Tag Archives: SEC

Seismic company states that former management misappropriated nearly $17 million

SAExploration Holdings has restated its annual report for 2018 and selected financial data going back to 2014. As a result, at December 31, 2018, stockholders’ equity swung from equity of $15.4 million, as originally reported, to a deficit of $17.4 million!



Furthermore, the company states that former CEO Jeff Hastings and former CFO Brent Whiteley misappropriated $16.6 million between 2012 and 2019. Not surprisingly, the company stated that the Securities and Exchange Commission and the Department of Justice are conducting parallel investigations.

SAEX is a global provider of seismic data and processing services. It has its head office in west Houston. It currently has a market capitalization of $13 million.

At some point in 2019, the SEC started an investigation in relation to revenue recognition, accounts receivable and tax credits. In August 2019, the Board established a special committee of independent directors to oversee an external investigation with respect to the matter.

Vendor and customer secretly controlled by CEO and CFO

The special committee identified that Global Equipment Solutions, one of the company’s vendors in 2015 and 2016, was actually formed by Brent Whiteley and controlled by Mr Whiteley and/or Mr Hastings. The company paid $12 million to this entity in these two years.  $5.9 million of this ended up being a capital contribution to a company called ASV. The company had originally recorded third party revenue from ASV in 2015 and 2016 of $84 million and $57 million respectively.

In the original 10-k filing, nearly all of that revenue from ASV in 2016 was still outstanding as a receivable in 2018. There was also a convoluted explanation about how the customer – ASV wasn’t named in the 2018 financial statements – was going to pay SAEX using monetization of exploration tax credits from the state of Alaska. That got the attention of the SEC. In the restated financials, this receivable was written off and ASV has been consolidated as a variable interest entity.

Consulting firm secretly controlled by CFO

Furthermore, from 2012 to 2019, payments of $4.1 million were made to a company called RVI Consulting. This was secretly controlled by Mr Whiteley. The payments were originally recorded as legal and professional expenses.

The special committee also identified the misappropriation of $0.5 million in 2013 in relation to the reimbursement of the individual tax liability of Mr Hastings.

In total, the amount of funds that the company states was misappropriated was $16.6 million ($12+$4.1+$0.5 million).

The company fired Mr Whiteley in August 2019. It suspended Mr Hastings on the same day and terminated him in November 2019.

The aftermath

The company has spent $6.9 million in legal and professional fees in relation to the SEC investigation in the nine months ended September 30, 2019. For good measure, the Alaskan Department of Revenue is also conducting an investigation into the issuance of tax credits and may impose its own sanctions.

The company has been selling off assets to try and improve its financial situation. In November it sold its assets in Australia for $9 million. In January, 2020 it sold certain seismic data assets for $15 million plus a possible earnout of $5 million.

At September 2019, the company had debt of $119 million and negative equity of $31 million.

https://www.sec.gov/Archives/edgar/data/1514732/000156459020003869/0001564590-20-003869-index.htm

Houston accounting firm barred from performing public company audits

LBB Associates and its managing partner and majority partner, Carlos Lopez, have been barred by the Securities and Exchange Commission from performing public company audits. Or in the language of the SEC ‘LBB and Lopez are denied the privilege of appearing or practicing before the Commission as accountants’.



LBB, based in NW Houston, has two partners and approximately eight accountants on staff. It has about 28 public company clients. The stock of these clients is generally not publicly-traded but the clients follow SEC rules and filing requirements.

The case arose out of the collapse of an audit client, Behavioral Recognition Systems in 2015. At the time, that company was owned by Ray Davis. The SEC later filed a complaint against BRS and Davis. It alleged that they engaged in a fraudulent scheme to raise $28 million from BRS investor funds and divert $7.8 million for Davis’s personal use. The SEC alleged that Davis used the funds to purchase ancient jewelry, gold and other artifacts. Davis allegedly tried to cover his tracks by submitting fake consulting invoices to BRS from two related companies that he controlled.

