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Securities and Exchange Commission v. Gary A. Prince

May 2, 2013

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
GARY A. PRINCE, DEFENDANT.



The opinion of the court was delivered by: Gladys Kessler United States District Judge

MEMORANDUM OPINION

Plaintiff United States Securities and Exchange Commission ("SEC" or "the Commission") brings this civil action against Defendant Gary A. Prince ("Prince") alleging violations of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77a et seq., the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78a et seq., and various Rules promulgated under the Exchange Act. On December 10, 2012 through January 4, 2013, the Court held a bench trial in which fifteen witnesses testified. Based on the testimony presented by those witnesses, the voluminous number of exhibits admitted into evidence, the parties' representations of what facts were not in dispute, and the applicable caselaw, the Court makes the following findings of fact and conclusions of law.

TABLE OF CONTENTS

I. FINDINGS OF FACT .......................................... 5

A. Creation of Integral Systems, Inc. ....................... 5

B. Prince's Duties and Activities Between 1982 and 1998 ..... 5

C. Prince's Duties and Activities Between December 1998 and August 2006 .................................................. 8

1. Prince Becomes a Full-Time Employee at Integral ........ 8

2. Mergers and Acquisitions Program ...................... 11

3. Prince's Compensation ................................. 13

4. Prince's Stock Options ................................ 13

5. Executive Management Salaries/Bonuses ................. 14

6. The "Gang of Six"/"Gang of Seven" ..................... 14

7. Advisor to Chamberlain ................................ 15

8. Prince's Responsibility for the Contracts Department .. 17

9. Drafting the MD&A Section of Public Filings ........... 19

10. Reviewing and Commenting on Drafts of Public Filings .. 20

11. Prince's Role During Brown's Maternity Leave .......... 21

12. Financial Press Releases .............................. 23

13. Financial Forecasting ................................. 23

14. Financial Presentations ............................... 23

15. Attendance at Board of Directors Meetings ............. 24

16. Prince's Involvement with the Accounting Department ... 24

D. Integral's Knowledge and Actions from December 1998 to August 2006 ................................................. 26

E. Role and Involvement of Counsel ......................... 28

1. Venable Becomes Corporate Counsel ..................... 28

2. The Relationship Between Venable and Integral ......... 29

3. Consultation with Venable Regarding Prince's Hiring ... 30

4. Venable's Knowledge of Prince's Duties and Activities . 32

5. Integral's Conversations with Venable about Prince's Possible Officer Status .................................... 34

a. Fall of 1999 ........................................ 34

b. January 2001 ........................................ 37 --2--

c. Spring and Summer of 2002 ........................... 38

6. Venable's Termination as Corporate Counsel ............ 39

7. Venable's Rehiring by the Board of Directors Audit Committee .................................................. 40

8. DLA Piper's Resignation as Corporate Counsel and Venable's Rehire ........................................... 42

9. In December 2005, Venable Again Researched Whether Prince Needed to Be Disclosed in Public Filings ................... 42

10. Integral's Filing of a Form 8-K Disclosing Wachtel's Allegations ................................................ 44

11. NASDAQ and SEC Investigations ......................... 45

12. In August 2006, Prince Is Named an Executive Officer and Disclosed to the SEC ....................................... 51

13. Advice from Venable to Integral ....................... 53

F. Post-2006 Activities and Procedural History ............. 54

II. CONCLUSIONS OF LAW ...................................... 56

A. Legal Framework ......................................... 56

B. Prince's De Facto Officer Status ........................ 62

1. Prince's Duties, Functions, and Responsibilities Did Not Involve Performing Policy Making Functions ................. 66

C. Count VI: Liability under Section 16(a) and Rule 16a-3 of the Exchange Act ............................................ 73

D. Count II: Liability Under Section 10(b) and Rule 10b-5 of the Exchange Act ............................................ 74

