Commercial Transactions Due Diligence

SEC issues warning about investing in reverse merger companies

 

On June 9, 2011, the Securities and Exchange Commission (SEC) issued an Investor Bulletin about investing in companies that enter U.S. markets through the so-called “reverse mergers.” These mergers allow private companies, including those outside the U.S., to access U.S. investors and markets by merging with an existing public shell company. The SEC and U.S. exchanges recently suspended trading in more than a dozen reverse merger companies, citing a lack of current, accurate information about these companies and their finances.

“Given the potential risks, investors should be very careful when considering investing in the stock of reverse merger companies,” said Lori J. Schock, director of the SEC’s Office of Investor Education and Advocacy. “As with any investment, investors should thoroughly research the company – including ensuring there is accurate and up-to-date information – before making a decision to invest.”

The SEC’s warning is especially strong regarding Chinese companies, as more than 150 entities have recently put their shares up for grabs to American investors through the backdoor “without any of the vetting from underwriters and investors that companies undergo when they perform a traditional IPO,” as noted by Commissioner Luis Aguilar.

Shareholders already have sued a string of China-based, U.S.-listed companies for fraud, claiming that they lost money when stocks plummeted after the financial scandals. They charge that the companies operated sham businesses, inflated revenue or gave vastly different information to U.S. and Chinese regulators. And they are starting to sue the auditors who signed off on the financial statements. But it will be tough to win these cases in American courts, as Chinese entities often have refused to comply with U.S. court proceedings.

The best hope for investors may be the SEC, which has launched an inquiry into U.S. audit firms with China-based clients. Investors could benefit if the SEC, which can force companies and auditors to cooperate in investigations, sues more auditors or companies.

 

June 15th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , |

Asset searches: who can get bank account information and why

A quick Internet search for ways to get someone’s bank or investment account information returns at least a dozen private investigation companies that promise to find these records “anywhere in the US and worldwide” for judgment collections, verification of net worth and for “just about any other purpose.” But a closer look at these Web sites reveals a fine-print disclaimer stating that the information is from public records such as divorce cases and probate filings. And there are a few that do not bother with a disclaimer, providing only an 800 number to call.

Asset searches, which may include bank and investment accounts, are not illegal; however, certain actions to obtain this information, such as pre-texting, are illegal. And although there are methods that can be used to obtain financial information covertly, most if not all, are questionable and often futile. There is no clear way for anyone other than the account holder, a designated representative or a party with a valid court order to get account information without violating the law.

There is a general misconception that a judgment, just by virtue of its issuance, can be used to force a bank or financial institution to disclose account information, but the enforcement of judgments is governed by each state’s laws. In California, for example, a writ of execution is necessary. These writs are rendered on a county-by-county basis and direct a levying officer (usually a sheriff) to serve the writ on the named institution. The institution then may be required to freeze the account and in some cases to hand over the account balance. State laws also allow the creditor, after a judgment is obtained, to examine and request asset information from the debtor. This, however, puts the debtor on notice and may result in draining an account before a writ of execution is served.

The privacy protection laws that govern access to financial information under false pretenses depend on whether the affected customer is a consumer or a business entity. The more significant legislation is directed at protecting consumers, defined generally in the laws and in interpretative decisions as ”individuals consuming goods or services for personal or household use.” The Gramm-Leach-Bliley Act (GLBA) prohibits obtaining customer information from a financial institution under false pretenses and imposes an obligation to protect customer information. Under the GLBA, a customer means “an individual consumer,” which is essentially the same as the definition of a consumer under the Fair Credit Reporting Act (FCRA). In addition to the GLBA and FCRA, there are other potentially applicable federal privacy laws, as well as a long list of state laws. But even if a specific law may cover only consumers, the financial institution’s contract with the business customer would certainly be construed as preventing third-party access.

June 10th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , , , |

Dodd-Frank rule disqualifies felons and bad actors from securities offerings

On May 25, 2011, the Securities and Exchange Commission (SEC) proposed a rule to deny certain securities offerings from qualifying for exemption from registration if they involve “felons and other bad actors.”

When an individual or a company offers or sells a security such as a stock or bond, generally the offering must be registered with the SEC. However, the SEC’s Regulation D provides three exemptions that can used to avoid such registration.  The most widely used exemption is Rule 506, which accounts for more than 90% of the offerings made, as well as the majority of capital raised. If an offering qualifies for the Rule 506 exemption, an issuer can raise unlimited capital from an unlimited number of “accredited investors” and from up to 35 non-accredited investors.