The alleged fraud was discovered shortly after Davis sold the company in July 2015. However, Davis died in July 2018 before the case could be concluded.

The SEC started disciplinary proceedings against LBB in January 2019, alleging professional misconduct. The primary allegation was that Lopez relied on BRS management representations concerning the related party transactions and failed to perform any audit work around them.

Without admitting or denying the findings of the SEC, LBB and Mr Lopez agreed to the sanctions imposed. After two years, Lopez and LBB may apply to the Commission to be reinstated. However such future work would have to be reviewed by an independent audit committee of the public company.

https://www.sec.gov/litigation/admin/2020/34-88140.pdf

Houston men settle with SEC over insider trading allegations

Two Houston-area men, Balajj Sundarraj of Sugar Land and David O’Brien of Houston, have agreed to pay fines and penalties to settle allegations by the SEC of insider trading.

Mr Sundarraj owns and operates a company that supplies directional drilling products. Mr  O’Brien is a purchasing manager in the oil and gas industry.



According to the SEC, Mr Sundarraj’s brother-in-law was an associate lawyer at a law firm engaged by Oracle to perform legal due diligence. The brother-in-law worked from his home in Sugar Land and took steps to make sure his work remained confidential.

In April 2016, the brother-in-law was on a conference call discussing Oracle’s proposed acquisition of Opower. Mr Sundarraj was in an adjacent room and overheard details. He then told Mr O’Brien about the call. So, after researching the company on library computers, they each purchased shares of Opower.

In late April, Mr Sundarraj bought 5,000 shares for $39,359, while Mr O’Brien bought 8,858 shares for $68,729.  On May 2, Oracle announced it would buy Opower. The same day, Sundarraj and O’Brien sold all their shares, realizing gains of $12,050 and $22,900 respectively.

Without admitting or denying the findings, Sundarraj agreed to pay disgorgement of $12,050, interest of $1,650 and a penalty of $34.950. O’Brien agreed to pay disgorgement of $22,900, interest of $3,137 and a penalty of $22,900.

SEC action – Sundarraj and O’Brien

Houston hospitality company releases findings prompted by anonymous bloggers

RCI Hospitality has announced its findings following an SEC inquiry and allegations by certain anonymous internet bloggers. These involve related party transactions and undisclosed perks enjoyed by senior management. The company had delayed its quarterly filings due to the investigation.

RCI operates 39 adult nightclubs (including Rick’s Cabaret) and 8 restaurant/bars under the Bombshells brand name.

In short, Big Rick Invest & Detroit Bear, the anonymous bloggers, were substantially vindicated!



You can read Detroit Bear’s extensive article here.

Special Committee

An international law firm was hired to conduct a review and found the following;

  • RCI paid Ed Anakar, Director of Operations, between $471,154, $450,000 and $375,000 for the three years ended September 2018. Ed Anakar, his brother is a director and supposedly an independent one. (That wasn’t too difficult to figure out as company stated this in its 10-K!)
  • A company (Sherwood Forest Creations) owned by the brother of Eric Langan, the CEO, was hired to make furniture for the Bombshells locations. The company was paid $633,000 over 3 years.  (Big Rick made no mention of this company. Instead he alleged that the construction company (Tannos Construction) hired to build the Bombshell bars was part owned by the CEO. This is not mentioned in the review).
  • Personal use of aircraft by the CEO and CTO Travis Reese was incorrectly calculated for 2018 and not included in the 2017 and 2016 annual statements. The correct amounts for the CEO are $96,797, $79,748 and $55,101 respectively. (Big Rick nailed this one – he also stated that the CTO, the number 2 executive in the company, happens to be a pilot).
  • Not disclosed in the annual reports was that Steve Jenkins, a director, filed for Chapter 13 bankruptcy in Aug 2010 and October 2015 (the bloggers missed this one).