1. Prince Did Not Act With Scienter When He Did Not File Section 16(a) Reports ...................................... 76

a. Integral Requested and Received Venable's Advice After Making Complete Disclosure ............................... 77

b. Integral Relied on Venable's Advice in Good Faith ... 81

c. In Subsequent Years, Venable Reiterated its Conclusion That Prince Could Work at Integral Without Disclosure .... 82

2. The SEC Did Not Establish That a "Scheme to Defraud" Existed .................................................... 91

E. Count III: Liability under Section 13(a) and Rules 13a-1 and 12b-20 of the Exchange Act .............................. 92

1. Scienter .............................................. 93 --3--

F. Count V: Liability Under Section 14(a) and Rule 14a-9 of the Exchange Act ............................................ 94

G. Count VII: Practicing Accounting Before the Commission .. 95

1. Prince Violated the Commission Rule 102(e) Order Barring Him from Appearing or Practicing Before the Commission as an Accountant ................................................. 95

2. Prince Did Not Obtain or Rely on Advice of Counsel Regarding Practicing Accounting Before the Commission ..... 109

H. Relief ................................................. 112

III. CONCLUSION ............................................. 118

I.FINDINGS OF FACT

A.Creation of Integral Systems, Inc.

1. Integral Systems, Inc. ("Integral") is incorporated and headquartered in Maryland. It makes and sells satellite ground systems, including satellite communications systems and software products for satellite command and control.

2. Integral was founded in 1982. One of the founders was Steven R. Chamberlain, who served as Integral's Chairman and Chief Executive Officer ("CEO") from 1982 until 2006.

3. Integral became a public company in 1988. At all times relevant to this action, Integral was an issuer of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, 15 U.S.C. § 78l.

B.Prince's Duties and Activities Between 1982 and 1998

4. In 1982, Prince was retained as a consultant by Integral to help set up its financial books and record systems. He also served as a Director on Integral's Board.

5. In 1992, Prince became Vice President and Chief Financial Officer ("CFO") of Integral during which he had the "final call" on accounting matters. He was not a full-time employee and performed his duties as a part-time consultant.

6. In June 1993, as a consequence of Prince's conduct as CFO of the public company Financial News Network, the SEC filed suit against Prince for violation of the federal securities laws.

7. On July 9, 1993, Integral issued a Form 8-K (a filing that a company is required to make disclosing any material event important to shareholders or the SEC) disclosing that Prince had been charged by the SEC.

8. On August 18, 1994, Judge Charles R. Richey of the U.S. District Court for the District of Columbia entered an Order of Final Judgment of Permanent Injunction against Prince. S.E.C. v. Gary A. Prince, Civ. No. 93-1331 (D.D.C. 1994). That Judgment prohibited Prince from violating the securities laws in the future, including Section 10(b) and Rule 10b-5 of the Exchange Act.

9. On March 31, 1995, Prince resigned as a Director and CFO of Integral.

10. On May 10, 1995, Integral filed a Form 10-Q (a quarterly financial report filed with the SEC) disclosing that Prince had resigned his Director and Officer positions at Integral and noting that Integral would continue to use his services as a consultant.

11. After Prince's resignation, Prince continued to act as a consultant to Integral from April 1995 until he joined the company on a full-time basis in December 1998. In this capacity, Prince reported directly to Chamberlain. His work included performing financial analyses, evaluating companies for purposes of acquisition and/or merger, drafting the "Management Discussion and Analysis" ("MD&A") section of the Form S-1 (a registration statement filed with the SEC to register a company's securities), making revenue forecasts, drafting press releases, offering bonus suggestions for members of executive management, and helping to prepare public filings. Prince ceased to be responsible for day-to-day accounting decisions and no longer had the "final call" on accounting matters.

12. On September 5, 1995, Prince entered a plea of guilty to two felony counts in the District Court for the Central District of California charging him with conspiracy under 18 U.S.C. § 371 and making a false statement to the SEC in violation of 18 U.S.C. § 1001. The charges also arose from Prince's conduct as CFO of Financial News Network. He was sentenced in late 1995 to two months' incarceration, two months of home detention, a $50,000 fine, and three years of probation.

