More On Legal & Compliancefrom The Advisor's Professional Library
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
- Anti-Fraud Provisions of the Investment Advisers Act RIAs and IARs should view themselves as fiduciaries at all times, whether they meet the legal definition or not. Deviating from the fiduciary standard of full disclosure while courting clients may cause the advisor significant problems.
BP was slapped with the third largest penalty in the SEC’s history on Thursday for misleading investors about the rate of the oil flow in the Deepwater Horizon disaster in the Gulf of Mexico in 2010.
Additional recent actions taken by the SEC were charges filed against three executives of an electronic game card company and its independent auditor for fraud, and charges filed against an investment advisor for fraud and diversion of client funds.
BP Agrees to Pay $525 Million Penalty Over Gulf Spill
British oil company BP agreed Thursday to pay $4.5 billion to the government in fines and other charges, including $525 million to the SEC—the third largest penalty ever assessed by the SEC—over the oil spill in the Gulf of Mexico.
Criminal charges account for $4 billion of that amount, according to a company statement, and BP also agreed to plead guilty to 14 criminal charges. Eleven people died and 17 were injured in the Deepwater Horizon oil rig explosion in April 2010. Oil flooded the Gulf for three months before it was capped, contaminating beaches with millions of gallons of oil from the damaged rig. Three BP employees also faced criminal charges from the Justice Department.
The SEC charged BP with misleading investors by significantly understating the flow rate of the oil gushing into the Gulf in multiple reports filed with the SEC. Although BP repeatedly indicated in fraudulent public statements that the flow rate was estimated at 5,000 barrels per day, its own internal data indicated that potential flow rates could be as high as 146,000 barrels of oil per day.
BP executives also made numerous public statements after the filings were made in which they stood behind the flow rate estimate of 5,000 barrels of oil per day. In fact, they criticized other much higher estimates by third parties as scaremongering.
According to the SEC’s complaint filed in the U.S. District Court for the Eastern District of Louisiana, BP stated that the flow rate was estimated to be 5,000 barrels of oil per day (bopd) in three separate Form 6-Ks filed with the SEC following the Deepwater Horizon oil rig explosion on April 20, 2010. In a 6-K filed on April 29, BP stated in part, “[e]fforts continue to stem the flow of oil from the well, currently estimated at up to 5,000 bopd[.]” BP filed another report the next day similarly referencing “[e]fforts to stem the flow from the well, currently estimated at up to 5,000 barrels a day are continuing[.]”
The SEC alleges that when the company made those statements, BP possessed at least five different flow rate calculations, estimates or data indicating a much higher flow rate. BP did not possess or generate any piece of data suggesting that 5,000 bopd represented a ceiling for the rate of oil flowing into theGulf of Mexicoor was the best estimate. The failure to disclose the existence of these higher estimates rendered BP’s statements in its Reports on Form 6-K materially false and misleading.
According to the SEC’s complaint, BP issued another 6-K on May 4 that stated, “Accurate estimation of the rate of flow is difficult, but current estimates by the U.S. National Oceanic and Atmospheric Administration (NOAA) suggest that some 5,000 barrels (210,000USgallons) of oil per day are escaping from the well.”
The SEC alleges that BP omitted from its disclosure the material fact that, by this date, it possessed at least six estimates, calculations and data indicating that the oil flow rate far exceeded 5,000 bopd. Therefore, it was no longer accurate to suggest that 5,000 bopd was the best estimate or that the NOAA estimate was the current estimate.
The SEC’s complaint further alleges that BP executives made numerous public statements in May 2010 supporting the 5,000 bopd flow rate estimate and criticizing other estimates despite internal evidence showing that flow rates were likely well in excess of 5,000 bopd. Eventually on Aug. 2, the Flow Rate Technical Group, consisting of government and academic experts tasked with reaching a final official flow rate estimate, announced that the flow rate estimate was actually more than 10 times higher at 52,700 to 62,200 bopd. BP never corrected or updated material misrepresentations and omissions it made about the flow rate in SEC filings for investors.
The SEC plans to establish a Fair Fund with the BP penalty to provide harmed investors with compensation for losses they sustained in the fraud. The SEC’s investigation is continuing as well.
Game Over: Execs Charged With Lying to Investors
The SEC recently charged three executives with repeatedly lying to investors about the operations and financial condition of an Irvine, Calif.-based company that purported to sell credit card-size electronic games. The agency also charged the company’s independent auditor with facilitating the scheme.
According to the SEC’s complaint filed in federal court in Manhattan, chief executive officer Lee Cole and chief financial officer Linden Boyne orchestrated a scheme in which Electronic Game Card Inc. (EGMI) enticed investors by claiming to have millions of dollars in annual revenue, hold millions of dollars in investments, and own an offshore bank account worth more than $10 million.
