NOT RECOMMENDED F OR F ULL-TEXT PUBLICATION File Na me: 12a1294n.06 No. 11-2624 UNITED STAT ES COURT OF AP P EALS F OR THE S IXTH CIRCUIT UNI TED STATES SECURI TI ES AND ) EXCHANGE COMMI SSI ON, ) ) Plaintiff-Appellee , ) ) ON APPEALFROM THE U NI TED v. ) STATES DI STRI CT COURT FOR ) THE EASTERN DI STRI CT OF ) MI CHI GAN DEL PHI CORPOR ATI ON, ETAL ., ) ) Def endants, a nd ) ) PAULR. FREE, ) ) Def endant- Appellant. )

BEFORE: MARTIN and GRIF F IN, Circ uit Jud ges; and BECKWITH, Seni or Distr ict

Judge * BECKWITH, Senior District Judge. Def endant- Appellant Paul R. Fr ee appea ls from the judgme nt of the United States District Court for the Easter n District of Michig an finding him civilly liable for a number violations of the fede ral secur ities laws. For the rea sons that follow, we aff irm. I

. Gene rally speaking , this case conc erns alleg ed fra udulent acc ounting prac tices committed by Def endant- Appellant Paul R

. Fr ee during his employ ment as the chief acc ounting office r

The Honora

ble Sandra S. Be ckwith, Senior United States District J udg e for the Southern * District of Ohio, sitting by desig nation. 1(“CAO” ) for Delphi Corporation (“D el p h i ”). Delphi is an automotive parts manufa cture r and

s u p p l i er t h at was spun off from Gene ral Motors Corporation (“G M”) in 1999. As the CAO for De l p hi, two of Fr ee’ s major responsibilities wer e insuring that Delphi’s acc ounting prac tices complied with Gene rally Acc epted Acc ounting Principles (“G AAP”) and rules promulg ated by the Financ ial Acc ounting Standards Boa rd (“F ASB” ) to file acc urate and truthful quarte rly and annual financ ial repor

ts for De lphi with the Securities and Exchang e Commissi on (“SEC”). The SEC broug ht a civil enfor ceme nt action ag ainst Fr ee, Delphi and a number o f other for m er Delphi office rs and executives as a result of the acc ounting for four transac tions which ultimately cause d Delphi to issue amende d financ ial repor ts for 2000 and 2001. The jury found Fr ee liable in some respe ct as to all four transac tions, but Fr ee appea ls only the jury ’s verdic ts on two of the transac tions. Neve rthele s s , a brief summary of all four transac tions and the rea sons the

acc ounting f

or them wa s err oneous will be helpful.

A. The G M Settlement Transac tion After the spin off from GM was completed, t h er e we re a number of war ranty claims

o u t s t an d ing ag ainst GM and GM claimed that Delphi was financ ially responsible for at least a portion of those claims. Additionally , there was a d ispute betwee n GM and Delphi conce rning pension liabiliti es for cer

tain employ ees whose employ ment chang ed from GM to Delphi then back to G M. Delphi ultimately ag ree d to pa y GM $237 milli on to se ttle the se issues, but the settlement did not allocate the money betwee n war ranty claims and p en s i o n claims. I n acc ounting for the transac tion, Fr ee allocated the bulk of the settlement to the pension claims, which allowed Delphi to rec ord a reduc tion in its outstanding pension liabiliti es. Had the settlement been allocate d to the

war ranty claims, it would have be en an e x pense w hich would have reduc ed De lphi’s net income.

