc. and Direct Marketing Concepts5 about matters related to
8 the Q4 2007 $2.0 million bill and hold transaction. ITV was the customer for the
9 improper $2.0 million bill and hold sale transaction.
10
11 PERTINENT GAAP GUIDELINES
12 50. During the Class Period, each financial statement issued by the
13 Company stated that Nutracea’s financial statements conformed with GAAP, the
14 uniform rules, conventions and procedures that define accepted accounting
15 practices. As set forth in Statement of Financial Accounting Concepts (“SFAC”)
16 No. 1, Objectives of Financial Reporting by Business Enterprises, one of the
17 fundamental objectives of financial reporting is to provide accurate and reliable
18 information concerning an entity’s financial performance. Specifically:
19Financial reporting should provide information about
20 an enterprise’s financial performance during a period.
21Investors and creditors often use information about thepast to help in assessing the prospects of an enterprise.
22 Thus, although investment and credit decisions reflectinvestors’ and creditors’ expectations about future
23 enterprise performance, those expectations are24
25 5 ITV, ITV Direct, and Direct Marketing Concepts were affiliates of each
26 other, shared the same office address, and had overlapping management. Maihos
27 at all relevant times was a control person of ITV.
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1 commonly based at least partly on evaluations of past
enterprise performance.2
3 SFAC No. 1, ¶ 47.
4 51. The SEC requires that public companies prepare and file quarterly
5 and annual financial statements in conformity with GAAP. SEC Rule 4-01(a) of
6 Regulation S-X states that “[f]inancial statements filed with the Commission
7 which are not prepared in accordance with generally accepted accounting
8 principles will be presumed to be misleading or inaccurate.” 17 C.F.R. § 210.4-
9 01(a)(1) (emphasis added).
10 52. Management retains responsibility for preparing financial statements
11 that conform with GAAP. The American Institute of Certified Public Accountants
12 (“AICPA”) Professional Standards provide:
13
14The financial statements are management’sresponsibility . . . Management is responsible for
15 adopting sound accounting policies and forestablishing and maintaining internal controls that will,
16 among other things, record, process, summarize, and
17 report transactions (as well as events and conditions)consistent with management’s assertions embodied in
18 the financial statements. The entity’s transactions and
19 the related assets, liabilities, and equity are within thedirect knowledge and control of management. . . .
20 Thus, the fair presentation of financial statements in
21 conformity with generally accepted accountingprinciples is an implicit and integral part of
22 management’s responsibility.
23
24 AIPCA, Professional Standards, vol. 1, AU § 110.02 (1998).
25 53. Restatements are required for material accounting errors that existed
26 at the time financial statements were prepared. See Statement of Financial
27 Accounting (“FAS”) 154, ¶ j.
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1 54. Changes in accounting principles or changes in accounting estimates
2 do not result in a restatement of financial statements, rather such changes result in
3 “retrospective application.” FAS 154, ¶B10. A restatement is “the process of
4 revising previously issued financial statements to reflect the correction of an error
5 in those financial statements.” FAS 154, ¶J.
6 55. An accounting “error” is a term of art and results from, among other
7 things, an error in recognition, measurement, or mistakes in the application of
8 GAAP. SFAS 154, ¶ h.
9 56. Under FAS 154, errors result from (i) mathematical mistakes, (ii)
10 mistakes in application of GAAP, or (iii) oversight or misuse of facts that existed
11 at the time the financial statements were prepared.
12 57. Under GAAP, revenue should not be recognized until it is realized
13 or realizable and earned. SFAC No. 5, ¶¶ 83-84.
14 58. SEC Staff Accounting Bulletin (“SAB”) 104 states that revenue is
15 generally realized or realizable and earned when all the following criteria are met:
16 a. Persuasive evidence of an arrangement exists;
17 b. Delivery has occurred or services have been rendered;
18 c. The seller’s price to the buyer is fixed or determinable; and
19 d. Collectability is reasonably assured.
20 59. When a right of return exists in a sales transaction, Statement of
21 Financial Accounting Standards No. 48 mandates that revenue from a sales
22 transaction to a reseller or customer “shall be recognized at the time of sale only if
23 all of the following conditions are met:”
24 a. “The seller’s price to the buyer is substantially fixed or
25 determinable at the date of sale;
26
27
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1 b. “The buyer has paid the seller, or the buyer is obligated to
2 pay the seller and the obligation is not contingent on the resale of the
3 product;
4 c. “The buyer’s obligation to the seller would not be changed in
5 the event of theft or physical destruction or damage of the product;
6 d. “The buyer acquiring the product for resale has economic
7 substance apart from that provided by the seller;
8 e. “The seller does not have significant obligations for future
9 performance to directly bring about resale of the product by the buyer.
10 f. “The amount of future returns can be reasonably estimated
11 (paragraph 8).”
12
13“Sales revenue and costs of sales that are not recognized at the time of salebecause the foregoing conditions are not met shall be recognized either
14 when the return privilege has substantially expired or if those conditions
15subsequently are met, whichever occurs first.” FAS no. 48, ¶ 6.
1660. Under a “bill and hold” arrangement, the seller of goods bills a
17 customer for products but does not ship the products until a later date. According
18 to SAB 104, revenue may be recognized on a “bill and hold” arrangement only
19 when delivery of the product is made to the purchaser’s place of business or
20 another site specified by the purchaser and the other general GAAP requirements
21 for revenue recognition are met. In order to comply with GAAP when delivery
22 has not occurred in a “bill and hold” arrangement, under SAB 104 revenue cannot
23 be recognized until:
24a. the risks of ownership must have passed to the buyer;
25b. the customer must have made a fixed commitment to
26purchase the goods, preferably in written documentation;
27
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1 c. the buyer, not the seller, must request that the transaction be
2 on a “bill and hold” basis;
3 d. the buyer must have a substantial business purpose for
4 ordering the goods on a “bill and hold” basis;
5 e. there must be a fixed schedule for delivery of the goods;
6 f. the date for delivery must be reasonable and must be
7 consistent with the buyer's business purpose (e.g., storage periods are
8 customary in the industry);
9 g. seller must not have retained any specific performance
10 obligations such that the earning process is not complete;
11 h. the ordered goods must have been segregated from the seller's
12 inventory and not be subject to being used to fill other orders; and
13 i. the equipment [product] must be complete and ready for
14 shipment.
15 61. Pursuant to SAB 104, “[i]f a company has different policies for
16 different types of revenue transactions ... the policy for each material type of
17 transaction should be disclosed.”
18 62. The Company stated publicly that the Company complied with its
19 revenue recognition policies and GAAP. Specifically, the Company’s Form 10-K
20 filed with the SEC on April 2, 2007 states that: (i) “[r]evenues from product sales
21 are recognized when products are shipped and when risk of loss has transferred to
22 buyer. Deposits are deferred until either the product has shipped or conditions
23 relating to sale have been substantially performed”; (ii) as to purchase orders with
24 multiple deliveries, the Company stated that each delivery “is generally considered
25 to be a separate unit of accounting for the purpose of revenue recognition and, in
26 all instances, persuasive evidence of .... collectability, must be determined or
27 accomplished...” (emphasis added); and (iii) as to grants of exclusive use of the
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1 Company’s labels in specific territories, the Company stated it follows EITF-00-
2 21 Revenue Recognition with Multiple Deliverables, and confirmed that the
3 Company follows SAB 104 in recognizing revenue. Nearly identical disclosures
4 were contained in the Company’s 10-K filed with the SEC on March 17, 2008.
5 SUBSTANTIVE ALLEGATIONS OF FRAUD
6 A. Defendants Engaged in a Series of Accounting Improprieties Designed
7 to Inflate the Company’s Financial Results in Violation of GAAP and
8 the Company’s Own Stated Accounting Policies
9 63. The Company failed to satisfy the criteria established under SAB
10 104. The $2.6 million in revenue it recorded in Q2 2007 for the sale of Dr. Vetz
11 PetFlex products should not have been recorded because there was no evidence of
12 collectability and the down payment for the sale was provided by a related party –
13 a Company consultant who is also a former officer of the Company. As disclosed
14 in the Company’s February 23, 2009 and April 23, 2009 announcements, the
15 recognition of the $2.6 million revenue was “improper”, must be reversed, and all
16 associated financial statements restated because the applicable criteria for revenue
17 recognition were not met. The February 23, 2009 announcement revealed that the
18 $1 million deposit received in connection with the sale was provided to the
19 purchaser from a consultant to and former officer of the Company.
20 64. The Company also recorded a $1 million liability on its balance
21 sheet pending its resolution of “certain issues relating to the $1 million.”
22 65. In addition to the suspicious circumstances surrounding the
23 previously undisclosed related party nature of the $2.6 million sale (it was funded
24 by a consultant and former Nutracea officer), the Company also violated its own
25 stated revenue recognition policy that required deferral of revenue from down-
26 payments for sales of items that had not been shipped or were subject to
27 conditions relating to the sale that had not yet been substantially performed.
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1 66. The Company failed to satisfy SAB 104 with respect to the $2
2 million of revenue recorded on the purported sale of RiceNShine product near the
3 end of Q4 and FY 2007, as it was an improper “bill and hold” transaction. The
4 Company admitted in its February 23, 2009 announcement that the sale “did not
5 meet the accounting requirements for recognition of revenue in bill and hold
6 transactions and that the transaction should not have been recognized as revenue
7 in the Company’s 2007 results.”
8 67. Additionally, Nutracea’s recognition of this transaction as revenue in
9 December 2007 was done in a fraudulent manner. In June 2006, CW3 had a
10 telephone call with Robert Maihos of ITV. During the call, Mr. Maihos made the
11 following representations to CW3 about the nature of the $2 million sale Nutracea
12 recorded in Q4 2007:
13 a. ITV ordered approximately 150,000 of RiceNShine (“RnS”)
14 from Nutracea in the 4th quarter of 2007.
15 b. The order was for fully completed individual units of a new
16 30 serving size of RnS and totaled approximately $2 million.
17 c. ITV maintains their own warehouse facilities and there was
18 no business reason to have Nutracea or their co-packer (Innovative Health
19 Products “IHP”) to hold units in storage for them or otherwise fail to ship
20 the full order as soon as it was produced.
21 68. Mr. Maihos made the following statements to CW3 during the
22 telephone call, which clearly show that Nutracea knowingly and falsely recorded
23 the revenue in Q4 2007 by manufacturing a bill and hold transaction.
24 a. ITV received the 1 st units of their order in January 2008. In
25 February 2008 Nutracea informed ITV that an ingredient in the formulation
26 was out of stock and Nutracea would not be able to continue to produce
27 units for a period of several weeks.
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1 b. IHP suffered another production problem in April 2008
2 involving spoilage of IHP’s stored inventory of the key ingredient that
3 came from Nutracea. This caused an additional delay as Nutracea and IHP
4 resolved which of those two parties bore responsibility and the cost of
5 replacement.
