SEC Charges Another China Based Firm With Fraud

The key to China based Longwei Petroleum Investment Holding Limited’s business was its storage facilities for oil, gas, fuel oil and solvents, claimed to be the largest in the area. While the firm repeatedly made representations about its storage capacity which were the same, the number of tanks it owned varied. And, questions were raised in the media about its sales which were followed by misrepresentations designed to trick shareholders into exercising warrants, giving the firm an infusion of cash. SEC v. Toups, Civil Action No. 23584 (June 27, 2016).

Defendant Michael Toups was the CFO of Longwei, a Colorado corporation with its primary place of business in Shanxi province China. The firm’s shares were at one time listed on the New York Stock Exchange.

Longwei built is storage business by making three acquisition. The first was in June 2008 which gave it 50,000 metric tones of storage, according to the firm. The number of tanks listed varied from 8 to 14. The second was in 2009 when it acquired 70,000 metric tons of storage capacity. The number of tanks listed varied from 7 to 8 to 14. The third was in 2012 when the firm acquired 100,000 metric tons of storage. With this addition the company claimed to be the largest of any private enterprise in Shanxi, China. In making the storage capacity estimates the firm never allowed for the density of the material which changes the amount of product that can be stored.

In late 2012 a shareholder questioned the claims regarding storage. Mr. Toup took a variety of steps to investigate the claim. Eventually he learned that the firm was overstating not just its storage capacity but also its inventory. Nevertheless, in January 2013 Mr. Toup drafted a press release for the firm which claimed the representations regarding storage were made in accord with industry standards. The stock price jumped the day of the release. The same day Mr. Toup received documents from the Fire Protection Bureau in Shanxi, China demonstrating that the capacity claims were incorrect. No corrective disclosure was made.

The day after the press release was issued a research firm published a report claiming that Longwei was a “massive fraud.” In part the report alleged that the firm was overstating its sales. The stock price dropped 73%. The firm’s U.S. based auditors traveled to China to visit. They were prevented from accessing portions of the facilities and speaking from certain executives. Mr. Toups and the auditors were also denied access to the company records. A request by the chair of the audit committee to fund an investigation was ignored. Eventually he resigned. The firm issued a press release reiterating the representations made earlier about its storage capacity and representing that management was cooperating with the inquiry. Later the NYSE delisted the stock.

In October 2012, shortly before certain warrants were due to expire, an advisor to the firm’s CEO told Mr. Toups that the company was in urgent need of cash. To raise the funds Mr. Toups was asked to pressure warrant holders to exercise their holdings before month end. He did without disclosing that the warrants were going to be extended. This gave the firm a cash injection. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a). The case is pending. The Commission has also instituted a proceeding under Exchange Act Section 12j as to the firm. See Lit. Rel. No. 23584 (June 27, 2016).

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SEC Charges Business Media Star With Fraud

The Frack Master was a media star with frequent appearances on CNBC, CNN International, Fox Business news, the BBC and a weekly radio talk show in Dallas, all discussing oil-and-gas topics. He marketed interests in oil and gas properties at prices which far exceeded the expected operating expenses, yielding huge profits. Investors flocked to the offerings, yielding over $80 million. Yet the operation ran short of cash. Seems the Frack Master was really the Spend Master – so much of the investor money was diverted to a “Wolf of Wall Street” type life style the properties could not be operated. The Commission charged fraud. SEC v. Faulkner, Civil Action No. 3;16-cv-01735 (N.D. Tx. Filed June 24, 2016).

The action names as defendants: Christopher Faulkner, the Frack Master, President and CEO of defendant Breitling Energy Corporation, registered under Section 12(b) with the SEC; Breitling Oil & Gas Corporation; Crude Energy, LLC and Patriot Energy, Inc., both controlled by Mr. Faulkner; Jeremy Wagers, a Texas Attorney; Judson Hoover, a CPA and Breitling Energy Corp. CFO; Parker Hallam; co-founded of Breitling and president of defendant Crude Energy; Joseph Simo, the owner of Simo Energy, LLC, a Dallas petroleum geology consulting firm that services Breitling Oil, Breitling Energy, Crude Energy and Patriot Energy; Dustin Miller Rodreguez, co-founder of Breitling Oil and its CIO; Beth Handkins, Crude Energy’s COO; and Gilbert Steedly, Breitling Energy’s v.p. of capital markets.

Frack Master Faulkner created a fraudulent offering scheme using Breitling Oil which was later essentially replicated with other firms, including publically traded Breitling Energy. He began in 2011 with privately held Breitling Oil. The firm told investors it was offering “turnkey” oil and gas working interests. Mr. Faulkner ran the operations in large measure while Messrs. Hallam and Miller directed the sale process.

The sales process was built on a series of misrepresentations. Those began with the background of Mr. Faulkner who falsely claimed to hold masters and doctorate degrees and have extensive oil and gas experience – the media appearances were arranged by Mr. Faulkner’s public relations firm to promote his book.

Interests were acquired in oil-and-gas properties. Many of the agreements had a continuous drilling provision which if not complied with would result in the interest reverting to its original holder. The provisions were not disclosed. Investors were furnished with an estimated cost to drill and complete the wells as well as the amount the investment would earn. Mr. Faulkner received estimates for drilling and completion costs from operators that actually drilled and completed the wells in which Breitling Oil and the other firms held interests. Investors were not told that he took those estimates and inflated them before using them to market the shares to the public.

The offering materials also included reports by geologist Joseph Simo. Those reports recommended drilling wells on the prospects. The reports frequently included production projections. Those projections were built on historical performance numbers from property in the vicinity and an assumption that a new drilling would perform as well as the best properties. No basis was offered for this assumption. Mr. Simo was held out to the public as an independent expert – his affiliation with Breitling Oil was not disclosed.

Over time Breitling Energy, a public company, essentially became Breitling Oil’s success along with Crude Energy and later Patriot Energy. Crude Energy became the covert marketing arm of Breitling Energy. Interests were marketed using essential the same approach as that used for Breitling Oil.

Beginning in late 2013, and continuing through April 2015, Mr. Faulkner directed that about $36 million be transferred from Crude Energy to Breitling Energy. He also had Breitling Energy make payments of over $18 million on his American Express cards in addition to other claimed reimbursements he recieved that had no support. Reports were filed with the Commission for the firm at the direction of Mr. Faulkner. Those reports did not disclose the firm’s relationship with Crude Energy or the results of operations.

In late 2014 the share price of Breitling Energy tumbled along with those of other oil firm stocks as the price of oil plummeted. In an effort to prop up the price, Mr. Faulkner diverted hundreds of thousands of dollars from Breitling Energy to two stock trading accounts he controlled. He engaged in heavy trading through the two nominee accounts and at some points marked the close in an effort to manipulate the share price.

In December 2015 the oil and gas sales operation for Breitling Energy was moved from Crude Energy to Patriot Energy following a dispute involving Mr. Faulkner and one of his confederates. Mr. Faulkner directed the transfer of millions of dollars from Patriot Energy to Breitling Energy. Portions of the money went to pay his personal expenses.

By April 2016 the scheme began to collapse. Despite raising significantly more money than was required to drill, test and complete prospects, Mr. Faulkner had drained so much cash from the operation that business could not continue. Operations were shuttered. This triggered certain provisions in many of the agreements under which the interests were re-acquired by the original holder. The investors were left with nothing. Overall Defendants had raised about $80 million in more than 20 oil and gas offerings from hundreds of investors. Mr. Faulkner had misappropriated at least $30 million.

The Commission’s complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 14(a) and 16(a). The case is in litigation. See Lit. Rel. No. 23582 (June 24, 2016).

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