13. On June 24, 1997, the Commission issued an Order pursuant to Commission Rule 102(e), 17 C.F.R. § 201.102(e), permanently prohibiting Prince from exercising "the privilege of appearing or practicing before the Commission as an accountant." ("Accounting Bar"). Pl.'s Ex. 2. The Commission provided no further guidance to Prince on what the Accounting Bar permitted him to do and not do.

C.Prince's Duties and Activities Between December 1998 and August 2006

1.Prince Becomes a Full-Time Employee at Integral

14. In December 1998, Prince and Chamberlain began discussing how to structure a role for Prince as a full-time employee at Integral.

15. Chamberlain wanted to create a position for Prince that would not require Integral to disclose Prince's legal history in its public filings. Since Chamberlain knew that officers had to be disclosed in a public company's filings, Prince could not serve as an officer. Chamberlain also wanted to create procedures ensuring that Prince would not be involved with the accounting department and the accounting data.

16. Moreover, Chamberlain was clear that he did not want Prince to become an officer because the bylaws gave all officers the ability to sign contracts and bind the company. Chamberlain did not want Prince to have that sort of unchecked authority because Chamberlain, though very appreciative of Prince's skills and experience, also believed that Prince had an inflated sense of his own worth and a propensity to meddle in areas beyond his responsibilities.

17. A series of "carveouts" were created to "fence in" Prince's roles and duties. Prince was not allowed to sign contracts or checks or bind the company in any way; he was not allowed to hire or fire staff without permission; and he was not allowed to hold himself out to be a vice president or officer of Integral.

18. Prince was not allowed to participate in accounting staff meetings and was not allowed to work on preparation of Integral's financial statements. In general, he was also denied "write" privileges to the network drives where the accounting numbers were stored, and at times he was denied "read" access to the interim numbers.

19. Around the time Prince was hired as a full-time employee, Chamberlain communicated these "carveouts" in person to Elaine Brown,*fn1 the company's Chief Financial Officer, and Thomas Gough, the company's President and Chief Operations Officer. Although these "carveouts" were never put in writing, they were well-known and understood throughout the company, and were monitored by Chamberlain.

20. Prince's primary responsibility was development of a mergers and acquisitions program. Prince would also continue the work he had been doing as a consultant including drafting the MD&A, making revenue forecasts, drafting press releases, offering bonus suggestions for members of executive management, and helping to review and prepare public filings. Finally, Prince would also function as a general advisor and staff member to Chamberlain, as well as to other members of management.

21. As part of his general advisory role, Prince would regularly share his opinion on a variety of subjects beyond those directly related to his financial background and experience. This activity was consistent with the broader culture established by Chamberlain, who encouraged all employees to share their opinions on any subject. Prince, a bit of a gadfly, was particularly likely to share his opinions, except on technical details to which he admitted total lack of knowledge. His considerable business acumen and experience and his close relationship to Chamberlain meant that he had a significant amount of influence. However, the other employees regularly disagreed with and disregarded his opinions, if and when they thought necessary. Moreover, Chamberlain retained control over all final decisions.

22. On December 30, 1998, Prince was hired as a full-time employee and given the title "Director of Mergers and Acquisitions."

2.Mergers and Acquisitions Program

23. As the Director of Mergers and Acquisitions, Prince investigated possible acquisitions of other companies for Integral and reported his findings directly to Chamberlain. Chamberlain would then negotiate the price and the contract details based on Prince's information.

24. Once a subsidiary was acquired, Prince's primary responsibility was to assess the financial health of the business and effectiveness of its existing management. After acquisition or merger, Prince was in charge of overseeing the operations of the subsidiaries. After acquisition, he also supervised the activities of those companies who were acquired and in some cases later shut down.