6 c. Maihos stated that ITV did not receive any RnS shipments in
7 February 2008, and the next shipments came in early March 2008.
8 Shipments then periodically arrived into June and the order had still not
9 been filled in total as of the date of the June 2008 telephone call.
10 d. In latter half of December of 2007 an executive of Nutracea
11 emailed to Maihos a letter and asked him to sign it and send it to IHP. The
12 letter was prepared by Nutracea. The letter sought to have ITV make
13 certain knowingly false claims related to the order and to have ITV falsely
14 represent their recognition that their order had been completed to
15 specification in 2007 and that ITV requested the units be held in storage by
16 IHP into 2008 (the “Bill and Hold Letter”).
17 e. Because Maihos had not signed the letter as requested by
18 Nutracea, Maihos was once again contacted by a Nutracea executive in
19 February 2008 asking him to sign the Bill and Hold Letter. Following this
20 second request by Nutracea, Mr. Maihos executed a copy of the letter and
21 back-dated the letter to December 2007 at the request of Nutracea, and sent
22 the Bill and Hold Letter to IHP.
23 f. The RnS production problems (described above) disrupted
24 ITV’s business as it had to place new customer orders on backorder and
25 accordingly were unable to “up-sell” the more profitable expedited
26 shipment options.
27
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1 g. Maihos stated that under no circumstances did ITV have any
2 liability to Nutracea or IHP for this RnS order until the finished product
3 was manufactured to specification and made available to them and ITV had
4 no liability to IHP related to the order.
5 69. These representations are corroborated by an email issued by ITV to
6 certain of its members on February 22, 2008. That email, which is posted on a
7 website forum named ITV Ventures, on the same date, states as follows:
8 FRIDAY, FEBRUARY 22, 20089
10New Rice ‘n Shine® is Out of Stock
11 Due to amazing demand of the new 30-day supply ofRice ‘n Shine®, we are currently backordered on all
12 flavors. We anticipate receiving new inventory within
13 approximately 2 weeks. Unfortunately, due tomanufacturer’s limitations we cannot provide a more
14 specific date at this time. Please be assured we will
15 ship your order as soon as we receive inventory.
16 While the option of cancelling this order is available to
17 you up until the date the product ships, it’s importantto know that any items that do not ship due to a
18 backorder situation will not negatively affect your
19 OAP or monthly volume levels. However, ordercancellations may affect these things.
20
21 If you have any questions please send an e-mail [email protected] .
22
23 We apologize for any inconvenience this may cause.
24 Sincerely,
25The ITV VenturesTM Team
26
27
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1 http://ventures.fallback.com/phpbb/viewtopic.php?p=337&sid=7c5c3ef3f4
2 d9741883fac24c1bd4e308
3 70. The Company also violated SAB 104 for the $2.0 million bill and
4 hold transaction because SAB 104 required Nutracea to disclose, and it never did
5 disclose, its practice of recognizing revenue for bill and hold arrangements.
6 71. Not until August 11, 2008, when the Company filed its Form 10-Q
7 for Q3 2008, did the Company reveal that it had engaged in “bill and hold”
8 arrangements. Through its initial omission, the Company led investors to believe
9 that it had not engaged in such arrangements in prior periods.
10 72. The Company violated GAAP mandates of SAB 104 and FAS 48
11 with respect to the $1.6 million in revenue Nutracea recorded in connection with a
12 purported sale of Dr. Vetz PetFlex products to Famous Discoveries in December
13 2006 near the end of Q4 and FY 2006. The Company admitted in its April 23,
14 2009 announcement that it had “improperly accounted for” this transaction
15 because the Company did not have sufficient evidence as to the collectability of
16 the sale, was too inexperienced in the infomercial market to adequately understand
17 the distribution channel, could not account for the customer’s fluctuating sales,
18 and was not sufficiently aware of the potential of product return.
19 73. The Company also violated SAB 104 in this regard because it never
20 disclosed its revenue recognition policy with respect to transactions in which there
21 was a right of return. The only mention of a right of return with respect to revenue
22 recognition was selectively disclosed in the Company’s August 11, 2008 10-Q.
23 However, even there the right of return was mentioned only in connection with
24 “bill and hold” arrangements.
25 74. The December $1.6 million transaction with Famous Discoveries
26 was also a sham. According to CW 1 (the CEO and one of the founders of Famous
27 Discoveries) CW 1 was the person that primarily engaged in negotiating the
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1 arrangement. CW 1 states that Famous Discoveries did not commit to buy or take
2 delivery of $1.6 million worth of Dr. Vetz PetFlex products. According to CW 1,
3 the true nature of Famous Discoveries’ arrangement with Nutracea merely allowed
4 Famous Discoveries to market the Dr. Vetz PetFlex product in an effort to obtain
5 firm purchase orders from customers. Once firm purchase orders were obtained
6 by Famous Discoveries or payment was made to Famous Discoveries from its
7 customers, Nutracea would ship the Dr. Vetz PetFlex products to Famous
8 Discoveries so that Famous Discoveries could ship the products to its customers
9 when Famous Discoveries was paid. According to CW 1 the $1.6 million of Dr.
10 Vetz PetFlex products were never shipped to Famous Discoveries. Rather the
11 product was stored at a warehouse under the full control of Nutracea.
12 75. CW 1 explained that Famous Discoveries had no obligation to
13 purchase the product if Famous Discoveries was unable to sell the Dr. Vetz
14 PetFlex product and had “no risk” associated with the arrangement.
15 76. CW 1 stated that he negotiated the terms of this arrangement with
16 defendant Edson.
17 77. CW 1 stated that Famous Discoveries’ business model did not call
18 for Famous Discoveries to take on large amounts of inventory prior to Famous
19 Discoveries either receiving a firm purchase order from a customer or payment
20 from a customer.
21 78. CW2, another founder of Famous Discoveries and its President,
22 confirmed that CW 1 had primarily engaged in negotiations with defendant Edson
23 and that the purported $1.6 million arrangement was CW 1’s responsibility.
24 79. CW2, further stated he was involved in certain negotiations with
25 Edson for additional potential purchases of product from Nutracea and received
26 various proposals from Edson about Nutracea selling its products to Famous
27 Discoveries at or around the time of the $1.6 million transaction. During CW2’s
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1 discussions with Edson, CW2 told Edson that Famous Discoveries was a small
2 company and that Famous Discoveries did not want to take on large trade payables
3 for inventory because Famous Discoveries wanted to ensure that its ability to
4 obtain financing for operations was not impeded. Thus, CW2 rejected Edson’s
5 numerous proposals to sell Nutracea product to Famous Discoveries on credit.
6 CW2 confirmed that the terms of the $1.6 million transaction that Nutracea
7 described to its auditors and the public – a $1.6 million sale on credit – are wholly
8 inconsistent with the manner in which Famous Discoveries operated its business at
9 that time.
10 80. Nutracea also violated SAB 104 and EITF-00-21 Revenue
11 Recognition with Multiple Deliverables, which is the same as the Company’s own
12 revenue recognition policy, with respect to $5 million in revenue recognized in
13 June 2007--near the end of Q2 2007. According to the Company’s April 23, 2009
14 announcement, the perpetual and exclusive distribution rights payment of $5
15 million “should have been considered as one arrangement with multiple
16 deliverables instead of stand-alone transactions.” The Company admitted that the
17 recognition of the $5 million license fee “did not qualify as revenue to the
18 Company under Generally Accepted Accounting Principles.”
19 81. Additionally, in this transaction, PAHL paid $5.0 million to
20 Nutracea for a license to market and distribute certain products.
21 Contemporaneously, a Nutracea subsidiary, Medan LLC, purchased capital stock
22 for $10.675 million in two transactions ($8.175mm and $2.5 mm) from of an
23 Indonesian company from Fortune Overeas Ltd. (“FFOL”) and Nutracea recorded
24 the value of the stock on its balance sheet at $10.675 million. FFOL is owned and
25 controlled by PAHL. Essentially, the $5.0 million license fee was immediately
26 returned to PAHL through the purchase of the Indonesian company’s stock. As
27 part of the restatement, Nutracea was forced to write-down the value of the second
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1 stock purchase from $8.175 million to $3.175 million and reverse the $5.0 million
2 license fee revenue it had recorded.
3 B. The Companv Issued False and Misleading Statements of Material
4 Fact Concerning its Business During the Class Period
5 82. Defendants knew or recklessly disregarded numerous facts known to
6 them before and during the Class Period concerning, inter alia, that the
7 Company’s revenue recognition practices did not comply with GAAP, that the
8 Company’s revenue recognition practices did not comply with the Company’s
9 own stated policy of revenue recognition, and that the Company overstated its
10 reported revenue, net income, and understated its net loss for fiscal years
11 December 31, 2006 and 2007 and related interim quarterly periods.
12 Notwithstanding the foregoing, the Defendants made the following materially
13 false and misleading statements of material fact:
14 i. False and Misleading April 2007 Announcements
15 83. The Class Period begins on April 2, 2007 when the Company issued
16 a false and misleading press release entitled “Nutracea Announces Record Fourth
17 Quarter and Record Fiscal Year” referring to those ended December 31, 2006.
18 The announcement reported net income of $778,000 on $5,196,000 of revenue for
19 Q4 2006 and net income before income taxes of $1,585,000 on $18,090,000 of
20 revenue for FY 2006.
21 84. In commenting on the “record” results, defendant Edson is quoted in
22 the press as saying “We are pleased to report our fourth consecutive record quarter
23 and record year, notably our first full year of profitability.”
24 85. In conjunction with the Company’s April 2 press release, that same
25 day the Company filed its annual report for fiscal 2006 on Form 10-K with the
26 SEC that repeated the same net income and revenue amounts for Q4 and FY 2006.
27 The Form 10-K was signed by defendants Edson and Crow and separately
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1 certified by them pursuant to the Sarbanes-Oxley Act of 2002 (“SOX”) attesting
2 that the 10-K did not “contain any untrue statement of material fact or omit to state
3 a material fact necessary to make to make the statements made, in light of the
4 circumstances under which such statements were made, not misleading ....”
5 86. The April 2, 2007 press release and 10-K were materially false and
6 misleading at the time the statements were issued as evidenced by the Company’s
7 April 23, 2009 admission that the Company:
8 a. improperly recorded revenue in violation of GAAP on a $1.6
9 million sale of its Dr. Vetz PetFlex product to Famous Discoveries in
10 December 2006 because the receivable on this sale lacked evidence it was
11 collectable, and because of the Company’s inexperience in the infomercial
12 market to adequately understand the distribution channel, and the
13 fluctuating nature of the sales, and potential for product returns;
14 b. the recognition of such revenue violated the Company’s own
15 revenue recognition and accounting policies as set forth above; and
16 c. consequently, the Company’s “record” revenue for Q4 2006
17 was overstated by $1,551,000 or by 43% and net income before income
18 taxes originally reported in the amount of $778,000 for Q4 2006 was in
19 actuality a net loss of $505,000. The “record” revenue of $18,090,000 for
20 FY 2006 was overstated by $1,551,000 or by 9% and net income before
21 income taxes for FY 2006 was overstated by $1,283,000 or 425%.
