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UNITED STATES DISTRICT COURT
Plaintiff United States Securities and Exchange Commission ("Commission ") for its Complaint alleges: NATURE OF ACTION 1. This case concerns a blatant accounting fraud perpetrated by paper manufacturer American Tissue, Inc., ("American Tissue" or "the Company") and three of its senior corporate officers: Mehdi Gabayzadeh ("Gabayzadeh"), the Company's former president, chief executive officer and director; Edward I. Stein ("Stein"), its former executive vice president and chief financial officer; and John Lorenz ("Lorenz"), its former vice president for finance (collectively, "Defendants"). 2. In 2000 and 2001 — a period during which American Tissue offered and sold $165 million of securities to investors — Defendants fraudulently and materially inflated American Tissue's revenues and earnings in periodic reports filed with the Commission by, among other things, improperly capitalizing expenses as assets, overvaluing the Company's inventories and creating millions of dollars in phony revenue and accounts receivable through bogus "bill and hold" sales. By engaging in this scheme, the Company was able to conceal its financial weakness and thereby induce its lenders to continue to extend commercial credit and advances based on, among other things, the Company's bogus receivables and the Company's overstated reported financial condition and operating results. 3. As a consequence of this accounting scheme, American Tissue's annual report on Form 10-K for the fiscal year ending September 30, 2000 reported net income for that year of $24.5 million. In fact, American Tissue had suffered a loss for the period of at least $3.6 million. Similarly, the quarterly report filed by American Tissue for the third fiscal quarter of 2001, ending June 30, 2001, overstated the Company's reported net income of $15.5 million for the first nine months of fiscal 2001 by at least $21.8 million, thereby hiding a loss of at least $6.3 million. 4. By filing materially false reports with the Commission, defendant American Tissue violated the following provisions of the federal securities laws: (i) the antifraud provisions (Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and Exchange Act Rule 10b-5), (ii) the reporting provisions (Section 15(d) of the Exchange Act, and Exchange Act Rules 12b-20, 15d-1 and 15d-13), (iii) the books and records requirements (Section 13(b)(2)(A) of the Exchange Act), and (iv) the internal control provisions (Section 13(b)(2)(B) of the Exchange Act). 5. By engaging in their fraudulent accounting scheme, defendants Gabayzadeh, Stein and Lorenz violated (or aided and abetted violations of) the following provisions of the federal securities laws: (i) the antifraud provisions (Section 10(b) of the Exchange Act, and Exchange Act Rule 10b-5), (ii) the reporting provisions (Section 15(d) of the Exchange Act, and Exchange Act Rules 12b-20 and 15d-13), (iii) the books and records requirements (Section 13(b)(2)(A) of the Exchange Act and Exchange Act Rules 13b2-1 and 13b2-2), and (iv) the internal control provisions (Sections 13(b)(2)(B) and 13(b)(5)) of the Exchange Act. In addition to the foregoing provisions of the federal securities laws, Stein and Lorenz also aided and abetted American Tissue's violation of Exchange Act Rule 15d-1. 6. Unless enjoined by order of this Court, defendants American Tissue, Gabayzadeh, Stein and Lorenz, are likely to engage in such acts, practices, and transactions similar to those described herein. 7. The Commission seeks a judgment permanently enjoining American Tissue, Gabayzadeh, Stein, and Lorenz, from further securities law violations and imposing civil monetary penalties, disgorgement and officer and director bars. JURISDICTION AND VENUE 8. The Commission brings this action pursuant to the authority conferred upon it by Sections 21(d) and (e) of the Exchange Act, 15 U.S.C. §§ 78u(d) and (e), to enjoin permanently the Defendants from future violations of the federal securities laws and granting other relief. 9. This Court has jurisdiction over this action, and venue is proper, pursuant to Sections 21(d)(3), 21(e) and 27 of the Exchange Act [15 U.S.C. §§ 78u(d)(3), 78u(e) and 78aa]. 10. Each of the defendants, directly or indirectly, made use of the means or instrumentalities of interstate commerce, or of the mails, in connection with the transactions, acts, practices, and courses of business described in this Complaint, certain of which have occurred within this judicial district. DEFENDANTS 11. American Tissue, Inc., a Delaware corporation headquartered in Hauppauge, New York, is a manufacturer of tissue and paper products with paper mills and converting facilities located throughout the United States and Mexico. American Tissue has been a reporting company under Section 15(d) of the Exchange Act since February 7, 2000, when it offered and sold $165 million of senior secured notes to investors. On September 11, 2001, American Tissue filed a petition under Chapter 11 of the U.S. Bankruptcy Code in contemplation of the liquidation of the Company. 12. Mehdi Gabayzadeh, a resident of Kings Point, New York, was the president, chief executive officer and a director of American Tissue until November 9, 2001, when he resigned from those positions. 13. Edward I. Stein, a resident of Boca Raton, Florida, was the executive vice president and chief financial officer of American Tissue until September 3, 2001, when he resigned from those positions. During the relevant time period, Stein was a certified public accountant in the state of New York. 14. John Lorenz, a resident of Lexington, Kentucky, was American Tissue's vice president for finance from on or about July 17, 2000 until May 14, 2002 when he resigned from that position.
