Among recent enforcement actions by the SEC were charges for microcap fraud against a so-called health food company and its CEO; against two Florida-based attorneys for their part in an offering fraud; against a Silicon Valley-based software firm and two former executives for accounting fraud; sanctions against a Scottsdale, Arizona-based software company for inadequate internal accounting controls over its financial reporting; and suspensions in trading for nine penny stocks in its fight against microcap fraud.
“Health Food” Company, CEO Fined by SEC
The SEC filed charges against a Florida-based penny stock company, Heathrow Natural Food & Beverage Inc., and its CEO Michael Pagnano with defrauding investors after it put out phony press releases proclaiming large sales and fantastic revenue projections.
Meanwhile, the purported health food company had never actually manufactured any of the products it was supposed to have sold, nor did it have any of the distribution agreements with major retail chains that it claimed.
At the time, Pagano was busy prompting the illegal, unregistered distribution of billions of shares of company stock to several people or entities, including himself. He profited by more than $150,000 by selling 877 million of his shares into the market, capitalizing on the phony press releases that boosted public demand for Heathrow stock.
Pagano also is charged with insider trading because he sold his shares while in possession of material nonpublic information about the falsehood of the press releases.
The SEC separately charged New Jersey-based transfer agent Registrar and Transfer Co. (R&T) and its CEO Thomas Montrone with violating the registration provisions of the federal securities laws and failing to supervise firm employees who enabled Heathrow’s unregistered distribution of billions of purportedly unrestricted shares of its stock.
An SEC examination revealed that R&T repeatedly failed to detect and address blatant red flags in connection with more than 54 share issuance requests from Pagnano, including the fact that none of them were accompanied by legal opinions pertaining to the shares to be issued.
In every instance, the shareholder for whom the issuance was requested was not the shareholder covered by the attached opinion letter. R&T issued more than a billion shares to Pagnano directly in spite of the firm’s own written policy against honoring requests by company officers to issue unrestricted shares to themselves. R&T even made special accommodations so the firm could keep track of Heathrow’s unusually large and frequent issuance requests, which totaled 5.6 billion shares in 27 months.
Without admitting or denying the findings, R&T agreed to settle the charges and pay disgorgement of $24,265.86 plus prejudgment interest of $3,401.78 and a penalty of $100,000, and Montrone agreed to pay a $25,000 penalty.
Two Attorneys Charged in Offering Fraud
The SEC has charged Jonathan Flom and James Schmidt II, Florida-based attorneys, for their parts in an offering fraud conducted by Cecil Franklin Speight and his firm International Stock Transfer Inc., already charged in the case in July.
Flom and Schmidt were designated to receive wire transfers from investors solicited by cold callers using boiler-room tactics to convince them their investments would yield high rates of return.
Cold callers told investors to wire their money to either Schmidt or Flom in order to purchase purported securities that included fake foreign bond certificates and stock certificates for a publicly traded microcap company with no connection to IST.
Wiring the money to a licensed attorney made the “investment opportunity” look safe, and kept investors from finding out what happened to their money after it went to Flom and Schmidt. The attorneys kept 2% of the money they received from investors, and sent the rest of it on to Speight, who promptly used it for personal expenses or to make Ponzi-like payments. Speight never made any of the investments he’d promised to investors. According to the agency, Schmidt and Flom knowingly participated with Speight in the sale of fraudulent securities. Flom received e-mails from Speight that explicitly discussed the misappropriation of investor funds. Schmidt collaborated with Speight on answers to numerous investors who complained about nonexistent coupon payments they were promised, as well as about the counterfeit appearance of the stock certificates they got and the fact that they couldn’t contact the cold callers who solicited them.
Flom and Schmidt enabled Speight and IST to steal more than $3.3 million from at least 70 investors. Approximately $2.7 million of scheme proceeds flowed through Schmidt’s account and more than $580,000 passed through an account controlled by Flom.
Flom and Schmidt were arrested in parallel criminal actions brought by the U.S. Attorney’s Office for the Eastern District of New York.
