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UNITED STATES DISTRICT COURT
COMPLAINT Plaintiff Securities and Exchange Commission ("Commission") alleges the following against defendants Ira A. Gerard ("Gerard") and Karen S. Harris ("Harris"): SUMMARY 1. This enforcement action involves the material understatement of expenses in Mercator Software, Inc.'s ("Mercator") publicly released financial statements for the first and second quarters of 2000.1 During those quarters, Defendant Gerard (Mercator's Chief Financial Officer ("CFO")) and Defendant Harris (Mercator's Controller) failed to record certain expenses in the quarter during which they were incurred, resulting in understated losses for both quarters. This practice understated the extent of Mercator's losses and resulted in Mercator misstating its net losses in financial statements filed in its Form 10-Q for the first quarter and in its earnings release at the conclusion of the second quarter. Gerard and Harris each knew, or were reckless in not knowing, that these certain expenses were not reported. Gerard and Harris excluded theexpenses from the financial statements in an attempt to meet Wall Street analysts' earnings expectations for the two quarters. On August 21, 2000, Mercator announced that it had understated expenses for the first quarter by $1.3 million and for the second quarter by $1.1 million. As a result of the understated expenses, first quarter net loss, operating loss and loss per share were each understated by 14% and second quarter net loss, operating loss and loss per share were each understated by 10%. 2. By engaging in the transactions and practices alleged in this Complaint, Gerard violated Section 17(a) of the Securities Act and Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and he aided and abetted Mercator's violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Rules 12b-20 and 13a-13 thereunder. Harris violated Section 17(a) of the Securities Act and Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder and she aided and abetted Mercator's violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. 3. Accordingly, the Commission seeks the imposition of civil monetary penalties against Gerard and Harris. JURISDICTION AND VENUE 4. The Commission seeks the imposition of civil monetary penalties pursuant to Section 20(d) of the Securities Act [15 U.S.C. §77t(d)] and Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]. 5. This Court has jurisdiction over this action pursuant to Sections 20(d) and 22(a) of the Securities Act [15 U.S.C. §§77t(d), 77v(a)], Sections 21(d), 21(e) and 27 of the ExchangeAct [15 U.S.C. §§78u(d), 78u(e), 78aa] Venue is proper in this District because the locus of the Commission's investigation in this matter was in this District. 6. In connection with the conduct described in this Complaint, Gerard and Harris directly and indirectly made use of the mails or the means or instruments of transportation or communication in interstate commerce. DEFENDANTS AND RELEVANT ENTITY 7. Gerard, age 53, of Ridgefield, Connecticut, was CFO and Vice-President of Finance for Mercator from October 1995 until August 1, 2000. In the first quarter of 2000, Mercator's CEO began an active search for a replacement CFO.2 As of August 1, 2000, Gerard stepped down as CFO and Mercator named him Vice President of Finance. On August 20, 2000, Gerard was terminated by the company in connection with the company's announcement on August 21 of the restatement of financial results for the first and second quarters of 2000. Gerard has never been licensed as a Certified Public Accountant and is currently self-employed. 8. Harris, age 41, of Riverside, Connecticut, was Controller at Mercator from December 1997 until August 20, 2000, when she was relieved of her duties in connection with the company's announcement of the restatement of financial results for the first and second quarters of 2000. Harris resigned from Mercator in February 2001 and is currently not licensed as a Certified Public Accountant. 9. Mercator is a Delaware corporation with its principal place of business in Wilton, Connecticut. Mercator was incorporated in Connecticut in 1985 as TSI International Software,Inc. and reincorporated in Delaware in September 1993. The company changed its name to Mercator, effective April 3, 2000. At all relevant times, Mercator's securities were traded on the NASDAQ National Market and registered with the Commission pursuant to Section 12(g) of the Exchange Act, and the company was required to file reports with the Commission pursuant to Section 13(a) of the Exchange Act. STATEMENT OF FACTS Background 10. Mercator specializes in software that allows businesses to integrate different types of systems and applications. In 1999, Mercator's annual revenues were $99 million. Starting in late 1998 through the end of 1999, Mercator made three substantial acquisitions which placed a strain on its operational resources and its internal controls. Although Mercator's business grew substantially as a result of the acquisitions, its accounting staff was not correspondingly expanded at the time of the acquisitions. 