FACTS
Defendants American Tissue, Stein and Lorenz
15. In American Tissue's annual report filed on Form 10-K for the fiscal year ending September 30, 2000, the Company reported assets and net income that the defendants American Tissue, Stein and Lorenz had fraudulently inflated by overvaluing the Company's finished goods inventory. 16. According to Generally Accepted Accounting Principles ("GAAP"), inventory is required to be valued at the lower of its cost or market value. Market value may not exceed the net realizable value of the inventory, that is, the estimated selling price of the inventory less the costs of disposal. 17. However, Lorenz, at Stein's direction, overvalued American Tissue's finished goods inventory by at least $12.5 million at fiscal year end 2000 by failing to mark down the inventory to its market price (as represented by actual selling prices for American Tissue's products) or net realizable value. 18. American Tissue overstated its finished goods inventory at fiscal year-end 2000 by at least $12.5 million — or 17% of its reported $72.6 million in finished goods inventory. This, in turn, caused a corresponding overstatement of at least $12.5 million, or 51%, of its reported net income of $24.5 million for fiscal year 2000. 19. Defendants American Tissue, Stein and Lorenz knew, or were reckless in not knowing, that American Tissue's inflation of the Company's finished goods inventory was improper and that it caused the Company to report materially inflated income and earnings in the Company's annual report on Form 10-K for fiscal year 2000. American Tissue Improperly Capitalizes Expenses to Increase Income 20. In August 2000, American Tissue started to improperly capitalize previously expensed supplies. This resulted in a further material misstatement of American Tissue's reported income for the fiscal year ending September 30, 2000. 21. Lorenz, at the direction of Stein, caused entries to be made in American Tissue's books and records that reclassified $15.6 million of previously expensed supplies — of the type typically consumed in the normal operation of the business — as a Company asset designated "supplies inventory." By capitalizing American Tissue's supplies (in violation of GAAP and the Company's own accounting policies), defendants American Tissue, Stein and Lorenz improperly reduced the Company's reported expenses, thereby increasing its reported income. 22. Without the fraudulent capitalization of supply expenses, American Tissue's reported net income for fiscal 2000 would have been reduced from $24.5 million to $8.9 million and the Company would have been in violation of certain of the financial covenants set forth in its loan agreement with its banks. 23. As a result of its improper capitalization of supplies inventory, together with its overstatement of finished goods inventory, American Tissue's reported pre-tax income of $24.5 million for the fiscal year ended September 30, 2000 was overstated by at least $28.1 million. 24. Defendants Stein, Lorenz and American Tissue knew, or were reckless in not knowing, that American Tissue's capitalization of the Company's supplies expenses was improper and that it caused the Company to report materially inflated income in the Company's annual report on Form 10-K for fiscal year 2000.
