Preet Bharara, the United States Attorney for the Southern District of New York, Diego Rodriguez, the Assistant Director-in-Charge of the New York Field Office of the Federal Bureau of Investigation (“FBI”), and Philip R. Bartlett, Inspector-in-Charge of the New York Office of the U.S. Postal Inspection Service (“USPIS”), announced today the arrests of KALEIL ISAZA TUZMAN and ROBIN SMYTH. TUZMAN, the former chairman of the board of directors and chief executive officer of the technology start-up company KIT digital, was arrested yesterday in Colombia on market manipulation and accounting fraud charges. TUZMAN is being held in Colombia pending extradition proceedings. SMYTH, the former chief financial officer (“CFO”) of KIT digital, a publicly traded company that was based in New York, New York, and Prague, Czech Republic, was arrested today in Australia on accounting fraud charges. SMYTH is being held in Australia pending extradition proceedings.
Manhattan U.S. Attorney Preet Bharara said: “As alleged, Kaleil Isaza Tuzman and Robin Smyth engaged in an elaborate conspiracy to mislead investors and regulators about the financial health of the publicly traded company they oversaw. I want to thank the FBI and the Postal Inspection Service for helping to bring these two alleged fraudsters to justice.”
FBI Assistant Director Diego Rodriguez said: “As alleged, Tuzman and Smyth conspired to personally profit through market manipulation and accounting fraud in the tens of millions of dollars. Despite being as far away as Australia and Colombia, we seek to bring them to justice in the United States to face their accusers and alleged victims. The FBI will continue to work with U.S. Postal Inspection Service and our other partners in an effort at ensuring that our financial markets are legal, fair, and equitable.”
USPIS Inspector-in-Charge Philip R. Bartlett said: “These individuals took extraordinary steps to conceal their deceit from auditors and clients, creating instability in investor portfolios. Their actions highlight their arrogance and disregard for rules and regulations.”
According to the Indictment unsealed in Manhattan federal court As the introductory phrase signifies, the entirety of the text of the Indictment and the description of the Indictment set forth below constitute only allegations, and every fact described should be treated as an allegation., TUZMAN and SMYTH engaged in the following fraudulent schemes during their tenures as KIT digital’s Chairman and CEO, and CFO, respectively:
The Market Manipulation Scheme
Between in or about December 2008 and in or about September 2011, TUZMAN and a co-conspirator (“CC-1”), who operated a hedge fund (the “Hedge Fund”), engaged in a scheme to artificially inflate the share price and trading volume of KIT digital’s shares. Specifically, at various times when KIT digital’s shares traded on the OTC Bulletin Board and later on the NASDAQ, TUZMAN directed a scheme in which KIT digital shares were purchased and sold through the Hedge Fund, at times for the purpose of manipulating the stock price and at times for the purpose of creating the illusion of greater volume in the trading of KIT digital shares. TUZMAN personally invested his own money into the Hedge Fund and also arranged for KIT digital to invest money in the Hedge Fund, thereby using the Hedge Fund as a vehicle by which KIT digital, at TUZMAN’s direction, invested in itself without disclosing that fact, or the fact of the manipulation, to the investing public.
Specifically, CC-1, with TUZMAN’s knowledge and approval, frequently engaged in match trading in which CC-1 caused an account under CC-1’s control to buy or sell KIT digital stock, and on the same day caused an account under CC-1’s control to take the opposite position. TUZMAN also directed CC-1 to make timely purchases of KIT digital stock in an effort to manipulate the price of KIT digital shares at certain critical moments, including, for instance, when KIT digital was seeking to raise additional capital and in the weeks before KIT digital’s stock began trading on the NASDAQ. At times, CC-1 was responsible for nearly all of the day’s trading activity in KIT digital stock.
Between 2009 and 2010, TUZMAN caused KIT digital to invest approximately $1,150,000 in company cash in the Hedge Fund but failed to disclose to KIT digital shareholders that these investments with the Hedge Fund were not part of an arms-length relationship. Instead, TUZMAN portrayed these investments as efforts to safely invest assets of KIT digital. In reality, TUZMAN caused KIT digital to make these investments in order to help fund CC-1’s purchases of KIT digital shares, as part of the effort to manipulate the market described above. And, on one occasion, TUZMAN caused KIT digital to invest $250,000 in the Hedge Fund so that CC-1 could reimburse TUZMAN for a prior, personal investment that TUZMAN made with the Hedge Fund, thereby using KIT digital as his personal bank.
The Accounting Fraud Scheme
From at least in or about 2010 through in or about 2012, TUZMAN and SMYTH, with others, engaged in an illegal scheme to deceive KIT digital shareholders, members of the investing public, KIT digital’s independent auditors, and others concerning KIT digital’s true operating performance and financial results.
