by T. GormanPosted on Posted in SECActions

The standards by which issuers or market professionals are governed are critical. Those standards guide the dealings of investment advisers, for example, entrusted by clients with their capital. It is for this reason that many of the Commission’s enforcement actions center on a breach or violation of the governing standards of the organization. Examples of those cases run the gamete from insider trading which is based on a breach of standards to those involving investment advisers who fail to properly disclose fees.

The Commission’s most recent action against a CFO dealing with questions regarding related party transactions or RPTs is based on this approach. There the CFO essentially did an end run around the firm’s well-established principles governing RPTs. In the Matter of Mark E. Kchenrither, Adm. Proc. File No. 3-19009 (March 1, 2019).

Mark Kuchenrither served as Executive Vice President and CFO of EZCORP, a firm with two classes of shares. The Class A shares are listed on NASDAQ but do not carry voting rights. The Class B shares do have voting rights. All of those shares are owned by the Controlling Shareholder.

The board of directors approved a Policy for Review and Evaluation of Related Party Transactions in September 2009. The firm’s General Counsel developed a process to implement the RPT Policy under the supervision of the audit committee which had been delegated authority to assess the fairness of related party transactions. The process was designed to ensure that transactions involving the company and the Controlling Shareholder were fair.

The Audit Committee retained an Advisor to furnish an opinion each year on whether the annual consulting agreement with the Controlling Shareholder was financially fair to EZCORP. That process in part hinged on a comparison of the proposed fee involved in the arrangement with the Controlling Shareholder with EZCORP’s projected revenue, earnings and other metrics for the coming year.

Over a four year period, beginning in 2009, the Advisor provided an opinion that the proposed consulting agreement was fair. The company then disclosed the agreement in a Form 8-K as a related party transaction.

In 2014 the Advisor informed the company that it would not approve the proposed Consulting Agreement because the consulting fee exceeded the acceptable fee-to-earnings ratio based on EZCORP’s financial projections. The Controlling Shareholder rejected a request to reconsider the fee.

The Audit Committee Chairman then asked Mr. Kuchenrither to reassess the financial position of the company since the Advisor’s determination hinged on the fact that the firm’s projected earnings were less than $240 million. The CFO revised the earnings projection over the next four days, increasing it from $187 million to $242.9 million. The increase was based on two assumptions: 1) that EZCOERP would complete a $300 million high-yield debt offering and 2) that the firm would use part of the proceeds to acquire several companies during the year. After reviewing the revisions, the Advisor approving the Consulting Agreement.

The CFO did not, however, have a reasonable basis for the two assumptions on which the new projections were based. The CFO essentially double counted the impact of the high-yield debt offering since it was included in the original financial projections. Reliance on the contemplated acquisitions was equally flawed. Indeed, the firm had conducted few discussions with its list of proposed targets. That fact was known, or should have known, to the CFO since he was a member of the acquisition committee. Nevertheless, EZCORP proceeded to disclose the new agreement filings with the Commission. The filing did not include any discussion regarding the Advisor’s initial opinion or the CFO’s revamping of the financial projections based on flawed assumptions. The Order alleges violations of Securities Act Sections 17(a)(3).

To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order. He also agreed to pay a penalty of $50,000.

Program: Women in Compliance, March 19, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.

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by T. GormanPosted on Posted in SECActions

The SEC and Elon Musk were at odds again this week. The Commission filed motion papers requesting that the Tesla founder be held in contempt for issuing a tweet about the firm’s potential production numbers for the year without first obtaining approval in accord with the terms of the earlier settlement. A subsequent tweet, issued with approval, clarified the first. The information in the tweets was taken from company releases. Mr. Musk and the company admit that the first tweet was not pre-cleared. The action is pending.

The Commission also filed three civil injunctive actions this week. Two of the cases were offering frauds. One centered on soliciting two investors using false claims to convince them to invest capital in a private firm that supposedly was going to produce a motion picture. The second, conducted by a convicted felon, used misrepresentations to solicit investors to put their investment dollars in a claimed real estate deal. A third case centers on executives who used false claims and sham transactions in applying for aid from a federal program for university operators.

SEC Enforcement – Filed and Settled Actions

The Commission filed 3 civil injunctive actions and no administrative proceedings this week, exclusive of 12j and tag-along actions.

Offering fraud: SEC v. Adams, Civil Action No. 2:19-cv-01312 (C.D. Cal. Filed Feb. 26, 2019) is an action against: Daniel Adams, a film writer and convicted felon; Michael Flanders, a music producer; Spiderworx Media LLC and L.A. Minute LLC. In 2016 Messrs. Adams and Flanders sought to raise capital to make a movie titled An L.A. Minute. One investor was induced to participate based on false assertions that the writer and music producer had invested in the endeavor – they had not. A second investor said he would put capital in the project if $200,000 was raised. After being shown false records about a claimed investment in that amount the investor put in his capital. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a)(2). The case is pending. See Lit. Rel. No. 24411 (C.D. Cal. Filed Feb. 26, 2019).