Software Company, Former Execs Charged With Fraudulent Accounting
A fraudulent accounting scheme has gotten Silicon Valley-based Saba Software and two of its former executives, vice presidents Patrick Farrell and Sajeev Menon, charged with a fraudulent accounting scheme that falsified time sheets to hit quarterly financial targets. The agency also ordered a “clawback” of $2.5 million from CEO Babak “Bobby” Yazdani, even though he was not charged in the scheme.
According to the agency, Farrell and Menon cooked up the scheme, in which U.S.-based managers directed consultants in India to either falsely record time that they had not yet worked, or purposely fail to record hours worked during certain pay periods to conceal budget overruns from management and finance divisions.
That enabled Saba Software to achieve its quarterly revenue and margin targets by improperly accelerating and misstating virtually all of its professional services revenue during a four-year period as well as a substantial portion of its license revenue.
The agency said that Saba Software often sold professional services along with its products, and maintains a group of consultants at its Indian subsidiary to help deliver those services. Farrell and Menon were responsible for ensuring that the professional services group within Saba Software met financial targets set by senior management.
Farrell knew about situations where consultants planned to prebook hours to make quarterly revenue targets, but didn’t stop them. Other times, when they had overrun their budgets, he told them to “eat” the hours or back them out of the timesheet database.
Menon directed consultants reporting to him to book time to the timesheet database at quarter-end even though those hours would not be worked until the following quarter. In other instances, he advised them to avoid inputting in the timekeeping system nonbillable hours that they had worked.
The SEC found that internal accounting controls were unequal to the task of coping with revenue and margin targets set by senior management. This problem was particularly acute in Saba Software’s India-based consulting group, which was referred to throughout the consulting organization as a “black box,” because U.S. and European managers were approving the time records of India-based consultants when they had little means of verifying who had done which work and when.
Without admitting or denying the SEC’s charges, Saba Software agreed to pay $1.75 million to settle the SEC’s charges, and Farrell and Menon agreed to settle the case as well. In addition to the financial penalty, Saba agreed to pay further penalties if it has not filed restatements of its earnings during those periods by later this year, and revocation of the registration for its securities if it doesn’t file those restatements by early next year.
Farrell and Menon likewise neither admitted nor denied the charges, but Farrell agreed to pay disgorgement and prejudgment interest of $35,017 and a penalty of $50,000, and Menon agreed to pay disgorgement and prejudgment interest of $19,621 and a penalty of $50,000.
Software Company Sanctioned for Inadequate Internal Accounting Controls
Scottsdale, Arizona-based JDA Software Group Inc. was sanctioned by the SEC for having inadequate internal accounting controls over its financial reporting, which resulted in misstated revenues in public filings.
According to the agency, the company failed to properly recognize and report revenue from certain software license agreements it sold to customers because its internal accounting controls failed to consider information needed for determining a critical component of revenue recognition for software companies.
The agency said that JDA’s internal accounting controls surrounding VSOE were inadequate in several ways. For instance, JDA lacked adequate revenue recognition policies and procedures and failed to identify all service-related contracts needed for VSOE testing to determine the fair value of certain services. Also, JDA did not have sufficient internal accounting controls to determine whether a software license agreement and related services contract were linked to each other.
Because of these internal control failures, some of JDA’s financial statements for 2008, 2009, 2010, and 2011 were materially misstated. JDA restated those financial statements in August 2012, reporting that it had overstated its revenue for fiscal year 2010 by 4% and overstated EBITDA by approximately 18%. In connection with the restatement, JDA identified control deficiencies that constituted a previously undisclosed material weakness in its internal control over financial reporting related to revenue recognition.
JDA agreed to settle the SEC’s charges by paying a $750,000 penalty.
Nine Penny Stock Companies See Trading Suspended
The SEC has announced suspensions in trading for nine different microcap companies in its ongoing microcap fraud enforcement initiative.
According to the agency, the companies involved in the trading suspension were identified during an SEC analysis of heavily promoted microcap issuers.
The companies are: All Grade Mining Inc. (HYII); Bluforest Inc. (BLUF); DHS Holding Co. (DHSM); Essential Innovations Technology Corp. (ESIV); Global Green Inc. (GOGC); Inova Technology Inc. (INVA); mLight Tech Inc. (MLGT); Solar Thin Films Inc. (SLTZ); and Xumanii International Holdings Corp. (XUII).
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