Section 926 of the Dodd-Frank Act requires the SEC to adopt rules that would deny this exemption to any securities offering in which certain “felons and other bad actors” are involved. This new rule is substantially similar to the bad actor disqualification provisions of another limited offering exemptive rule – Rule 262 of Regulation A – which provides for an exemption from registration for certain small offerings.

Under the proposed rule, an offering cannot rely on the Rule 506 exemption if the issuer or any other person covered by the rule (including the issuer’s predecessors and affiliated issuers, directors, officers, general partners and managing members of the issuer, 10% beneficial owners and promoters of the issuer, persons compensated for soliciting investors, and the general partners, directors, officers and managing members of any compensated solicitor) has had a “disqualifying event” identified as follows:

  • Criminal conviction in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The criminal conviction would have to have occurred within 10 years of the proposed sale of securities (or five years, in the case of the issuer and its predecessors and affiliated issuers).

    •  

  • Court injunction and restraining order in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The injunction or restraining order would have to have occurred within five years of the proposed sale of securities.

    •  

  • Final order from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration that bar the issuer from: 1) associating with a regulated entity; 2) engaging in the business of securities, insurance or banking; 3) engaging in savings association or credit union activities, or 4) orders that are based on fraudulent, manipulative or deceptive conduct and are issued within 10 years before the proposed sale of securities.

    •  

  • Certain commission disciplinary order relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons, which would be disqualifying for as long as the order is in effect.

    •  

  • Suspension or expulsion from membership in a “self-regulatory organization” or from association with an SRO member, which would be disqualifying for the period of suspension or expulsion.

    •  

  • Commission stop order and order suspending the Regulation A exemption issued within five years before the proposed sale of securities; and

    •  

  • U.S. Postal Service false representation order issued within five years before the proposed sale of securities.

The proposed rule would provide an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed. Any pre-existing convictions, suspensions, injunctions and orders would be disqualifying. For further information, see http://www.sec.gov/rules/proposed/2011/33-9211.pdf

 

 

 

 

 

 

May 26th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , |

Spotlight on insider trading

Many people associate the term “insider trading” with illegal conduct. But the term refers to both legal and illegal activities. The SEC’s legal version is that corporate insiders, i.e., officers, directors, employees, or anyone with at least a 10% stake in a company, can buy and sell stock in the company providing they abide by the SEC’s restrictions and transactional requirements.

In 2002, the SEC tightened its rules by adopting the Regulation Fair Disclosure to curb the practice of company executives giving securities analysts an inside track; the rules mandate that anything disclosed to an outsider must be revealed to the general public. The SEC also includes in its definition of insiders those who have “temporary” or “constructive” access to the material information, such as business associates, friends, family members, brokers, attorneys and “other tipees.” The U.S. Supreme Court ruled recently that any individual, with or without ties to the particular company, who is in possession of material information, even if the information was stolen, is an insider.

Illegal insider trading, according to the SEC, refers to the buying or selling of a security in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information. Insider trading violations include “tipping” such information, trading in securities by the person “tipped” and trading by those who misappropriate the information.

The SEC considers the prosecution of insider trading violations a top priority. The exhaustive publicity of illegal insider trading cases sends a strong message that no one is outside its radar. A spokesperson for the Division of Enforcement said that the SEC is aggressively rooting out and identifying hard-to-detect insider trading by connecting patterns of trading to sources of material nonpublic information, whether those sources are law firms, banks or others with a duty to keep the information confidential. Prosecutors add that illegal trading is now easier to prove as direct evidence of fraudulent intent can be obtained through wiretaps, e-mails, text messages, social media contacts, etc. And that evidence also is useful to convince co-conspirators to turn on each other and provide even more substantial proof of fraud. Going after the violators is critical because their actions hurt individual investors and undermine public confidence that allows firms to raise money in the capital markets.

