//By Stefan Linssen

Earnings were strong. The stock price had nearly doubled within a year, from $7.50 to over $14 a share, creating millions of dollars in wealth for shareholders and management alike.

President and Chief Executive Officer Doug Faggioli, was particularly pleased. Faggioli took over the helm of the company in late 2003 after it had been struggling for several years. Under his leadership, new revenue streams were unleashed and expenses kept under control.

The news was only going to get better. Business Ethics Magazine was about to notify Nature’s Sunshine that for the second year in a row the company earned a spot on the magazine’s Top 100 Corporate Citizens list. Upon learning the news, CEO Faggioli and CFO Craig Huff were thrilled. They decided to issue a press release to investors.

“We are pleased and appreciative of this recognition,” Faggioli said. “Nature’s Sunshine has always maintained the highest ethical standards in the way we conduct our business, just as we are committed to the highest quality in the products we make and sell.”

Ah, beautiful June days. But storm clouds were gathering.

ANOTHER PRESS RELEASE CHILLIER CONDITIONS
February’s weather in Provo is far less inviting. Temperatures hover in the low 40s most days. A mere 19 months after Nature’s Sunshine’s triumphant Best Business Ethics press release, the company faced issuing a public notice that could result in significant repercussions.

The press release focused on the prior quarter’s financial results, which though strong, included a small sentence buried within that disclosed that the Audit Committee of the Company had engaged external counsel to conduct an independent investigation into “certain transactions of the Company’s foreign subsidiaries.”

Nature’s Sunshine’s executive team must have held its breath as the release went over the wires. Burying notice of an investigation in paragraph five of a press release sent out on a Friday just might reduce the impact of any negative disclosure.

The blunting of the news worked. While trading volume was heavy at eight times normal volume, the stock did not plunge as some had feared. It did ease down $1, however, to $17 per share by the end of the trading day.

A collective relief swept over employee shareholders, but it was too early to celebrate. The storms were only about to begin.

AN AWKWARD MEETING
The news release set off alarm bells at Nature’s Sunshine Auditor, KPMG. On March 15, 2006, three weeks after the press release announced the investigation, the Audit Committee and KPMG assembled to hear the initial findings of the external law and accounting firms’ investigation. Due to the great sensitivity of the alleged parties involved, supposedly the report was only provided orally. No notes. And it was a bombshell.

According to reports and KPMG’s own investigation, allegations included that:

• The President and CEO (Doug Faggioli) knew of alleged fraud in the international operations of the company, yet signed letters to KPMG to the contrary in March and August of 2005
• The President and CEO approved of a payment in direct violation of the Foreign Corrupt Practice Act (FCPA)
• The Audit Chair knew of the fraud yet didn’t tell KPMG

The investigator concluded the report by recommending the immediate termination of CEO Faggioli. Nature’s Sunshine’s Chairman (and major shareholder) Kristine Hughes, however,refused the suggestion on the spot.

FINANCIALS NO LONGER RELIABLE
Working through the weekend in crisis mode, the Audit Committee assembled three days later on Saturday, March 18, for a status review. Based upon the report’s findings, it decided that the financial statements for the past four years (from 2002 through 2005) could no longer be relied upon as accurate.

Therefore, as soon as the SEC opened for business on Monday, the Company filed a Form 8-K informing the SEC of the Company’s decision to self-report the alleged fraud to the U.S. Department of Justice and other regulators.

KPMG RATTLED
While the initial news from February was enough to create concern at KPMG about its audit client, subsequent disclosures, the March 15 oral report and its own investigation rattled the company. The audit firm quickly became concerned about its reputation should it continue to handle the Nature’s Sunshine account.

Nature’s Sunshine and KPMG held a conference call on Wednesday, March 22, which only raised more questions.

Before the week was out, on March 24, KPMG demanded an immediate meeting with the Audit Committee with one unique condition: if the Chair of the Audit Committee attended the meeting, they would call it off.

A conference call was hastily arranged for the weekend with Audit Chair Franz Cristiani not participating. On the call, KPMG reiterated the investigator’s recommendation that the CEO be fired immediately. Chairman Hughes again refused.

On Monday, March 27, KPMG sent an email with terms under which it would continue as the company’s auditor, including:

Curiously, the very same day, Craig Huff, EVP and CFO of the company, suddenly resigned. The suspicious timing of the CFO’s resignation after 24 years with the company set off rumors.

Could someone be setting up Huff to be the fall guy? Or did Huff see how things could get worse and espy potential personal liability should he continue to stay at the company? Was Huff planning on cooperating with governmental investigators?

No one but Huff knows the answers to those questions.

BRINKSMANSHIP
With the CFO gone, Nature’s Sunshine apparently decided to play brinkmanship, thinking perhaps that KPMG would not really resign such a profitable account.

Just before KPMG’s deadline on March 29, Nature’s Sunshine emailed a letter to KPMG stating that its CEO had “stepped aside,” and that a committee of four other executives would perform the function. Furthermore, the company noted that the Chair of the Audit Committee would be replaced by another member of the committee.

KPMG was incensed. Nature’s Sunshine’s executive team had seemingly ignored the audit firm’s two key demands, as Audit Chair Cristiani remained on the board and CEO Faggioli, while relinquishing the President and CEO titles, remained an employee of the company.

The next day, KPMG contacted the company and provided yet another ultimatum: Remove Cristiani from the board and terminate Faggioli by 5 p.m. local time the following day, March 31, or else. While Cristiani tentatively offered to resign from the board, the company did not give in immediately on Faggioli and asked for the weekend to consider it.

