How Falsifying Compliance With A Lease Became Securities Fraud
The CEO and CFO of a successful senior living firm sought to expand the business by acquiring the operations of another firm and leasing its facilities. Despite warnings that the lease terms were far to onerous, the deal was concluded. The result was securities fraud, according to a proceeding filed by the SEC. In the Matter of Laurie Bebo and John Buono, Adm. Proc. File No. 3-16293 (December 3, 2014).
Ms. Bebo and Mr. Buono were, respectively, the CEO and CFO of Assisted Living Concepts, Inc., a publicly-traded assisting living and senior residence based in Wisconsin. Ms. Bebo was also a member of the board of directors. During the period 2008 to 2012 the firm operated more than 200 senior living residences in the U.S. and employed about 4,200 people.
In 2007 Ms. Bebo and the board sought to expand the firm’s operations. Assisted Living was offered the opportunity to acquire the operations of a firm which operated eight assisted living facilities that were leased from Ventas, Inc. The facilities were located in four states. To make the acquisition, Assisted Living had to enter into a lease with Ventas.
Effective January 1, 2008 Assisted Living acquired the operations of the Ventas facilities. The firm also entered into a lease to operate those facilities. At the time of the transaction a number of officers and directors cautioned against the deal because of the burdensome provisions in the lease. Those included requirements that Assisted Living demonstrate on a quarterly basis compliance with certain financial covenants and provide detailed financial data prepared in accordance with GAAP. There were also certain occupancy requirements.
Shortly after the transaction closed, occupancy began to decline. In an effort to avoid default on the lease covenants, Ms. Bebo devised a plan to include Assisted Living employees who stayed overnight at the Ventas facilities as occupants of the properties for purposes of complying with the lease provisions. After reviewing the lease provisions the firm’s general counsel advised that permission must be secured in writing from Ventas. The advice was ignored.
By the first quarter of 2009 Assisted Living was on the verge of default. Ms. Bebo directed CFO Buono and his staff to include employees and other non-residents in the financial covenant calculations. To effectuate this directive four key steps were taken:
- At the end of each month the accounting staff determined the amount by which the firm would fail to meet the covenants and then reverse engineered the number of residents needed to meet the lease covenants;
- Journal entries were then prepared to record the revenue;
- At the end of the period the financial covenant calculations were made; and
- After determining the number of residents required, Ms. Bebo determined the identity of each person and lists were prepared.
Using this approach, beginning in the first quarter of 2009, the firm furnished Ventas the necessary financial data. Those materials demonstrated compliance by Assisted Living with the lease covenants.
The impact of the scheme reached beyond the information given to Ventas. Specifically, the Forms 10-K for the years ending December 31, 2009, 2010 and 2011 and the Forms 10Q for the first three quarters of those years contained representations that Assisted Living was in compliance with the financial covenants in the Ventas lease. Ms. Bebo and Mr. Buono signed the Forms 10-K. Mr. Buono signed the quarterly reports. In addition, the Form 10-K for the year ending December 31, 2011 and the Forms 10-Q for the second and third quarters represented that the firm did not believe it was likely to breach the Ventas lease covenants. In connection with these filings the two officers also certified that the filings did not contain material misstatements and that the financial information was fairly presented.
Ms. Bebo and Mr. Buono also made representations to the auditors regarding compliance with the lease provisions. Each officer executed representation letters to the auditors stating that the firm was in compliance with all aspects of its agreements that would materially impact the financial statements. In 2011 the two officers also represented to the auditors that they had no knowledge of any fraud or suspected fraud.
The scheme unraveled over a 2012 lawsuit filed by Ventas which was unrelated to the lease covenants. In connection with attempting to settle that suit, the Assisted Living board insisted that a release be secured from Ventas regarding the practice of including employees in the calculations for compliance with the covenants. When this was disclosed to Ventas, the firm amended its complaint to include a claim based on the practice.
Eventually the suit was settled. Assisted Living paid about $100 million to settle the suit and acquire the operations. Since an appraisal demonstrated that the facilities were only worth about $62.8 million, the financial statements for the second quarter of 2012 contained an expense of $37.2 million described as “lease termination and settlement.” The remaining lease intangible assets associated with the Ventas facilities were written off at a $8.96 million.
The Order alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)B) and 13(b)-5. The proceeding will be set for hearing.