False disclosure: SEC v. Massimino, Civil Action No. 2:19-cv-01374 (C.D. Cal. Filed Feb. 25, 2019). Defendants Jack Massimino and Robert Owen were, respectively, the CEO and CFO of Corinthian Colleges, Inc., a publicly traded operator of 125 for profit colleges. About 80% of the firm’s revenue came from the federal government through student loans and grants under Title IV of the Higher Education Act of 1968. Receipt of revenue under Title IV depended on the company achieving a certain composite score calculated by the U.S. Department of Education from certain financial metrics. Long term debt increased the institution’s composite score. To ensure that Corinthian achieved a score that assured Title IV Funds would flow, at year-end 2011, 2012 and 2013 the company boosted its long-term debt through borrowings on its line of credit. In each instances a short while later the borrowings were repaid. The Department of Education sent Corinthian a letter in mid-August 2013 stating in part that the year-end borrowings were incorrectly included in long term debt for FY 2011, calling them “questionable accounting treatment.” Corinthian excluded the borrowings and filed a Form 8-K later the same month. The filing stated that the Department of Education required the elimination of the long term debt for 2011, that the company disagreed and that there could be no assurance there would not be “additional disagreements” with the government. The disclosures were false and misleading, according to the complaint. Material facts were omitted because the filing did not disclose the 2012 and 2013 borrowings which were identical to those in 2011 and which were under review. The firm also failed to disclose the risk that the Department of Education would require the elimination of the claimed long-term borrowings in those two years and the impact of such a determination. The suggestion that there might be additional disagreements was not sufficient to alert investors the complaint asserted. The complaint alleges violations of Securities Act Section 17(a)(3) and Exchange Act Section 13(a). To resolve the case each Defendant consented to the entry of a permanent injunction based on the sections cited in the complaint as to Mr. Massimino and on Section 13(a) as to Mr. Owen. Mr. Massimino will also pay a penalty of $80,000 while Mr. Owen will pay $20,000. See Lit. Rel. No. 24410 (February 25, 2019).

Offering fraud: SEC v. Castleberry Financial Services Group, LLC, Civil Action No. 10-80244 (S.D. Fla. Filed Feb. 19, 2019) is an action which names as defendants the firm, T. Johnathan Turner, its COO and Norman Strell, the CEO of the firm. Defendants have defrauded at least 15 investors out of over $3.6 million in the last twelve months. Specifically, Defendants have touted the firm’s success which resulted in it being well capitalized, the safety of investing with them and the investments which would be in businesses and real estate. Investments were also supposedly insured by firms such as CNA Surety and Chubb Group and made by skilled professionals. Each claim was false. The investor funds were misappropriated, there was no business and Mr. Turner is a convicted felon who is on supervised release following years in prison. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). A temporary freeze order has been entered and an accounting ordered. The case is pending. See Lit. Rel. No. 24412 (Feb. 27, 2019).

Criminal cases

Offering fraud: U.S. v. Liberty, No. 2:19-cr-00030 (D. Me. Filed Feb. 27, 2019) charges Michael Liberty and Paul Hess with conspiracy to commit wire fraud, four counts of wire fraud and one count of securities fraud. The charges center on a scheme in which Defendants solicited investments for Mozido, a privately held tech firm that offered users an ability to make payments using their mobile phone. Millions of dollars were raised in the scheme, much of which was diverted to the personal use of Defendants. The case is pending. See also SEC v, Liberty, Civil Action No. 99139 (D. Me. Filed March 30, 2018).

Crypto currency: U.S. v. Crater, No. (D. Mass. Filed Feb.27, 2019) charges Rondall Crater with four counts of wire fraud and three counts of unlawful monetary transactions. The charges are based on a three year scheme that began in 2014 in which investors were solicited to invest in a crypto currency firm, My Big Coin Pay Inc. and its coins. Mr. Crater told investors that the crypto coin was a fully functioning crypto currency backed by gold that could be used as a currency. The claims were false. Mr. Crater is alleged to have misappropriated over $6 million in connection with the scheme. The case is pending.

FCPA/Anti-Corruption

U.S. v.Pinto (S.D. Tx. Filed Feb. 26, 2019) is another in a series of actions centered on a bribery scheme involving Petroleos de Venezuela S.A. (PDSA). Specifically, Defendants Rafael Erinque Pinto Franceschi and Franz Herman Muller Huber, respectively, a sales representative and the President of a Florida based firm, were charged in a five count indictment for participating in a corrupt scheme that began in 2009 and continued until about 2013. The scheme centered on the payment of bribes to officials at PDVSA to secure contracts and the payment of past due invoices. The two business men also received over $1 million in kickbacks from the officials as part of the scheme. Two of the three officials bribed have pleaded guilty in connection with the scheme. The indictment alleges one count of conspiracy to commit wire fraud, one count of conspiracy to violate the FCPA, two counts of wire fraud and one count of conspiracy to launder money. The Defendants made their first appearance earlier this week. To date the DOJ has charged 21 people in connection with the scheme, 15 of whom have pleaded guilty.

U.K.

Remarks: Andrew Bailey, Chief Executive of the Financial Conduct Authority, delivered remarks on MiFID II at the European Independent Research Providers Association, London (Feb. 25, 2019). His remarks expressed support for the MiFID II reforms, noted that many asset managers now focused on their investments, that many were voicing concern regarding this trend and noted that they would continue to examine it (here).

Declinations: The Serious Frauds Office announced the closing of two significant corruption investigations. First, the SFO announced that no individuals would be prosecuted in connection with the investigation regarding Rolls-Royce PLC. That inquiry focused on bribery and corruption to obtain business in Indonesia, Thailand, India, Russia, Nigeria, China and Malaysia. Previously the firm entered into a deferred prosecution agreement with the SFO.

Second, the SFO announced that its investigation of GlaxoSmithKline PLC regarding the commercial practices of the company, its subsidiaries and associated persons is being closed. Each announcement followed a detailed review and analysis of the available evidence.

Program: Women in Compliance, March 19, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.

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