11. From the time Mercator began publicly trading in 1997 until the end of 1999, the company met analysts' earnings expectations for every fiscal quarter. During the first and second quarters of 2000, Gerard placed substantial pressure on Harris to continue to meet analysts' earnings expectations in reported financial results. As a result of that pressure, Harris intentionally failed to record certain operating expenses that were material to both quarters. Gerard was informed of, or was reckless in not knowing of, the underreporting in both quarters. 12. In addition to Gerard and Harris being aware of the underreporting of certain expenses, Mercator also failed to report expenses material to both quarters because its internal controls relating to expense reporting were inadequate. Both Gerard and Harris hadresponsibility for implementing adequate internal controls. In particular, Mercator had inadequate procedures in place to ensure accurate and timely communication between the accounting department and other areas of the company, with the result that certain expenses were not internally reported to the accounting department until after the financial statements for the period had already been publicly released. Failure To Properly Record Expenses in the First Quarter 13. In its Form 10-Q filed on May 15, 2000, Mercator understated actual first quarter expenses by approximately $1.3 million. Gerard signed the Form 10-Q on behalf of Mercator. At the time the Form 10-Q was filed, Gerard and Harris both knew, or were reckless in not knowing, that at least $750,000 in first quarter expenses had not been included in the financial statements for the first quarter. The balance of the unreported expenses (approximately $550,000) was excluded largely as a result of either inadvertence or failure of internal controls relating to expense reporting. 14. Mercator also filed a Form S-3 registration statement on May 15 that became effective on June 1. The registration statement incorporated by reference Mercator's filings with the Commission, including the misleading Form 10-Q for the first quarter. 15. The unreported $750,000 in first quarter expenses was comprised of three categories: (1) legal expenses; (2) bonus expenses; and (3) expenses related to a shareholder value study completed in the first quarter. The understatement of legal and bonus expenses began because Mercator had inadequate procedures in place for ensuring that its accounting department was informed of such expenses in a timely manner. By the time the Form 10-Q was filed, however, both Gerard and Harris knew, or were reckless in not knowing, that legalexpenses and bonus expenses were not being tracked adequately by Mercator's internal expense reporting systems. Both also knew, or were reckless in not knowing, that Mercator had incurred substantial legal and bonus expenses during the first quarter that were not included in the first quarter financial statements. In addition to being aware of the unrecorded legal and bonus expenses, both Gerard and Harris knew that a substantial non-recurring expense relating to a shareholder value study had been incurred in the first quarter and that the expense had not been recorded in the first quarter financial statements. Gerard and Harris did not include the $750,000 in expenses in financial statements filed with the Form 10-Q. Neither notified Mercator's outside auditors that substantial expenses had been excluded from the financial statements. 16. The numbers reported in the Form 10-Q allowed the company to meet analysts' expectations. If all first quarter expenses had been reported, Mercator would not have met analysts' earnings expectations. As a result of the total $1.3 million in excluded expenses, Mercator's first quarter net loss, operating loss and loss per share each were understated by 14%. Failure to Properly Record Expenses in the Second Quarter 17. On July 20, 2000, Mercator announced financial results for the second quarter that understated expenses by approximately $1.1 million. Gerard and Harris intentionally excluded approximately $850,000 of those expenses. An additional $850,000 of second quarter expenses was excluded largely as a result of Mercator's inadequate internal expense reporting controls and through inadvertence.3 18. Harris realized by June 2000 that revenue figures for the second quarter would not be high enough for the company to meet published analysts' earnings expectations. During the second quarter, Harris expressed concerns to Gerard that expenses were likely to be higher than anticipated and second quarter revenue figures were turning out to be lower than anticipated. When Harris closed the accounts payable system after the end of the second quarter, she kept track of invoices for second quarter expenses that had not been entered into the accounts payable system. As second quarter expenses came in to the accounting department, Harris added them to her list but did not include them in the financial statements she was