by T. GormanPosted on Posted in SECActions

The Court entered a final judgment by consent against a former bank officer in another Commission market crisis case, SEC v. Wu, Civil Action No. CV-11-2988 (N.D. Cal. Filed Oct. 11, 2011). The settlement was with the former Chief Operating officer of UCBH Holdings, Inc., Ebrahim Shabudin. The agency was aided in the prosecution of this case by a cooperation agreement entered into with another employee of UCBH Holdings, the publicly traded holding company of United Commercial Bank.

Mr. Shabudin was one of four senior officers of UCBH Holdings named by the Commission in Wu. The others were Chief Executive officer, Thomas Wu, senior officer Thomas Yu and Chief Financial Officer Craig On. The case centered on claims that there were improper delays in the recording of loan loses suffered at the end of 2008 and in the first quarter of 2009. Specifically, Messrs. Wu, Yu and Shabudin learned that that as the real estate market deteriorated during the market crisis there were increasing loan delinquencies and decreasing collateral values for the bank’s portfolio of commercial and construction loans. Defaults were increasing. Messrs. Wu, Yu and Shabudin concealed this information from investors and the auditors, according to the complaint.

Mr. On, who previously settled with the Commission, was alleged to have negligently mislead the outside auditors and in the filing of false financial statements. Although the bank received assistance from TARP, eventually it failed. This was one of the largest commercial bank failures.

Mr. Shabudin settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 13(b)(5) and Securities Act Sections 17(a)(1) and (3) and from aiding and abetting violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). He did not admit or deny the allegation in the complaint. Mr. Shabudin was also barred from serving as an officer or director of a public company and has been ordered to a penalty of $175,000. That penalty was partially reduced by the amount paid as a penalty in a related action brought by the FDIC. See also Lit. Rel. Nos. 22786 (August 22, 2013) and 22121 (October 11, 2011).

The allegations in this action are similar to those asserted in other market crisis cases by the agency involving financial institutions. See, e.g., SEC v. Morrice, Civil Action No. CV 09-01426 (C.D. Cal. Filed Dec. 7, 2009)(action against the senior officers of subprime lending giant New Century Financial); SEC v. Perry, Civil Action No. CV 11-021309 (C.D. Cal. Filed Feb. 11, 2011)(similar claims against former officers of IndyMac Bancorp).

The Commission’s prosecution of the action involving Mr. Shabudin was aided by a cooperation agreement entered into with John Cinderey, a vice president of the bank. Mr. Shabudin is alleged to have altered memoranda addressing the risks associated with certain large loans and potential losses the bank faced. Those memoranda were furnished to the auditors. For example, one memorandum given to the auditors regarding a large construction loan omitted certain information and added misleading statements regarding the borrowers. Another provided the auditors incomplete or misleading information to support the risk rating for a loan to developers building a large block of condominiums.

Mr. Cindery entered into a cooperation agreement with the Commission. He also consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 13(b)(5) and from aiding and abetting violations of Secton 13(b)(2)(A). No penalty was assessed based in part on the $40,000 civil penalty paid in a related FDIC proceeding. SEC v. Cinderey, Civil Case No. CV 12-1519 (N.D. Cal. Filed March 27, 2012).

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by T. GormanPosted on Posted in SECActions

This is the eighth and concluding segment in a series of articles examining the creation of the Financial Reporting and Audit Task Force along with a Center for Risk and Quantitative Analysis. Today’s article analyses the likely focus of the New Task Force, suggesting steps that issues can take now to avoid liability tomorrow.

The new financial task fraud task force is currently being formulated. Its path has yet to be charted. Yet, if history is any guide, issuers and their directors, executives and auditors would do well to be prepared.

Following Chairman Levitt’s “Numbers Game” speech the Commission launched a very successful campaign against financial statement fraud. Significant cases were brought against dozens of issuers and their executives. In some instances the outside auditors of the firm and even business partners became embroiled in enforcement litigation. In several instances criminal prosecutions were brought.

Now under a new Chair, and with a freshly minted “get tough” policy, the Commission is launching a similar campaign. The new campaign has more weapons than in the past. There is a rich history of cases illuminating wrongful practices to serve as an initial guide. The SOX certification process provides a potential guide for investigators to what should be key company financial issues while serving as an enhancement to potential liability for the CEO and CFO. The electronic tags added to financial data filed with the SEC facilitate data evaluation. And, a reorganized enforcement program is keyed to risk and data analysis as well as the use of industry metrics to measure and evaluate performance as an indication of possible wrongful conduct.

In view of this, issuers and their executives should consider four key points. First, the lessons from the financial statement fraud actions brought in the wake of the “Numbers Game” speech that will serve as the roots of the new Task Force should be carefully assessed. An analysis of cases such as HealthSouth, Time Warner, Bristol-Myers, Xerox, GE and others yields a guide to improper practices which can be used as a red flag check list to identify improper practices. See generally Richard H. Walker, Director, Division of Enforcement, 27th Annual National AICPA Conference on Current SEC Developments (Dec. 7, 1999) (Identifying 10 lessons from financial statement fraud cases).

Second, the market crisis financial cases point to another key metric which the Task Force will clearly consider. Actions such as Mozilo where deteriorating assets were masked giving investors a distorted view of the company will surely be a central issue. This counsels a careful analysis of valuation and reserve issues as well as disclosure controls.

Third, the analytic and big data approach illustrated by the Aberrational Performance Inquiry offers a good guide for issuers evaluating performance. The focus is a risk based set of industry metrics that identify outliers. Issuers can conduct this same kind of analysis by evaluating trends in their performance in view of specific metrics. If, in view of those metrics, the company is an outlier or its performance is too good to be true, further inquiry may be warranted. Conducting that inquiry now before any SEC investigation is not just prudent, it is good business.

Finally, the stakes in these cases could not be higher. Senior executives of the company are frequently charged as in Cendant, Enron, WorldCom, Adelphia and other cases. In some instances business partners are charged as in Koninkijke Ahold. In others the outside auditors are named in Commission enforcement actions as in Xerox and Bally. And, since the line between civil and criminal securities fraud is at best murky, there may be criminal liability as in many instances. See, e.g., Thomas O. Gorman, SEC Enforcement Trends 2011, Financial Fraud, Secactions (April 18, 2011), available at https://www.secactions.com/sec-enforcement-trends-2011-financial-fraud.

Those who believe that the new Financial Task Force will find a vastly changed financial reporting landscape and fewer cases would do well to remember the predicate for Chairman Levitt’s “Numbers Game” speech. It was the constant pressure on companies and executives to meet street expectations, according to the Chairman. The string of cases brought in the wake of that speech bore out Chairman Levitt’s point. Today’s 24/7 news cycle, active class action bar, and waiting whistleblowers have done nothing but intensify those pressures. With a new SEC task force looming, the prudent company and executive will understand that acting today is good business for tomorrow. Acting today can ensure that those pressures do not turn their financial reporting into a “Numbers Game.” See, e.g., Ex-Olympus Chairman Gets Suspended Sentence for Fraud, Bloomberg (July 3, 2013) (Chairman of Olympus sentenced on criminal charges related to financial statement fraud).

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