SEC Charges CEO Re Undisclosed Related Party Transactions, Perks
Corporate executives cannot use the company as their personal bank. Conflicts of interest and related party transactions require disclosure. Yet these are the predicates for the Commission’s latest case in this area – a founder and CEO who used his firm and its vendors to support his life style. Eventually the firm collapsed into bankruptcy. SEC v. Schiller, Civil Action No. 4:18-cv-02433 (S.D. Tx. Filed July 16, 2018).
Defendant John Schiller is the founder, president and CEO during the time of the events involved here of Energy XXI, Ltd. The firm, founded in 2005, became one of the largest producers of oil and gas on the shelf of the Gulf of Mexico. Its shares were registered with the Commission and listed on NASDAQ from August 2007 through May 2016. By December 2016 the firm’s bankruptcy reorganization plan was confirmed and the company dissolved.
In March 2010 Mr. Schiller opened a margin account secured by a portfolio of the firm’s stock. By February 2014 he had borrowed over $23 million. The account was highly leveraged, according to the complaint. Faced with margin calls and the prospect of selling large blocks of firm stock Mr. Schiller sought additional financing. He found it in arrangements with three of the firm’s outside vendors:
First: In February 2014 a line of credit was obtained from Vendor A, a firm that sought to do business with EXXI. Contemporaneous emails reflect the fact that the owners of Vendor A understood the firm would receive business in return for the loan.
Second: In August 2014 a $3 million loan was obtained from Vendor B following another margin call. The firm had a pre-existing business relationship with this vendor.
Third: Following a drop in the share price of EXXI shares a loan totaling $3 million was arranged from Vendor C in September and October 2014. In return Vendor C was promised all of the firm’s lifeboat business.
Following the loans Mr. Schiller had a material interest in the vendor’s business with EXXI since he received the loans in exchange for future business. The business with the vendors constituted related party transactions and should have been disclosed. It were not. Indeed, the loans were not disclosed to the board of directors or in the firm’s proxy statement.
In October 2014 Mr. Schiller obtained an additional loan of $3 million which was not documented from Norman Louie, the managing director of Mount Kellett Capital Management L.P., a registered investment adviser that beneficially owned 6.3% of EXXI’s stock. Mr. Louie was under consideration for a position on EXXI’s board of directors. He became a director. The loan was not disclosed. Later Mr. Louie was appointed to serve on the firm’s audit committee and compensation committee. Under NASDAQ listing requirements directors holding those positions are required to be independent. Mr. Louie was not.
Finally, over a period of four years, beginning in 2016, Mr. Schiller obtained undisclosed compensation and perquisites by submitting as business expenses to the firm items which were personal in nature and often lacked documentation. The charges totaled at least $1 million and were not included in the proxy statements.
The complaint alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act section 14(a) and certain rules. To resolve the action Mr. Schiller consented to the entry of a permanent injunction based on the sections cited in the complaint. The judgement also imposes a penalty of $180,000 and an officer director bar for five years. See also In the Matter of Norman M.K. Louie, Adm. Proc. File No. No. 3-18596 (July 16, 2018)(proceeding against Mr. Louie and the adviser on the conduct described above alleging violations of Exchange Act Section 13(a) and Adviser Act section 206(2) as to Mr. Louie and Exchange Act section 13(d) and Advisers Act section 206(4) by the adviser; resolved by consents to cease and desist orders based on the sections cited as to each Respondent, a censure of the adviser and the payment of a penalty in the amount of $100,000 by Mr. Louie and $160,000 by the adviser).