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The SEC's Charges Against Former MusclePharm Executives: Implications for Microcap Markets

On June 27, 2023, the Securities and Exchange Commission (SEC) filed a settled complaint against former executives of MusclePharm Corp., a Las Vegas-based nutritional supplement company. The charges were brought against Brian H. Casutto, the former Executive Vice President of Sales and Operations, Matthew J. Zucco, the former Vice President of Sales, and Kevin R. Harris, the former contract Chief Financial Officer. The SEC also separately charged Ryan C. Drexler, the company's former Chief Executive Officer, with fraud for disclosure violations and control failures.

The SEC's complaint alleges that Casutto, with the assistance of Zucco, engaged in a fraudulent scheme to prematurely recognize revenue for orders that remained in MusclePharm's control. The complaint further alleges that Harris should have known that MusclePharm prematurely recognized certain revenue and that MusclePharm overstated other revenue by misclassifying customer credits as advertising expenses rather than as reductions to revenue.

The defendants' misconduct allegedly inflated the company's publicly reported quarterly revenues by as much as 25 percent and gross profits by as much as 49 percent. The SEC's complaint against Drexler alleges that, while CEO, he misled investors about the catastrophic impact of the company's default with institutional noteholders and that he falsely certified that he evaluated the company's internal controls.

The SEC's actions against the former MusclePharm executives highlight the regulatory body's commitment to maintaining the integrity of financial markets. Jason J. Burt, Regional Director of the SEC's Denver Office, stated, "Honest and transparent financial disclosures are the bedrock of our markets, but as alleged in our complaint, MusclePharm's executives disregarded these fundamental rules by continuously inflating reported revenue. These actions highlight that the SEC will not hesitate to bring enforcement actions against individuals who threaten the integrity of our markets."

Without admitting or denying the SEC's allegations, Casutto, Zucco, and Harris have each consented to the entry of judgments, subject to court approval, permanently enjoining them from violating the antifraud provisions and other provisions of the federal securities laws. The proposed judgments require Casutto and Zucco to pay disgorgement with prejudgment interest of $79,760.01 and $15,033.06, respectively; require Casutto and Harris to pay a civil penalty of $207,183 and $50,000, respectively, and reserve the issue of Zucco's civil penalty for further determination by the court; and bar Casutto from serving as an officer or director of a public company for five years.

The SEC charged Drexler with violating and/or aiding and abetting violations of the antifraud provisions and other provisions of the federal securities laws and seeks injunctive relief, civil penalties, reimbursement to MusclePharm under SOX 304(a), and an officer and director bar. Both complaints were filed in the U.S. District Court for the Central District of California.

The implications of these charges for microcap markets are significant. Microcap companies, like MusclePharm, are often subject to less scrutiny than larger firms, which can make them attractive targets for fraudulent activity. The SEC's actions send a clear message that it will not tolerate fraudulent behavior, regardless of the size of the company involved. This case serves as a stark reminder for microcap companies and their executives of the importance of maintaining robust internal controls and adhering to proper accounting practices.

The SEC's charges against the former MusclePharm executives also underscore the importance of transparency in financial reporting. Investors rely on accurate financial disclosures to make informed investment decisions. When companies inflate their revenues or misclassify expenses, they undermine investor trust

and distort the true financial health of the company. This can lead to significant financial losses for investors when the truth is eventually revealed.

The MusclePharm case also highlights the potential personal consequences for executives who engage in fraudulent behavior. The proposed judgments against Casutto, Zucco, and Harris not only involve significant financial penalties but also include a bar from serving as an officer or director of a public company. This serves as a strong deterrent for other executives who might be tempted to engage in similar fraudulent behavior.

Furthermore, the SEC's actions against Drexler, the former CEO, underscore the importance of executive accountability. As the CEO, Drexler was responsible for ensuring the accuracy of MusclePharm's financial disclosures and the effectiveness of its internal controls. His alleged failure to fulfill these responsibilities resulted in significant harm to MusclePharm's investors and the broader market.

The SEC's charges against the former MusclePharm executives also have broader implications for the regulatory landscape. They demonstrate the SEC's commitment to enforcing the federal securities laws and protecting investors from fraudulent behavior. This case is likely to encourage other regulatory bodies to take similar actions against executives who engage in fraudulent behavior, further strengthening the integrity of financial markets.

In conclusion, the SEC's charges against the former MusclePharm executives serve as a stark reminder of the importance of transparency, accountability, and proper accounting practices in financial reporting. They highlight the potential consequences for executives who engage in fraudulent behavior and underscore the SEC's commitment to protecting investors and maintaining the integrity of financial markets. As a result, these charges are likely to have significant implications for microcap markets, potentially leading to increased scrutiny of these companies and stronger enforcement of the federal securities laws.