22 87. The excuse for this error in the Company’s April 23, 2009
23 announcement is materially false and misleading.
24 a. The December 2006 $1.6 million sale of the product was
25 made to Famous Discoveries. As described above, the true nature of the
26 transaction was a consignment sale in which Famous Discoveries would
27 pay for the goods only if and when it was able to sell them to a customer.
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1 Under GAAP, such a consignment sale did not permit recognition of
2 revenue by Nutracea.
3 b. On April 17, 2006 the Company issued a press release
4 announcing that it had entered into a private label agreement with Famous
5 Discoveries whereby Famous Discoveries would market Nutracea’s
6 PetFlexTM under the brand name Dr. Vetz PetFlex in infomercials, TV
7 shopping channels and retail internet distribution channels. The
8 announcement touted Famous Discoveries’ experience and track record in
9 direct response marketing, and claimed that Famous Discoveries had sold
10 $950 million in products through television alone. Famous Discoveries
11 owned the trademark Dr. Vetz at that time.
12 c. On December 13, 2006, Nutracea created a Nevada
13 Corporation called Nutramercials, Inc. a wholly–owned subsidiary of
14 Nutracea. On the same date, Nutracea and Famous Discoveries entered
15 into a joint-venture by creating a Delaware LLC, called Infomaxx, LLC
16 (“Infomaxx”). The Company and Famous Discoveries each owned 50% of
17 Infomaxx.
18 d. According to the Company’s 2006 10-K, Infomaxx was
19 created to promote infomercials for the marketing of Nutracea’s and
20 Famous Discoveries’ products in, among other things, infomercials.
21 e. The Company’s excuse that it did not have sufficient
22 experience in the infomercial market as a reason for the restatement was
23 false and misleading. Famous Discoveries was an expert in the infomercial
24 market and the Company had a distribution agreement with them dating
25 back to April 2006. Additionally, over 50% of Nutracea’s sales in 2006
26 were made to ITV, another infomercial customer. Nutracea was also in the
27 infomercial market with its relationship with ITV dating back to August of
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1 2005. In 2005 ITV accounted for 54% of the Company’s revenues, and in
2 2006 ITV accounted for 45% of the Company’s revenues. Thus,
3 Defendants’ excuse that it did not have experience in the infomercial
4 market was false.
5 f. The Company’s excuse that it did not have adequate evidence
6 to determine its joint venture partner Famous Discoveries could pay the
7 $1.6 million receivable at the time of the sale was false as the Company
8 certainly had access to information concerning Famous Discoveries’
9 financial condition when it entered into the Infomaxx joint venture with
10 Famous Discoveries in December 2006—the same month the $1.6 million
11 sale was recorded as revenue, and months before when it entered into the
12 private label agreement with Famous Discoveries in April of 2006.
13 Moreover, as explained above, the true nature of the transaction was a
14 consignment sale. Under GAAP, the revenue was not recognizable by
15 Nutracea for the consignment sale regardless of Famous Discoveries
16 ability to pay, as Famous Discoveries was not obligated to ever pay for the
17 goods unless and until it has sold the goods to a customer and received
18 payment. According to CW2, he told Edson at the time of the $1.6 million
19 transaction that Famous Discoveries was a small company and did not want
20 to take on large payables as it would impede its ability to obtain financing
21 for operations.
22 88. Following these false earnings announcements, on April 11, 2007
23 the Company announced that its Chief Operating Officer Ike Lynch resigned from
24 the Company, but would remain a consultant to the Company.
25
26 ii. False and Misleading May 2007 Statements
27
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1 89. On May 15, 2007 the Company issued a false and misleading press
2 release entitled “Nutracea Announces First Quarter Results” relating to the period
3 ended March 31, 2007. The Company reported a net loss before income taxes of
4 $247,000 on $2 million in revenue for Q 1 2007.
5 90. In conjunction with the Company’s May 15, 2007 press release, that
6 same day the Company filed its Q1 2007 results with the SEC on Form 10-Q
7 containing the same net income and revenue for Q1 2007. The 10-Q was signed
8 by defendants Edson and Crow and separately certified by them pursuant to SOX,
9 attesting that the 10-Q did not “contain any untrue statement of material fact or
10 omit to state a material fact necessary to make to make the statements made, in
11 light of the circumstances under which such statements were made, not misleading
12 ....”
13 91. The Company admitted in its April 23, 2009 announcement that its
14 Q1 2007 financial results should not be relied upon and had to be “restated.”
15 Thus, the Company’s Q 1 2007 10-Q and related public announcements were false
16 when made.
17 92. The May 15, 2007 press release provides a false excuse why the
18 Company’s first quarter revenue and income did not meet its prior publicly
19 announced estimates. The press release states in relevant part:
20
21The shortfall in revenues was primarily attributable to$2.6 million of purchase orders for product we
22 produced from three new customers, for which we did
23not recognize revenues for reasons including thetiming of the acceptance of delivery by customers and
24 product labels not being completed by the third partyco-packer. We anticipate that this revenue will be
25 recognized in the second quarter.
26 93. Defendant Edson also falsely reassured investors in the same press27 release that the revenue shortfall was merely the result of timing. He is quoted as28
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1 saying in relevant part: “Despite the revenue shortfall, which should be viewed as
2 a timing issue, ...”
3 94. The Company Q1 2007 10-Q also provided similar false
4 reassurances. The 10-Q states in relevant part:
5
6 During quarter ended March 31, 2007 we received
$2,600,000 of purchase orders for product that we
7 produced for to three [sic] new customers but we did
8 not recognize revenues for reasons including the
timing of the acceptance of delivery by the customers
9 and labels not being completed by the third-party co-packer. The labeling is the responsibility of the
10 customer. We anticipate recognizing the revenue from
11 these orders in the second quarter of 2007 when we
12receive payment.
1395. During the May 16, 2007 earnings conference call, Defendant Edson
14 falsely reassured investors that he communicated with the Company’s auditors
15 about the Company’s revenue recognition polices to ensure the Company’s
16 revenue recognition complied GAAP and no mistakes were made. Edson stated in
17 relevant part:
18 <JONATHAN MORELAND>: Okay, uhhhmm.
19 Lastly, what can be done about this, this uh, timingissue, uh, has anything been done make su... to guard
20 against it happening again in the future, or is it just the
21 way it goes?
22 <BRAD EDSON>: Well, I think it’s an unfortunate
23 issue, and, ah, really caught us off-guard. I, I will tellyou that I take these things very seriously. I had
24 intense discussions with our auditors, and I’m
25 gonna do everything that I can with our accountingstaff to make sure that our paperwork on orders,
26 ah will comply with all of the rules and regulations
27 so that we don’t have a recognition issue, uh,because we obviously wanna book all the revenue
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1 we can in the quarter that we expended the aeh, the
time and the effort and the money, so we’re gonna
2 do everything we can. I understand the importance
3 of it, uhm, you know, people make mistakes, but I
will tell you I usually don’t make a mistake twice.4
5 (emphasis added).
6 96. During the same call Edson falsely reassured investors as follows:
7 ....What I will assure you is that in conjunction with
8 our accountants, we now are every clear on what ourpurchase orders will state, so that there won't be any in
9 the future, any of these revenue recognition items
10 because of some of these intricacies of the accountingrules.
11
1297. Defendants’ May 2007 reassurances were false. As reported by the
13 Company in its February 23, 2009 8-K, this $2.6 million in revenue should have
14 not been recorded because there was no evidence supporting the purchaser’s
15 ability to pay and because of the related party nature of the transaction.
16 Defendants manufactured the $2.6 million sale a as a desperate measure to meet
17 the Company’s revenue and income projections. Additionally, Edson’s
18 reassurance that he did not make a mistake “twice” and that he was intensely
19 involved in ensuring revenue is properly recorded evidences his culpability in
20 improperly recording the $2.6 million of false revenue. The February 23, 2009 8-
21 K states in relevant part:
22 The Company recognized revenue in the second
23 quarter of 2007 on a $2.6 million sale of its Dr. VetzPetFlex brand product with respect to which the
24 applicable criteria for revenue recognition were not
25 met. Based upon facts discovered during the AuditCommittee investigation, the Company has now
26 concluded that a $1.0 million down payment
27 received by the Company in that transaction wasprovided to the purchaser through a loan from a
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1 person who at the time was a consultant to and a
former officer of NutraCea, and that the evidence
2 originally relied upon to determine and support the
3 purchaser’s ability to pay the remaining $1.6
million receivable balance was subsequently
4 determined to be inaccurate.
5 (emphasis added).
6 98. The $2.6 million sale should never have been recorded as revenue.
7 The February 23, 2009 8-K states in relevant part:
8Based on the findings of the Audit Committee's
9 investigation to date, the Company currently estimates
10 that $4.6 million of the approximately $22.2 million ofpreviously reported revenue for 2007 is expected to be
11 affected by the restatement. With respect to the
12 transaction in the second quarter of 2007, approximately $2.6 million of the adjustment is not
13 expected to be recorded as revenue. However, with
14 respect to the Company’s reported results for the 2007year, when the purchaser did not pay the $1.6 million
15 receivable balance, the Company established an
16 $800,000 reserve against the receivable balance in thethird quarter of 2007 and an additional reserve of
17 $800,000 in the fourth quarter of 2007. That reserve is
18 expected to be reversed, which would reduce theCompany’s reported expense for 2007 by $1.6 million.
19 * * * *
20 The Company preliminarily estimates that theadjustments will also .... (iii) reflect a deferred
21 liability of $1.0 million pending resolution of
22 certain issues relating to the $1.0 million downpayment provided in connection with the Dr. Vetz
23 PetFlex transaction in the second quarter of 2007
24 which the Company has determined no revenueshould have been recognized.
25(emphasis added).
2699. According to the Company’s April 23, 2009 announcement
27concerning the accounting entries for the restatement of this transaction, the
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1 company simultaneously increased and decreased the costs of good sold for this
2 transaction by $557,000. Essentially, the Company determined that the products
3 that were purportedly sold were now worthless and wiped them from its books,
4 along with the $2.6 million in revenue.
5 iii. False and Misleading August 2007 Statements
6 100. On August 14, 2007 the Company issued a false and misleading
7 press release entitled “Nutracea Announces Record Second Quarter and Six
8 Months” for the period ended June 30, 2007. The announcement reported for Q2
9 net income before income taxes of $2,087,000 on Q2 revenue of $12,996,000.
10 The press release noted these figures represented year over year gains from the
11 prior periods that had reported Q2 2006 net income of only $399,000 and Q2 2006
12 revenue of $4,166,000.
13 101. The Q2 2007 revenue and net income also returned the Company to
14 profitability for the six months ended June 30, 2007 which was also reported in
15 the announcement. For the six months ended June 30, 2007, the Company
16 reported revenue of $14,993,000 and net income before income taxes of
17 $1,840,000.
18 102. In the press release, Defendant Edson commented that “Nutracea has
19 delivered a solid quarter of sales growth and initiatives.”