25. Prince served as Board Chairman and/or a Director for the corporations created to acquire various subsidiaries.

26. Prince also played a role in assessing officer compensation for the subsidiaries and recommended whether certain subsidiaries' officers should be promoted, demoted, or terminated. The ultimate decision on those issues, however, remained with Chamberlain.

27. As part of his assessment of the financial health of newly-acquired subsidiaries, Prince interacted with their accounting staffs. He investigated their financial statements, made suggestions on how they should record certain transactions, and consulted with Integral's accounting staff on how the subsidiaries' financial statements would be consolidated with Integral's statements. Prince also consulted with outside auditors about financial questions related to subsidiaries.

28. While Prince "wouldn't hesitate to ask questions and review [a subsidiary's] financial results," the accounting itself was done by the subsidiary's accountants, who were supervised by and reported to Brown as Integral's CFO. Test. of Elaine Brown, Trial Tr. Dec. 14, 2012, P.M. Session 24-25.

29. Prince regularly made presentations to Integral's Board of Directors regarding potential acquisitions and issues regarding subsidiaries.

3.Prince's Compensation

30. Between December 1998 and August 2006, Prince was consistently one of the five highest paid individuals at Integral.

4.Prince's Stock Options

31. Prince was granted Integral stock options in 2000, 2001, 2002, 2003, and 2004.

32. Prince did not file a Form 3 (an initial statement to the SEC regarding beneficial ownership of securities), Form 4 (a statement to the SEC of changes in beneficial ownership of securities), or Form 5 (an annual statement to the SEC of changes in beneficial ownership of securities) between December 1998 and July 2006.

5.Executive Management Salaries/Bonuses

33. At various times, Prince proposed what bonus amounts members of executive management should receive. This was done in collaboration with others. The bonuses recommended by the group would then go to Chamberlain for final approval. After he approved, Brown or Gough would present the recommendations to the independent Directors for approval.

34. Prince also collaborated with members of executive management in recommending salary increases for Chamberlain.

6.The "Gang of Six"/"Gang of Seven"

35. Chamberlain, Gough, Brown, and Prince, as well as two or three additional executive-level employees, were referred to as the "Gang of Six" or "Gang of Seven," or "G6" or "G7" ("G6/G7").

36. The group was formed by Chamberlain in order to discuss companywide policies on a variety of issues, including human resource decisions, benefits, personnel, and mergers and acquisitions. Prince participated in G6/G7 meetings as an equal member.

37. Brown, Gough, Peter Gaffney,*fn2 Prince, and Chamberlain all testified*fn3 consistently and credibly that G6/G7 served as an advisory vehicle to assist Chamberlain in making policy for the company, and that Prince did not have authority to make policy as a member of G6/G7.

7.Advisor to Chamberlain

38. In addition to advising Chamberlain in his capacity as a member of G6/G7, Prince also served as a general advisor to Chamberlain. His office was located immediately next to Chamberlain's office.

39. Prince could not and did not make policies or rules or standards within the company. Until the summer of 2005, see infra ¶¶ 41-49 (describing Prince's authority over Contracts Department), he did not have a Group*fn4 that reported to him and therefore had no staff to direct, hire, or fire. Generally, Prince would advise and make recommendations to Chamberlain, who would then accept or reject them. Once Chamberlain made a decision, Prince or the relevant Group head would then implement it.

40. Prince's influence with Chamberlain was well-recognized throughout the company. For example, because of Prince's relationship with Chamberlain, people would often consult him to get a sense of how Chamberlain might react to a particular idea or suggestion. However, despite his significant influence, the Integral employees testified consistently that they felt free to disagree with Prince and regularly did disagree with him.

8.Prince's Responsibility for the Contracts Department

41. Prior to July 2005, Brown was head of the Contracts Department at Integral.*fn5

42. In the first half of 2005, at least two contracts were signed by Group heads containing significant errors which injured Integral financially. Chamberlain concluded that further review of contracts was needed before any contracts were finalized.

