by T. GormanPosted on Posted in SECActions

Student loans, and the debt burdening many students at graduation, is an important political topic. It is not generally a subject for the Securities and Exchange Commission. Nevertheless, at the center of is most recent enforcement action is an educational institution that was forced to restate its financial statements as a result of delinquent pools of student loans it held off the books but which had been guaranteed. SEC v. ITT Educational Services, Inc., Civil Action No. 15-cv-00758 (S.D. Ind. Filed May 12, 2015).

Named as defendants are: ITT Educational, a higher education company with over 50,000 student whose shares are trade on the NYSE; Kevin Modany as ITT’s CEO; and Daniel Fitzpatrick, the firm’s CFO.

Most of ITT’s revenue is generated by tuition. Students generally pay that tuition with federal and state student loans. Historically students relied on traditional private education loans. In 2008 and 2009 ITT tried to secure a new source of private loans for its students but failed. The firm then used a temporary credit system for students that required loans.

In 2009 ITT formed two private student loan programs known as PEAKS and CUSO. PEAKS was structured as a trust that sold securities to investors. It used the funds to make over $300 million in loans to ITT students. The CUSO student loan program was funded by a group of credit unions organized by ITT. It made about $141 million in loans to ITT students. Guarantees were extended by ITT to mitigate the risk. If the students defaulted on their loans ITT could be liable for significant guarantee payments.

PEAKS and CUSCO were designed to enable ITT to avoid reporting on their finances. Both were variable interest entities or VIEs. Under GAAP a company must consolidate the financial results of a VIE if its directs the activities that most significantly impact the economic performance of the entity. For PEAKS and CUSCO that activity was loan underwriting and performance. ITT did not, however, consolidate the financial results of the two entities – ITT shareholders were not furnished with direct information about the two programs.

By 2012 the loans in the programs had extremely high default rates. ITT’s guarantee obligations increased. To conceal the poor performance of the two loan programs, and its impact on ITT, the firm and Messrs. Monday and Fitzpatrick used various devices. For example, they created the Payments on Behalf of Borrowers or POBOB program. Under this program the company made payments on behalf of student borrowers who failed to make timely payments. This had the effect of temporarily delaying defaults. Public filings did not mention this program. Rather, those filings made it appear that the student loans were performing well.

Another approach used to conceal the impact of the defaulting loans was “netting.” Under this approach the near term PEAKS guarantee payments ITT projected making were netted against potential future recoveries that were not projected to be realized for years. The disclosed amount was thus millions of dollars lower than the more than $100 million in near term payments ITT was projected to make. The PEAKS program was not consolidated into ITT’s financial statements despite having the kind of control that required such action.

For CUSO the defendants only made the minimum guarantee payments. This was a practice “akin to making minimum payments on a high interest credit card . . .” according to the complaint. Messrs. Modany and Fitzpatrick also concealed important information about the PEAKS and CUSO programs form the auditors. That included internal projections about future guarantee payments and other matters.

The scheme unraveled in early 2014. The auditors began to discover previously undisclosed information about the programs. Eventually ITT was required to restate its financial statements to consolidate PEAKS for periods beginning in the first quarter of 2013 and to reclassify and disclose the timing for CUSO liabilities. In March 2014 ITT paid $40 million to settle claims by PEAKS program participants tied to the firm’s circumvention of the guarantees through the POBOB program. Overall ITT paid millions of dollars on the guarantees because of poor loan performance.

The complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2), 13(b)(5) and control person liability under 20(a) and Securities Act Section 17(a) and a failure to reimburse under SOX 304. The case is pending.

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by T. GormanPosted on Posted in SECActions

The SEC filed another offering fraud action, a staple of Enforcement. This action centers on two recidivist radio talk show hosts selling interest in life settlements based on enhancements of their investment credentials, omissions of their regulatory history and a series of misrepresentations. SEC v. Novinger, Civil Action No. 4:15-cv-00358 (N.D. Tex. Filed May 11, 2015).

The defendants names in the action are: Christopher Novinger, licensed by the Texas Department of Insurance; Brady Speers, also licensed by the Texas Department of Insurance; NFS Group, LLC, d/b/a Novers Financial which is the name Messrs. Novinger and Speers conduced business under prior to the firm’s formation in late 2012; Ican Investment Group, LLC, a firm formed by Mr. Novinger in the Fall of 2013; and Speers Financial Group, LLC formed by Mr. Speers, which then established Speers Financial to receive commissions on the sales of life settlement interests to investors.

Messrs. Novinger and Speers began working together in the late 1990s, selling various goods, services and investment interests. In early 2012 the two men were introduced to life settlements, fractionalized interest in the benefits payable under life insurance policies that are payable on the death of the insured. The interests are securities.

The two men hosted a weekly radio show called the “Retirement Experts Radio Show” in the Dallas/Fort Work area. Messrs. Novinger and Speers represented themselves as “licensed consultants,” or “licensed financial strategists.” They also employed slogans to describe themselves such as “The Low Risk, Safe Money Guys” or retirement experts or “the largest non-risk investment consulting firm in the Southwest.”

From February 2012 through January 2014 Defendants Novinger, Speers and NFS Group, d/b/a Novers Financial, offered and sold life settlement interest. In soliciting investors the two men assured them that: 1) the interests were safe and guaranteed; 2) had annualized average returns of 7-11%; 3) were as safe as a CD; and 4) they were federally insured.

Investors were not told that despite their claimed titles, Mr. Novinger and Mr. Speers had little expertise or training in the area. Also omitted was their regulatory history. In September 2013 the Oklahoma Department of Securities issued a cease-and-desist order against Messrs. Novinger and Speers and Novers for their fraudulent offer of unregistered life settlements in that state. Also not disclosed were the facts that the Texas Attorney General, the FCC and the State of California each took regulatory action against a prior company owned, managed and directed by Defendants Novinger and Speers which had participated in a fraudulent scheme to mass-market discount health plans.

Investors were told that they had to be “accredited.” That term is defined under Rule 501 of Regulation D which requires the investor’s net worth or income meet certain thresholds. To help investors meet those thresholds Messrs. Novinger and Speers used a “Net Worth Calculator” which improperly included the tabulation of 20 years worth of future social security, pension and other similar payments.

As a result Messrs. Novinger and Speers and Novers sold more than $4.3 million of life settlement interests to 26 investors. At least three were not accredited investors. These sales generated about $515,000 in commissions that were paid directly to Ican Investment and Speers Financial. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending.

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