by T. GormanPosted on Posted in SECActions

The SEC regularly touts the benefits of cooperation, encouraging companies and individuals to self-report and cooperate with its investigations. Since cooperation is typically tied to the facts and circumstances of the case, the description of what is expected and its benefits is often general and somewhat vague. While this may be understandable, it leaves those who might be considering whether to step forward wondering just what benefit they might receive.

When, however, a case is settled where cooperation is involved the SEC has an opportunity to give definition to the nature of the cooperation and the benefits of it. The Commission had this opportunity in two proceedings filed which arose out of the financial fraud at Diebold, Inc. In the Matter of Michael McKenna, CPA, Adm. Proc. File No. 3-17002 (December 14, 2015); In the Matter of Charles Loveless, CPA, Adm. Proc. File No. 3-17001 (December 14, 2015). Mr. McKenna was the vice president of Global Finance at Diebold from 2002 through 2005. Mr. Loveless was a finance manager at the firm from 2001 to 2006.

The financial fraud at Diebold, Inc. began in 2002 and culminated in a $127 million 2008 restatement. Prior to the restatement the financial fraud resulted in over forty misstated annual, quarterly, and other reports being filed with the Commission, along with dozens of inaccurate press releases. SEC v. Diebold, Inc., Civil Action No. 1:10-CV00908 (D.D.C. Filed June 2, 2010).

During the five-year fraud Diebold, a manufacturer and seller of automated teller machines:

Inflated revenue: Improperly inflated revenue on what were called “F-term” orders, or factory orders, when shipping products. The company used improper “bill and hold” transactions which failed to comply with GAAP to materially overstated earnings. For example, in 2003 those practices resulted in the premature recognition of $29.5 million.

Improper buy-backs: Improperly recognized revenue on a lease transaction which was subject to a side buy-back agreement. As a result of this transaction the company improperly recognized $5 million in revenue in the first quarter of 2005.

Accruals: Manipulated its reserves and accruals. For example, in 2004 the company improperly released from a reserve $1 million in the first quarter, another $1.25 million in the second quarter and an additional $5.25 million in the third quarter. Diebold also under-accrued liabilities.

Capitalization: Improperly delayed and capitalized expenses.

Inventory: Improperly increased the value of inventory.

In 2008, Diebold restated its financial statements for the years 2003 through 2006 and the first quarter of 2007.

To resolve the Commission’s action, Diebold consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and the related rules. The company also agreed to pay a $25 million civil penalty.

Mr. McKenna participated in the fraud by directing employees to ship certain F-term orders from factory to warehouse before the shipment dates agreed to with customers. This practice was known as pulling in F-term orders. It had varying effects from quarter to quarter but in many instances was done purposely to inflate earnings to meet forecasts. As a result Mr. McKenna caused Diebold’s violations of Exchange Act Section 13(b)(2)(A).

In 2002 and 2003 Mr. Loveless knew that an account which consolidated several sub-accounts in the North American business units was frequently under accrued. This resulted from the fact that the business units were not properly recording liabilities. Mr. Loveless was also responsible for an account which at times was used as a cookie jar reserve. As a result he caused Diebold’s violations of Exchange Act Section 13(b)(2)(A).

In resolving the proceedings, each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Each paid disgorgement with Mr. McKenna paying $42,700 while Mr. Loveless will pay $7,724.

The Orders state that Messrs. McKenna and Loveless cooperated with the Commission’s investigation. The section of each Order describing the cooperation is identical. Each lists a series of actions brought by the SEC related tied to the Diebold financial fraud. Neither, however, specified what either man did. There is no indication if either reported the fraud to the SEC before it was discovered. There is no indication if either testified in one or both of the actions identified by the agency as contested. There is no suggestion that either furnished the SEC with critical evidence that might not otherwise been discovered or that the investigation was accelerated because of the cooperation.

In contrast the fact that neither was charged with fraud nor was a penalty imposed clearly indicates that the two men benefitted in the charging process. At the same time there is no indicated of the basis for requiring that disgorgement be paid. Thus, while the two actions give some indication of the benefits of cooperation, the Commission appears to have missed an opportunity to illustrate what is expected and the full benefits of cooperation.

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by T. GormanPosted on Posted in SECActions

It was touted as “the largest publicly traded diversified portfolio of professional sports teams in the world.” The firm actually owned interests in a U.K. football team and other sports teams. The company was put together by a former registered representative. In 18 months over 150 investors bought shares for a total of $6.5 million. While the firm was real, the sales pitch used to sell its shares was fraud, geared to the unsophisticated. SEC v. Oxford City Football Club, Inc., Civil Action No. 15-62584 (S.D. Fla. Filed Dec. 10, 2015).

Defendant Thomas Guerriero is a former registered representative who masterminded the scheme. Defendant Oxford was formed in 2003, as Smart Kids Group, Inc. Following a reverse merger in 2012 with a publicly traded company called WMX which offered executive training certificates in financial planning, the company changed its name to Oxford City Football Club, Inc. Oxford had acquired a 1% interest in an entity that operated Oxford City Football Club of Oxford, England. At the time of the merger Mr. Guerriero controlled both entities.

Oxford had two basic portfolios. One focused on professional sports teams. It had interests in the football club as well as a number of semi-pro indoor and outdoor soccer teams and a basketball team. Its second portfolio focused on academic institutions. It consisted of two schools which offered bachelors, masters and doctoral degree programs in economics and financial markets. The firm also claimed to have a media and entertainment portfolio that included a South Florida radio station and a real estate and property management portfolio. By the end of its first full year of operation Oxford reported just over $600,000 of revenue and a net loss of over $7 million.

Following a 4,000 to 1 reverse stock split at a time when the shares were trading for about a penny, Mr. Guerriero set up a call center. A sales team – referred to as consultants – was established to sell shares in Oxford. A basic script was developed and potential investor lists were acquired. The shares were not registered, although an exemption was claimed under Regulation D. Inquiry was not made to determine if the potential investors were accredited.

Investors were typically told that they could purchase the shares at a deep discount of about $1 or $2 per share, although the stock was trading at about $4 to $6. Investors were not told that the defendants artificially maintained the share price. Likewise, they were not told that since the shares were unregistered there was a holding period before the securities could be resold. Investors were told about a valuable real estate portfolio, a possible listing on the New York Stock Exchange, a dividend and financial projects that were very positive. The claims were false.

One approach used with investors was to secure their signature on a Subscription Agreement. Following their agreement to purchase shares certain investors received a three page agreement. The signature pages were supposed to attest to their accredited status. The appropriate boxes on the forms were all filled in. The signature pages were then added to the executed Subscription Agreement by the firm.

Other investors were sent a written confirmation of a claimed purchase after a telephone call in which they furnished basic identifying information to the firm. If the investor disputed the purchase he or she was told that there was a Verbal Verification System which had recorded the order and that it was legally binding.

Defendants have continued to solicit investors during the SEC’s investigation. On December 8, 2015 Mr. Guerriero furnished a potential investor with overstated profit projections and used other deceptive sales tactics. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of Section 17(a). It also alleges violations of Exchange Act Sections 10(b), each subsection of Rule 10(b)-(5), and 20(b). The case is pending.

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