Defendants Gabayzadeh, Stein and Lorenz Engage in a Fraudulent
25. In fiscal 2001, American Tissue experienced increasing cash flow deficiencies. Under its revolving credit agreement with is primary lender, American Tissue could borrow up to 85 percent of the face amount of its accounts receivable assigned to the lender. To increase the amount of cash available under that credit line, Gabayzadeh, Stein and Lorenz engaged in a scheme to fraudulently to create fictitious accounts receivable. 26. During the fiscal quarter ending June 30, 2001, Lorenz, at the direction of Stein and with the knowledge and participation of Gabayzadeh, recorded approximately $21.8 million in bogus "bill and hold" sales and resulting accounts receivable. A bill and hold sale is a transaction in which the buyer orders a quantity of product from the seller but requests that shipment be delayed. The $21.8 million of bill and hold sales recorded by American Tissue were fraudulent because the customers had not ordered any quantity of product from the Company. None of the invoiced product was ever shipped to customers but instead was included in American Tissue's reported fiscal 2001 third quarter end inventory. 27. Phony invoices were created by, or at the direction of, defendants Gabayzadeh, Stein and Lorenz and forwarded to American Tissue's primary lender to document the fraudulent receivables in order to obtain cash advances on the credit line. In addition, in furtherance of the scheme, Stein and Gabayzadeh contacted certain customers of American Tissue and asked them to furnish phony purchase orders to further document the bogus sales. 28. As a result of recording these bogus sales, American Tissue's reported net income for the first nine months of fiscal 2001of $15.5 million was overstated by approximately $21.8 million. 29. Defendants knew, or were reckless in not knowing, that the creation of phony "bill and hold" transactions, including false documentation of those purported transactions, would falsify the Company's books and records and would cause the Company to report materially inflated income in its quarterly report on Form 10-Q for the third fiscal quarter of 2001. Defendants Failure to Disclose American Tissue's Breach of Loan Covenants 30. Defendants Stein and Lorenz knew, or were reckless in not knowing, that American Tissue's annual report on Form 10-K for fiscal year 2000 contained the material affirmative misrepresentation that the Company was in compliance with its loan covenants with its lenders -- when it was not -- and omitted to disclose that the Company's failure to comply with such covenants adversely affected the Company's liquidity and ability to continue as a going concern. Defendants' Misrepresentations to American Tissue's Accountants 31. In connection with American Tissue's annual audit for Fiscal Year 2000, defendants Stein and Lorenz each signed a management representation letter to the company's accountants which falsely stated, among other things, that (i) the company's financial statements were fairly presented in conformity with GAAP, and (ii) and that there had been no fraud at he company involving management or employees that could have a material effect on the financial statements. 32. Moreover, defendants Gabayzadeh, Stein and Lorenz made materially false or misleading statements or omissions concerning the Company's fraudulent bill and hold sales -- or caused another to make such materially false or misleading statements or omissions -- to an accountant in connection with the preparation and/or filing of American Tissue's quarterly report on Form 10-Q for the third fiscal quarter of 2001. FIRST CLAIM
[Defendants American Tissue, Gabayzadeh, Stein and Lorenz]