2B. The BB K Tra nsaction The BB K Transa ction and the Ba nk One Transa ction, d i s cu s s ed next, are separ ate transac tions but wer e essentially identical in nature and purpose. The evidenc e at trial showed that during 2000, one of Delphi’s g oals was to incre ase its cash flow by reduc ing its inventory and Delphi had set a specific cash ta

rg et to meet. I n further ance of meeting this g oal, on Dec ember 27, 2000, Delphi sold its entire inventory of eng ine g ener ator c ores a nd battery core s to a company called BB K, L td. for approxi mately $70 milli on. At the same time, Delphi enter ed into an ag ree ment with BB K to repur chase the entire stock of g ener ator core s and battery core s only six day s later for approximately $71 milli on. Fr ee rec orded this transac tion as a sale, instead of inventory financ ing, which allowed Delphi to incre ase its income for 2000 by $70 milli on. I f Fr ee would have rec orded the transac tion as inventory financ ing, Delphi would have had to show an outstanding liability (the $71milli on obligation to repur chase the core s) and ther e would have been no inc rea se in Delphi’s income

. 3. The B ank One or PGM Transa ction Delphi had in inventory

a lar g e supply

of platinum g roup metals (“ PGM”) - pla tinum, palladium, and rhodium - which are used in manufa cturing cata ly tic conver ters. GM require d Delphi to maintain a larg e inventory of PGM’s to ensure ag ainst a supply disruption. As part of the spin off, GM had ag ree d to purcha se a larg e part of Delphi’s PGM inventory in ear ly 2001, but during 2000 was g iving indica

tions that it was g oing to r eneg e on this commitment. Ag ain, supposedly as an eff ort t o re d u ce its inventory and to incre ase its cash flow, in Dec ember 2000, Delphi sold its entire PGM inventory to Ba nk One for approximately $199 milli on.

3At t h e same ti me, Delphi enter ed int o a “forwa rd purchase ag ree ment” with Ba nk One wher ei n i t ag ree d to r epurc hase the entire PGM inve ntory from Ba nk One in 30 day s for a

pproxi mately

$202 milli on. The sale of the PGM inventory technica lly g ave Ba nk One the rig ht to rese ll the inventory to a third party , and if it had done so, at the end of the 30 d ay s , Ba n k On e wa s o bligated to pay Delphi the cash value of the in v en t o ry . As a prac tical matter, howeve r, Ba nk One could not take possession of the PGM inventory both beca use it was sprea d out acr oss the world and beca use some of it was actua lly in slurry form and was being used in production by Delphi. To cover this problem, Ba nk One pa id Delphi a “ba ilment fee” for ke eping the PGM inventory

. Simi lar to the BB K transac tion, Fr ee rec orded this transac tion as a sale of the PGM inventory to Ba nk One rathe r than as inventory financ ing. This permitted Delphi to incre ase its income for 2000 by the $198 milli on “sal e price ” of the inventory

. Had the transac tion been rec orded as inventory financ ing, Delphi would have had an outstanding liabili ty of $201 milli on instead of an incre ase in income

. D. The ED S Transac tion Evidence at trial showed that it was an acc epted industry prac tice for a customer todemand “re bates” or “blood money” from its suppliers. I n other words, it was an industry cus t o m fo r a customer to demand from and be paid kickbac ks by its suppliers. Appar ently GM was particula rly

asser tive in de manding and rec eiving “blood money ” pay ments from Delphi. In any event, dur ing 2001, Delphi decide d to turn the “blood money” tables on its suppliers and, in particula r, demande d

a $50 milli on “re bate” from EDS, its computer sy stems vendor. Delphi and E DS n ego t i at ed the “re bate” during the latter half of 2 0 0 1 an d fi n ally ag ree d that EDS would make a $20 milli on pay ment in Dece mber 2001 a nd a $30 million pay

ment in ear ly

2002.

