by T. GormanPosted on Posted in SECActions

The Commission filed two settled offering fraud actions centered in part around an entity engaged in the purchase and sale of thoroughbred horses called Raintree Racing. A second involved an offering of interests in a real estate investment firm known as Atlanta Rehab which had invested in Raintree Racing. In the Matter of Russell C. Schalk, Jr., Adm. Proc. File No. 31555 (April 17, 2015); In the Matter of Joseph John Labadia, Adm. Proc. File No. 3-16499 (April 17, 2015). Mr. Schalk is currently a vice president of sales for Travel International. He is also the sole control person and a one third owner of Raintree Racing and the control person and CEO of a related entity, Raintree Farm. Mr. Labadia was an unregistered investment adviser who was a one third owner and member of the management committee of Raintree Racing. He is also a certified financial analyst and holds certain securities licenses.

From 2007 through 2012 Messrs. Schalk and Labadia raised over $1.9 million from investors for Raintree racing. Investors were told that they were making short term principal protected investments in the venture which were characterized as loans. Investors were told that the current rate of return was 20% and that the venture was extremely low risk.

Raintree Racing, however, lacked cash flow and did not have the financial ability to pay the promised 20% return. In fact Raintree Racing was dependent on the infusion of funds from investors for the continuation of its operations. Nevertheless, investors did receive interest and principal payments.

While investors were assured that their funds was a safe, over a three year period beginning in 2007, Mr. Schalk transferred about $668,000 from Raintree Racing to Raintree Farm. These transfers were contrary to the representations made to investors and not authorized by the documents they were provided. Indeed, Raintree Racing suspended operations at the end of 2012.

Some Raintree Racing investors were also offered the opportunity to invest in Raintree Farm. Investors did in fact purchase shares. The PPM, prepared by Mr. Schalk, failed to tell those investors that the Farm was operating at a material net loss, its operations were being funded by Racing and that it had minimal assets. Nevertheless, in late 2012 and early 2013 Mr. Schalk prepared and distributed to investors in Farm statements showing a per share value of $3.34. In fact those shares had little or no value, according to the Order. From 2007 through 2011 Mr. Schalk also diverted about $220,000 from Raintree Racing and Raintree Farm accounts to his personal bank account.

Mr. Labadia sold unregistered shares in a second venture, Atlanta Rehab, raising over $1.1 million. Atlanta Rehab investors were furnished with statements showing that the enterprise had an investment in Raintree Racing, valuing it at the offering price. At the time, a substantial portion of Atlanta Rehab funds were invested in Raintree Racing.

The Order in each proceeding alleges willful violations of Securities Act Sections 5(a), 5(c) and 17(a) and of Exchange Act Section 10(b). The Order as to Mr. Labadia alleges violations of Advisers Act Sections 206(1) and 206(2). Each Respondent settled, consenting to the entry of a cease and desist order based on the Sections cited in the Order in their action. Mr. Sahalk also agreed to pay disgorgement of $1,472,959, prejudgment interest and a third tier civil penalty of $1.6 million. An Administrative Law Judge will determine his ability to pay. Mr. Labadia is also barred from the securities business and from serving as an officer or director of a public company. He was ordered to pay disgorgement of $48,337 and prejudgment interest. Payment is suspended based on a sworn statement of an inability to pay.

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by T. GormanPosted on Posted in SECActions

Cooperation credit and conducting internal investigations were key themes in recent remarks by Assistant Attorney General Leslie Caldwell at New York University Law School’s Program on Corporate Compliance and Enforcement (April 17 2015)(here). These have long been critical issues for corporations facing a question of self-reporting, particularly in the FCPA area.

Companies considering whether to seek cooperation credit must do more than simply conduct an internal investigation and report to the Department, the Assistant AG noted. To earn credit “we expect that company to conduct a thorough internal investigation and to turn over evidence of wrongdoing to our prosecutors in a timely and complete way. Perhaps more critically, we expect cooperating companies to identify culpable individuals—including senior executives if they were involved – and provide the facts about their wrongdoing.”

While noting that the Department does not want to tell firms how to conduct an internal investigation, there is no such thing as an “off the rack” inquiry, Ms. Caldwell noted On the other hand there are what she called “hallmarks of all good internal investigations. Chief among them is the identification of wrongdoers. The mere voluntary disclosure of corporate misconduct—by itself—is not enough.”

It is critical that investigations be independent and designed to uncover the facts, not “spread company talking points or whitewash the truth.” The complete facts must be provided in a timely fashion. This does not mean that the investigation has to extend into unnecessary areas, expending millions of dollars. “This is particularly true in the FCPA context where the need for international evidence can add to the expense and burden of an investigation.”

While in many instances companies spend large sums on investigations it is not always necessary, according to the Assistant AG. The Department expects internal investigations to be thorough but “we do not expect companies to aimlessly boil the ocean.” For example, if an FCPA violation is discovered in one country and there is no basis to suspect violations are occurring elsewhere, “we would not necessarily expect it [the company] to extend its investigation beyond the conduct in that country. On the other hand, if the same people involved in the violation also operated in other countries, we likely would expect the investigation to be broader.”

Companies may chose not to cooperate. While this may delay the Department’s inquiry, it “rarely thwarts . . .” the investigation. A good example in the FCPA area is the Alstom inquiry. There the Criminal Division performed an extensive investigation without the cooperation of the company. The result: “Today, four individual Alstom executives have been charged with FCPA crimes, three of the executives have pleaded guilty; Alstom’s consortium partner, Marubeni, was charged and pleaded guilty after also opting not to cooperate, and Alstom pleaded guilty and paid a $772 million penalty – the largest criminal penalty in the history of the FCPA.”

Firms should carefully consider these facts when evaluating whether to self-report and cooperate. In the end, the Department will continue its investigation Ms. Caldwell noted regardless of the decision by the company. At the same time if the company intends to cooperate, it is critical that in internal investigation be designed to fit the situation, comprehensive, timely and that those responsible be identified.

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