As highlighted in this recent post, the SEC has not brought an individual Foreign Corrupt Practices Act enforcement action involving foreign bribery in nearly three years.
However, as often highlighted on these pages, the FCPA’s books and records and internal controls provisions are often implicated in conduct that has nothing to do with foreign bribery. For lack of a better term, these actions have long been called “non-FCPA, FCPA enforcement actions” on these pages.
The latest example occurred earlier this week when the SEC brought an action against former executives of MusclePharm Corp. (a Las Vegas based nutritional supplement company). As stated by the SEC, the company’s “former Executive Vice President of Sales and Operations, Brian H. Casutto, former Vice President of Sales, Matthew J. Zucco, and former contract Chief Financial Officer, Kevin R. Harris, [engaged] in improper revenue recognition practices to achieve revenue growth demanded by its former Chief Executive Officer, Ryan C. Drexler.”
This settled civil complaint against Casutto, Zucco and Harris alleges in summary fashion:
“Beginning in 2017, the Defendants engaged in a variety of improper conduct that materially inflated the reported quarterly revenues and gross profits of MusclePharm, a publicly-traded nutritional supplement company, by as much as 25 percent and 49 percent, respectively. As a result, in March 2019, MusclePharm announced that its previously reported financial statements should no longer be relied upon and in August 2020, MusclePharm restated its financial statements for 2017 and the first three quarters of 2018 (the “Restatement Period”).
First, MusclePharm prematurely recognized $9.2 million in revenue during the Restatement Period by booking sales at quarter end even though it did not ship the “sold” product to customers but instead placed the product in storage trailers and third-party warehouses at the company’s expense. Casutto, MusclePharm’s Executive Vice President for Sales and Operations, directed and condoned this practice, and Zucco, MusclePharm’s Vice President for Sales, implemented the logistics necessary to carry out Casutto’s directives. Harris, MusclePharm’s contract CFO, on several occasions failed to correct the accounting for these transactions when he received information that should have suggested that revenue had been recognized prematurely for certain orders.
Second, MusclePharm prematurely recognized $12.8 million in revenue during the Restatement Period by recognizing revenue at the time of shipment and before delivery despite MusclePharm’s most significant customer contracts requiring delivery before revenue could be recognized, as Harris should have known.
Third, MusclePharm overstated revenues during the Restatement Period by $15.5 million by classifying credits that MusclePharm granted to certain customers, which allowed the customers to pay a reduced price for MusclePharm products based on the customers’ marketing of the products, as expenses rather than reductions to revenue. As Harris should have known, generally accepted accounting principles (“GAAP”) require such credits to be accounted for as reductions to revenue.”
Based on the above, the SEC alleged that the defendants violated (among other things) the books and records and internal controls provisions of the FCPA and aided and abetted MusclePharm’s violations of the same provisions.
As stated in the SEC’s release:
“Casutto, Zucco, and Harris have each consented to the entry of judgments, subject to court approval, permanently enjoining them from violating the antifraud provisions and other provisions of the federal securities laws; requiring Casutto and Zucco to pay disgorgement with prejudgment interest of $79,760.01 and $15,033.06, respectively; requiring Casutto and Harris to pay a civil penalty of $207,183 and $50,000, respectively, and reserving the issue of Zucco’s civil penalty for further determination by the court; and barring Casutto from serving as an officer or director of a public company for five years.”
A separate compliant against Drexler alleges in summary fashion:
“Drexler, during his tenure as Chairman, President, and Chief Executive Officer (“CEO”) of MusclePharm, a publicly-traded nutritional supplement company, engaged in a scheme to defraud MusclePharm’s investors about the strength of the company’s controls over financial reporting and disclosures and the devastating impact of MusclePharm’s debt default in the third quarter of 2022. His conduct also ran afoul of critical rules regarding the processes, controls, and procedures that public companies, like MusclePharm, must have in place to provide assurance that their accounting and public reports are accurate.
Drexler’s fraudulent and deceptive conduct manifested itself in two specific ways. First, Drexler failed to ensure that, and made false statements about whether, MusclePharm had basic processes, controls, and procedures in place to ensure that its accounting for revenue, profit, and other important financial metrics – all of which was reported to and relied on by investors – was correct.
[…]
Second, in the third quarter of 2022, Drexler engaged in deceptive conduct and made misleading statements by hiding from investors that a $10 million debt to MusclePharm creditors had been automatically accelerated and was presently due, resulting in immediate and catastrophic consequences for the company and its investors.”
Based on the above, the SEC alleged that Drexler (among other things) aided and abetted MusclePharm’s violation of the FCPA’s internal controls provisions.
In the SEC release, Jason Burt (Regional Director of the SEC’s Denver Office) stated:
“Honest and transparent financial disclosures are the bedrock of our markets, but as alleged in our complaint, MusclePharm’s executives disregarded these fundamental rules by continuously inflating reported revenue. These actions highlight that the SEC will not hesitate to bring enforcement actions against individuals who threaten the integrity of our markets.”
