by T. GormanPosted on Posted in SECActions

Offering frauds and Ponzi schemes mixed with a few misappropriation cases have become the staples of SEC enforcement. The cases and schemes on which frauds are built range from the simple investment scheme in which shares of a company are supposedly sold to raise operating capital for what may or may not be a legitimate business to esoteric schemes based on what are supposedly visionary schemes that will be unveiled in the future. One action filed this week sought to take advantage of the interest in IPOs, offering pre-IPO shares in what were claimed to be unicorns. SEC .v Quartararo, Civil Action No. 21-cv-02305 (E.D.N.Y. Filed April 27, 2021). A second centers on a Ponzi scheme. SEC v. Harbor City Capital-Corp.,, Civil Action No. 6:21-cv-694 (M.D. Fla. Filed April 20, 2021).

Quartararo is an action which names as a defendant Peter Quartararo who was previously barred from associating with any broker/dealer by FINRA. Mr. Quartararo began soliciting investors in mid-2019 to purchase shares in well known unicorns. Investors were told that they could acquire pre-IPO shares in firms such as Peloton Interactive, Inc and Airbnb, Inc.

Over a period of several months at least four investors invested about $436,000 in what they believed were pre-IPO shares. Investors were told to make out their checks for the investment to Leonard Quartararo, the barred broker’s father, or Private Equity Solutions. That firm was owned by Paul Casella, who had also worked in the securities industry and been barred by FINRA. In addition, he had been convicted on federal racketeering charges for human trafficking.

The pre-IPO shares never existed. Defendant made a series of payments to his girlfriend and family. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25083 (April 27, 2021).

Harbor City Capital is based on a Ponzi scheme. The defendants include the firm and a series of related entities and Johnathan P. Maroney, the CEO of the firm and the related entities. In 2020 the Alabama Securities Commission issued a cease-and-desist order prohibiting Mr. Maroney from selling securities in the state.

Since at least 2015 Mr. Maroney has have been selling either promissory notes or bonds tied to his entities. The notes or bonds were supposed to pay 1% to 5% per month to the holders. The funds were supposedly for “lead generation.” Investors were not told of Mr. Maroney’s regulatory history. The solicitations yielded over $17.1 million. Much of the investor capital was misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 2502 (April 27, 2021).

Comment

These cases are typical of the dozens of offering fraud actions the Commission has brought in recent months. While the Commission filed Harbor City while the scheme was on-going and the Court set a hearing on a preliminary injunction, in probability much of the investor capital in that case, as well as the first is, gone.

The Commission will in probability end the securities business activities of the Defendants in each case. Yet a little due diligence by potential investors in each instance would have uncovered the background of those stealing their money, halting the fraudulent schemes much earlier and saving their investments. Each case should serve as a warning to investors looking to place their money in good securities.

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by T. GormanPosted on Posted in SECActions

The question of using a SPAC/Special Purpose Entity/Blank Check Company to become a public entity has come into vogue as the number of IPOs skyrocketed in recent months – as least up to the end of the first quarter of 2021 when the trend suddenly halted. To a large extent much of the conversation focuses on the question of whether a private entity merging with a public SPAC is prepared for the obligations and burdens of being the steward of a public company.

A number of commentators have suggested that the Commission had some impact on the demise of the SPAC-IPO trend. Perhaps. The Commission has published two statements recently on the question. One by the Division of Trading and Markets, discussed in an earlier article (here); a second, was penned by Acting Chief Accountant Paul Munter (here). While there is some overlap in the statements, each serves as a cautionary note and checklist for those about to assume the responsibilities of senior positions with a public company, viewed from a different prospective.

Mr. Munter begins his statement by focusing on financial reporting. Regardless of the form or structure used to become public, the key is “[h]igh quality financial reporting – a result of stakeholder(s) throughout the financial reporting system working together . . . for the shareholders. The merger of a SPAC and private enterprise thus presents a series of difficult and complex financial reporting and governance questions. Those include questions regarding the market and timing, financial reporting considerations, internal control issues, corporate governance points and considerations regarding auditors.

First, a key point centers on the markets and the question of timing, according to Mr. Munter. The transition from private company to public entity represents a significant undertaking. Yet SPAC transactions typically take place over a period of months. In contrast, in the more traditional model the transaction may take place over a period of years. This difference – the compression of preparation time – can significantly impact the new management team. Yet as a public company that group will be called on to deal with a range of questions from understanding the dictates and requirements of public reporting to maintaining an effective system of internal controls. All of these issues are critical to the proper functioning of a public company. The compression, coupled with the difficulty of the responsibilities assumed by the new management team, puts a large premium on the selection of members for the team as well as their preparation requiring a carefully prepared and well-thought-out plan.

Second, issues regarding financial reporting require a knowledge of the obligations imposed by the Commission and others along with the participations of skilled accounting professionals. This is because the management team will be confronted with a series of financial reporting issues in addition to the management and government questions that will arise. The questions will include:

· Determining if the financial statements should conform to GAAP or IFRS

· Questions regarding the form and content of the financial statements

· The identification of the surviving entity for accounting purposes

· Accounting for earn-out or compensation arrangements and complex financial instruments, and

· The application of GAAP for public business entities

Third, internal controls are a key consideration. Generally, the controls govern financial reporting and disclosures. Under SOX Section 404 “management generally needs to conduct an annual evaluation of its ICFR. . .” It is critical that management understand the timing of the first annual assessment required. Management must also be prepared to evaluate the effectiveness of a “public company’s DCP [disclosure controls] as of the end of each fiscal quarter . . .”

Fourth, to ensure proper corporate governance it is important that the different groups involved managing the entity understand their roles, responsibilities, and obligations. The board, for example, should have a clear understanding of its role along with the obligations of the fiduciary duties assumed. It is equally important that management has fully assessed its role, obligations and methods for communicating with management. In addition, the role of the audit committee and its important obligations must be understood by the board, management and those who will join the committee. And, each group involved should be prepared to establish the proper tone at the top of the organization. All of this hinges on effective communication.

Finally, the new organization must be prepared to deal with the auditors and their key role. This requires familiarity with the requirements of the PCAOB and the SEC in this regard, including the key independence rule. It is also important that the audit firm be prepared for the issues that will arise during the transition from private to public company on a compressed time line. All of these considerations, and others should be carefully assessed early in the process of transiting from a private firm to one that is public.

Comment

The apparent rush to an IPO by SPACs reflected in the statistics at the end of the first quarter has ended. Whether that resulted from the publication of the statements by the Acting Chief Accountant and the Division of Trading and Markets or for other reasons is a matter of conjecture.

What is important is that those involved with the IPO of a SPAC are properly prepared. Read together, the two statements from the Commission staff provide an important check list for those involved with these transactions. Investors considering purchasing shares of the new firms would also do well to carefully consider the points presented before purchasing shares.

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