4EDS made the $20 milli on pay ment in Dec ember 2001 and Fr ee rec orded the transac tion as

a $20 milli on decr ease in expense, which resulted in an incre ase in income for Delphi. Supposedly unknown to Fr ee, there was a side letter ag ree ment betwee n Delphi and EDS wher ein Delphi ag ree d to repa y the $20 milli on in 6 0 m o n t h l y installments. Delphi’s ag ree ment to repa y EDS made the “re bate” a loan. Consequently , the t ransa ction should have b ee n re co rd ed as a liability instead of income. E. Procedur al History The SEC filed a civil enfor ceme nt action against Fr ee, Delphi and others asser ting eig ht differ ent sec urities violations with respect to ea ch of the above tr ansac tions. As is relevant to this appea l, how ever , the SEC char g ed that Fr ee violated Section 10(b) of the Securities Ex chang e Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b -5, 17 C.F.R. § 240.10b-5, in acc ounting for the Ba nk One and EDS Transa ctions. Tog ether , Section 10(b) and Rule 10b-5 prohibi t fr au dulent, materia l misstatements or omissions in connec tion with the sale or purcha se of a secur ity

. Zaluski v. United Am. Healthcare Corp. , 527 F.3d 564, 570 (6th Cir. 2008). Section 10(b) and Rule 10b-5 claims require proof of scienter , i.e. , a mental state indicating intent to dece ive, manipulate or defr aud. In

re Comshare, Inc. Sec. Liti g. , 18 3 F. 3 d 542, 548 (6th Cir. 1999). After a leng thy trial, the jury returne d verdic ts finding t h at Free violated Section 10(b) and Rule 10b-5 in acc ounting for these transac tions. Fr ee then filed a motion for judgme nt as a matter of law, or for a new trial, pursuant to Rule 50 of t he Feder al Rules of C ivil Procedur e. Fr ee a rg ued that the e vidence was insuffic ient for the jury to find that he acte d with intent to defr aud. Fr ee contend ed t h at while he might have made

acc ounting mistakes and perha ps exercised err oneous judgme nt, he acte d in g ood faith at all times.

5Fr ee’ s position was that he took rea sonable steps to understand the transac tions at issue, rea sonably

relied on information provided to him by subordinates, and rea sonably relied on advice provided by Delphi’s outside auditors in approving t h e ac co u n ting trea tment for these transac tions. He also argued that the SEC fa iled to e stablish some of the traditional indicia of sc ienter, such as a motive to profit from the tra

nsactions. I n a written decision deny

ing Fr ee’ s motion for judgme nt as a matter of law, the district court found that the jury could have conclude d that Fr ee w as re ckless, and there fore acte d with sc ienter, in acc ounting f

or these tr ansac tions based on the following evidenc e: 1. Fr ee once told Ba

rbar a Novak, Delphi’s in-house secur ities lawy er, “when t h er e’s ag g ressive acc ounting, y ou rea lly don’t want to disclose it beca use it will be a red flag to the SEC[ .]” The district court conclude d that the jury could find based on this testimony that Fr ee’ s approa ch to the SEC’s disclosure re quirements wa s dishonest. 2. I n discussing the GM Settlement transac tion with Pete Bib l e, GM ’s C AO, Fr ee was “uncha rac teristcally abrupt” about the acc ounting for it. The district court stated that the jury could have concluded that Fr ee was not honest wi t h Bible about the accounting for the GM transac tion, and, henc e, wa s not being honest about the a ccounting for the othe r transa ctions. 3. Fr ee’ s testimony on some subjects was contra dicted by the testimony of other witnesses. Ba sed on those contra dictions, the district court conclude d that the jury could have discounted much of F ree ’s testimony

. 4. I n ear ly Fe bruar

y 2001, one of Fr ee’ s subordinates, L aura Marion, provided Fr ee with an analy sis of the PGM and BB K transac tions which sug g ested that these wer e financ ing transac tions and not ac tual sales of the se inventories.

