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The SEC announced that three former directors of DHB have agreed to more than $1.6 million in monetary sanctions to settle charges that they were involved in an accounting fraud.  The SEC stated “These directors failed to comply with their responsibilities by ignoring the repeated red flags of the massive accounting fraud that senior management orchestrated . . While we won’t second guess the good-faith efforts of most company directors, we will hold accountable those who completely abdicate the duties they owe to the companies and shareholders they represent.”  When the case was filed, the SEC noted “This massive accounting fraud permeated throughout an entire company and was facilitated by the egregious, wholesale failure of the company’s board to act in the face of mounting red flags. As the fraud swirled around them, the directors, Messrs. Krantz, Chasin, and Nadelman, ignored the obvious and submitted to the directives and decisions of DHB’s senior management while themselves profiting from sales of the company’s securities.”

In the initial complaint, the SEC noted Krantz, Nadelman, and Chasin lacked impartiality to serve as independent Board or Audit Committee members. They were the CEO’s, David Brooks, longtime friends and neighbors, with personal relationships with Brooks that spanned decades.  In addition to a close personal relationship, Krantz, Nadelman, and Chasin, the SEC alleged each had business relationships with Brooks that influenced their impartiality and independence.  Brooks demanded unquestioned loyalty from anyone associated with DHB and exercised absolute control over every aspect of the company, including the Board of Directors.

The SEC’s complaint alleges numerous red flags that the directors ignored.  For instance, on August 20,2003, Grant Thornton resigned and issued a material weakness letter to the Audit Committee concerning DHB’s internal control over financial reporting. The material weakness letter highlighted DHB’s failure to disclose a related entity that the Brooks family controlled, understaffing in the company’s accounting department, and the lack of a comprehensive or formal inventory management system. Grant Thornton resigned the day it issued the material weakness letter. Despite the auditors’ subsequent material weakness letter and resignation, the Audit Committee subsequently failed to examine or monitor transactions with the related entity or to independently investigate the nature of the business arrangement.

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