In reality, many of the company’s purported contracts were phony, the purported investments were merely in entities affiliated with Cole or Boyne, and the bank account did not exist.
The SEC alleged that EGMI’s material misrepresentations and omissions in SEC filings and public statements occurred from 2007 to 2009. The company repeatedly reported nonexistent revenues and assets, misrepresented its business operations, and failed to disclose related-party transactions. Those misrepresentations and others like them were part of a scheme Cole and Boyne orchestrated through EGMI to reap approximately $12 million in unlawful gains.
While they were making material misrepresentations to inflate EGMI’s stock price, the two also secretly funneled millions of shares of EGMI stock to entities based in Gibraltar that they secretly controlled, then directed the Gibraltar entities to sell the shares. The proceeds of those sales were transferred to people or entities associated with Cole and Boyne or to EGMI itself. Cole and Boyne bolstered their lies by providing falsified documents to the company’s outside auditors.
The SEC also charged the company’s outside auditor, CPA Timothy Quintanilla, with repeatedly issuing clean audit opinions about EGMI based on reckless and deficient audit work. The SEC alleges that as EGMI’s engagement partner, Quintanilla and the public accounting firm Mendoza Berger & Co. issued clean audit opinions for EGMI’s year-end financial statements for 2006, 2007, and 2008, even though those statements were riddled with material misstatements and omissions.
Mendoza Berger and Quintanilla, alleged the agency, knowingly or recklessly misrepresented that the firm had conducted audits of EGMI’s financial statements “in accordance with the standards of the Public Company Accounting Oversight Board (United States).” Mendoza Berger’s opinion stated that EGMI’s financial statements “present[ed] fairly, in all material respects, the financial position” of EGMI.
In fact, Mendoza Berger had not audited critical aspects of EGMI’s financial statements, and its work did not conform to the standards of the Public Company Accounting Oversight Board (PCAOB). Quintanilla had no meaningful basis to have Mendoza Berger issue an opinion on EGMI’s financial statements.
Also charged is Kevin Donovan, who later replaced Cole as CEO, ignored many red flags about the accuracy of the company’s public statements and the integrity of Cole andBoyneand even provided false information during conference calls with analysts and investors.
The SEC alleges that shortly after Donovan became CEO, he was notified of many red flags related to the company’s public statements about its operations, finances and share count. Donovan violated the antifraud provisions of the securities laws when he led several public conference calls with securities analysts and investors in 2009, and knowingly or recklessly relayed false financial information about the company that had been provided to him by Cole and Boyne.
As a result of EGMI’s false claims, the company’s outstanding common stock was once valued as high as $150 million. EGMI is now bankrupt and its stock is worthless. The SEC’s investigation is ongoing.
The SEC’s complaint seeks, among other things, a final judgment ordering Cole, Boyne, Donovan, and Quintanilla to pay financial penalties and permanently enjoining them from future violations of the securities laws; enjoining Cole, Boyne, and Donovan from serving as officers and directors of public companies and from participating in penny stock offerings; and ordering Cole, Boyne, and Quintanilla to disgorge their ill-gotten gains with prejudgment interest.
Advisor Charged With Hiding Trading Losses, Diverting Client Funds
A Miami-based investment advisor, Anand Sekaran, was charged by the SEC for defrauding his clients by concealing trading losses and diverting investor funds for personal use.
The SEC alleges that Sekaran and his firm, Wasson Capital Advisors Ltd., fabricated documents showing illusory profits after his trading strategy became unprofitable in 2008 and produced substantial losses for clients. Sekaran also misused client funds to pay various personal and business expenses, and he collected fees in excess of what he was due under the arrangements he had with clients.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Sekaran provided investors with a spreadsheet inaccurately showing Wasson as profitable. He inflated account balances on some clients’ account statements, using the letterhead of a defunct British Virgin Islands trust company for one client and the letterhead of a New Zealandfirm for another client. He also misappropriated investor money for personal mortgage and maintenance payments, restaurant and travel expenses, entertainment and event tickets, employee salaries and health insurance, and rent and office expenses.
Sekaran and Wasson agreed to resolve the SEC’s charges, as well as a parallel criminal action announced by the U.S. Attorney’s Office for the Southern District of New York.
In settling the SEC’s charges, Sekaran and Wasson consented to a final judgment imposing permanent injunctions from future violations of the antifraud provisions of the federal securities laws. Sekaran separately consented to an SEC order barring him from the securities industry and penny stock industry; he is also required to pay $2.3 million to satisfy restitution and forfeiture orders in the criminal matter.
Check out last week's enforcement roundup: FINRA Enforcement Roundup: Hudson Valley CEO Barred Over Sneaky Day Trading, Fraud at AdvisorOne.