6The dist rict court, there fore , denied Fre e’s moti on for judgment as a matter of la

w or for a

new trial. The district court order ed Fr ee to disgor g e $38,0 0 0 , wh i ch repr esente d the incre ase in bonus that Fr ee rec eived as a result of t h e i m p ro p er acc ounting for all of the transac tions, and imposed a civil penalty of $80,500. The district court also enjoined Fr ee from committing violations of the same secur ities laws in the future. Fr ee now ap p ea l s t h e judgme nt of the district court, contending that the evidenc e was insufficient for the jury to find that he acte d with scienter in acc ounting for the Ba nk One and EDS Transa ctions. I I

. The Court of Appea ls revie ws de novo the district court’s denial of a party ’s rene wed motion for a judgme nt as a matter of law. Radvansky v. City of Olmsted Falls , 496 F.3d 609, 614 (6th Cir. 2007). We “appl[y ] the same defe rential standard as the district court,” and may g rant the motion “only if in viewing the evidenc e in the light most favor able to the non-moving party , there is no g enuine issue of materia l fac t for the jury , and rea sonable minds could come to but one conclusion, in favor of the moving party .” Id. I n cond u cting its revie w, the Court must not “re weig h the evidenc e or assess the cre dibilit y of witnesses.” Id. We revie w a district court’s denial of a motion for a new trial for abuse of discretion, reve rsing only if we have a “def inite and firm conviction that the trial cour

t committed a clea

r er ror of judgme nt.” Id. I I I

. Fr ee argues that the evidenc e was insufficient for the jury find that he acte d with scienter with respe ct to the subject transac tions. As stated above, scienter is a state of mind encompa ssing intent to dece ive, manipulate or defr aud. In re C omshare, Inc. Sec. Liti g. , 183 F.3d 542, 548 (6th Cir.

71999). Scienter may be established by proof of rec kless conduct, i.e. , “hig hly unrea sonable conduct

wh ich i s an ex treme departur e from the s tandar ds of ordinary car e. Whil e the dang er need n o t b e known, it must at least have been so obvious that any rea sonable man would have known of it.” Id. A traditional but not exhaustive lis t of fac tors rele vant to scienter include: (1) insider tr ading at a suspicious time or in an unusua l amount; (2) diverg ence betwee n internal repor ts and external statements on the same subject; (3) c loseness in time of an a lleg edly fra udulent statement or omission and the later disclosure of inc onsistent information; (4) e vidence of briber

y by a top company

officia l; (5) exis tence of an ancillar y lawsuit char g ing fra

ud by a company and the company ’s quick settlement of that suit; (6) disre g ard of

the most curre nt fac tual information bef ore ma king statements; (7) disclosure of acc ounting information in such a way that its neg ative implications could only

be under stood by

someone with a hig h deg ree of sophistication; (8) the persona l inter est of cer tain direc tors in not informing disinterested direc tors of an impending sale of stoc k; and (9) the self-inter ested motivation of defe ndants in the form of saving their salarie s or jobs. Helwig v. Venc or, Inc. , 251 F.3d 540, 552 (6th Cir. 2001), abrogated on other grounds by Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007). Reg arding GAAP violations, rec klessness

can be inferr ed wher e the defe ndant ignor es multipl e and obvious red flag s that would have reve aled

acc ounting e rror s. PR Diamonds, Inc . v. Chandler , 91 F. App’ x . 418, 431 (6th Cir. 2004). I n his appellate brief, Fr ee argues, much as he did in the court below, that he acte d rea sonably with respe ct to eac h of the transac tions. He relied on experience d subordinates to advise him on the

8transac tions, vetted the transac tions with Delphi’s outside auditors, and made an indep en dent

assessment of the fac ts befor e him in approving the acc ounting trea tment for these transac tions. Fr ee argues that in finding that there was sufficie nt ev i d en ce to sustain the jury ’s finding that he acte d with sci en t er , the district court cited documents that he did not see or did not know about and improperly conclude d that attacks on his cre dibilit y could substitut e for a culpable state of mind. On de novo revie w, howeve r, we find that the re cord c ontains sufficient e vidence to sustain the jur y ’s verdic ts. First, we find that there was sufficie nt evidenc e that Fr ee acte d rec klessly or turned a blind ey e to the fac t that the Ba nk One Transa ction lacke d economic substance as a sale. See, e.g., In re Suprema Specialties, Inc. Sec. Liti g., 438 F.3d 256, 281 (3rd Cir. 2006) (auditors acte d with scienter by turning blind ey e to acc ounting violations); United States v. Ferguson , 676 F.3d 260, 278 (2d Cir. 2011) (“Red flag s about the leg itimacy of a transac tion can be used to show both actua l knowledg e and consc ious avoidance .”). Second, we find that there wer e a number of re d flag s indicating that the EDS Tra

