The Securities and Exchange Commission recently charged a hedge fund advisor with taking unearned management fees and a sports nutrition company for failing to disclose executive perks. It also charged three traders of residential mortgage-backed securities (RMBS) and two video management company executives with fraud.
In addition, the agency charged auditing firm BDO USA and five of its partners with issuing false and misleading audit opinions; a father and son and a friend of the father for insider trading; and three business associates who promised “indestructible wealth” with stealing investors’ money.
‘Indestructible Wealth’ Taken in Scam
The SEC has charged three California business associates with fraud and obtained an asset freeze to halt what it said was an ongoing real estate investment scheme making off with investors’ money while promising them “indestructible wealth.”
According to the agency, Paul Ricky Mata, David Kayatta and Mario Pincheira stole investor proceeds for their own use and diverted money to unrelated businesses. They raised more than $14 million from more than 100 investors in California and several other states for two unregistered funds that supposedly invested in real estate.
Online videos posted to Mata’s website and YouTube channel helped attract investors to attend investment seminars with such titles as “Finances God’s Way” or “Indestructible Wealth,” where they encouraged many retirees to sell their existing securities holdings and invest in the funds, which guaranteed promising returns. The funds have never actually made a profit.
Mata, a former licensed securities professional with an extensive disciplinary history, hid that so investors only heard about Mata’s “22 years of experience as a financial advisor.” He and Kayatta promised guaranteed returns for one fund, despite having been sanctioned by a state regulator for making guarantees.
They diluted the value of investments of the other fund by allowing in new investors, despite being questioned by their accountant and attorney about doing so, and they lied to existing investors to reassure them that both funds were performing well despite their actions.
All three charged their personal dinners, travel, entertainment, and other items on Pincheira’s personal American Express card and used investor money to pay off the card balances, which routinely exceed $40,000 a month, the SEC said.
The freeze order came to stop a planned three-day “Indestructible Wealth Bootcamp” in Los Angeles next month. The three are prohibited from seeking any additional investments or spending any investor money.
Hedge Fund Pumped Up Value to Pocket Extra Fees: SEC
The SEC charged Bellevue, Washington-based Summit Asset Strategies Investment Management and its CEO Chris Yoo with fraudulently inflating the values of investments in the portfolio of Summit Stable Value Fund, a private fund they advised, so they could attain unearned management fees. The agency also charged the firm’s outside auditors with performing a deficient audit that enabled the firm to send misleading financial statements to investors.
According to the agency, Yoo and Summit Asset Strategies Investment Management were entitled to withdraw the net profits of Summit Stable Value Fund as compensation. Those profits were calculated by determining realized and unrealized gains and losses. They also were required to return any excess net profits to the fund as determined in an annual audit.
However, beginning in 2011, Yoo directed the firm to withdraw fees based on fraudulently inflated investment values or that were otherwise disproportionate from the fund’s actual profits. As part of the scheme, Yoo claimed that the fund owned a specific bank asset that had appreciated to a value of approximately $2 million.
But the fund never owned that asset; instead, it owned one that was worth less than $200,000. That meant that the fund’s 2013 financial statements materially overstated the fund’s investment values. Altogether, Yoo and Summit Asset Strategies Investment Management withdrew nearly $900,000 in fees to which they were not entitled.
Without admitting or denying the charges, Yoo and Summit Asset Strategies Investment Management agreed to pay disgorgement of $889,301 plus prejudgment interest of $104,632 and a penalty of $150,000, and Summit Asset Strategies Wealth Management agreed to pay disgorgement of $81,729.14 plus prejudgment interest of $6,611.75 and a penalty of $100,000. Yoo also agreed to be barred from the securities industry.
The external auditors, Raymon Holmdahl and Kanako Matsumoto, failed to find the fraud because they did not question Yoo’s valuations, despite having reason to do so. They also agreed to settle the charges without admitting or denying the findings, and have agreed to be suspended for three years from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC.
Hidden Executive Perks Bring SEC Charges to Sports Nutrition Company
Denver-based MusclePharm Corp., a sports supplements and nutrition company, three of its current or former executives and its former audit committee chair have agreed to settle SEC charges that the company committed a series of accounting and disclosure violations, including the failure to properly report perks provided to its executives as compensation.
According to the agency, MusclePharm omitted or understated nearly a half-million dollars’ worth of perks it gave its executives, including approximately $244,000 paid to CEO Brad Pyatt related to automobiles, apparel, meals, golf club memberships and his personal tax and legal services.