33. The Commission repeats and incorporates by reference paragraphs 1 through 32 of this Complaint. 34. Defendants American Tissue, Gabayzadeh, Stein and Lorenz, in connection with the purchase or sale of American Tissue's securities, by the use of means or instrumentalities of interstate commerce, or the mails, or of any facility of any national securities exchange, directly or indirectly: (a) employed devices, schemes, or artifices to defraud; or (b) made untrue statement of material fact or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) engaged in acts, practices, or courses of business which operated or would have operated as a fraud or deceit upon any person, in violation of Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)] and Exchange Act Rule 10b-5 [17 C.F.R. §240.10b-5]. 35. Defendants Gabayzadeh, Stein and Lorenz knowingly or recklessly made material misrepresentations, or omitted material facts in connection with, among other things, American Tissue's Form 10-Q for the third quarter for fiscal year 2001. Defendants American Tissue, Gabayzadeh, Stein and Lorenz also made material misstatements or omissions related to American Tissue's overstatement of accounts receivable and net income. 36. Additionally, defendants American Tissue, Stein and Lorenz knowingly or recklessly made material misrepresentations, or omitted material facts in connection with American Tissue's financial statements included in its annual report on Form 10-K for fiscal 2000 concerning American Tissue's overstatement of inventory and net income. 37. By reason of the foregoing defendants American Tissue, Gabayzadeh, Stein and Lorenz, each violated Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)] and Exchange Act Rule 10b-5 [17 C.F.R. §240.10b-5]. SECOND CLAIM
[Defendants American Tissue, Gabayzadeh, Stein and Lorenz]
38. The Commission repeats and incorporates by reference paragraphs 1 through 37 of this Complaint. 39. American Tissue filed with the Commission an annual report on Form 10-K for its fiscal year ended September 30, 2000 and a quarterly report on Form 10-Q for its fiscal quarter ended June 30, 2001, which contained untrue statements of material fact and omitted to state material facts required to be stated therein or necessary to make the statements made not misleading, concerning, among other things, American Tissue's inventory, accounts receivable, expenses, revenues and net income. 40. By reason of the foregoing American Tissue violated Section 15(d) of the Exchange Act [15 U.S.C. §78o(d)] and Exchange Act Rules 12b-20, 15d-1 and 15d-13 [17 C.F.R §§ 240.12b-20, 240.15d-1, and 240.15d-13]. 41. By causing American Tissue to file with the Commission the described false and misleading Form 10-K report, defendants Stein and Lorenz, each aided and abetted American Tissue's violations of Section 15(d) of the Exchange Act [15 U.S.C. §78o(d)] and Exchange Act Rules 12b-20 and 15d-1 [17 C.F.R §§ 240.12b-20 and 240.15d-1]; and by causing American Tissue to file with the Commission the described false and misleading Form 10-Q report, Defendants Gabayzadeh, Stein and Lorenz each aided and abetted American Tissue 's violation of Section 15(d) of the Exchange Act [15 U.S.C. §78o(d)] and Exchange Act Rules 12b-20 and 15d-13 [17 C.F.R §§ 240.12b-20 and 240.15d-13]. THIRD CLAIM
[Defendants Gabayzadeh, Stein and Lorenz]
42. The Commission repeats and incorporates by reference paragraphs 1 through 41 of this Complaint. 43. Defendants Gabayzadeh, Stein and Lorenz, knowingly circumvented or knowingly failed to implement a system of internal accounting controls and/or knowingly falsified American Tissue's books, records or accounts. 44. By reason of the foregoing, defendants Gabayzadeh, Stein and Lorenz each violated Section 13(b)(5) of the Exchange Act [15 U.S.C. §78m(b) (5)]. FOURTH CLAIM
[Defendants American Tissue, Gabayzadeh, Stein and Lorenz]
45. The Commission repeats and incorporates by reference paragraphs 1 through 44 of this Complaint. 46. Defendant American Tissue violated Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. §78m(b)(2)(A] by maintaining false and misleading books and records that, among other things, materially overstated American Tissue's inventory and net income for its fiscal year 2000 and materially overstated its accounts receivable and net income for the third quarter of its fiscal year 2001. 47. Defendant American Tissue violated Section 13(b)(2)(B) of the Exchange Act [15 U.S.C. §78m(b)(2)(B)] by failing to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that its transactions were recorded as necessary to permit preparation of financial statements in conformity with GAAP. 48. By causing American Tissue to maintain false and misleading books and records and to fail to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that its transactions were recorded as necessary to permit preparation of financial statements in conformity with GAAP, defendants Gabayzadeh, Stein and Lorenz each aided and abetted American Tissue's violations of Section 13(b)(2)(A) and (B) of the Exchange Act [15 U.S.C. §78m(b)(2)(A)&(B)]. FIFTH CLAIM