nsaction wa s not a true r ebate that Fr ee ig nored. The following evidenc e supports the jury ’s deter mination that Fr ee acte d with scienter as to the Ba nk One Transa ction. First, Fr ee admitted that the Ba nk One Transa ction was unusually larg e,

even for a company like Delphi. (Doc

. No. 326, at 18-19) (Rec. 18746-18747). Second, Fr ee knew that under standard auditing principles, unusual transac tions enter ed int o at or near the end of a repor ting period require closer scrutiny to ensure their leg itimacy

. Id. at 37-38 (Rec. 18765-18766). Third, L aura Marion’s analy sis of the transac tion, which a juror could h av e conclude d that Fr ee

rec eived, sug g ested t h at t h e transac tion was a financ ing arr ang ement, and not a sale, beca use it included financ ing expenses. Four th, Fr ee admitted that the Ba nk One Transa ction had elements of product financ ing as opposed to a sale. Id. at 50 (Rec. 18778). Fifth, the SEC’s acc ounting expert,

9J ohn Gar

vey , testified that the Ba

nk One Transa ction did not have economic substance as a sale and that should have been obvious to Fr ee. Doc. No. 319, at 192 (Rec. 17818) (t es t ify ing that proper

acc ounting f

or B ank One Transa ction “wa s not a close c all.”). Despite at least five red fl ag s about the leg itimacy of the Ba nk One Transa ction, Fr ee persona lly did not conduct a critica l inve stigation into it be fore approving the acc ounting. Rather, Fr ee o n ly superf

icially examined the form of the transac tion rathe r than its substance. I ndeed, it

seems that Fr ee rea lly only examined the contra ct to ensure that it nominally provided for the transfe r of risk of loss - which is only the bare minimum require ment to acc ount for a transac tion as a sale. Fr ee essentially admitted that the PGM contra ct was structure d in such a way as to shield Ba nk One from any risk of loss. I n fac t, it also g uara nteed Ba nk One a $3 milli on profit for simply not rese lling the inventory

. Do c. No

. 326 at 27 (Rec. 18755). A rea sonable juror, there fore , could have conclude d that Fr ee w as willfully blind, or rec kless, as to the true na ture of this transa ction. The jury ’s verdic t on the EDS Transa ction was also supported b y t h e ev i dence

. Fr ee contends that he was never awa re that the Delphi I T depar tment rea ched a secr et side ag ree ment for Delphi to repa

y the “re bate” over five y ea rs. Ag ain, howeve r, there wer e multipl e red flag s that should have a lerted F ree that the pay ment from EDS wa s a loan a nd not a re bate. First, two ear ly draf

ts of the side letter descr ibed the pay ment from EDS as “non-r efunda ble” but the final draf

t did not state that the pay

ment was non-re fundable

. The jury could have rea sonably conclude d that the deletion of “non-r efunda ble” from the final side-letter should ha ve aler ted Fr ee that the pay

ment was re pay able. Also Catharine Roz anski, Fr ee’ s direc tor of fina ncial ac counting and repor ting, testified that she kept the lang uag e in the side letter “intentionally vag ue” so that both EDS and Delphi could achie ve their acc ounting g oals. Doc. No. 316, at 124. (Rec. 17216). The jury

