The Securities and Exchange Commission filed accounting fraud charges against two former top executives of a now-bankrupt online video management company, accusing them of falsifying financial statements to make the company appear more profitable than it was in reality.

The SEC alleges that then-CEO Kaleil Isaza-Tuzman and then-CFO Robin Smyth employed a variety of schemes to manipulate KIT Digital’s books and mislead investors, including an off-the-books slush fund used to generate payments back to the company and create the false appearance that KIT Digital was being paid for its products.

“We allege that Isaza-Tuzman and Smyth brazenly falsified the financial condition of a public company and misled investors and auditors about the company’s revenues and ability to deliver the products it was touting,” said Andrew M. Calamari, director of the SEC’s New York Regional Office, in a statement.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Isaza-Tuzman and Smyth.

“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,” said Preet Bharara, U.S. Attorney for the Southern District of New York, in a statement. 

According to the SEC’s complaint filed in federal court in Manhattan Wednesday, in one scheme, Isaza-Tuzman and Smyth used KIT Digital’s own money to make it look like customer receivables were being paid. They added $7.85 million in cash consideration to an acquisition transaction with the secret understanding that the seller would not receive any of that money. Smyth instead had the money wired to third parties so at least $4.3 million was returned to KIT Digital as purported payments from customers.

Isaza-Tuzman and Smyth also allegedly caused KIT Digital to improperly recognize nearly $1.34 million in sales revenue for the quarter ended June 30, 2010, even though they knew or recklessly disregarded that the company had not delivered the required product to the purchaser and thus was not entitled to recognize revenue on the sale. They worked to obtain a false confirmation of delivery from their customer, altered purchase order language to hide a product deployment schedule, and misled the company’s auditors into thinking that the purchaser’s website was being run on the software that KIT Digital had promised, when it was not.

In addition, according to the SEC, Isaza-Tuzman fraudulently failed to disclose that he had arranged with a hedge fund manager to use KIT Digital’s own money to trade the company’s stock to increase the volume or support the price at opportune moments. Isaza-Tuzman allegedly hid the fact that $2 million in offshore investments were inappropriately being characterized as cash or cash equivalents when the company had no chance at readily getting its money back.

The SEC’s complaint charges Isaza-Tuzman and Smyth with violating various securities laws. The SEC is seeking disgorgement of ill-gotten gains plus prejudgment interest and penalties as well as permanent injunctive relief and officer-and-director bars.

Tuzman was arrested in Colombia on Tuesday on market manipulation and accounting fraud charges and is being held in Colombia pending extradition proceedings. Smyth was arrested Wednesday in Australia on accounting fraud charges and is being held in Australia pending extradition proceedings.

Tuzman, 43, was charged by prosecutors with eight counts. For the market manipulation scheme, Tuzman was 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 was 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, was 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 up to 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.

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