The company began an internal review of undisclosed executive perks and then-audit committee chair Donald Prosser became directly involved in the process. But MusclePharm continued filing financial statements that failed to disclose private jet use, vehicles, and golf club memberships for its executives.
Among the violations enumerated by the SEC by MusclePharm, Prosser, Pyatt, and former chief financial officers L. Gary Davis and Lawrence Meer were failure to disclose related party transactions with a major customer and failure to implement sufficient policies to identify and disclose related party transactions; failure to disclose bankruptcies related to two executive officers, and misstatements that no members of the board of directors or other executives had been involved in any bankruptcy proceedings; improper accounting for advertising and promotional related costs that resulted in the company overstating its revenue; failure to disclose continuing sponsorship commitments for which the company eventually made payments totaling $6.9 million; understatements concerning rent expense due to the omission of a $100,000 charge related to an aircraft lease agreement; and failure to implement internal accounting controls.
In addition, the SEC said that the company issued stock without a registration statement so that it could sell shares to raise approximately $1.1 million to pay its vendors when it was short on cash.
MusclePharm, Prosser, Pyatt, Davis and Meer settled without admitting or denying the SEC’s findings. MusclePharm agreed to pay a $700,000 penalty and hire an independent monitor for one year among other undertakings. Pyatt agreed to pay a $150,000 penalty, and Prosser and Davis each agreed to pay $30,000 penalties. Meer and Davis agreed to be suspended from practicing as an accountant on behalf of any SEC-regulated entities with a right to reapply after three and two years, respectively.
Three Nomura Traders Charged With Fraud
The SEC has charged three RMBS traders with repeatedly lying to customers relying on them for honest and accurate pricing information about the securities they were buying.
According to the agency, the lies and omissions to customers of Ross Shapiro, Michael Gramins and Tyler Peters brought in at least $5 million in additional revenue for Nomura Securities International, the New York-based brokerage firm where they worked.
They misrepresented bids and offers provided to Nomura for RMBS, as well as the prices at which Nomura bought and sold RMBS and the spreads the firm earned intermediating RMBS trades. They also trained, coached, and directed junior traders at the firm to engage in the same misconduct; that brought in at least another $2 million in profits for the firm.
The three went so far as to invent phantom third-party sellers and fictional offers when Nomura already owned the bonds the traders were pretending to obtain for potential buyers. As a result, with Nomura calculating bonuses for them partly based on revenue generation, the firm paid total compensation of $13.3 million to Shapiro, $5.8 million to Gramins and $2.9 million to Peters during the years the scheme went on.
The three, who no longer work at Nomura, also face criminal charges in a parallel action from the U.S. Attorney’s Office for the District of Connecticut. The SEC’s investigation is continuing.
The SEC separately entered into deferred prosecution agreements with three other individuals who have cooperated extensively in the matter.
Video Management Company Execs Charged With Fraud
Kaleil Isaza-Tuzman and Robin Smyth, former chief executive officer and chief financial officer of the now-bankrupt online video management company KIT Digital, have been charged with accounting fraud by the SEC for falsifying financial statements to make the company appear more profitable than it actually was.
According to the agency, the pair employed a variety of schemes to manipulate the books and mislead investors. In one scheme, they used KIT Digital’s own money to make it look like customer receivables were being paid. They added $7.85 million in cash consideration to an acquisition transaction with the secret understanding that the seller would not receive any of that money. Smyth instead had the money wired to third parties so at least $4.3 million was returned to KIT Digital as purported payments from customers.
In another scheme, the two caused the firm to improperly recognize nearly $1.34 million in sales revenue for the quarter ended June 30, 2010, even though they knew or ignored the fact that the company had not delivered the required product to the purchaser and wasn’t entitled to recognize the revenue. They got a phony delivery confirmation from their customer, changed purchase order language to hide a product deployment schedule and misled the company’s auditors into thinking that the purchaser’s website was being run on the software that KIT Digital had promised, when it was not.
Isaza-Tuzman also failed to disclose that he had arranged with a hedge fund manager to use KIT Digital’s own money to trade the company’s stock to increase the volume or support the price at opportune moments. He hid the inappropriate characterization of $2 million in offshore investments as cash or cash equivalents, when the company had no chance at readily getting its money back.
The SEC is seeking disgorgement of ill-gotten gains plus prejudgment interest and penalties, as well as permanent injunctive relief and officer-and-director bars.
