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From Securities Regulation Daily, July 7, 2016

Top execs hid tax liability from public

By Rodney F. Tonkovic, J.D.

Top company officers participated in hiding tax withholding liability from public view, a district court found. The complaint alleged that Corporate Resource Services, Inc. failed to disclose that a service company with which it was closely intertwined had a $100 million tax withholding liability. The court found that the complaint adequately alleged that not disclosing the liability was a material omission, and that the officers acted knowingly or recklessly in failing to disclose (Calfo v. Messina, July 5, 2016, Schofield, L.).

Purchasers of shares in CRS, a technology, staffing, recruiting and consulting services firm, alleged violations of the antifraud and controlling persons provisions of the Exchange Act. According to the complaint, CRS failed to disclose that TS Employment, Inc., a company that provided professional employment organization services to CRS, had a $100 million material tax withholding liability involving CRS employees. CRS and TSE were under the common control of Robert Cassera, and some executives at CRS held positions or had offices at TSE. The shareholders bringing the complaint allege that they were damaged when the corrective disclosures of the withholding tax liability were made.

Undisclosed tax liabilities. TSE managed the payment of CRS’s payroll taxes, and starting in 2011, CRS was in debt to TSE for back payroll covered by TSE while CRS expanded. Some of this debt was paid with CRS stock. Because TSE was unable to borrow against or sell the CRS stock, however, it was unable to make timely payroll tax payments to the IRS. CRS discovered these tax liabilities during a 2013 audit, but decided not to disclose it on its financial statements.

In February 2015, TSE filed for bankruptcy, announcing that it had recently discovered that it owed the IRS $100 million in payroll taxes. CRS then announced that it could lose its main source of external financing as a result of this liability, and its share price subsequently dropped by 59 percent. By the end of February, CRS had announced that its financial statements for 2013 and the first three quarters of 2014 could no longer be relied upon, that Cassera and three audit committee members had resigned, and that it was being delisted by NASDAQ. CRS ultimately declared bankruptcy in July 2015.

Material omission. The court first found that the omission of TSE's tax liability was material. Disclosure of this significant liability, which began to accrue as early as 2012, was required because it was necessary to make statements, in the light of the circumstances under which they were made, not misleading and because of its implications for CRS's financial statements. Disclosure of a $100 million liability would have painted a very different picture of CRS's financial condition, the court remarked.

Scienter. The court then found that the complaint sufficiently alleged that three of the defendants knowingly or recklessly omitted TSE's tax liability from CRS's public disclosures. First, the allegations were sufficient to show that Cassera knew about TSE’s material tax liability and failed to disclose it when necessary to make statements by CRS not misleading. Further, as a majority shareholder who also pledged personal assets, the court said, Cassera would also be motivated to hide facts that would cause the stock price to drop and force him to pay on the personal guarantee.

The complaint also adequately alleged that John Messina, CRS's CEO and a Vice President at TSE, and CRS CFO Michael Golde acted with scienter. Given Messina’s position at the two companies and his role in approving all payments by CRS to TSE, the court concluded that the claims against him in the complaint were at least as compelling as any nonfraudulent inference. The court also found that the complaint alleged strong circumstantial evidence of conscious misbehavior or recklessness by Golde. As CFO, Golde received monthly reports that included CRS's tax liabilities, and he was one of the senior executives who decided that this liability did not need to be disclosed for 2013.

Finally, the court found that Cassera, Messina, and Golde were liable as controlling persons. Each of these defendants, the court said, held top management positions and culpably participated in hiding the CRS's tax withholding liability from public view.

The case is No. 15 Civ. 4010.

Attorneys: Jeremy Alan Lieberman (Pomerantz LLP) for Stephen Calfo. Michael Fred Bachner (Bachner & Associates, P.C.) for John P. Messina, Sr.

Companies: Corporate Resource Services, Inc.; TS Employment, Inc.

MainStory: TopStory FraudManipulation NewYorkNews

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