20 103. In conjunction with the Company’s August 14, 2007 press release,
21 the Company had filed its Q2 2007 results on Form 10-Q with the SEC three days
22 earlier on Saturday August 11, 2007. The 10-Q contained the same false revenue
23 and income numbers as the press release. The 10-Q was signed by defendants
24 Edson and Crow and separately certified by them pursuant to SOX, attesting that
25 the 10-Q did not “contain any untrue statement of material fact or omit to state a
26 material fact necessary to make to make the statements made, in light of the
27 circumstances under which such statements were made, not misleading ....”
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1 104. The August 14, 2007 press release and corresponding 10-Q were
2 materially false and misleading at the time issued as evidenced by the Company’s
3 April 23, 2009 announcement which revealed that the Company:
4 a. improperly recorded revenue in violation of GAAP and the
5 Company’s revenue recognition policy because both required the $5
6 million license fee received from the PAHL to be treated a one transaction
7 with multiple deliverables and because the arrangement had various
8 obligations the as set forth above;
9 b. improperly recorded revenue in violation of GAAP and the
10 Company’s revenue recognition policy in recording $2.6 million sales of
11 Dr. Vetz PetFlex products due to the lack of evidence of collectability and
12 the related party nature of the transaction as set forth above;
13 c. the Company’s failure to disclose its revenue recognition
14 policy for product sales that had a right of return in violation of GAAP; and
15 d. consequently, the Company’s reported revenue for Q2 2007
16 was overstated by $7.6 million or 141%. Net income before income taxes
17 for Q2 was overstated by at $6,801,000 or 144% and turned the originally
18 reported net income before income tax of $2,087,000 to a net loss before
19 income tax of $4,714,000. For the six months ended Q2 2007, revenue was
20 overstated by $7.6 million or 103% and the Company originally reported
21 net income before income taxes $1,840,000 was in reality a net loss before
22 income tax of $4,961,000— an overstatement of $6,801,000 or 137%.
23 iv. False and Misleading November 2007 Statements
24 105. On November 14, 2007, during an investor conference call
25 concerning the Company’s Q3 ended September 30, 2007 financial results,
26 defendant Crow provided investors false reassurances as to the legitimacy of the
27 Company’s $2.6 million of revenue recognized in the Q2 2007 for its sale of Dr
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1 Vetz PetFlex products. A question was posed by an analyst as to the Company’s
2 provision for $800,000 in doubtful accounts as follows:
3<Michelle Stein> And also, where does the $800,000
4provision for doubtful accounts come from?
5<Todd Crow> That was – we have a customer that
6 essentially is a slow paying customer and keeping
7 compliance with our collection policy if it’s a slow payand it’s not meeting the terms of agreed payment
8 schedules then we establish a 50% reserve.9
<Michelle Stein> And what was the reason for the
10 slow pay, was everything delivered, or is it simply –11
<Todd Crow> Everything [sic] was delivered, several
12 inquiries were made, but there was a lack of response
13 from that particular customer at our reporting time asto when we’ll start to receive payments on that trade
14 receivable.
15 106. Crow’s statement about a slow paying customer was knowingly
16 false and misleading. The reality was that there was no evidence supporting the
17 customer’s ability to pay, not that the customer was slow to pay. As explained
18 above, this $800,000 reserve should have never been recorded because the
19 underlying revenue should not have been recorded in the first place in Q2 2007
20 because of the related party nature of the transaction and the fact that there was no
21 evidence of collectability at that time.
22 107. On November 14, 2007 the Company issued a false and misleading
23 press release entitled “Nutracea Announces 2007 Third Quarter and Nine Month
24 Financial Results” for the period ended September 30, 2007. The announcement
25 reported revenue for the nine months ended Q3 2007 of $16.5 million and a net
26 loss before income taxes of $3 million.
27
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1 108. In conjunction with the Company’s November 14, 2007 press
2 release, that same day the Company filed its Q3 2007 financial statements on
3 Form 10-Q with the SEC that repeated the same net loss and revenue numbers for
4 the nine months ended September 30, 2007. The 10-Q was signed by defendants
5 Edson and Crow and separately certified by them pursuant to the SOX attesting
6 that the 10-Q did not “contain any untrue statement of material fact or omit to state
7 a material fact necessary to make to make the statements made, in light of the
8 circumstances under which such statements were made, not misleading ....”
9 109. The November 14, 2007 press release and corresponding 10-Q were
10 materially false and misleading because the cumulative results for the nine months
11 ended September 30, 2007 included the inflated revenue and net income reported
12 by the Company in Q2 2007 as set forth above. After taking into consideration the
13 Q2 2007 misstatements, revenue for the nine months ended September 30, 2007
14 was overstated by $6,050,000 or 58%. Net loss before income taxes for the nine
15 months ended September 30, 2007 was understated by $5,518,000 or 65%.
16 v. False and Misleading March 2008 Statements
17 110. On March 17, 2008 the Company filed its Q4 and FY ended
18 December 31, 2007 financial results on Form 10-K with the SEC. For the fiscal
19 year ended 2007 the Company’s net loss before income before income tax of
20 $11,891,000 on revenue of $22,161,000. For Q4 2007, the 10-K reported revenue
21 of $5,648,000 and a net loss of $8,882,000.
22 111. The Form 10-K was signed by defendants Edson and Crow and
23 separately certified by them pursuant to SOX, attesting that the Form 10-Q did not
24 “contain any untrue statement of material fact or omit to state a material fact
25 necessary to make to make the statements made, in light of the circumstances
26 under which such statements were made, not misleading ....”
27
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1 112. The March 17, 2008 10-K was materially false and misleading at
2 the time the statements were issued as evidenced by the Company’s February 23,
3 2009 and April 23, 2009 announcements which revealed that the Company:
4 a. improperly recorded $1,920,000 million revenue on “bill and
5 hold” arrangement from the sale of RiceNShine product to ITV during Q4
6 2007 in violation of GAAP;
7 b. failed to disclose it was employing a “bill and hold” revenue
8 recognition policy in violation of GAAP;
9 c. as set forth above, improperly recorded revenue, in violation
10 of GAAP and Company policy, for the $5 million of license revenue from
11 PAHL and the $2.6 million sale; and
12 d. consequently, the Company’s reported revenue for FY 2007
13 were overstated by $7,970,000 or 56% and net loss before income taxes
14 was understated by $5,354,000 or 31%. Q4 2007 revenue was overstated
15 by $1,920,000 or by 52%.
16 113. As explained above in detail, in latter half of December of 2007 an
17 executive of Nutracea prepared and emailed to Robert Maihos of ITV the Bill and
18 Hold Letter asking Maihos to sign it and send it to IHP. The letter sought to have
19 ITV make certain knowingly false claims related to the order and to have ITV
20 falsely represent their recognition that their order had been completed to
21 specification in 2007 and that ITV requested the units be held in storage by IHP
22 into 2008. Because Maihos did not sign the Bill and Hold Letter, a Nutracea
23 executive made a second request in February 2008 asking Maihos to sign the
24 letter. Maihos agreed and back-dated the letter to a date in December 2007 at the
25 request of Nutracea and sent the letter to IHP.
26 114. A day after Crow signed the Company’s annual report as CFO, on
27 March 18, 2008 the Company filed an 8-K with the SEC announcing that effective
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1 March 31, 2008 defendant Crow would resign as the Company’s CFO. The 8-K
2 also noted that on March 14, 2008 the Company had appointed Ken Mueller as
3 CFO effective March 31, 2008.
4 115. Three days later, on March 21, 2008 the Company filed an 8-K/A
5 with the SEC announcing that “Todd Crow has agreed not to resign effective
6 March 31, 2008 and will continue to be chief financial officer for Nutracea until
7 the search for his replacement was completed.” The announcement also stated
8 that Mr. Mueller’s employment agreement would be rescinded because “Mr.
9 Mueller, due to personal reasons, did not commence employment as specified in
10 the Employment Agreement.”
11 116. On April 23, 2008 the Company issued a press release announcing
12 that it had appointed Jeffrey Sanders as CFO to replace defendant Crow effective
13 May 13, 2008. Defendant Crow would remain on as a consultant to assist in the
14 transition. Notably, the effective date of Mr. Sanders appointment as CFO was
15 one day after the Company filed its Q1 2008 results on Form 10-Q, that would
16 have required him to sign that 10-Q and to execute a SOX certification.
17 117. On July 21, 2008 the Company filed a Form 8-K with the SEC
18 announcing that on July 18, 2008 Jeffrey Sanders had formally tendered his
19 resignation as CFO effective July 21, 2008. The 8-K states that Defendant Crow
20 would replace Sanders until a new CFO could be hired because Crow had
21 remained actively employed by Nutracea in connection with financial and
22 accounting matters after Mr. Sanders was initially appointed. According to the 8-
23 K, Mr. Sanders purportedly resigned because the CFO position at Nutracea was
24 not a good fit for him and it was difficult for him to adjust to working in a small
25 company. Mr. Sanders’ resignation occurred less than three weeks before he
26 would have been required to sign and execute a SOX certification for the
27
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1 Company’s Q2 2008 Form 10-Q, which was filed with the SEC on August 11,
2 2008.
3 118. On November 7, 2008 the Company issued a press release stating
4 that defendant Crow had yet again retired as CFO and would be replaced by Olga
5 Hernandez-Longan. According to the corresponding 8-K filed by the Company on
6 November 13, 2008, Crow’s retirement was effective November 6, 2008. The 8-K
7 also disclosed that the Company’s Senior Vice President and Corporate Secretary,
8 Margie Adelman had resigned, effective November 11, 2008.
9 119. On July 15, 2009 the Company announced that effective July 9,
10 2009 its CFO, Olga Hernandez-Longan, had resigned her position effective July
11 31, 2009.
12
13 C. Truth Begins to Emerge
14i. February 23, 2009 Announcements
15120. In the morning of February 23, 2009, before the market opened, the
16 Company issued a press release, and later filed a corresponding 8-K with the SEC,
17 entitled “Nutracea to Restate Financial Statements for 2007 and 2008.” Through
18 the announcement, the public first learned certain details of the accounting fraud
19 to overstate revenue and income. In the announcement, the Company announced
20 for the first time that it would restate its financial statements for the fiscal year
21 ended December 31, 2007 and the associated second, third and fourth quarters of
22 2007, and all of the quarters of 2008. The press release states in relevant part:
23NutraCea to Restate Financial Statements for 2007 and
24 2008
25PR Newswire PHOENIX, Feb. 23
26 Internal Review Indicates Improper Revenue
27Accounting Related to Two Transactions
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1 PHOENIX, Feb. 23 /PRNewswire-FirstCall/ --
NutraCea (OTC Bulletin Board: NTRZ), a world
2 leader in stabilized rice bran (SRB) nutrient research
3 and technology, today announced that based on the
preliminary findings and recommendations of the
4 Audit Committee of its Board of Directors, it willrestate its financial statements for the fiscal year ended
5 December 31, 2007. This includes the associated
6 second, third and fourth quarters in 2007, and all of the
7quarters in 2008.
