90. Over the next several months, Trans World, Robert Higgins and I did in fact work together, in a series of meetings at the Trans World offices and during a trip to Chicago to consult with the firm Diamond Cluster, by sharing control and expenses in our common interest according to the terms that I had promised Robert Higgins I would consent to, through my meeting with Bill Duker.
91. However, during my work with Trans World, I soon discovered that the payments that Labels and Studios made to “special purpose” entities such as Media Logic far exceeded any measurable fair value that the vendors received in return. Instead, I learned, these excessive payments were an indirect or “off-balance sheet” source of available cash flow for Trans World, and equaled Trans World’s $70 million in profit in the year 2000.
92. I also learned that Labels and Studios profited from the scheme by using the payments as kickbacks to coerce Trans World to manipulate and inflate reporting of the vendors’ revenue and profit.
D. The Labels and Studios Scheme to Inflate Revenue and Profit by Paying Kickbacks to Trans World
93. Labels and Studios use promotional funds paid to the distributor Trans World, amounting to millions of dollars each year, to exert coercive pressure on Trans World to increase its prices, and to inflate Labels’ and Studios’ revenue and profit. To fraudulently conceal their scheme, Labels and Studios and various co-conspirators pay bribes to Trans World’s affiliates and subsidiaries, using slush funds, improper accounting, and money laundering, knowing full well that there was no fair value received in exchange for the cash considerations, in violation of Generally Accepted Accounting Principles (“GAAP”).
94. Labels and Studios and various co-conspirators conspired to and did: a) fraudulently inflate their reported revenue and profit by improperly inducing Trans World to accept unnecessary, excess, shipments of CDs and DVDs, and b) fraudulently conceal these crooked practices by increasing Labels’ and Studios’ costs-of-goods-sold rather than reducing their revenues in violation of GAAP.
95. In turn, Trans World and various co-conspirators conspired to and did fraudulently conceal these crooked practices by booking phantom revenue and expenses for its affiliates and subsidiaries in violation of GAAP.
96. As a result, Trans World and its co-conspirators misrepresented their revenue numbers in their annual reports mailed to shareholders and their 10-K filings with the S.E.C. during the relevant period.
E.The Labels and Studios Use “Promotional Funds” to Control the Trans World Retail Stores.
97. Suppliers in many industries use promotional funds to help customers pay the costs of promoting the supplier’s product.
98. Under federal law, a customer’s failure to use all or some of the allowance on advertising as promised usually requires disgorgement or forfeiture of the unapplied amount. Promotional funds are granted to customers based on some measure of past performance, such as volume.
99. The amount of the marketing allowance is calculated using a predetermined formula that generally applies to all customers.
100. Equal application of a standardized formula and a disgorgement penalty ensure proportional treatment for the customers in accordance with the Robinson-Patman Act’s prohibition against unfair competition and unlawful price discrimination under 15 U.S.C. § 13.
101. In addition, the Federal Trade Commission has issued detailed regulations governing promotional allowances, at 16 C.F.R. § 240.1 et seq., to prevent such unlawful price discrimination and unfair competition. Under these regulations, persons granting promotional allowance had an affirmative legal duty to validate the use of such monies. If customers failed to use the monies as promised, then the company granting the allowances was by law required to have the customer return them.
102. In spite of clear federal law, however, Labels and Studios payment of “promotional funds” to Trans World is fraud. In the year 2000, Labels and Studios paid Trans World approximately $70 million in preferential pre-arranged promotional funds. These pre-arranged promotional funds resulted in the total profit made by Trans World during the year.
103. In return for these promotional funds, Labels and Studios were permitted in effect to operate the Trans World retail stores – not Trans World. The Labels and Studios controlled the stocking of the Trans World retail stores, as well as the reports of anticipated sales, eventual returns, and the supposed net profit to Labels and Studios.
104. Labels and Studios thus aid and abet a massive fraud in which consumers, investors and artists are deceived into believing that Trans World is independently operated. In fact, however, Trans World acts more like a landlord of its real estate, and receives a pre-arranged profit artificially determined by the Labels’ and Studios’ payments of promotional funds.
105. Labels and Studios payment of promotional funds to Trans World includes fraudulent “stock credits,” bid-rigging and kickbacks to related third-parties.