preparing for the second quarter because she was concerned that, if she did, the company would not meet earnings expectations. In early July 2000, Harris informed Gerard about her decision not to record certain expenses in the second quarter. Gerard approved Harris' decision, telling her not to worry about it and that there was an expense cushion in the budget in the fourth quarter that would cover those expenses. In addition to excluding the expenses described above, Gerard and Harris excluded certain second quarter bonus expenses from the financial statements. The total second quarter expenses that Gerard and Harris decided to exclude was $850,000. Neither notified Mercator's outside auditors that substantial expenses had been excluded from the financial statements. 19. Notwithstanding the exclusion of second quarter expenses from the financial statements, Mercator did not meet analysts' earnings expectations for the second quarter. Mercator issued an earnings warning after the close of the market on July 14, 2000 indicating that it expected pro-forma earnings per share to be $.04, which was $.04 lower than expectations. The preliminary figures that Mercator released on July 14, 2000 were misleading because theydid not include the $850,000 in expenses that Gerard and Harris had excluded, nor did they include the additional $850,000 in expenses that were excluded due to inadvertence and poor internal controls. 20. On July 20, 2000, Mercator issued a press release and financial statements that still did not include those second quarter expenses. As a result of the excluded expenses, second quarter net loss, operating loss and loss per share each were understated by 10%. Mercator's reported pro-forma numbers were also substantially inaccurate; on a pro forma basis, the understatement resulted in earnings per share being overstated by 100%, operating income being overstated by 168%, and net income being overstated by 139%. Mercator Restates Earnings For First and Second Quarters of 2000 21. In late 1999, Mercator's Chief Executive Officer (the "CEO") removed certain non-financial responsibilities from Gerard. In the first quarter of 2000, the CEO began an active search for a replacement CFO. On August 1, 2000, Gerard was replaced by a new Chief Financial Officer (the "new CFO"). 22. On the morning of July 20, 2000, prior to Mercator's second quarter earnings release, Harris met informally with the new CFO. At that meeting Harris informed the new CFO that she had concerns about the recording of expenses in both the first and the second quarter financial statements. When the new CFO started work on August 1, 2000, he began investigating Harris' claim that the company's first and second quarter expenses were understated. By August 9, 2000, the new CFO's investigation revealed that substantial expenses had not been recorded in the first and second quarters. On August 10, 2000, the new CFO contacted Mercator's in-housecounsel about the accounting issues and instructed him to contact outside counsel and the audit committee. The new CFO also tendered his own immediate resignation. 23. On August 10, 2000, the company began an internal investigation. On August 14, 2000, Mercator placed Gerard (who had previously been replaced on August 1, 2000) on administrative leave and terminated his employment on August 20, 2000. Also on August 20, 2000, Mercator relieved Harris of her duties and of all responsibility for accounting decisions. 24. On August 21, 2000, Mercator announced that the previously released financial statements for the first and second quarters were inaccurate and that it had hired its outside auditors to conduct a special review of its systems and controls and to make recommendations for improvements. The company filed an amended Form 10-Q for the first quarter and a Form 10-Q for the second quarter reflecting restated results. The restatement revealed that the first quarter net loss, operating loss and loss per share were each understated by 14%. For the second quarter, net loss, operating loss and loss per share were each understated by 10%. FIRST CLAIM FOR RELIEF
25. The Commission repeats and incorporates by reference the allegations in paragraphs 1-24 of the Complaint as if set forth fully herein. 26. Gerard and Harris, directly and indirectly, acting intentionally, knowingly or recklessly, in the offer or sale of securities by the use of the means or instruments of transportation or communication in interstate commerce or by the use of the mails: (a) have employed or are employing devices, schemes or artifices to defraud; (b) have obtained or are obtaining money or property by means of untrue statements of material fact or omissions to statea material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (c) have engaged or are engaging in transactions, practices or courses of business which operate as a fraud or deceit upon purchasers of the securities. 27. As a result, Gerard and Harris have violated Section 17(a) of the Securities Act [15 U.S.C. §77q(a)]. 28. Gerard and Harris' violations of Section 17(a) of the Securities Act have involved fraud, deceit or deliberate or reckless disregard of regulatory requirements and directly or indirectly have resulted in substantial losses or significant risk of substantial losses to other persons, within the meaning of Section 20(d) of the Securities Act [15 U.S.C. §77t(d)]. SECOND CLAIM FOR RELIEF
