The Securities and Exchange Commission (SEC) reached a settlement last week with CMS Energy and a former CMS executive, Terry Woolley, over charges that the company engaged in $5 billion in deceptive round-trip energy trades. The SEC also filed civil lawsuits against two other CMS officials for allegedly orchestrating and hiding the round-trip trades.

“The misleading presentation of the revenues and volumes generated by the sham round-trip trades distorted the public appearance of this company’s operations, making it falsely appear a revitalized powerhouse,” said Harold F. Degenhardt, administrator for the SEC’s Fort Worth, TX, office. “CMS’s failure to ensure complete and accurate financial disclosure reflects a shameful indifference to the need for transparency in the public markets. Today’s action sends another clear message that such indifference will not go unpunished.”

Round-trip trades are pre-arranged deals that provide zero economic gain but grossly inflate reported revenues and are designed to help propel a company into the upper echelon of the energy-trading volume rankings, the SEC explained. CMS disclosed in May 2002 that certain employees of CMS MST had engaged in round-trip energy trades to raise the subsidiary’s profile as an energy marketer with the goal of enhancing its ability to market its services.

According to the SEC, CMS overstated its revenue by a total of $5.2 billion over five quarters: $1 billion, or 20%, for the last two quarters of 2000; and $4.2 billion, or 36%, for the first three quarters of 2001. CMS also overstated its trading subsidiary’s reported energy-trading volume by 78% over the last two quarters of 2000 and 72% over the first three quarters of 2001.

Since publicly acknowledging the actions, the company has exited the wholesale energy trading business, closed its Houston office, and phased out most of the remaining CMS MST operations. Former CEO William T. McCormick resigned along with several other company officials, including Pallas. The company also subsequently restated its financial reports for 2000 and 2001 to eliminate all revenues and expenses from the round-trip trades.

Pursuant to the SEC settlement, CMS and Woolley, the former controller of CMS’s energy trading subsidiary, agreed to cease and desist from committing or causing violations of the antifraud, reporting, books and records and internal controls provisions of the federal securities laws. Woolley also agreed to pay a $25,000 penalty. However, CMS paid no fine and neither admitted nor denied the findings in the SEC order. The company also said the settlement won’t require any further adjustments to its financial statements.

Jeffery Cohen, assistant district administrator at the SEC’s Fort Worth office, said the actions taken by CMS following the scandal obviously were a factor in the agency’s decision not to seek a financial penalty from the company. He noted that CMS fired those involved, promptly revealed all the details of the situation to the public and restated its financial results. “I don’t think there is any expressed rationale in the order for the absence of a penalty but you can draw your own conclusions because I think they are there to be drawn,” said Cohen.

CMS also announced on Wednesday that it fired its former chief accounting officer, Preston D. Hopper, after the SEC filed a complaint against him and CMS Marketing, Services and Trading (CMS MST) CEO Tamela C. Pallas for fraud and other securities law violations. The SEC intends to pursue monetary penalties from Hopper and Pallas. It’s also seeking court orders barring them from serving as officers or directors of public companies.

The complaint against the two former CMS executives alleges that Pallas, who resigned in May 2002 over the scandal, orchestrated the sham transactions to simulate robust operations within CMS’s marketing and trading subsidiary, while Hopper failed to ensure disclosure of the true nature of the trades.

The complaint charges that Hopper sponsored improper accounting for the sham transactions, and that when CMS’s outside auditors forced CMS to reverse the reporting of the round-trip trade revenue, Hopper fraudulently failed to disclose the reasons for the reversal.

He also improperly caused the revenue to be reported in CMS’s SEC filings and earnings releases, according to the SEC. When CMS’s outside auditors required CMS to reclassify the revenues and expenses from the 2001 trades in its 2001 Form 10-K on a “net,” rather than a “gross” basis, nullifying the impact of the trades on the CMS income statement, Hopper allegedly failed to ensure that material details about the reclassification were disclosed in the Form 10-K.

The SEC further alleges that Pallas violated the antifraud and other provisions of the securities laws by orchestrating the round-trip trading without ensuring that the resulting volume and revenues were excluded from CMS’s public disclosures and SEC filings.

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