8 -- NutraCea (the "Company") currently estimates that$4.6 million of the approximately $22.2 million of
9 previously reported revenue for 2007 will be affected
10 by the restatement.
11 -- Approximately $2.6 million of the total adjustment
12 is expected not to be recorded as revenue.
13 -- Approximately $2.0 million of the remaining
14 amount reported as 2007 revenue is expected to bereversed and recorded as revenue during 2008 and
15 possibly 2009.
16
17 121. The announcement also revealed for the first time the existence of an
18 internal review, that the review had commenced in December 2008, and that the
19 Company had retained independent outside counsel and forensic accounting
20 consultants to assist. The press release states in relevant part:
21During December 2008, the Audit Committee
22 commenced an internal review of certain matters with
23respect to the Company's accounting and reportingpractices, and retained independent outside counsel
24 and forensic accounting consultants to assist in this
25analysis.
26
27
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1 122. The announcement revealed two transactions the Company
2 improperly recorded as revenue in 2007 that were a part of the accounting fraud to
3 inflate revenue and earnings. The press release states in relevant part:
4
5 Based on its review to date, the Audit Committee has
determined that the Company improperly recognized
6 revenue on two transactions in 2007 with entities that
7 are not currently customers of the Company. * * * *
8 $2.6 Million Sale of Dr. Vetz PetFlex in 2Q 2007impacted by Customer Credit Issues That Change
9 Applicability of Revenue Recognition Criteria.10
The Company recognized revenue in the second
11 quarter of 2007 on a $2.6 million sale of its Dr. Vetz
12 PetFlex brand product. In this sale, the applicablecriteria for revenue recognition were not met. Based
13 upon facts discovered during the Audit Committee
14 investigation, the Company has now concluded that a$1.0 million down payment received by the Company
15 in that transaction was provided to the purchaser
16 through a loan from a person who at the time was aconsultant to and a former officer of NutraCea, and
17 that the evidence originally relied upon to determine
18 and support the purchaser's ability to pay theremaining $1.6 million receivable balance was
19 subsequently determined to be inaccurate. When the
20 purchaser did not pay the $1.6 million receivablebalance, the Company established an $800,000 reserve
21 against the receivable balance in the third quarter of
22 2007 and an additional reserve of $800,000 in thefourth quarter of 2007. That reserve is expected to be
23 reversed. Therefore, the net impact is expected to
24include both a reduction of revenue in 2007 by $2.6million, as well as the reduction of the Company's
25 reported expense for 2007 by $1.6 million.
26 Revenue from $2.0 Million Sale of RiceNShine in 4Q
27 2007 Improperly Recognized due to Bill and Hold
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1 Requirements: Revenue to be Recognized in 2008 and
Possibly 20092
3 The Company also determined that a $2.0 million sale
of its RiceNShine product in December 2007 did not
4 meet accounting requirements applicable torecognition of revenue in bill and hold transactions and
5 that the transaction should not have been recognized as
6 revenue in the Company's 2007 results. However, theCompany expects that approximately $2.0 million in
7 revenue will be recognized in the Company's for 2008
8 and possibly 2009.
9
10123. The Company also cautioned in the announcement that the internal
11 review is continuing and that “[f]urther investigation and assessment may result in
12 additional matters that require restatement for the periods referenced ..., or for
13 additional fiscal periods.”
14124. The announcement also contained previously undisclosed details
15 about an informal inquiry instituted against the Company by the SEC that the
16 Company learned of in mid-January concerning, among other things, the
17 transactions implicated in the restatement. The announcement states in relevant
18 part:
19 Subject To Informal Inquiry Including Requests for
20 Documents
21 NutraCea received a letter mid-January 2009 from the
22 SEC indicating that it has opened an informalinquiry and another in February 2009 requesting
23 that NutraCea voluntarily produce documents
24 relating to a number of transactions, including thetransactions mentioned above. NutraCea is in the
25 process of responding to the request for documents,
26 and is working closely with Perry-Smith LLP, theCompany's independent registered accounting firm.
27 NutraCea voluntarily reported to the Securities and
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1 Exchange Commission that the Audit Committee was
conducting an internal review of certain matters.2
3 (emphasis added)
4 125. Market reaction to the February 23, 2009 press release was swift.
5 The adverse news of the accounting restatement caused the price of Nutracea
6 common stock to fall from the prior day’s closing price of $.35 per share to $.29
7 per share, or 17% on February 23, 2009 and an additional decline of 14% the
8 following day. In total, the February 23, 2009 press release caused Nutracea’s
9 stock price to fall 29% on February 23, and 24 from $.35 to $.25.
10 126. On March 10, 2009 the Company issued a press release announcing
11 that defendant Edson had tendered his resignation as Company CEO, President,
12 and Board Member. Upon information and belief, Edson was forced out as a
13 result of the accounting fraud.
14 ii. April 23, 2009 Announcement
15 127. On April 23, 2009 the Company filed an 8-K with the SEC
16 announcing additional restatement adjustments discovered during the Company’s
17 now expanded internal review. The 8-K states in relevant part:
18 Following the date of the Original Filing, the AuditCommittee expanded its review to include the
19 Company's accounting treatment of additional
20 transactions in 2006, 2007 and 2008 ("SubsequentReview"). Based upon the Subsequent Review, the
21 Audit Committee determined on April 23, 2009 that
22 the Company also would restate its financialstatements for the year ended December 31, 2006,
23 including the fourth quarter of 2006, and the first
24 quarter of 2007, and that these financial statementsshould not be relied upon. Similarly, related press
25 releases, reports and shareholder communications
26 describing the Company's financial statements forthese periods should no longer be relied upon. The
27 Company intends to restate the financial statements
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1 referenced above in its Annual Report on Form 10-K
for the fiscal year ended December 31, 2008.2
In connection with the Subsequent Review, the
3 Company determined that it improperly accounted for
4 the following transactions in 2006, 2007 and 2008:
5 • The Company recorded revenue of $1.6 millionin the fourth quarter of 2006 from the December 2006
6 sale of Dr. Vetz Pet Flex product to an infomercial
7 customer. The Company recorded an $800,000 reservefor this receivable in the second quarter of 2007. In the
8 third quarter of 2007 the customer returned the product
9 and the Company recorded a sales return of $1.6million and reversed the reserve it had recorded in the
10 second quarter of 2007. The Company has now
11 determined that it will reverse this sale in 2006 insteadof in 2007 because (i) the Company does not have
12 adequate evidence to conclude that the receivable
13relating to this sale was collectable in the quarter it wasrecognized and (ii) the Company did not have
14 sufficient experience in the infomercial market to
15adequately understand the distribution channel, thefluctuating nature of sales into this channel or the
16 potential for product return. The effect of the reversal
17will be to (1) reduce total revenue by $1.6M in 2006,(2) reduce cost of sales by $268K in 2006, (3) reduce
18 net income by $1.4M in 2006 and (4) increase net
19income by $1.4M in 2007.
20 • In June 2007 the Company granted to PacificHoldings Advisors Limited ("PAHL") perpetual and
21 exclusive license and distribution rights (the
22 "License") for the production and sale of stabilizedrice bran and stabilized rice bran derivative products in
23 certain countries in Southeast Asia. PAHL agreed to
24pay the Company a $5 million one-time license fee("Licence Fee"), which was due and payable on the
25 fifth anniversary of the commencement of stabilized
26rice bran production at a facility established by PAHLor a joint venture of PAHL and the Company. The
27 Company recorded this $5 million License Fee in the
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1 second quarter of 2007. Contemporaneous with the
grant of the License, the Company and PAHL jointly
2 formed Grain Enhancements, LLC ("GE"). Pursuant to
3 GE's limited liability company agreement, PAHL
sublicensed its rights under the License to GE.4
Upon further analysis of these transactions, the
5 Company has concluded that the License Fee did not
6 qualify as revenue to the Company under generally
accepted accounting principles. Through our
7 Subsequent Review of the transactions, including the
8 License and other agreements that the Company
entered into in connection with the formation of GE,
9 we determined that the transactions should have been
10considered as one arrangement with multipledeliverables instead of stand-alone transactions. The
11 various obligations under this one arrangement wouldhave precluded immediate revenue recognition of the
12 License Fee. Accordingly, this transaction will be
13 reversed, which will decrease the Company's licensefee revenue in 2007 by $5 million and increase the
14 Company's net loss in 2007 by $5 million.
15 . On March 2008, Medan, LLC, a wholly-owned
16 subsidiary of the Company, purchased ("First
17Purchase") from Fortune Finance Overseas LTD("FFOL") for $8.175 million 9,700 outstanding shares
18 of capital stock of PT Panganmas Int Nusantara, anIndonesian company ("PIN"). In June 2008, Medan
19 purchased directly from PIN 3,050 additional shares of
20 PIN capital stock for $2.5 million. Following thesepurchases, Medan and FFOL own 51% and 49%,
21 respectively, of PIN's outstanding capital stock. The
22 capital contributions that the Company made to Medan
23funded the purchase of the PIN shares.
24The determination of the purchase price of the PINshares was based upon a feasibility study of the PIN
25 project that the Company obtained from a third partyvaluation firm. Based upon this study, the Company
26 recorded the value of the PIN shares on its balance
27 sheet at $10.675 million, which was the price the
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1 Company paid for the PIN shares. Upon further
review, the Company has determined that there was
2 not sufficient evidence at the time of their acquisition
3 to support the $10.675 million valuation for the PIN
shares. Accordingly, the Company has decided to
4 restate its consolidated balance sheet to reduce thevalue of the PIN shares by $5 million to $5.675
5 million as outlined below.
6 • In March 2008, PAHL paid to the Company $5
7 million for its License Fee described above. A
8principal shareholder of FFOL is also a principalshareholder of PAHL, and the Company's receipt of
9 payment for the License Fee was made at the same
10time the Company decided to make the First Purchaseof the PIN shares. Based in part upon the related
11 ownership of FFOL and PAHL, the timing of the
12payments, the sub-license of PAHL's rights under theLicense to GE and the Company's current
13 determination of the value of the PIN shares, theCompany now believes the First Purchase of the PIN
14 shares and the payment of the License Fee should be
15 viewed as a combined event with related parties,causing the Company to account for the First Purchase
16 of the PIN shares as a payment of $3.175 million
17 instead of $8.175 million.
18 128. The April 23, 2009 8-K also contained a table summarizing the
19 impact of the additional restatement adjustments and the previously identified
20 restatement adjustments in the February 23, 2009 8-K. The following is a
21 pertinent excerpt of a table from a corresponding press release the Company
22 issued to the 8-K.
