CEO, Attorney Plead Guilty to Market Manipulation

Microcap fraud has long been a focus of the Commission. The U.S. Attorney’s Office has also brought a series of criminal cases centered on market manipulation charges involving these entities. This week prosecutors in the Eastern District of New York secured guilty pleas from the CEO of microcap firm and its attorney. U.S. v. Shapiro, Case No. 14-cr-399 (E.D.N.Y.).

Named as defendants are Ira Shapiro and Darren Ofsink. Mr. Shapiro is the CEO of CodeSmart Holdings, Inc. Mr. Ofsink is a Manhattan based attorney. Each defendant pleaded guilty to one count of conspiracy to commit securities fraud.

The charges stem from the participation by each defendant in an $86 million market manipulation scheme centered on the shares of CodeSmart. In May 2013, according to the charging documents, the defendants and others took CodeSmart, then a privately held firm, public through a reverse merger with a public shell company. The defendants and their confederates then obtained control of the free trading shares of the new public firm.

Subsequently, the defendants assisted in pushing the share price up to artificial levels. Beginning in May 2013, and continuing through August of 2013, the co-conspirators manipulated the share price of CodeSmart stock, raising it from $1.77 to as much as $6.94 per share – an increase of 291%. The share price then dropped back to $2.19.

From late August 2013 through late September 2013 the co-conspirators repeated the process. This time the stock price went from $2.19 to a high of $4.60, an increase of about 104%. Then the price dropped back about 116% to $2.13.

At its highest point the firm had a market capitalization of over $86 million. Yet the same day the firm filed a Form 10-K with the SEC reporting total assets of $6,000, revenue of $7,600 and a net loss of $103,141. By the end of December 2013 the share price of CodeSmart stock was $0.66. By the middle of the next year it was $0.01. The date for sentencing has not been set.

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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 Riversdale 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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