By Sarah N. Lynch
WASHINGTON, March 11 Federal securities
regulators filed unusual civil charges on Tuesday against the
former independent audit committee chairman and top U.S.
officials of an animal feed company, saying they failed to
properly investigate an elaborate accounting fraud orchestrated
The Securities and Exchange Commission's case against K.
Ivan Gothner, who previously served as the audit committee
chairman for AgFeed Industries Inc, marks a rare move
by the agency. It comes as the SEC is seeking to hold
"gatekeepers" such as auditors, lawyers and board members more
The SEC's lawsuit, filed in a federal court in Tennessee,
also accuses four ex-AgFeed executives based in China of
manipulating the books at the now-bankrupt company to boost
Later, when U.S. managers and directors took over the reins
at AgFeed, the SEC said they "engaged in a scheme to avoid or
delay disclosure of the fraud."
"Today's enforcement action is a cautionary tale about what
happens when an audit committee chair fails to perform his
gatekeeper function in the face of massive red flags," SEC
Enforcement Director Andrew Ceresney told reporters on a
conference call about the case.
Bradley Bondi, head of the SEC enforcement practice at
lawyers Cadwalader, Wickersham & Taft, called the case "a
warning shot across the bow" for public company audit
"This is a reminder that audit committees must follow up on
red flags and seek outside counsel for assistance," said Bondi,
who is not involved in the case.
According to the SEC, AgFeed's Chinese management kept two
sets of books - a real one and a fake one to present to
From 2008 through June 2011, they inflated the company's
revenue by $239 million by using phony invoices for feed and hog
sales and by inflating hog weights because fatter hogs fetched
higher prices. To cover up the fraud, they later reported the
fake hogs had died.
AgFeed, which filed for bankruptcy in July 2013, was based
in China and publicly traded on the Nasdaq OMX stock
It merged with a U.S. company in 2010 and divided its
operations between the two countries.
By about February 2011, most of the company's board and
executive were replaced with American officials.
Gothner served as the chief executive officer of the company
from December 2011 through the summer of 2013, though the SEC's
complaint only charges him for events that occurred in his role
as an independent director, the company's audit committee
chairman and vice chairman at AgFeed.
TWO CALL CHARGES UNFAIR
Both he and Edward Pazdro, who at one point served as the
company's chief financial officer and director of internal and
external reporting, are fighting the SEC's charges.
Their lawyers say the SEC's case wrongly punishes them for
doing the right thing and trying to investigate the accounting
fraud properly as soon as they caught wind of it.
Gregory Bruch, an attorney at Bruch Hanna LLP who represents
Gothner, said his client was instrumental in calling for an
internal investigation as soon as the accounting irregularities
came to light.
In addition, the company hired outside experts to do a fixed
asset review and subsequently hired law firm Latham & Watkins
LLP and formed a special committee to investigate further.
By December 2011, he said, the company notified investors
not to rely upon the financial statements anymore. "This is not
a case where he is complicit in the fraud," Bruch said.
"He is acting in the interest of investors and this is the
result - that he is now the poster child for a pure case against
an audit committee chair which the SEC staff has been looking to
Lyle Roberts, a partner at Cooley LLP who represents Pazdro,
made similar comments, noting that his client was "instrumental
in investigating the misconduct."
"The SEC's attempt to wrap Mr. Pazdro into its case against
the company and its Chinese employees is misguided and
unwarranted," he said.
SIMILAR CASES UNCOMMON
The SEC has in the past filed cases against audit committees
or its members, though such enforcement actions are not common.
One of the more recent cases came in 2011, when the SEC
accused outside directors and audit committee members of a body
armor supply company with ignoring red flags of accounting
In Tuesday's case, the SEC also charged AgFeed and four of
its former Chinese executives with fraud.
Those four executives are: former Executive Chairman Songyan
Li, former Chief Executive Officer Junhong Xiong, former Chief
Financial Officer Selina Jin and Shaobo Ouyang, a former
controller for the Chinese hog operation.
An attorney representing the company declined to comment.
There is no known defense counsel for the four Chinese
executives, and they could not be reached for comment.
Two other former AgFeed U.S. executives reached separate
agreements with the SEC in the case.
Former interim CEO John Stadler settled without admitting or
denying the charges, agreed to pay $100,000 and will be barred
from serving as an officer or director.
Clayton Marshall, who also at one point served as the
company's CFO, reached a cooperation agreement with the SEC.
He will be suspended from practicing as an accountant for a
public company for five years, and neither admitted nor denied
the SEC's findings. The SEC said it has not yet been determined
whether or not Marshall will face a penalty.
Marshall's attorney declined to comment. Stadler's could not
be immediately reached for comment.