23 12/31/06 12/31/07
24 Total revenue as reported $18,090,000 $22,161,000
25 Decrease/Increase in total revenue
26 - $1.6 million sale(1,551,000) 1,551,000
27 Decrease in total revenue (2,601,000)
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1 - $2.6 million sale
2 Decrease in license revenue- Grain Enhancements
(5,000,000)
3Decrease in total revenue – ITV (1,920,000)
4Increase in total revenue – ITV
5
6 Total revenue as restated 16,539,000 14,191,000
7 Cost of goods sold as reported 9,130,000 9,898,000
8 Decrease/Increase in cost of goods sold- $1.6 million sale
(268,000) 268,000
9Decrease in cost of goods sold
10 - $2.6 million sale(557,000)
11 Increase in cost of goods sold
12 - $2.6 million sale write-off557,000
13 Decrease in cost of goods sold – ITV (1,283,000)
14 Increase in cost of goods sold – ITV
15 Cost of goods sold as restated 8,862,000 8,883,00016
Gross profit as reported 8,960,000 12,263,00017
Gross profit as restated 7,677,000 5,308,00018
19
20 Operating expenses as reported 7,913,000 27,393,000
Decrease in bad debt expense21
(1,601,000)- $2.6 million sale
22
23Operating expenses as restated 7,913,000 25,792,000
24Other Income (expense) as
25 reported/restated
538,000 3,239,000
26 Net income (loss) before income tax as
1,585,000 (11,891,000)27 reported
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1 Net income (loss) before income tax as 302,000 (17,245,000)restated
2
3 129. In the 8-K the Company cautioned that the review was ongoing and
4 that “[fJurther investigation and assessment may result in additional matters that
5 require restatement” for the periods already restated any other periods. The
6 announcement also revealed that the Company would take a whopping $32.33
7 million goodwill impairment charge as a result of the decrease of the Company’s
8 stock price and the decline of cash flow and current projected sales from the
9 Company’s RiceX business. The impairment charge is expected to be taken in the
10 Company’s yet to be filed annual report for 2008.
11 130. The 8-K also revealed that the Company’s previously announced
12 (February 23, 2009) SEC informal inquiry has been elevated to a formal
13 investigation.
14 131. As a result of the restatement, on May 5, 2009, the Company’s stock
15 was delisted from the NASDAQ Bulletin Board and began trading in the OTC
16 Pink Sheets.
17 132. To date, the Company has yet to file final restated financial
18 statements with the SEC.
19ADDITIONAL ALLEGATIONS DEMONSTRATING FALSITY AND
20 SCIENTER
21 133. The magnitude of Nutracea’s accounting errors relative to its overall
22 operations coupled with continuing discovery of additional accounting errors
23 through the Company’s subsequent investigation demonstrate a cogent and
24 compelling strong inference of scienter.
25 134. Nutracea’s admission that its previously issued financial statements
26 during the Class Period: (i) did not comply with GAAP; (ii) required a
27 restatement; and (iii) violated the Company’s own revenue recognition policy
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1 demonstrates that Nutracea’s financial statements were knowingly false and
2 misleading when issued.
3 135. The Company overstated revenues as high at 141% during the Class
4 Period and either overstated net income or understated net loss as high as 425%.
5 Such large percentages that enabled the Company to post its “record” results
6 during the Class Period demonstrate scienter.
7 136. That the accounting errors enabled the Company to post record
8 revenue and net income results in some periods, when in fact the Company had
9 incurred a net loss, and the fact that the improperly recorded transactions were
10 posted on the eve of the end of the reporting periods support a strong inference of
11 scienter.
12 137. That the Company had a handful of large customers which
13 accounted for a majority of its sales revenue along with the fact that the misstated
14 revenue herein involved large transactions, support an inference that Defendants
15 had knowledge of details of the transactions that were improperly recorded as
16 revenue, and/or recklessly disregarded such information. For example, the $2.0
17 million December 2007 sale involved ITV. In the fourth quarter of 2007 the $2.0
18 million revenue that was recorded represented nearly 34% of Nutracea’s reported
19 revenue of $5.3 million. ITV accounted for a significant portion of the
20 Company’s sales revenue during the Class Period. Sales to ITV in FY 2006 were
21 45% of the Company’s sale revenue. Moreover, Company sales made to ITV
22 were subject to commission payments paid to Patricia McPeak, the Company’s
23 former CEO and founder as reported by the Company in its SEC filings during the
24 Class Period. Thus, Defendants were aware of and monitored closely the sales
25 activity between itself and ITV.
26 138. A strong inference of scienter is demonstrated by the fraudulent Bill
27 and Hold Letter that Nutracea created and backdated in an effort to justify its
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1 improper bill and hold treatment on the $2.0 million December 2007 sale to ITV
2 detailed above by CW3.
3 139. A strong inference of scienter is also demonstrated by the sham $1.6
4 million sale to Famous Discoveries Nutracea recorded in December 2006. As
5 explained by CW 1 and CW2, this transaction was a sham because Famous
6 Discoveries never took delivery of $1.6 million of product nor did Famous
7 Discoveries have any obligation to pay Nutracea if they could not sell the product.
8 Defendant Edson, on behalf of Nutracea, negotiated this improper transaction with
9 Famous Discoveries. Edson knowingly intended to permit Nutracea to unlawfully
10 recognize this $1.6 million transaction as revenue in direct violation of GAAP.
11 Otherwise, Edson would not have misrepresented what was in truth a
12 consignment, as a completed sale to a customer with full ability to pay.
13 140. Additionally the relative size and significance of the improperly
14 recorded revenue transactions supports a strong inference of scienter. For
15 example, the $5 million license fee revenue and the formation of the joint venture
16 were important events for the Company and major news. Thus, Defendants were
17 aware of the terms and conditions of the $5 million license fee revenue and
18 recklessly disregarded the terms and conditions in improperly recording the
19 transaction as revenue in violation of GAAP and the Company’s own accounting
20 policies.
21 141. The $5.0 million license revenue transaction is strongly indicative of
22 scienter because it is a sham “round trip” transaction. According to the April 23,
23 2009 announcement, PAHL paid the $5.0 million license fee to Nutracea in March
24 2008, and Nutracea immediately paid the $5.0 million to another company
25 controlled by the same principal shareholder (FFOL) that also controls PAHL. In
26 effect, upon receipt, Nutracea immediately returned the $5.0 million license fee to
27 PAHL - rendering the whole arrangement nothing more than a sham round trip
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1 transaction. The April 23 announcement also states that “the Company now
2 believes the First Purchase of the PIN shares [from FFOL] and the payment of the
3 License Fee should be viewed as a combined event with related parties.” Proper
4 application of GAAP in the planned restatement will require the Company to
5 reverse these purchase transactions to the full extent of the $5.0 million license
6 fee.
7 142. Defendants were also motivated to artificially inflate the Company’s
8 stock price and engage in the accounting fraud.
9 a. On April 25, 2008 the Company issued a press release
10 announcing that it had entered into definitive agreements to sell 22,222,223
11 shares of Nutracea common stock and warrants to purchase up to 6,666,666
12 of Nutracea common stock to certain institutional investors for aggregate
13 gross proceeds of $20 million. The announcement stated that the private
14 offering was to close on April 30, 2008 and that the shelf registration
15 statement had been declared effective on April 8, 2008. Deducting
16 expenses, net proceeds to the Company from this offering were
17 $18,775,000.
18 b. This offering was commenced and completed only a few
19 weeks after the Company had filed its materially false and misleading Q4
20 and FY 2007 results with the SEC on March 17, 2008. As set forth above
21 the Company had overstated Q4 and FY 2007 revenues by 52% and 56%,
22 respectively. Moreover, the Company had also understated net loss by 31%
23 for FY 2007. Thus, Defendants had a clear financial motive to engage in
24 the accounting fraud and these facts support a strong inference of scienter.
25 c. On April 25, 2008, defendant Edson was awarded a
26 discretionary bonus of $280,000 in cash. This cash bonus exceeded his
27 salary for 2007 of $255,769. According to the Company’s proxy
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1 statements filed during the Class Period, the Company did not ordinarily
2 pay cash bonuses.
3 143. The SEC’s formal investigation of the Company supports a strong
4 inference of scienter. The Company has admitted that the formal SEC
5 investigation focuses specifically on the transactions that are the subject of the
6 restatement and that form the basis of the securities fraud claims herein.
7 144. Defendants have a pattern of concealing material information from
8 investors, further demonstrating scienter. Nutracea failed to disclose that it issued
9 to Edson – through his relatives - 1,000,000 shares of the Company’s restricted
10 common stock in connection with a consulting agreement he entered into with the
11 Company on July 14, 2004.
12 145. It was not until September 17, 2007, in response to a letter the
13 Company received and the portions of that correspondence being publicly released
14 on internet message boards that the Company revealed that Edson’s family
15 members received 1,000,000 shares of restricted common stock in FY 2004. The
16 stock was issued in connection with a consulting agreement Nutracea had entered
17 into with Edson on July 14, 2004 for a six month term, prior to Edson becoming
18 President of the Company in December 14, 2004.,
19 146. Defendant Edson has also concealed in Nutracea’s proxy statements
20 and annual reports that he was Chief Executive of Campers Club of America, Inc.
21 from 1991 through 1997 and that this company filed for bankruptcy in 2002.
22 147. The suspicious circumstances of the departures of Defendants Edson
23 and Crow from the Company support a strong inference of scienter. Upon
24 information and belief, Edson’s departure from the Company was not innocent.
25 Rather he was forced to resign on March 10, 2009 in the wake of the disclosure of
26 the accounting fraud on February 23, 2009.
27
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1 a. That Nutracea paid to Edson much less severance
2 compensation than his employment agreement provided for indicates that
3 the board forced Edson out of the Company as a result of misconduct in
4 connection with the accounting fraud.
5 b. On March 10, 2009, Nutracea filed an 8-K with the SEC
6 announcing the terms of Edson’s severance. According to the
7 announcement, Edson was to receive: six months of his salary or $156,050,
8 with $78,205 payable March 9, 2009, and the remaining half payable in
9 three consecutive monthly payments beginning on April 1, 2009; COBRA
10 payments until October 31, 2009; $15,000 a month for two months of
11 consulting services; and no impact on his prior stock and warrants.
12 c. Pursuant to Edson’s employment agreement filed as an
13 exhibit to the Company’s 2004 annual report filed on Form 10KSB and the
14 pertinent amendment to the agreement Nutracea filed with the SEC on
15 Form 8-K on January 15, 2008, had Edson been terminated without cause
16 or resigned with “good reason,”6 then Edson would have been entitled to
17 his salary for the remaining term (not less than 12 months) payable
18
19
20 6 The employment agreement defines “good reason.” “Good Reason shallmean: (i) the assignment to Employee of duties inconsistent with the position
21 and nature of Employee's employment, the reduction of the duties of EmployeeWhich is inconsistent with the position and nature of Employee's employment, or
22 the change of Employee's title indicating a change in the position and nature of23 Employee's employment; (ii) a reduction in compensation and benefits of
Employee without Employee's written consent; (iii) the failure by Employer to24 obtain from any successor, an agreement to assume and perform this
25 Agreement; or (iv) in the event that the current Chief Executive Officer of theEmployer for any reason no longer holds. Such position, the failure of the
26 Board of Directors of Employer to appoint Employee as Chief Executive
27 Officer of Employer; or(v) a corporate "Change In Control" (as definedbelow.)”
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1 immediately, plus bonuses throughout the expiration of the term of the
2 agreement.