In a parallel action, the U.S. Attorney’s Office for the Southern District of New York has announced criminal charges against Isaza-Tuzman and Smyth.
BDO USA, Five Execs, Former Lt. Governor Charged on Audits
The SEC has charged auditing firm BDO USA with dismissing red flags and issuing false and misleading unqualified audit opinions about the financial statements of staffing services company General Employment Enterprises. It also charged five of the firm’s partners for their roles in the deficient audits, and filed fraud charges against the client company’s then-chairman of the board and majority shareholder Stephen Pence, who is a former U.S. attorney and a former lieutenant governor of Kentucky.
According to the agency, near the end of BDO’s 2009 audit of General Employment, BDO was advised by the company that $2.3 million purportedly invested in a 90-day nonrenewable CD wasn’t repaid by the bank upon its maturity date. BDO also learned that a bank employee indicated there was no record of a CD being purchased from the bank. The $2.3 million represented approximately half of the company’s assets and substantially all of its cash.
Company management and board members provided BDO with multiple conflicting stories about the status of the purported CD, and the company received a series of deposits totaling $2.3 million from three entities unaffiliated with the bank. One entity was purportedly owned by Pence.
BDO asked more questions, and the company responded by claiming that the deposits were proceeds of an agreement to assign the purported CD to an unrelated party in return for the value of the CD. But BDO never got reasonable explanations about why the money went missing in the first place, and why an equivalent amount was later received by the company under suspicious circumstances.
BDO’s engagement partner on the audit, Sean Henaghan, and concurring reviewer, John Rainis, subsequently consulted with senior BDO partners including regional technical director James Gerace, national director of accounting Leland Graul, and national SEC practice director Wendy Hambleton. BDO then issued a five-page letter to the company highlighting the conflicting information and demanding an independent investigation overseen by the audit committee.
But just days later, with no reasonable explanation from the company, BDO withdrew its demand and issued unqualified opinions on the financial statements included in General Employment’s 2009 and 2010 annual reports.
According to the SEC, Pence made materially misleading statements and omissions to BDO audit professionals when asked about the purported $2.3 million CD and related-party transactions. He also signed the company’s 2009 annual report, knowing it held lies about the missing money. He make it look as if he were acting independently in his capacity as the majority shareholder and chairman of General Employment, when in fact he was acting as an agent for a convicted felon named Wilbur Anthony Huff, who had funded Pence’s purported acquisition of a majority stake in the company.
Pence got at least a half-million dollars from Huff in 2009 and 2010, as well as a luxury Cadillac Escalade valued at approximately $50,000. Huff has since been sentenced to prison for his involvement in a wide-ranging conspiracy, which included misappropriating the $2.3 million.
BDO has agreed to admit wrongdoing, pay disgorgement of its audit fees and interest totaling approximately $600,000, and pay a $1.5 million penalty in addition to complying with undertakings related to its quality controls. The five partners also agreed to settle the charges against them. Without admitting or denying the SEC’s findings, Henaghan, Rainis, Gerace and Graul agreed to be suspended from practicing public company accounting for varying periods. Henaghan agreed to pay a $30,000 penalty, Rainis agreed to pay a $15,000 penalty, and Gerace, Graul, and Hambleton each agreed to pay $10,000 penalties. In addition, two former CEOs of General Employment, Ronald Heineman and Salvatore Zizza, agreed to settle separate charges without admitting wrongdoing; they were ordered to pay $150,000 each.
The litigation continues against Pence.
Father, Son and Friend Charged with Insider Trading
John McEnery III, his son John McEnery IV and McEnery III’s friend Michael Rawsiter have been charged by the SEC with insider trading after McEnery III learned about a planned merger of health care companies from another friend who worked at one of the companies, and chose to capitalize on the knowledge.
According to the agency, McEnery III shared the news of the planned acquisition of Clarient Inc. by GE Healthcare. He told McEnery IV and Rawsiter, and the three made more than $50,000 on their subsequent stock trades when the company stock rose by 33%.
Without admitting or denying wrongdoing, McEnery III agreed to pay disgorgement of $32,482, prejudgment interest of $4,919.25 and a penalty of $64,156; McEnery IV agreed to pay disgorgement of $3,288, prejudgment interest of $497.92 and a penalty of $3,288; and Rawitser agreed to pay disgorgement of $28,386, prejudgment interest of $4,081.87 and a penalty of $28,386. The settlement is subject to court approval.
— Check out DOJ Finally Concedes It Prosecutes Corporate Crime All Wrong on ThinkAdvisor.