SEC Charges Rio Tinto, Executives With Fraud

The Commission charged mining giant Rio Tinto Plc, its subsidiary Rio Tinto Limited, and two of its executives, former CEO Thomas Albanese and former CFO Guy Elliott, with fraud. The case centers on the acquisition of a coal property carried on the books for over three billion dollars at a time when an internal analysis showed the property had a negative value. SEC v. Rio Tinto Plc, (S.D.N.Y. Filed Oct. 17, 2017).

In July 2007 Rio Tinto acquired Alcan, Inc., an aluminum processing company for $38 billion. By February 2009 the firm announced a $7.9 billion impairment charge to Alcan’s carrying value. Additional impairment charges were announced later. Eventually virtually all of the value of the acquisition, made under the watch of CEO Albanese and CFO Elliott, was written off.

Acquisitions were necessary to sustain the growth of the firm since mining assets deplete as CEO Albanese and CFO Elliott knew. At the same time the two men knew that they could not afford another failure as they approached the acquisition of Riversdale Mining Limited, a coal business in Mozambique. The executives knew that their reputations could not sustain another Alcan.

Pre-acquisition due diligence by Rio Tinto identified a series of risks with the Riverdale property. Those included transportation of the coal from the mining property. The proposal to the board of directors regarding the property at a December 2010 meeting claimed the purchase of the property would double Rio Tinto’s managed production of coal to over 30 million tons per year after 2020. The coal would be transported by barge or railroad from the site. The value of the deal was $3.6 billion. The directors were not informed of the significant risks associated with the acquisition.

Later in December the Rio Tinto made a proposal to acquire Riversdale. By early April 2011 the firm had acquired a majority interest in the company, paying about $3.7 billion net of cash acquired at acquisition. That price represented a substantial premium to Riversdale’s market capitalization at the time. The deal was presented as consistent with Rio Tinto’s strategy of developing large, long term, low cost assets.

Difficulties developed almost immediately. By October 2011 it was determined that the barging capacity was limited to about one third of the capacity previously believed. This alone had a measurable and immediate effect on the property valuation – it reduced it to about $2.1 billion because of the loss of barging capacity and the ability to move the coal from the site. The next month the Government of Mozambique notified the firm that it would not permit barging on the Zambezi River because of environmental concerns. While coal could still be moved by rail, capacity was limited. Rio Tinto could only move a small fraction of the coal originally planned. By year end 2011 and in early 2012 the firm created valuations for the acquisition that ranged from negative $3.45 to negative $9 billion – all based on aggressive assumptions.

Despite the transportation difficulties and negative valuations Mr. Albanese downplayed the Government’s actions. The board of directors was not informed that barging could not be done. The Audit Committee and independent auditors were not told about the adverse events. This resulted in misrepresentations and omissions in Rio Tinto’s 2011 Annual Report and financial statements. The CEO continued to promote the project.

In April 2012 CFO Elliott requested an “all hands” meeting with the CEO and others to review the status of the project. The meetings convened in mid-May in Brisbane, Australia. Employees involved with the firm’s impairment process were not invited to the meeting. During the meetings the CEO and CFO learned that based on the best information available at best the coal property was worth negative $680 million. In fact the only way to deliver the necessary capacity of coal from the property at a competitive cost was to build a new rail line at a cost of $16 billion. That project, however, would not create a positive valuation for the coal property. The rail line was rejected. By the end of the meeting Messrs. Albanese and Elliot concluded that it was premature to settle on a valuation for the property.

While the firm began an impairment review of the property, the CEO and CFO did not disclose the information they had about the property. In the half year financial reports of the company the property was valued at over $3 billion. Over the balance of the year Mr. Albanese and Mr. Elliott continued to promote the property.

As year-end approached, a firm executive who had conducted an evaluation of the property and determined it had a negative value first informed CEO Albanese. When nothing happened the executive shared the information with the Chairman of the board who requested in investigation. By mid-January 2013 the firm issued a press release stating that it expected to recognize a non-cash impairment charge of about $14 billion on its full 2012 results. That included a $3 billion impairment charge on the Riversdale property. The CEO stepped down by mutual agreement.

The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The case is pending.

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SEC Charges Firm, Officers Re False Statements in Private Offerings

The Commission has long focused on microcap frauds, repeatedly brining cases in this area. It has also focused in recent years on offering fraud actions, filing a string of cases. The agency began this week with another offering fraud action. This time rather than the usual unregistered securities charge tied to selling interests in a limited partnership, a pyramid scheme or a Ponzi scheme, the action centers on the sale of shares through private placements for a privately held development stage company. In the Matter of Mergenet Medical Inc., Adm. Proc. File No. 3-18253 (October 16, 2017).

Respondent Mergenet is a Florida based firm engaged in the development of medical devices for pulmonary and respiratory conditions. Also named as Respondents are: Bruce Sher, the firm’s co-founder, co-president and a director; Shara Hernandez, a co-founder and co-president of the firm; and Peter DeCicco Jr., an employee in the firm’s public relations department.

Over a three year period beginning in 2012 the firm raised about $1.4 million from 72 accredited investors. The sales were marketed using private placement memoranda, written company presentations, videos, and oral communications. The PPM and other written materials were mailed to prospective investors.

During the relevant period Respondents made misstatements or omissions to investors regarding the status of its High Flow Therapy or HFT device. While the company has devices with FDA approval, from 2010 through 2015 investors were told that the HFT had also received FDA clearance and/or approval when in fact the agency deemed the applications for the device withdrawn. Investors were also told about the projected sales for the HFT device and the related supplies during the same period. Based on this conduct the Order alleges violations of Securities Act Sections 17(a)(2).

To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. In addition, Respondents Sher and Hernandez will each pay a penalty of $60,000 while Respondent DeCicco will pay $50,000.

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