A FINANCIAL FRAUD ACTION CENTERED ON A FICTITIOUS CUSTOMER

The SEC filed an amended complaint, adding Jon Latorella and James Fields as defendants to an action alleging a financial fraud and stock manipulation involving two companies they control. SEC v. LocatePlus Holdings Company, Case No. 1:10-cv-11751 (D. Mass. Nov. 11, 2010) (previously discussed here). LocatePlus provides online access to public record databases for investigative searches. Mr. Latorella was its CEO from 2002 until March of 2007 and the Chairman of the Board until 2008. Mr. Fields was its acting CFO for a time and became the CEO in 2007 and the chairman of the board the next year. The two men also founded and controlled Paradigm Tactical Products, Inc. which sold hand held metal detectors called “FriskerPros.”

Beginning in 2005, the Commission’s complaint claims, the defendants engaged in two schemes. The first was to falsify the financial statements of LocatePlus. The second focused on manipulating the shares of Paradigm once a trading market for those shares was established.

The revenues of LocatePlus were fraudulently inflated over a two-year period by defendants Latorella and Fields by causing the company to recognize about $2 million in fictitious revenue. That revenue supposedly came from transactions with customer Omni Data. In one transaction, Omni Data paid $600,000 to LocatePlus for services. In a second, an additional $250,000 was paid to the company. The proceeds of these transactions were reported by LocatePlus as revenue.

In fact, during 2005 and 2006 LocatePlus did not have any revenue from Omni Data. The company was not a customer. The $600,000 came from a round trip transaction in which Messrs. Latorella and Fields paid $650,000 to an entity controlled by James Fields. Eventually, $600,000 from that transaction was cycled back to LocatePlus. In the second transaction, Messrs. Latorella and Fields transferred $250,000 from the sale of unregistered Paradigm shares through Omni Data to LocatePlus. Although the cash paid to LocatePlus from Omni Data came from sham transactions, the company reported it in filings with the Commission as revenue.

Messrs. Latorella and Fields also manipulated the share price of Paradigm after establishing a trading market for its shares based on false information, according to the Commission. Following a reverse merger, the two men furnished false information about the shareholdings of the company to a market maker in papers required to put a quote in the Pink Sheets for the company. At the time, they sought to establish a trading market for the shares of Paradigm.

Subsequently, Messrs. Latorella and Fields backdated share certificates to make it appear those shares had been held for the time required by Rule 144. This permitted the restrictive legend to be removed from the shares, allowing them to be sold. Those unregistered shares were then sold to the public resulting in proceeds of $950,000. Press releases containing false claims about the company’s financial condition were subsequently issued to push up the share price.

The Commission’s complaint alleges violations of Securities Act Sections 5 and 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 in litigation. See also Litig. Rel. 21735 (Nov. 10, 2010).

FOR GOLDMAN THE ABACUS DEAL JUST KEEPS COMING BACK

The ABACUS deal has become the one that just will not go away for Goldman Sachs. First, the deal became the predicate for an SEC enforcement action against the pillar of Wall Street and one of its employees, Fabrice Tourre. That high profile case resolved with an even higher profile settlement in which untarnished Goldman consented to the entry of a fraud injunction. To make matters worse the firm agreed to pay the largest civil penalty ever levied against a Wall Street bank, $535 million (here).

Next, U.K. regulator the Financial Services Authority concluded that Goldman Sachs International had violated its rules in connection with the SEC action based on the ABACUS deal (here). Specifically, Goldman failed to tell the FSA that it had received a Wells Notice from the SEC. That violated FSA rules which require that the firm conduct its business with due skill, care and diligence. It also violated the requirement that the firm deal with its regulator in an open and cooperative fashion. More adverse publicity and another fine, this time for $26 million. (The firm did receive a 30% discount for cooperating with the FSA investigation).

Now, Goldman will be required to pay a fine to FINRA. Again, the firm failed to tell a regulator about the Wells notices. Specifically, FINRA found that Goldman failed to disclose that two of its registered representatives, including Mr. Tourre, had received Wells notices from the SEC. Mr. Tourre’s notice was based on the ABACUS transaction at the center of the SEC’s enforcement action in which he is a defendant. Firms are required to update a representative’s regulatory record by filing a Form U4 reporting the receipt of a Wells Notice within 30 days.

FINRA also concluded that Goldman does not have adequate supervisory procedures and systems in place to ensure proper disclosure. Its written supervisory procedures, manuals and policies fail to mention “Wells Notices.” More adverse publicity and another fine, this time for $650,000.

Goldman can afford to pay the fines. The firm’s reputation is ultimately what is most important. It is that reputation which makes it an icon on Wall Street and brings clients to the firm. Repeatedly being chastised by the regulators soils that image. It is more of a sanction than the monitory penalties. And, it is not over. The SEC enforcement action against Mr. Tourre is in discovery and heading for trial.