[Defendants Gabayzadeh, Stein and Lorenz]
49. The Commission repeats and incorporates by reference paragraphs 1 through 48 of this Complaint. 50. Defendant Gabayzadeh, Stein, and Lorenz directly or indirectly falsified, or caused to be falsified American Tissue's books, records, and/or accounts required to be maintained under Section 13(b)(2) of the Exchange Act [15 U.S.C. §78m(b)(2)]. 51. By engaging in a scheme to record the Company's overvalued inventory and/or phony accounts receivable, Gabayzadeh, Stein, and Lorenz each violated Exchange Act Rule 13b2-1 [17 C.F.R. §240.13b2-1]. SIXTH CLAIM
[Defendants Gabayzadeh, Stein and Lorenz]
52. The Commission repeats and incorporates by reference paragraphs 1 through 51 of this Complaint. 53. Defendants Stein and Lorenz, as officers of American Tissue, directly or indirectly, made materially false and/or misleading statements, or omitted to state, or caused another person to omit to state material facts necessary in order to make statements made, in light of the circumstances under which they were made, not misleading to American Tissue 's accountants in connection with the audits of American Tissue's financial statements for fiscal year 2000. 54. Defendants Gabayzadeh, Stein and Lorenz, as officers of American Tissue, directly or indirectly, made materially false and/or misleading statements, or omitted to state, or caused another person to omit to state material facts necessary in order to make statements made, in light of the circumstances under which they were made, not misleading to American Tissue 's accountants in connection with the preparation of the Company's Form 10-Q for the third quarter of 2001. 55. By reason of the foregoing, defendants Gabayzadeh, Stein and Lorenz each violated Exchange Act Rule 13b2-2 [17 C.F.R. §240.13b2-2]. PRAYER FOR RELIEF WHEREFORE, Plaintiff Commission respectfully requests that this Court enter an Order: (a) permanently restraining and enjoining defendant American Tissue, its agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 10(b), 15(d) and 13(b)(2)(A) and (B) of the Exchange Act [15 U.S.C. §§ 78j(b), 78o(d), 78m(b)(2)(A) and (B)] and Exchange Act Rules 10b-5, 12b-20, 15d-1, and 15d-13 [17 C.F.R. §240.10b-5, 12b-20, 15d-1, and 15d-13]; (b) permanently restraining and enjoining defendant Gabayzadeh, his agents, servants, employees, attorneys, and all persons in active concert or participation with him who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. §78j(b) and 78m(b)(5)] and Exchange Act Rules 10b-5, 13b2-1, and 13b2-2 [17 C.F.R §§ 240.10b-5, 13b2-1 and 13b2-2], and from aiding and abetting future violations of Sections 15(d), 13(b)(2)(A) and (B) of the Exchange Act [15 U.S.C. §78o(d), and 78m(b)(2)(A) and (B)] and Exchange Act Rules 12b-20 and 15d-13 [17 C.F.R. §§240.12b-20 and 15d-13]; (c) permanently restraining and enjoining defendants Stein and Lorenz, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. §78j(b) and 78m(b)(5)]and Exchange Act Rules 10b-5, 13b2-1, and 13b2-2 [17 C.F.R §§ 240.10b-5, 13b2-1 and 13b2-2], and from aiding and abetting future violations of Sections 15(d), and 13(b)(2)(A) and (B) of the Exchange Act [15 U.S.C. §78o(d), and 78m(b)(2)(A) and (B)] and Exchange Act Rules 12b-20, 15d-1, and 15d-13 [17 C.F.R. §§240.12b-20, 15d-1 and 15d-13]; (d) imposing civil penalties against Defendants Gabayzadeh, Stein, Lorenz, pursuant to Section 21(d)(3) of the Exchange Act [15 U.S.C. §78u(d)(3)]; (e) ordering Defendants Gabayzadeh and Stein to disgorge ill-gotten gains from engaging in the conduct herein, together with prejudgment interest thereon; (f) permanently barring each of Gabayzadeh, Stein and Lorenz from serving as an officer or director of a publicly-held company, pursuant to Section 21(d)(2) of the Exchange Act [15 U.S.C. § 78u(d)(2)]. (g) granting such other and further relief as this Court deems just and proper.
Robert B. Blackburn (RB 1545)
http://www.sec.gov/litigation/complaints/comp18022.htm
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