That was the final straw for KPMG. They were fed up to the point of resigning the account immediately. The evening of Friday, March 31, the fax machine in Nature’s Sunshine’s executive offices began to churn out KPMG’s official resignation as the company’s independent registered public accounting firm.

STOCK PLUNGES BRING ON THE LAWYERS
On the following Monday, the company was silent. No news. Stock volume was normal. But the company’s stock drifted down slightly more than may be expected, from $12.50 to just over $12.00.

On Tuesday the news broke. The company issued a press release announcing that it would be de-listed for not filing reports on time.

That was perhaps not what concerned investors most… more interesting (and of greatest concern in all likelihood) was a single line buried in the middle of the paragraph which read: “In addition, the Company has also reported that KPMG LLP resigned as the Company’s independent registered public accounting firm on March 31, 2006.”

No reason for the resignation was given. With trading volume at nearly 20 times the norm, the stock quickly dropped over 30 percent from the prior Friday’s close when the company first learned of KPMG’s resignation. Not surprisingly, the first shareholder lawsuits were filed within days, naming the company, now-former CEO Faggioli, Audit Committee Chair Cristiani and the now-ex-CFO Craig Huff as co-defendants.

Then it started to get weird.

BACK TO NORMAL?
The company gets de-listed. The CFO, a long-time employee, quits. The accounting firm resigns. Was it time for Nature’s Sunshine to distance itself from the now-former CEO at the center of the controversy? No.

To the surprise of many, the company’s board of directors held a special meeting just a few months later on August 21 to reinstate Faggioli as President and CEO. No public pronouncement was made. Investors following SEC filings, however, noticed an 8-K filing in which the board said that it had reviewed and considered the “facts and circumstances identified in the investigation” and decided to reappoint Faggioli as CEO.

Investors, assuming this meant that the worst was behind for the company, pushed the stock price up nearly 40 percent in the ensuing days.

2007 brought more changes. After nearly a year without an auditor, the company announced in February that Deloitte & Touche LLP was engaged as the company’s new independent registered accounting firm.

Then, on March 1, 2007, embattled Audit Chair and Director Cristiani resigned. The company simultaneously announced a new General Counsel and compliance officer. A new accounting firm, a revamped board, the addition of a compliance officer and a recovering stock price: it seemed like things may have settled out and operations returned to normal.

Now all that was left was to get the pesky shareholder litigation dismissed, which the defendant filed for.

A MOVE FOR DISMISSAL BACKFIRES
The plaintiffs were prepared for the motion for dismissal. Court-filed documents not only addressed many of the issues that KPMG and the company had already disclosed, but the plaintiffs had discovered and added a new angle- evidence of large scale insider trading by Faggioli while he was CEO.

The plaintiffs argued that not only did Faggioli make payments in violation of the U.S. Foreign Corrupt Practices Act (FCPA), but that furthermore he falsely certified twice to the accuracy of the company’s financials, in violation of the Sarbanes-Oxley Act of 2002.

At issue was that Faggioli, who had not sold a single share of stock since becoming an officer of the company in 1989, started aggressively selling off his shares in the weeks before his first false management representation letter to KPMG. During December 2004 and September 2005, he sold off 46 percent and 74 percent of his holdings respectively.

The U.S. District Court, District of Utah, agreed with the plaintiffs. In May 2007, the courts found that “the alleged misstatements were material in that an investor would consider them important in determining whether to buy or sell [Nature's Sunshine's] stock,” particularly when later disclosure regarding the internal investigation caused the company’s stock price to drop precipitously.

The courts also agreed that Faggioli’s stock trading was questionable and thereby possibly illegal in that the “trades were at times and in quantities that were suspicious in light of his total stock holdings, that the trades were not normal and routine, and that profits reaped were substantial in relation to compensation levels.”

DOJ STEPS IN
For more than a year after the disclosure of inappropriate payments and the resignation of KPMG, the Department of Justice (DOJ) appeared to sit on the sidelines. With the DOJ distracted by internal turmoil, as well as the burdens of numerous parallel investigations into the burgeoning stock-option backdating scandal sweeping Silicon Valley, it appeared that Nature’s Sunshine would escape prosecutorial investigation.

However, with the Utah federal district court ruling that insider trading likely occurred as well, it became harder for the DOJ to ignore. Three weeks after the ruling, the company disclosed that the DOJ had requested documents related to the March 2006 independent investigation by the Audit Committee and that the IRS had decided to audit its tax returns for 2002-2006.

QUESTIONS REMAIN
What makes the Nature’s Sunshine case so interesting is that it is “off the radar” of the national financial media.

Yet, this simple fact is why it is so important. How do the Big Four accounting firms, the SEC and DOJ act when it is business fraud in a microcosm, as opposed to being covered in the national spotlight on CNBC or in the Wall Street Journal?

Here are some elements worth examining:

• Do KMPG and Deloitte & Touche have such different standards for companies that they would accept as clients, as might appear in this case?
• Will the DOJ follow through on this case or abandon it to focus on bigger fish?
• Why did the CFO, who was with the company for nearly 25 years, suddenly resign during the KPMG investigation, with no explanation to the SEC or investors?
• And finally, many boards fire CEOs for transgressions far less than what allegedly occurred here. What is it about this case’s facts, or the disposition of Nature’s Sunshine’s directors, which make them so willing to stand by their man, Faggioli?

The answers to these questions may come out of the shadows as the shareholder plaintiff’s case winds through the courts. Shining a light on the dealings of Nature’s Sunshine may have only just begun.