An International Financial Fraud Case

The SEC is bringing an increasing number of cases in cooperation with regulators in other countries. Frequently these involve insider trading, as discussed here.

In SEC v. Escala Group, Inc., Case No. 09 CV 2646 (S.D.N.Y. March 23, 2009), the Commission filed an international accounting fraud case with the assistance of the Special prosecutions office for Financial Offenses relating to Corruption, Madrid, Spain. The case names as defendants: 1) Escala Group, Inc., a Connecticut based entity that is a global network of companies in the collectibles market that was traded on Nasdaq (its parent is Afinsa Bienses Tangibles, S.A., a Spanish company engaged in commercial and trading activities); 2) Gregory Manning, the founder of Escala; and 3) Larry Lee Crawford, the CFO of Escala.

The fraudulent scheme is based, according to the Commission, on related party transactions between Escala and Afinsa. Those transactions added over $80 million to Escala’s revenues and permitted the company to meet earnings forecasts for fiscal 2004 and the first quarter of 2005. As a result of these transactions, Escala’s share price increased from $1.47 per share on the day the company and Afinsa entered into a merger agreement to $32 per share. In addition, Afinsa was able to obtain a constant supply of stamps to replace forgeries Mr. Manning discovered in the inventory of Afinsa and to supply investors.

The complaint alleges that the defendants achieved these results by engaging in a fraudulent scheme based on the manipulation of collectible stamp values. That scheme had three key facets: 1) failing to disclose the related party status of Barrett & Worthen, Inc. — a small privately held publishing company controlled by Arlene Driscoll, a close friend of Mr. Manning — resulting in the control of a stamp catalogue also controlled by Ms. Driscoll which was published by B&W, and failing to disclose the revenues obtained by virtue of Afinsa and Mr. Manning’s control of the prices in the catalogue; 2) falsely representing that Escala sold Afinsa several large stamp archives at arms-length prices, when in fact Mr. Manning set the catalogue prices and influenced and edited the appraisals; 3) selling back to Afinsa in a round-trip transaction inventory acquired from Afinsa; and 4) falsely reporting a payment for business combination related expenses as the “sale” of certain antiques.

The scheme came to an end in 2006 when Spanish authorities raided Afinsa’s offices. Charges were brought against certain individuals alleging that they had engaged in an unlawful pyramid scheme.

The SEC’s complaint alleged violations of the antifraud and reporting provisions of the federal securities laws. The action is pending, although there is a tentative settlement with the company.