29. The Commission repeats and incorporates by reference the allegations in paragraphs 1-28 of the Complaint as if set forth fully herein. 30. Gerard and Harris, directly or indirectly, acting intentionally, knowingly or recklessly, by the use of means or instrumentalities of interstate commerce and of the mails, in connection with the purchase or sale of securities: (a) have employed or are employing devices, schemes or artifices to defraud; (b) have made or are making untrue statements of material fact or have omitted or are omitting to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading; and (c) have engaged or are engaging in acts, practices or courses of business which operate as a fraud or deceit upon certain persons. 31. As a result, Gerard and Harris have violated Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)] and Rule 10b-5 thereunder [17 C.F.R. §240.10b-5]. 32. Gerard and Harris' violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder have involved fraud, deceit or deliberate or reckless disregard of regulatory requirements and directly or indirectly have resulted in substantial losses or significant risk of substantial losses to other persons, within the meaning of Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]. THIRD CLAIM FOR RELIEF
33. The Commission repeats and incorporates by reference the allegations in paragraphs 1-32 of the Complaint as if set forth fully herein. 34. Gerard and Harris' conduct as herein alleged constituted violations of Section 13(b)(5) of the Exchange Act [15 U.S.C. §78m(b)(5)] and Rule 13b2-1 thereunder [17 C.F.R. §240.13b2-1]. 35. Gerard and Harris' conduct as herein alleged justifies the imposition of a civil penalty within the meaning of Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]. FOURTH CLAIM FOR RELIEF (AGAINST GERARD)
36. The Commission repeats and incorporates by reference the allegations in paragraphs 1-35 of the Complaint as if set forth fully herein. 37. Gerard's conduct as herein alleged constituted violations of Rule 13b2-2 of the Exchange Act [17 C.F.R. §240.13b2-2]. 38. Gerard's conduct as herein alleged justifies the imposition of a civil penalty within the meaning of Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]. FOURTH CLAIM FOR RELIEF
39. The Commission repeats and incorporates by reference the allegations in paragraphs 1- 38 of the Complaint as if set forth fully herein. 40. Mercator's conduct as alleged herein constituted violations of Section 13(a) of the Exchange Act [15 U.S.C. §78m(a)] and Rules 12b-20 and 13a-13 thereunder [17 C.F.R. §§240.12b-20, 240.13a-13]. 41. Gerard and Harris knew or should have known that their conduct as herein alleged would aid and abet Mercator's violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. 42. Gerard and Harris' conduct as herein alleged justifies the imposition of a civil penalty within the meaning of Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]. FIFTH CLAIM FOR RELIEF
43. The Commission repeats and incorporates by reference the allegations in paragraphs 1- 42 of the Complaint as if set forth fully herein. 44. Mercator's conduct as alleged herein constituted violations of Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. §78m(b)(2)(A)] and 13(b)(2)(B) of the Exchange Act [15 U.S.C. §78m(b)(2)(B)]. 45. Gerard and Harris knew or should have known that their conduct as herein alleged would aid and abet Mercator's violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. 46. Gerard and Harris' conduct as herein alleged justifies the imposition of a civil penalty within the meaning of Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]. PRAYER FOR RELIEF WHEREFORE, the Commission respectfully requests that this Court: A. Enter a final judgment ordering Gerard to pay a civil penalty pursuant to 20(d) of the Securities Act [15 U.S.C. §77t(d)] and Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]; B. Enter a final judgment ordering Harris to pay a civil penalty pursuant to 20(d) of the Securities Act [15 U.S.C. §77t(d)] and Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]; C. Grant such other and further relief as the Court deems just and proper.
Footnotes1 Mercator's first quarter ended on March 31, 2000. Its second quarter ended on June 30, 2000. 2 During the first and second quarters of 2000, Gerard was undergoing treatment for a serious illness. 3 The total $1.7 million understatement was offset by approximately $550,000 in credits to the second quarter (for first quarter expenses that had been improperly recorded in the second quarter), resulting in the net restatement amount of approximately $1.1 million. http://www.sec.gov/litigation/complaints/comp17898.htm
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