There was no mention of the allegations by Big Rick that another of the independent directors is an attorney who has represented the company in previous lawsuits. Nor did they cover the alleged loans to the CEO from the company, Ed Anakar ($90,000) or from an independent lawyer that does work for RCI ($38,500). (It could be that the scope of the independent investigation was somewhat limited).

Proposed Actions

The audit committee and the Board of Directors anticipate taking the following actions

  • Appoint at least one new independent director
  • Appoint a Chief Compliance Officer will report to the audit committee
  • Strengthen the related party transaction policy
  • Adopt an enhanced code of conduct policy
  • Adopt an airplane policy outlining personal use by employees
  • Sell three residential houses that the company owns in Houston (the bloggers got this one right).



Auditors resign

In addition, last week, the company also disclosed that the external auditors, BDO, were resigning as the company’s auditors as BDO believes that

” the company has not performed sufficient investigatory procedures and has not taken timely and appropriate remedial action in response to certain deficiencies that BDO thinks exist in the way the internal review has been conducted, including:

  1. undue restriction on the scope of the internal review;
  2. failure to initiate certain forensic procedures;
  3. refusal to provide BDO access to pertinent interview summaries and other documents;
  4. lack of assessment as to the impact of the matters identified to date on existing and future regulatory filings, including financial statements related footnotes;
  5. restrictions, based on privilege, hindering BDO’s ability to properly shadow and evaluate the adequacy of the internal review.”

The company disagrees with BDO’s assessment.

Personal guarantees from CEO

Eric Langan has been the CEO since 1999. He has a base salary of $1 million and owns 7% of the company. Unusually for a public company, he also personally guarantees all of the commercial bank indebtedness of the company. That probably makes it harder for an activist investor to get involved.

Big Rick vindicated!

Back in June 2018, when Big Rick Invest started publishing the allegations, the share price of RCI was $30.  He believed it was worth between $14.32 and $17.41 a share. The current share price is …$16.07.

SEC filing – RCI Hospitality

 

Houston retailer settles with SEC over improper accounting practices

Conn’s Inc, has settled with the SEC and its former COO, Michael Poppe, that it deliberately understated the company’s allowance for bad debts and overstated income in its financial statements.

The company has its head office in The Woodlands and has a market cap of $584 million. It is a retailer of furniture and electronics and many of its customers are sub-prime borrowers.



Conn’s has agreed to pay a $1.1 million civil penalty. Mr Poppe will pay a $50,000 fine.

Mr Poppe joined the company in 2004 as its Controller. He was the CFO from February 2008 through April 2012 and its COO from April 2012 through May 2017.

The charges relate to the period from the quarter ending July 2012 to the quarter ending July 2014. The company made a fateful decision in 2012 to take more of the credit risk in-house.

Last month I wrote about some of the issues the company was facing when current CFO, Lee Wright, was promoted to COO.

Roll-rate model

The SEC states that Conn’s was using a ‘roll-rate’ model to measure potential credit portfolio losses by segmenting the portfolio into delinquency buckets and applying a roll-rate to each segments. A roll-rate is a measure of the percentage of receivables that will migrate into the next delinquency bucket the following month.

Historically, Conn’s used a roll rate that was based on the previous time period (month, quarter etc) or an average of several recent time periods. From July 2012, the roll rates used in the model were hard-coded plugs that reflected management’s unduly optimistic future expectations.

As a result, the bad debt expense was higher than projected/reserved charge-offs for 14 consecutive quarters. In the quarter ended July 2014, Conn’s finally began to build up its doubtful debt reserve. In the following quarter it removed the management plugs entirely. This caused a $20 million increase to the doubtful debt reserve. Conn’s share price dropped 30% on the day of the Q2 announcement and 41% on the day of the Q3 announcement.

Since October 2014, Conn’s has replaced all of its senior management team. Also, it no longer utilizes a roll rate model to calculate its allowance for doubtful accounts.

