by T. GormanPosted on Posted in SECActions

The CEO and CFO of a successful senior living firm sought to expand the business by acquiring the operations of another firm and leasing its facilities. Despite warnings that the lease terms were far to onerous, the deal was concluded. The result was securities fraud, according to a proceeding filed by the SEC. In the Matter of Laurie Bebo and John Buono, Adm. Proc. File No. 3-16293 (December 3, 2014).

Ms. Bebo and Mr. Buono were, respectively, the CEO and CFO of Assisted Living Concepts, Inc., a publicly-traded assisting living and senior residence based in Wisconsin. Ms. Bebo was also a member of the board of directors. During the period 2008 to 2012 the firm operated more than 200 senior living residences in the U.S. and employed about 4,200 people.

In 2007 Ms. Bebo and the board sought to expand the firm’s operations. Assisted Living was offered the opportunity to acquire the operations of a firm which operated eight assisted living facilities that were leased from Ventas, Inc. The facilities were located in four states. To make the acquisition, Assisted Living had to enter into a lease with Ventas.

Effective January 1, 2008 Assisted Living acquired the operations of the Ventas facilities. The firm also entered into a lease to operate those facilities. At the time of the transaction a number of officers and directors cautioned against the deal because of the burdensome provisions in the lease. Those included requirements that Assisted Living demonstrate on a quarterly basis compliance with certain financial covenants and provide detailed financial data prepared in accordance with GAAP. There were also certain occupancy requirements.

Shortly after the transaction closed, occupancy began to decline. In an effort to avoid default on the lease covenants, Ms. Bebo devised a plan to include Assisted Living employees who stayed overnight at the Ventas facilities as occupants of the properties for purposes of complying with the lease provisions. After reviewing the lease provisions the firm’s general counsel advised that permission must be secured in writing from Ventas. The advice was ignored.

By the first quarter of 2009 Assisted Living was on the verge of default. Ms. Bebo directed CFO Buono and his staff to include employees and other non-residents in the financial covenant calculations. To effectuate this directive four key steps were taken:

  • At the end of each month the accounting staff determined the amount by which the firm would fail to meet the covenants and then reverse engineered the number of residents needed to meet the lease covenants;
  • Journal entries were then prepared to record the revenue;
  • At the end of the period the financial covenant calculations were made; and
  • After determining the number of residents required, Ms. Bebo determined the identity of each person and lists were prepared.

Using this approach, beginning in the first quarter of 2009, the firm furnished Ventas the necessary financial data. Those materials demonstrated compliance by Assisted Living with the lease covenants.

The impact of the scheme reached beyond the information given to Ventas. Specifically, the Forms 10-K for the years ending December 31, 2009, 2010 and 2011 and the Forms 10Q for the first three quarters of those years contained representations that Assisted Living was in compliance with the financial covenants in the Ventas lease. Ms. Bebo and Mr. Buono signed the Forms 10-K. Mr. Buono signed the quarterly reports. In addition, the Form 10-K for the year ending December 31, 2011 and the Forms 10-Q for the second and third quarters represented that the firm did not believe it was likely to breach the Ventas lease covenants. In connection with these filings the two officers also certified that the filings did not contain material misstatements and that the financial information was fairly presented.

Ms. Bebo and Mr. Buono also made representations to the auditors regarding compliance with the lease provisions. Each officer executed representation letters to the auditors stating that the firm was in compliance with all aspects of its agreements that would materially impact the financial statements. In 2011 the two officers also represented to the auditors that they had no knowledge of any fraud or suspected fraud.

The scheme unraveled over a 2012 lawsuit filed by Ventas which was unrelated to the lease covenants. In connection with attempting to settle that suit, the Assisted Living board insisted that a release be secured from Ventas regarding the practice of including employees in the calculations for compliance with the covenants. When this was disclosed to Ventas, the firm amended its complaint to include a claim based on the practice.

Eventually the suit was settled. Assisted Living paid about $100 million to settle the suit and acquire the operations. Since an appraisal demonstrated that the facilities were only worth about $62.8 million, the financial statements for the second quarter of 2012 contained an expense of $37.2 million described as “lease termination and settlement.” The remaining lease intangible assets associated with the Ventas facilities were written off at a $8.96 million.

The Order alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)B) and 13(b)-5. The proceeding will be set for hearing.

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by T. GormanPosted on Posted in SECActions

The SEC filed a fraud action based on the misappropriation of shares of a private firm held by investors through an LLC. The shares were then resold and reissued to other investors. SEC v. Kumar, Civil Action No. 23145 (N.D. Cal. Filed December 2, 2014).

Defendant Vinay Kumar Nevatia solicited real estate and securities investments through a number of entities he owned or controlled from 2007 through 2013. Previously, he had worked as an executive search consultant.

In August 2008 Mr. Kumar and eight other investors purchased 179,900 shares in CSS Corp. Technologies (Mauritius) Limited, a privately held technology company. Mr. Kumar, who knew one of the co-founders of the company, told investors that the shares were only available to those with personal connections to the firm. This was represented to be an exclusive, pre-IPO, opportunity.

To simplify the transaction, according to Mr. Kumar, the shares would be held through VRSBS Investments, LLC. The investors, who contributed $899,500, became the sole members of the firm along with Mr. Kumar who invested $25,000 or less than 3% of the total funds.

VRSBS was governed by a document titled “Operating Agreement of BRSBS Investment, LLC.” That agreement stated that the sole purpose of the entity was to buy and hold CSS shares for the benefit of its members. Mr. Kumar, as the managing member, was required to provide other members with a description of the material terms of any potential sale and was prohibited from commingling his proceeds with personal accounts. Investors then requested that certificates be issued reflecting the number of shares owned by each individual investor. This would permit each investor to have a certificate as evidence of the investment. Mr. Kumar made the necessary arrangements.

In November 2011 Mr. Kumar sold about half of the CSS shares originally purchased by the VRSBS investors to three directors of a venture capital firm. The directors agreed to pay $359,800 for 89,950 CSS shares. The funds were not wired to VRSBS. Rather, Mr. Kumar arranged for the payment to be directed to his personal trust bank. When the directors requested the share certificates Mr. Kumar claimed that all of the stock was in one certificate which would have to be reissued.

Three months later, on February 16, 2012, Mr. Kumar entered into an agreement to sell another 25,000 CSS shares. This agreement was with two of the venture capital firm directors. The sales price was $100,000. Six days later Mr. Kumar agreed to sell another 60,000 CSS shares for $195,000, this time to a Cayman Islands private equity fund managed from Hong Kong. Both sales were of shares held by VRSBS. The venture capital directors wired payment to a bank account controlled by Mr. Kumar. The fund wired its payment to VRSBS. Virtually all of the funds were then diverted by Mr. Kumar to his account.

When the fund requested stock certificates, Mr. Kumar arranged for the reissuance of the CSS shares. He represented to the firm and its transfer agent that the original shares had been lost. Eventually the shares were reissued.

While the shares were being reissued, Mr. Kumar told the original investors that he was going to have new certificates issued in the name of each investor. He also told them that CSS was planning to conduct a potentially lucrative IPO.

In July 2013 some of the original investors learned from CSS that Mr. Kumar had sold nearly all of the shares. When confronted with these facts, Mr. Kumar claimed that he had only temporarily transferred the shares to protect them from his creditors. He then stopped communicating with the investors.

The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 23145 (December 2, 1014).