43. On July 6, 2005, Brown emailed the staff of Integral, telling them that only officers, including Prince, had the authority to sign contracts. She testified that she did not mean to suggest that Prince was an officer, and that after this email was sent she spoke to Prince and confirmed he was not in fact an officer and did not have authority to sign off on contracts. No formal correction was ever disseminated.

44. In the same email, Brown stated that Prince had been "designated by [executive management] to review/approve contracts and subcontracts" relating to specific business areas, and that individuals must "obtain and retain proof that [Prince] ha[d] reviewed/approved" a contract before it could be finalized. Pl.'s Ex. 95. The contracts that Prince had to approve were the "high value" or "primary" contracts.

45. Even after this email was sent, Prince did not execute or sign any contracts on behalf of Integral.

46. On August 1, 2005, Chamberlain sent an email to Integral managers stating that "effective immediately and until further notice, no contract with our customers, nor any subcontract with our teammates, is to be executed until approved by either Gary Prince or myself." Pl.'s Ex. 96; Def.'s Ex. 109. Thus, the system that emerged was that all major contracts were reviewed by Prince and required either Prince or Chamberlain's approval.

47. Albert Alderete, a contracts administrator at Integral, Gaffney, Brown, Gough, Chamberlain, and Prince all testified consistently that, while Prince reviewed contracts, the final decisions remained with the heads of the various Groups. Prince was never given the authority to sign off on contracts. Rather, he performed a screening role to ensure that contracts were properly drawn and, in particular, that all financial calculations were correct.

48. On August 12, 2005, the Contracts Department was notified that it was to be placed under Prince's direction. Prince began to supervise the two employees in the Contracts Department, including exercising hiring and firing power. He also made salary decisions and did performance reviews.

49. In this time period, Prince was named "Managing Director of Operations."

9.Drafting the MD&A Section of Public Filings

50. One of Prince's responsibilities included writing a first draft of the MD&A section of Integral's Form 10-Q and 10-K (an annual financial report filed with the SEC) filings.

51. The MD&A is a business discussion which attempts to explain the financial results for a particular period of time. It may include comparisons to prior periods and/or forecasts or projections for future periods. Before Prince took responsibility for the MD&A, Chamberlain, Steve Carchedi, Gaffney, and Gough all contributed to writing it. None of these individuals was an accountant.

52. Prince would update the prior filing's MD&A only after the accounting department had closed its books "for all intents and purposes." Test. of Elaine Brown, Trial Tr. Dec. 14, 2012, P.M. Session 22-23. His narratives were edited, and ultimately, it was Chamberlain who approved the final version of the MD&A that was filed.

10.Reviewing and Commenting on Drafts of Public Filings

53. When a reporting period ended, the accounting department would close its books, and then, using the prior reporting period's filing as a template, would update the numbers and language. Brown would then circulate this draft "among the management team, among the outside directors, and just solicit comments and feedback." Test. of Elaine Brown, Trial Tr. Dec. 14, 2012, P.M. Session 18. Brown served as the "gatekeeper" of the various comments she received from these individuals, and would incorporate the comments she believed were appropriate and ignore the ones she believed were not appropriate. Id. at 18-19.

54. Prince regularly reviewed and commented on these draft filings. Prince's comments included asking questions, asking for backup related to particular figures, pointing out internal inconsistencies, suggesting additional language, deletions, or rephrasings, adding information or correcting information related to mergers and acquisitions, and changing numbers related to future forecasts. In addition to reviewing and commenting on the drafts themselves, he occasionally raised questions about the accuracy of materials related to the public filings and made suggestions in email exchanges with Brown and others while the company was preparing its filing.

55. Prince's comments were not always accepted, and even when his suggestions were good ones, they were not always incorporated verbatim. Brown testified credibly that she did not feel any particular pressure to accept or reject suggestions made by Prince.

11.Prince's Role During Brown's Maternity Leave

56. Brown was on maternity leave in the fall of 2004 and early 2005 when Integral prepared its Form 10-K for fiscal year 2004 and its Form 10-Q for ...


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