3 d. Edson’s 2004 employment agreement was amended and
4 renewed on January 8, 2009 for another three year-term. The term of his
5 employment agreement began on January 1, 2008 and ended on December
6 31, 2010.
7 e. Had Edson been terminated without cause or resigned with
8 “good reason” Edson would have been entitled to at least 21 months of his
9 salary, or $596,410.27. 7
10 f. Clearly, Edson’s severance package, consisting of $186,050
11 cash to be paid on a schedule, as opposed to being paid $596,410.27 at the
12 time of his separation and potential bonuses of at least $550,000 based on
13 the Company’s guidance for 2009 and Edson’s bonuses tied to that
14 performance, clearly shows that Edson was forced out of Nutracea for
15 misconduct in connection with the accounting fraud.”
16 148. Upon information and belief, Crow’s departure from the Company
17 as CFO and the Company’s difficulty in finding a willing replacement resulted
18 from the accounting fraud and that these “resignations” were not innocent. During
19 the Class Period the Company had three CFOs (Mueller, Crow, and Sanders), two
20 of whom left their posts before they were obligated to sign any financial
21 statements. Likewise Olga Hernandez-Longan, Crow’s recent successor, also
22
23 7 The figure was calculated as follows. According to the severance
24 announcement, Edson’s base salary in 2009 was $312,100. His base salary for the
25 period 2010 would have been $343,310 because his employment contract required10% raise annually. Thus, for 2009 Edson salary from March 10, 2009 through
26 December 31, 2009 (296 days) would have been $253,100.27, along with his
27 salary he would have earned in 2010, Edson had $596,410.27, of base salary underhis employment agreement.
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1 resigned as CFO on July 9, 2009, effective July 31, 2009, before having to sign
2 any financial statements. No reason was provided announced by Nutracea for this
3 resignation. Thus from Crow’s first resignation in March of 2008 to July of 2008,
4 the Company had four different CFOs. This revolving door at Nutracea supports a
5 strong inference of scienter.
6 149. That the Company secretly used its “consultant” who is a former
7 Company officer to funnel a $1 million loan to a customer to enable a $2.6 million
8 sale transaction in violation of GAAP shows bad faith and intentional wrongdoing.
9 Defendants knowingly failed to disclose in its financial statements the $1 million
10 related party loan to its customer in violation of GAAP. Defendants also
11 improperly recognized the $2.6 million transaction as revenue in Q2 2007. This
12 under-the-table loan, hidden from the auditors and the public in violation of
13 GAAP supports an inference of scienter. Defendants violated Regulation S-K
14 Item 404 and FAS 57 by failing to disclose this related party transaction. Upon
15 information and belief, the undisclosed consultant and former officer was Ike
16 Lynch, who had resigned as Chief Operating Officer on April 11, 2007 and had
17 continued to remain at the Company as a consultant. During Q2 2007, Mr. Lynch
18 is the only such consultant disclosed in the Company’s filings.
19 150. Defendant Crow’s false reassurance to investors during the Q3 2007
20 conference call that the $800,000 reserve for $2.6 million transaction resulted
21 from a “slow paying” customer likewise shows his fraudulent intent to mislead
22 investors and cover-up the improperly recorded sales transactions. Crow’s
23 statements also demonstrate that Crow had actual knowledge of the specific
24 payment terms of the $2.6 million transaction and knew or should have known
25 that it should not have been recognized as revenue pursuant to GAAP.
26 151. As explained above, during the Company’s Q1 2007 earnings
27 conference call, Defendant Edson falsely assured investors that he had “intensive”
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1 communications with Nutracea’s auditors to ensure revenue from the $2.6 sale is
2 properly recognized, acknowledged that proper revenue recognition was
3 important, and then stated that while people make mistakes, that he does not make
4 “mistakes twice.” Edson thus had actual knowledge of the true terms of the $2.6
5 million transaction that violated GAAP. Not only was this a false reassurance, it
6 also demonstrates that he actively monitored and was involved in the Company’s
7 decision to recognize revenue for this as well as the other fraudulent transactions.
8 LOSS CAUSATION/ECONOMIC LOSS
9 152. During the Class Period, the Defendants engaged in a scheme to
10 deceive the market and a course of conduct that artificially inflated Nutracea’s
11 stock price and operated as a fraud or deceit on purchasers of Nutracea stock by
12 misrepresenting the Company’s financial performance through the accounting
13 fraud to inflate revenue and earnings. Once the Defendants’ misrepresentations
14 and fraudulent conduct were disclosed to the market, Nutracea’s stock price
15 dropped. As a result of Defendants’ fraud during the Class Period, Plaintiffs and
16 other members of the Class suffered economic loss.
17 153. Defendants’ false and misleading statements had the intended effect
18 and caused Nutracea stock to trade at artificially inflated levels throughout the
19 Class Period.
20 154. As investors and the market became aware of Nutracea’s prior
21 misstatements and omissions and that Nutracea’s actual financial performance was
22 not as represented, Nutracea’s stock price reacted negatively, damaging investors.
23 APPLICABLITY OF PRESUMPTION OF RELIANCE:
24 FRAUD-ON-THE-MARKET
25 155. At all relevant times, the market for Nutracea’s common stock was
26 an efficient market for the following reasons, among others:
27
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1 a. Nutracea’s stock met the requirements for listing, and was
2 listed and actively traded on the NASDAQ Bulletin Board, a highly
3 efficient and automated market;
4 b. During the Class Period, on average 5.25 million shares of
5 Nutracea stock were traded on a weekly basis based on trading data
6 available from Bloomberg LP. During the Class Period approximately 139
7 million shares were outstanding (average of the figures reported in
8 Nutracea’s 2006 and 2007 10-Ks). Approximately 3.7% of the all
9 outstanding shares were bought and sold on a weekly basis, demonstrating
10 a very strong presumption of an efficient market;
11 c. As a regulated issuer, Nutracea filed with the SEC periodic
12 public reports and was eligible to file S-3 registration statements, and did
13 file an S-3, with the SEC during the Class Period;
14 d. Nutracea regularly communicated with public investors via
15 established market communication mechanisms, including regular
16 disseminations of press releases on the national circuits of major
17 newswire services and other wide-ranging public disclosures, such as
18 communications with the financial press and other similar reporting
19 services;
20 e. Nutracea was followed by several securities analysts,
21 employed by major brokerage firms who wrote reports that were
22 distributed to the sales force and certain customers of their respective
23 brokerage firms during the Class Period, including Northland Securities,
24 and BI Research. Each of these reports was publicly available and entered
25 the public marketplace. The following investment funds and investment
26 advisory companies, also actively followed Nutracea’s stock during the Class
27 Period, including but not limited to, Insider Asset Management, H4 Capital
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1 Management, Emerald Advisors, Bifrost Capital, Pinnacle Fund, First Financial,
2 Hanna Bay Capital Management, Southwell Partners, Ignite Capital, and
3 Neuberger Berman;
4 f. During the Class Period numerous institutional investors bought,
5 sold or held Nutracea’s stock, including but not limited to, Voyager Asset
6 Management Inc., Mead Adam & Co., State Bank & Trust, and Parsons Capital
7 Management, Inc. At least over 30 NASD member firms were active market-
8 makers in Nutracea stock at all times during the Class Period according to
9 the NASDAQ OTC Bulletin Board Market Maker Price Movement
10 Reports; and
11 g. Unexpected material news about Nutracea was rapidly
12 reflected in and incorporated into the Company’s stock price during the
13 Class Period.
14 156. As a result of the foregoing, the market for Nutracea’s common
15 stock promptly digested current information regarding Nutracea from all publicly
16 available sources and reflected such information in Nutracea’s stock price. Under
17 these circumstances, all purchasers of Nutracea’s common stock during the Class
18 Period suffered similar injury through their purchase of Nutracea’s common stock
19 at artificially inflated prices, and a presumption of reliance applies.
20 PLAINTIFFS’ CLASS ACTION ALLEGATIONS
21 157. Plaintiffs bring this action as a class action pursuant to Federal Rules
22 of Civil Procedure 23(a) and (b)(3) on behalf of all persons and entities other than
23 Defendants who purchased the common stock of Nutracea during the period
24 between April 2, 2007 and February 23, 2009, inclusive (the “Class”)
25 158. The members of the Class are so numerous that joinder of all
26 members is impracticable. Throughout the Class Period, Nutracea’s securities
27 were actively traded on the OTC.BB . While the exact number of Class members
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1 is unknown to Plaintiffs at this time and can only be ascertained through
2 appropriate discovery, Plaintiffs believe that there are at least thousands members
3 in the proposed Classes. Members of the Class may be identified from records
4 maintained by Nutracea or its transfer agent and may be notified of the pendency
5 of this action by mail, using a form of notice customarily used in securities class
6 actions.
7 159. Plaintiffs’ claims are typical of the claims of the members of the
8 Class, as all members of the Class are similarly affected by Defendants’ wrongful
9 conduct in violation of federal law and Arizona law that is complained of herein.
10 160. Plaintiffs will fairly and adequately protect the interests of the
11 members of the Class and has retained counsel competent and experienced in class
12 and securities litigation.
13 161. Common questions of law and fact exist as to all members of the
14 Class and predominate over any questions solely affecting individual members of
15 the Class. Among the questions of law and fact common to the Class are:
16 a. whether the federal securities laws and Arizona state
17 securities laws were violated by Defendants' acts as alleged herein;
18 b. whether statements made by Defendants to the investing
19 public during the Class Period misrepresented material facts about the
20 business, operations and management of Nutracea; and
21 c. to what extent the members of the Class have sustained
22 damages and the proper measure of damages.
23 162. A class action is superior to all other available methods for the fair
24 and efficient adjudication of this controversy since joinder of all members is
25 impracticable. Furthermore, as the damages suffered by individual Class members
26 may be relatively small, the expense and burden of individual litigation make it
27 impossible for members of the Class to redress individually the wrongs done to
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1 them. There will be no difficulty in the management of this action as a class
2 action
3
4
5 FIRST CLAIM
6 Violation of Section 10(b) Of
7 The Exchange Act Against and Rule 10b-5
8 Promulgated Thereunder Against All Defendants
9
10 163. Plaintiffs repeat and reallege each and every allegation contained
11 above as if fully set forth herein.
12 164. During the Class Period, Defendants carried out a plan, scheme and
13 course of conduct which was intended to and, throughout the Class Period, did: (1)
14 deceive the investing public, including Plaintiffs and other Class members, as
15 alleged herein; and (2) cause Plaintiffs and other members of the Class to purchase
16 and sell Nutracea’s securities at artificially inflated and distorted prices. In
17 furtherance of this unlawful scheme, plan and course of conduct, Defendants, and
18 each of them, took the actions set forth herein.
