SEC Sanctions Executives for Wrongful Disclosure

Financial fraud actions frequently involve the improper use of accounting principles such as the premature recognition of revenue or the incorrect capitalization of expenses, each of which will improperly boost revenue and ultimately profit. The Commission’s most recent case in this area differs from the more traditional cases. It centers on what amounts to a series of sham transactions used to boost long term debt. The scheme, which continued even after the executives executing it were forced to reveal the conduct in part, was designed to secure certain government funds for the company. SEC v. Massimino, Civil Action No. 2:19-cv-01374 (C.D. Cal. Filed Feb. 25, 2019).

Defendants Jack Massimino and Robert Owen were, respectively the CEO and CFO of Corinthian Colleges, Inc., a publicly traded operator of 125 for profit colleges. About 80% of the firm’s revenue came from the federal government through student loans and grants under Title IV of the Higher Education Act of 1968.

Receipt of revenue under Title IV depended on the company achieving a certain composite score calculated by the U.S. Department of Education from certain financial metrics. Long term debt increased the institution’s composite score. If the score equaled or exceeded 1.5 the institution received unqualified access to Title IV Funds. If the composite score was below that point, the institution faced heightened scrutiny and possible delay in receiving the funds.

To ensure that Corinthian achieved a score that assured Title IV Funds would flow, at year-end the company boosted its long-term debt through borrowings on its line of credit. A short while later the borrowings would be repaid. Thus, for example, at FY year-end 2011 Corinthian borrowed $43 million which was initially added to its long term debt but was repaid within a few days. At FY 2012 the firm borrowed $52 million for the same reason which was also repaid a short time later. And, at FY 2013 year-end Corinthian borrowed $25 million, repaid within a few days.

The Department of Education sent Corinthian a letter in mid-August 2013 stating in part that the year-end borrowings were incorrectly included in long term debt for FY 2011, dubbing them “questionable accounting treatment.” Corinthian excluded the borrowings and filed a Form 8-K later the same month. The filing stated that the Department of Education required the elimination of the long term debt for 2011, that the company disagreed and that there could be no assurance there would not be “additional disagreements” with the government.

The disclosures were false and misleading, according to the complaint. Material facts were omitted because the filing did not disclose the 2012 and 2013 borrowings which were identical to those in 2011 and which were under review. The firm also failed to disclose the risk that the Department of Education would require the elimination of the claimed long-term borrowings in those two years and the impact of such a determination. The suggestion that there might be additional disagreements was not sufficient to alert investors the complaint asserted. The complaint alleges violations of Securities Act Section 17(a)(3) and Exchange Act Section 13(a).

To resolve the case each Defendant consented to the entry of a permanent injunction as to Mr. Massimino based on the sections cited in the complaint and as to Mr. Owen on Section 13(a). Mr. Massimino will also pay a penalty of $80,000 while Mr. Owen will pay $20,000. See Lit. Rel. No. 24410 (February 25, 2019).

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