Poppe received restricted stock awards

It’s not clear whether Mr Poppe received a severance payment when he left. He had a base salary of $460,000. At the time the SEC filing announcing his departure did not refer to any severance payment. In addition, the annual proxy filed the following year did not list him as one of the top 5 officers.



Mr Poppe only received a cash bonus of $50,000 for the year ended 30 January 2017 and none the previous two years. For those three years, he did receive restricted stock units that were cumulatively valued at almost $3 million in the annual proxy filed for the year ended 31 January 2017. It’s not clear how many were forfeited on Mr Poppe’s departure.

SEC press release – Conn’s

 

Entertainment company delays quarterly filing due to SEC investigation

RCI Hospitality Holdings (market cap $184 million) which has its head office in NW Houston, has announced that it will delay filing its quarterly 10-Q. It also received a delisting notice from Nasdaq.

RCI operates 39 adult nightclubs (including Rick’s Cabaret) and 7 restaurant/bars under the Bombshells brand name.

According to the SEC filing;

In mid- and late 2018, a series of negative articles about the registrant was anonymously published in forums associated with the short-selling community. Subsequently in 2019, the SEC initiated an informal inquiry. In connection with these events, a special committee of the registrant’s Audit Committee engaged independent outside counsel to conduct an internal review. The registrant and its management are cooperating with both the internal review and the SEC inquiry. Because the internal review is still ongoing, the registrant will be delayed in filing its Form 10-Q.



Anonymous allegations

That got me searching for the negative articles. They weren’t too difficult to find. You can read them here.

The anonymous author alleges, among other allegations

  • RCI made loans to the CEO, Eric Langan, that were not disclosed in SEC filings
  • One of RCI’s independent Directors is the brother of a senior executive. This is a violation of the SEC requirements for being an independent director
  • Another of the independent Directors represents RCI in lawsuits
  • CEO’s relative defaulted on a loan received from RCI – also not disclosed in SEC filings

Interestingly in the 10-K filed at the end of December for the year ended September 30, 2018, the company states that Nourdean Anakar is an independent director. Yet, under related party transactions, the company discloses that it borrowed $500,000 at 12% interest from Ed Anakar, an employee of the company and the brother of Nourdean. Ed Anakar is the Director of Operations at RCI.

Since the company disclosed the delay in filing the 10-Q, the stock price has dropped 15%.

Material Weaknesses

Unrelated to the allegations, the 10-K also disclosed material weaknesses in controls over

  • Revenues – segregation of cash counts
  • Complex accounting and management estimates
  • Financial statement close and reporting
  • IT – lack of controls to prevent unauthorized access to certain systems
  • Segregation of duties.

That’s the most comprehensive list of internal control weaknesses I have seen disclosed for a publicly-traded company. RCI did go live with a new ERP system in October 2017

 

SEC filing

Houston Oilfield Services company goes public via reverse takeover

 

MG Cleaners, a small oilfield services company based in the Galleria, has gone public via a reverse takeover of SMG Indium Resources (SMGI). The company specializes in the provision of products and services related to the washing and cleaning of drilling rigs.

SMGI agreed to purchase MG Cleaners for 4.6 million shares (shares traded at $0.30 on Friday) and $300,000 in cash. SMGI was originally formed to stockpile indium, a precious metal used in electronics manufacturing. After selling its stockpile in 2014, it became a cash shell.

The President of MG Cleaners is Stephen Christian who was a Rig Manager at Nabors Drilling until acquiring the company in 2010. The Chairman and CEO of MG Cleaners is Matthew Flemming.

Mr Flemming was the CEO of Houston-based HII Technologies when it was a cash shell public company. HII then made a few small acquisitions in the frac water management and safety & power segments of oilfield services during 2012-2013. The business peaked at $35 million in revenue in 2014  but filed for Chapter 11 in September 2015 after the downturn.