10could have rea sonably inferr ed that Roz anski told Fr ee the purpose of the letter as well beca use she kept him up to date and share d with him the status of the side letters. Id. at 130 (Rec. 17222). This testimony sug g ests scienter beca use it indicates that Fr ee , R o zanski, and others at Delphi wer e

sear ching for way s to paper the transac tion in a way that suited their objectives rathe r than acc ount for it in an honest fa shion. Second, the SEC produce d sever al documents that Fr ee rec eived which i n d i ca ted that the “re bate” would have to be repa id to EDS. A J uly 27, 2001 email broke down the cost of an outsourcing proposal from EDS as $347 milli on but Delphi would pay $397 over the course of the projec t beca

use it included “pay

back of the $50M they would pay us ear lier.” Doc. No. 388-3. A 1 September 2001 memorandum on which Fr ee was copied rec ommended that the $20M “re bate” be booked to reduc e headquar ters ex p ense” but “as we m ake future pay ments to EDS, the porti on of t h e pay ment related to the $50 milli on should be car ried in headqua

rters budg et/actua ls and n o t al l o ca ted direc tly to the divisions.” Doc. No. 388-4. This memo sug g ests, in other words, that Delphi headqua

rters should g et the cre dit for the pay ment on its curr ent budg et and also that it would take the budg et hit for the future repa y ments to EDS. I f the pay

ment from EDS wer e a true rebate, there would have been no need to decide which depar tment would bear the expense of repa y ing it. A s trateg y board presentation in April 2002 conce rning the costs of t he Veg a 2 project with EDS, in which Fr ee participated, contained the bullet point “Refle cts $20M pay ment from EDS to Delphi and pay back from Delphi to E DS.” Doc. No. 388-22, at 7. Finally , at around this same time, Fr ee approve d pay

ment of an invoice to EDS in the am o u n t o f $ 3 33,000, i.e. , one mont h’s i nstallment

The “blood money ” transac tion in i t i ally started out as an attempt by Delphi to g et $50 1 milli on from EDS - later it was decide d t o reduc e the “re bate” to two separ ate pay ments of $20 milli on and $30 million. Doc. No. 316, at 108 (Rec . 17200). 11repa

y in g $ 2 0 milli on over 5 y ear s, for “non-c ommutable costs.” Doc. No. 388-17, at 1. Fr ee admitted that there is no such acc ounting term as “non-c ommutable costs” and he did not rea lly know what the term meant. Doc. No. 325, at 189 (Rec. 18668). Fr ee testified that he approve d the pay ment afte r confe rring wi t h a subordinate, who told him that the pay ment was part of the resolution of a staffing dispute with EDS. Id. at 188 (Rec. 18667). Roz anski testified, howeve r, that when she saw the same invoice sever al y ear s later, she rec og nized it as a commitment by Delphi to repa y the $20 million “rebate .” Doc . No. 316, at 128-29 ( Rec. 17220-17221)

. I n summ ar y , ev en if, as Fr ee contends, no one ever told him about the side ag ree ment betwee n Delphi’s I T depar tment and EDS to repa

y the $20 milli on, there wer e multipl e red flag s of which Free was aware which reasonably should have alerte d him that this pay ment was not a true rebate. S i m i lar to the Bank One Transa ction, Fr ee did not persona lly undertake a more searc hing inquiry to verify the validity and true economic purpose of the EDS Transa ction. Consequently , the jury could rea sonably infer that Fr ee was rec kless and, there fore , acte d with sc ienter in a ccounting for this transa ction. Co n s id e r in g all four transac tions toge ther, the jury could have rea sonably conclude d tha t F r e e demonstrated a pattern of shielding himself from the true fac ts of the transac tions by over- relianc e

on information provided by subordinates and/or by elevating the form of the tran s action over the substance. Ther ef

o re , t here was sufficie nt evidenc e to support the jury ’s deter mination that Fr ee acte d with scienter as to both the Ba nk One and EDS Trans actions. Consequently , Fr ee was not entitled to judgme nt as a matter of law. For the same rea sons, the district cou rt d i d not abuse its discretion in deny

ing F ree ’s motion for a ne w trial. Acc ording ly , the judg ment of the district cour t is AF F IRMED.

12