TUZMAN, working with others, including SMYTH, devised and executed a scheme to inflate KIT digital’s revenue falsely. This scheme involved two principal methods: (a) the improper recognition of revenue from so-called “perpetual license” contracts for KIT digital software (contracts that gave the purchasing customer the right to use the licensed software indefinitely), and (b) the execution of fraudulent “round-trip” transactions which had the effect of using KIT digital’s own cash, rather than payments received from customers, to pay off bills, known as accounts receivable, that were due and owed to KIT digital from those customers, rather than disclose to KIT digital’s auditors and the investing public the fact that the bills were uncollectible.
With regard to the first method, TUZMAN and SMYTH knew that KIT digital had sold perpetual licenses for software that, at the time of sale, was not complete and required substantial future development. But instead of booking revenue ratably as KIT digital reached interim development milestones or recognizing revenue in full once software development was complete, TUZMAN and SMYTH caused KIT digital to recognize the entirety of the revenue from certain contracts at the time of sale despite the fact that KIT digital had not delivered a product to KIT digital’s customers. This premature revenue recognition violated relevant software accounting principles and was contrary to KIT digital’s statements to the investing public and its independent auditors, among others. Because of TUZMAN’s and SMYTH’s actions, KIT digital recognized approximately $6,000,000 in revenue that should not have been in its quarterly and annual reports submitted to the SEC, thus misleading the investing public and others about KIT digital’s true financial health.
With regard to the second method, TUZMAN and SMYTH, on at least one occasion, caused KIT digital to use company money, ostensibly escrowed in connection with a KIT digital corporate acquisition, to pay off suspicious or uncollectible receivables by year-end. Specifically, TUZMAN and SMYTH caused KIT digital to add an artificial $7,850,000 “restructuring fee” to the purchase price of a company that KIT digital sought to acquire. Once the purchase price was raised, TUZMAN and SMYTH established an escrow account that was funded with $7,850,000 in KIT digital cash which purported to represent the so-called restructuring fee. The use of the escrowed KIT digital money was governed by a “side letter” between KIT digital and the acquired company that SMYTH created but both defendants intentionally hid from KIT digital’s auditors and the investing public. The side letter dictated that escrowed funds could be used only to cover the costs KIT digital expected to incur from integrating the acquired company into KIT digital. However, TUZMAN and SMYTH used the escrowed money in a round-trip transaction that resulted in KIT digital using its own cash to pay down approximately $4,400,000 in suspicious or uncollectable accounts receivables. TUZMAN’s and SMYTH’s actions caused KIT digital’s 2011 annual financial report to overstate the company’s assets by $7,850,000 and to understate the company’s pre-tax, year-end losses by approximately $4,400,000.
TUZMAN, 43, is charged in eight counts. For the market manipulation scheme, TUZMAN is charged with one count of conspiracy to commit securities fraud, one count of securities fraud, one count of conspiracy to commit wire fraud, and one count of wire fraud. For the accounting fraud scheme, TUZMAN is charged with one count of conspiracy to commit securities fraud, make false statements in annual and quarterly SEC reports, and make false statements to auditors, one count of securities fraud, and two counts of making false statements in annual and quarterly SEC reports.
SMYTH, 61, is charged with one count of conspiracy to commit securities fraud, make false statements in annual and quarterly SEC reports, and make false statements to auditors, one count of securities fraud, and three counts of making false statements in annual and quarterly SEC reports.
The securities fraud and wire fraud counts each carry a maximum sentence of 20 years in prison and a maximum fine of $5,000,000, or twice the gross gain or loss from the offense. Each of the counts for conspiracy to commit securities fraud, make false statements in annual and quarterly SEC reports, and make false statements to auditors carries a maximum sentence of five years in prison. Each count for making false statements in annual and quarterly SEC reports carries a maximum sentence of 20 years in prison.
The statutory maximum sentences are prescribed by Congress and are provided here for informational purposes only, as any sentencings of the defendants would be determined by the judge.
Mr. Bharara praised the work of the Federal Bureau of Investigation and the United States Postal Inspection Service. He also thanked the SEC – which filed charges against TUZMAN and SMYTH today in a parallel civil case – for its assistance. He also thanked the Colombian government for its help in apprehending TUZMAN and thanked the Australian government for its assistance in apprehending SMYTH. He added that the investigation is continuing.
The charges were brought in connection with the President’s Financial Fraud Enforcement Task Force. The task force was established to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes. With more than 20 federal agencies, 94 U.S. attorneys’ offices, and state and local partners, it’s the broadest coalition of law enforcement, investigatory and regulatory agencies ever assembled to combat fraud. Since its formation, the task force has made great strides in facilitating increased investigation and prosecution of financial crimes; enhancing coordination and cooperation among federal, state and local authorities; addressing discrimination in the lending and financial markets; and conducting outreach to the public, victims, financial institutions and other organizations. Since fiscal year 2009, the Justice Department has filed over 18,000 financial fraud cases against more than 25,000 defendants. For more information on the task force, please visit www.StopFraud.gov.
This case is being handled by the Office’s Securities and Commodities Fraud Task Force. Assistant U.S. Attorneys Edward Y. Kim, Sarah E. McCallum, and Damian Williams are in charge of the prosecution.
The allegations contained in the Indictment are merely accusations, and the defendants are
presumed innocent unless and until proven guilty.