For the 6 months ended 30 June 2017, revenue for MG Cleaners was $1.2 million. The MG business had net income of $70,209. With the overhead costs of SMGI, the business lost $51,848 in the period. EBITDA was $259,478.

With the closing of the deal, Malone Bailey have been appointed as auditors to the company.

SEC filing

 

Former Executives of Houston-area Tech company settle with the SEC

The Securities and Exchange Commission (SEC) has announced that two former executives of a public company, based in The Woodlands until 2015, have agreed to pay penalties to settle charges that they misled investors about the production status and license agreement relating to its key product.

The company in question is Uni-Pixel which manufactures sensors for touch screens. It was formed in 2007 and started trading on the Nasdaq in 2010. Until December 2013 the CEO of Uni-Pixel was Reed Killion, a resident of Spring, TX . Jeffrey Tomz, a resident of The Woodlands, was the CFO until May 2015. The SEC alleged that, between December 2012 and February 2014, the company issued a series of press releases, supposedly announcing cutting-edge technologies and pivotal business relationships which then failed to achieve commercial quality and generated little or no revenues.

For example, in November 2013, the company issued a press release stating that it had ‘received its first purchase order from their lead PC OEM Partner for its revolutionary InTouch Sensors’. In reality, the OEM Partner (Dell) had ordered 1,000 sensors at $0.01 per unit for a total price of $10!

Between 2007 and 2012, the company had total revenues of $515,000 and cumulative losses of nearly $50 million, yet the market capitalization, at one point, rose to $415 million on the back of the press releases.

Killion purportedly made $770,000 and Tomz $1.2 million from stock sales during the period in question.

Without admitting or denying the SEC’s charges, Killion and Tomz agreed to pay civil penalties of $100,000 and $50,000 respectively. Killion was barred from serving as an officer or director for 4 years, while Tomz agreed not to participate in the financial reporting or audits of public companies for 4 years. In an earlier settlement in 2016, the company paid a penalty of $750,000.

At face value, it seems that the executives got off lightly in terms of penalties paid in relation to gains made. However, since 2016, the executives have been in dispute with the company (now based in Santa Clara) over the amount of legal defense fees that the company is meant to be covering. In August 2017 a court ordered the company to pay $1.4 million to the former executives for unpaid legal fees. Instead, the company filed for Chapter 11 leaving the executives as unsecured creditors, meaning they would have to pay the large legal bills themselves.

 

SEC charge former CEO and CFO of Rio Tinto with fraud

The Securities and Exchange Commission (SEC) has charged Rio Tinto, its former CEO Thomas Albanese and former CFO Guy Elliott with accounting fraud and it’s a doozy.

Rio Tinto is a London-based minerals company that is quoted in London, New York and Australia. Because the company is listed in New York it has to comply with Sarbanes-Oxley and false certifications under that law are a criminal offense.

Albanese became CEO in May 2007 and two months later acquired Alcan for $38 billion. Between 2009 and 2013, the valuation of that business was written down on four separate occasions. Eventually the whole investment was written off.

In 2010, the CEO decided to buy Riversdale, an Australian company that owned large coal mines in Mozambique. He decided that Rio Tinto could rapidly increase production to 30 million tons of coal a year, primarily by getting a permit from the government to barge most of the coal down the Zambezi river. That would justify the purchase price of $3.6 billion. The deal was finally closed in April 2011.

The SEC allege that the in-house due diligence team identified that there was a major risk that the permit would not be granted but the CEO withheld this information from the board when they signed off on the acquisition.

Within 7 months of the deal, Rio Tinto received a double blow. In October its VP of Logistics had determined that the maximum barging capacity was only 10 million tons, not 30. In any case, the following month the Mozambique government declined to issue a permit to barge. The company also over-estimated rail capacity in the country. As a result, the maximum coal production capacity was only 2 million tons, rendering the investment as basically worthless. Because of the debacle with the Alcan acquisition, the SEC allege that the CEO and CFO decided to withheld these facts from the auditors (PwC) conducting the audit for the 2011 report.