19 165. Defendants (a) employed devices, schemes, and artifices to defraud;
20 (b) made untrue statements of material fact and/or omitted to state material facts
21 necessary to make the statements not misleading; and (c) engaged in acts,
22 practices, and a course of business that operated as a fraud and deceit upon the
23 purchasers of the Company’s securities in an effort to maintain artificially high
24 market prices for Nutracea’s securities in violation of Section 10(b) of the
25 Exchange Act and Rule 10b-5 thereunder. All Defendants are sued either as
26 primary participants in the wrongful and illegal conduct charged herein or as
27 controlling persons as alleged below.
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1 166. Defendants, individually and in concert, directly and indirectly, by
2 the use, means or instrumentalities of interstate commerce and/or of the mails,
3 engaged and participated in a continuous course of conduct to conceal adverse
4 material information about the business, operations and future prospects of
5 Nutracea as specified herein.
6 167. These Defendants employed devices, schemes and artifices to
7 defraud while in possession of material adverse non-public information and
8 engaged in acts, practices, and a course of conduct as alleged herein in an effort to
9 assure investors of Nutracea’s value and performance and continued substantial
10 growth, which included the making of, or participation in the making of, untrue
11 statements of material facts and omitting to state material facts necessary in order
12 to make the statements made about Nutracea and its business operations and future
13 prospects in the light of the circumstances under which they were made, not
14 misleading, as set forth more particularly herein, and engaging in transactions,
15 practices and a course of business that operated as a fraud and deceit upon the
16 purchasers of Nutracea’s securities during the Class Period.
17 168. Each of the Individual Defendants’ primary liability, and controlling
18 person liability, arises from the following facts: (1) the Individual Defendants
19 were high-level executives, directors, and/or agents at the Company during the
20 Class Period and members of the Company’s management team or had control
21 thereof; (2) each of these Defendants, by virtue of his responsibilities and
22 activities as a senior officer and/or director of the Company, was privy to and
23 participated in the creation, development and reporting of the Company’s financial
24 condition; (3) each of these defendants enjoyed significant personal contact and
25 familiarity with the other Defendants and was advised of and had access to other
26 members of the Company’s management team, internal reports and other data and
27 information about the Company’s finances, operations, and sales at all relevant
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1 times; and (4) each of these Defendants was aware of the Company’s
2 dissemination to the investing public of information that they knew or recklessly
3 disregarded to be materially false and misleading.
4 169. Defendants had actual knowledge of the misrepresentations and
5 omissions of material facts set forth herein, or acted with reckless disregard for the
6 truth in that they failed to ascertain and to disclose such facts, even though such
7 facts were available to them. Such Defendants’ material misrepresentations and/or
8 omissions were done knowingly or recklessly and for the purpose and effect of
9 concealing from the investing public Nutracea’s operating condition and future
10 business prospects and supporting the artificially inflated price of its securities.
11 As demonstrated by Defendants’ overstatements and misstatements of the
12 Company’s financial condition throughout the Class Period, Defendants, if they
13 did not have actual knowledge of the misrepresentations and omissions alleged,
14 were reckless in failing to obtain such knowledge by deliberately refraining from
15 taking those steps necessary to discover whether those statements were false or
16 misleading.
17 170. As a result of the dissemination of the materially false and
18 misleading information and failure to disclose material facts, as set forth above,
19 the market price of Nutracea’s securities was artificially inflated during the Class
20 Period. In ignorance of the fact that market prices of Nutracea’s publicly-traded
21 securities were artificially inflated, and relying directly or indirectly on the false
22 and misleading statements made by defendants, or upon the integrity of the market
23 in which the securities trade, and/or on the absence of material adverse
24 information that was known to or recklessly disregarded by Defendants but not
25 disclosed in public statements by Defendants during the Class Period, Plaintiffs
26 and the other members of the Class acquired Nutracea securities during the Class
27 Period at artificially high prices and were or will be damaged thereby.
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1 171. At the time of said misrepresentations and omissions, Plaintiffs and
2 other members of the Class were ignorant of their falsity, and believed them to be
3 true. Had Plaintiffs and the other members of the Class and the marketplace
4 known the truth regarding Nutracea’s financial results, which were not disclosed
5 by defendants, Plaintiffs and other members of the Class would not have
6 purchased or otherwise acquired their NutraCea securities, or, if they had acquired
7 such securities during the Class Period, they would not have done so at the
8 artificially inflated prices that they paid.
9 172. By virtue of the foregoing, Defendants have violated Section 10(b)
10 of the Exchange Act, and Rule 1 0b-5 promulgated thereunder.
11 173. As a direct and proximate result of Defendants’ wrongful conduct,
12 Plaintiffs and the other members of the Class suffered damages in connection with
13 their respective purchases and sales of the Company’s securities during the Class
14 Period.
15 174. This action was filed within two years of discovery of the fraud and
16 within five years of each Plaintiff’s purchase of securities giving rise to the cause
17 of action.
18 SECOND CLAIM
19 Violation of Section 20(a) Of
20 The Exchange Act Against the Individual Defendants
21 175. Plaintiffs repeat and reallege each and every allegation contained
22 above as if fully set forth herein.
23 176. The Individual Defendants acted as controlling persons of Nutracea
24 within the meaning of Section 20(a) of the Exchange Act as alleged herein. By
25 virtue of their high-level positions, agency, and their ownership and contractual
26 rights, participation in and/or awareness of the Company’s operations and/or
27 intimate knowledge of the false financial statements filed by the Company with
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1 the SEC and disseminated to the investing public, the Individual Defendants had
2 the power to influence and control, and did influence and control, directly or
3 indirectly, the decision-making of the Company, including the content and
4 dissemination of the various statements that Plaintiffs contend are false and
5 misleading. The Individual Defendants were provided with or had unlimited
6 access to copies of the Company’s reports, press releases, public filings and other
7 statements alleged by Plaintiffs to have been misleading prior to and/or shortly
8 after these statements were issued and had the ability to prevent the issuance of the
9 statements or to cause the statements to be corrected.
10 177. In particular, each of these Defendants had direct and supervisory
11 involvement in the day-to-day operations of the Company and, therefore, is
12 presumed to have had the power to control or influence the particular transactions
13 giving rise to the securities violations as alleged herein, and exercised the same.
14 178. As set forth above, Nutracea and the Individual Defendants each
15 violated Section 10(b) and Rule 10b-5 by their acts and omissions as alleged in
16 this Complaint.
17 179. By virtue of their positions as controlling persons, the Individual
18 Defendants are liable pursuant to Section 20(a) of the Exchange Act. As a direct
19 and proximate result of Defendants’ wrongful conduct, Plaintiffs and other
20 members of the Class suffered damages in connection with their purchases of the
21 Company’s securities during the Class Period.
22 180. This action was filed within two years of discovery of the fraud and
23 within five years of each Plaintiff’s purchase of securities giving rise to the cause
24 of action.
25
26 THIRD CLAIM
27 Violation of A.R.S. § 44-1991(A)(3) & 44-2003(A)
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1 Against All Defendants
2 181. Plaintiffs repeat and reallege each and every allegation contained
3 above as if fully set forth herein.
4 182. This claim is brought against all Defendants for civil liability
5 pursuant to A.R.S. §44-2003(A) for their violation of A.R.S. § 44-1991(A)(3).
6 183. Defendants, individually and in concert, directly and indirectly,
7 engaged and participated in a continuous course of business under which they hid
8 adverse information concerning Nutracea’s actual revenue, net income, and assets.
9 Defendants knew or recklessly ignored that disclosure of Nutracea’s fraud would
10 reduce the value of Nutracea stock.
11 184. The course of business through which Defendants disclosed
12 information about Nutracea and marketed Nutracea stock without disclosing the
13 misstatements alleged herein violated A.R.S. § 44-1991(A)(3).
14 185. Individual Defendants aided, abetted, and culpably made and
15 participated in Nutracea’s violations of A.R.S. § 44-1991(A)(3). Under A.R.S. §
16 44-2003(A), Defendants are liable for their own and for Nutracea’s violations of §
17 44-1991(A)(3).
18 186. Because of the securities violations described in this Claim,
19 Plaintiffs and the Class are entitled to, and by this complaint demand, statutory
20 rescission under A.R.S. § 44-2001(A).
21 187. This action was filed within two years after the discovery of the facts
22 on which liability is based, or after the discovery should have been made by
23 exercise of reasonable diligence.
24 FOURTH CLAIM
25 Violation of A.R.S. § 44-1999(B) against Individual Defendants
26
27
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1 188. Plaintiffs repeat and reallege each and every allegation contained
2 above as if fully set forth herein.
3 189. Individually or as a group, or both, Individual Defendants were
4 statutory control persons with the power to control Nutracea.
5 190. With respect to the Nutracea’s violation of A.R.S. § 44-1991 (A)(3)
6 described in the Third Claim, the Individual Defendants are jointly and severally
7 liable to Plaintiffs as controlling persons of Nutracea under A.R. S. § 44-1999.
8 191. Because of the securities violations described in this Claim,
9 Plaintiffs and the Class are entitled to, and by this complaint demand, statutory
10 rescission under A.R.S. § 44-2001(A).
11 WHEREFORE, Plaintiffs pray for relief and judgment, as follows:
12 (a) Determining that this action is a proper class action, designating
13 Plaintiffs as a class representative under Rule 23 of the Federal Rules of Civil
14 Procedure and Lead Plaintiffs’ counsel as Class Counsel;
15 (b) Awarding compensatory damages in favor of Plaintiffs and
16 Class members against all Defendants, jointly and severally, for all damages
17 sustained as a result of Defendants’ wrongdoing, in an amount to be proven at
18 trial, including interest thereon;
19 (c) Awarding rescission or damages in favor of Plaintiffs on their
20 Arizona claims against all Defendants, jointly and severally, for all such relief
21 Plaintiffs are entitled as a result of Defendants’ wrongdoing, in an amount to be
22 proven at trial, including interest thereon;
23 (d) Awarding Plaintiffs and the Class their reasonable costs and
24 expenses incurred in this action, including counsel fees and expert fees; and
25 (d) Such other and further relief as the Court may deem just and
26 proper.
27
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1 JURY TRIAL DEMANDED
2 Plaintiffs hereby demand a trial by jury.
3
4 Dated: August 14, 2009 Respectfully submitted,
5
6 THE ROSEN LAW FIRM P.A.
7
8 /s/ Phillip Kim
Phillip Kim (pro hac vice)
9 Laurence Rosen (pro hac vice)
10Timothy Brown (pro hac vice)350 Fifth Avenue, Suite 5508
11 New York, NY 10118Telephone: (212) 686-1060
12 Fax: (212) 202-3827
13 Lead Counsel for Plaintiffs
14
15 TIFFANY & BOSCO, P.A.
16 Richard G. Himelrick (#004738)J. James Christian (#023614)
17 Third Floor Camelback Esplanade II
18 2525 East Camelback RoadPhoenix, Arizona 85016-4237
19 Telephone: (602) 255-6000
20 Fax: (602) 255-0103
21 Liaison Counsel for Plaintiffs
22
23
24
25
26
27
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