By May 2012, just over one year after the acquisition, the Rio Tinto executives in Mozambique had determined that the value of the business was a negative $680 million.

In March 2012, days after issuing the false audit report, the company issued four bonds totaling $2.5 billion. In August 2012, days after the half-yearly results were issued, they raised another $3 billion through three bonds.

In late 2012 the CEO and CFO began concealing information from the audit committee that was looking at possible impairment issues for the 2012 annual report.  Finally in December 2012, a senior executive found out about the withholding of the information and went directly to the Chairman with his concerns on the over-valuation.

The CEO was fired (technically stepping down ‘by mutual agreement’) in January 2013 and the investment was written down to $600 million. The CFO left in April 2013 and the Mozambique business was sold for $50 million in October 2014. The CEO and CFO didn’t get any cash bonuses in that period (because of the Alcan write-downs) but did receive long-term stock incentives.

Albanese, the CEO, receives an annual pension from Rio Tinto worth $738,000 a year. Elliott, the CFO, is a director of Shell and has a role on the UK’s Takeover Panel! (UPDATE: Elliott has resigned as a non-exec director of Shell)

It should be noted that, both the company and the CEO deny the allegations. In a separate statement the UK Financial Conduct Authority said that Rio Tinto will pay a fine of $36 million for breach of disclosure rules by failing to carry out an impairment test.

My take

  • Easy to make profits on a spreadsheet!
  • Don’t let a CEO ego get in the way of due diligence concerns!
  • The executives at the very top can often override system-wide internal controls and procedures. Companies should mitigate this risk.
  • I suspect that many senior executives kept quiet about their concerns on the over-valuations.
  • Hard to deny the allegations in the USA when you have just paid a fine in the UK!

https://www.sec.gov/news/press-release/2017-196

 

SEC charges Canadian E&P company and 3 former finance executives with accounting fraud

 

The SEC has filed charges against Penn West Petroleum and three of its former finance executives with accounting fraud conducted between 2012 and 2014.

Penn West (which renamed itself Obsidian Energy just two days ago) is an E&P company based in Calgary that is quoted on both the Toronto and New York stock exchanges. At the time it was one of the largest E&P operators in Canada.

The three finance executives are Todd Takeyasu, former CFO, Jeffery Curran, former VP of Accounting and Reporting and Wally Grab, former Operations Controller.

The fraud was highly sophisticated (…Not!). The three executives created manual journal entries to move cost from operating expense to capital expenses! They reclassified $40 million in 2012, $85 million in 2013 and  $15 million in 2014 before the practice was halted by new management in June 2014. Penn West had some of the highest operating costs per barrel of oil equivalent among Canadian operators.  After the adjustments, they were in line with most of their peers.

Via journal entry they also moved operating costs into the account for royalty payments owed to landowners (this account reduced gross revenues). This amounted to $101 million for 2012 and 2013.

Takeyasu was terminated in March 2014 and Curran in June 2014. 3 days after Curran left, the incoming CFO discovered the fraud when one of the more junior accountants raised her concerns about the improper accounting practices. Grab was terminated 5 days later.

Penn West restated its results in September 2014 and has been downsizing and selling assets ever since to try and stave off bankruptcy. In January 2016, it settled the class action lawsuits filed in the USA and Canada.

The SEC’s investigation found no personal misconduct by Penn West’s two former CEOs, Murray Nunns (CEO until June 2013) and David Roberts  (June 2013-Oct 2016), who have reimbursed the company for cash bonuses and certain stock awards they received during the period when the company allegedly committed accounting violations. Prior to joining Penn West, Roberts was the COO at Houston-based Marathon Oil.

This goes to show that no amount of controls can overcome a fraud committed at the top of the company and enabled by lax oversight from the CEO’s, Internal Audit, and the Board of Directors.

SEC charges Oil and Gas Company and Top Finance Executives with Accounting Fraud