Individuals who are convicted of criminal insider trading face prison terms (the Sarbanes-Oxley Act extended the maximum length of sentences) and fines in addition to civil penalties, which can be triple the realized profit or the loss avoided. Violators also may be charged with mail and wire frauds and possibly with tax evasion and obstruction of justice. Further consequences include being barred from serving as executives or directors of public companies and being named as defendants in multi-million dollar lawsuits. Corporations are subject to penalties for failure to establish compliance programs and for failure to ensure reasonable efforts to prevent violations under the theory of “controlling person” liability. Even if an insider trading investigation does not result in formal charges, the company’s reputation may suffer from the stigma and adverse publicity.

May 24th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , , |

FTC and CFTC will share information on energy investigations

The Federal Trade Commission (FTC) and the Commodity Futures Trading Commission (CFTC) announced yesterday that they entered into a Memorandum of Understanding (MOU) to share non-public information on investigations being conducted by the agencies, including investigations into the oil and gasoline markets. The agreement will help the FTC enforce its petroleum market manipulation rule, which prohibits fraudulent manipulation of U.S. petroleum markets. The information sharing also will assist the CFTC in exercising its authority in the oil markets.

Both the FTC and CFTC can take legal actions in connection with fraud-based manipulation of the petroleum markets, but the CFTC has exclusive jurisdiction to regulate exchanges, clearing organizations and intermediaries in the U.S. futures industry. This MOU will further facilitate information sharing on regulatory issues of common interest.

The MOU also directs the FTC and CFTC to ensure that the confidentiality of the non-public information is maintained, and provides that the agreement does not modify the agencies’ current abilities, responsibilities, or obligations to comply with existing laws or regulations, including the FTC’s confidentiality mandates under the pre-merger laws.

April 13th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , |

China’s bribery law amendment resembles a version of the FCPA

In February 2011, the People’s Republic of China (PRC) legislature, among 49 amendments, passed Amendment No. 8 to Article 164, which criminalizes the payment of bribes to non-PRC government officials and to international public organizations. Legal experts say that that the passing of this amendment is the PRC’s effort to comply with the United Nations Convention Against Corruption to which the PRC is a signatory. Although no interpretive guidance has been issued, the amendment resembles an early version of the Foreign Corrupt Practices Act (FCPA).

Before the amendment was passed, the PRC prohibited bribery of PRC officials and provided for civil and criminal liability for making commercial bribes to private parties for the purpose of obtaining illegitimate benefits, but had no specific law that criminalized the payment of bribes to non-PRC officials. Effective May 1, 2011, the amendment adds the following clause to Article 164 of the PRC Criminal Law:

“Whoever, for the purpose of seeking illegitimate commercial benefit, gives property to any foreign public official or official of an international public organization, shall be punished in accordance with the provisions of (Article 164.)”

Article 164 states that “if the payer is an individual, depending on the value of the bribes, he/she is subject to imprisonment for up to 10 years. If the payer is an entity, criminal penalties will be imposed against the violating entity and the supervisor chiefly responsible; other directly responsible personnel also may face imprisonment of up to 10 years. Penalties may be reduced or waived if the violating individual or entity discloses the crime before being charged.”

According to legal experts, the PRC Criminal Law applies to all PRC citizens (wherever located); all natural persons in the PRC regardless of nationality; and all companies, enterprises, and institutions organized under PRC law. Thus, in addition to PRC domestic companies, any joint venture or other business entity formed under PRC law, including ones involving non-PRC companies, may be criminally liable under the amendment. Non-PRC companies with representative offices in the PRC may also be subject to the provisions of the amendment.

 

April 4th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , , |

“Operation Empty Promises” yields more than 90 FTC enforcement actions

The Federal Trade Commission announced that it stepped up its ongoing campaign against scammers who falsely promise guaranteed jobs and opportunities to be “your own boss.” “Operation Empty Promises,” a multi-agency law enforcement initiative, resulted in more than 90 enforcement actions, including three new FTC cases and developments in seven other matters, 48 criminal actions by the Department of Justice (many involved the assistance of the U.S. Postal Inspection Service), seven additional civil actions by the Postal Inspection Service, and 28 actions by state law enforcement agencies in Alaska, California, Indiana, Kansas, Maryland, Montana, New Jersey, North Carolina, Oregon, Washington, and the District of Columbia.

In addition to making false claims about employment opportunities, one of the actions also alleged that the defendants overcharged for background checks. In its complaint against National Sales Group, Anthony J. Newton, Jeremy S. Cooley, and I Life Marketing LLC, also doing business as Executive Sales Network and Certified Sales Jobs, filed in the U.S. District Court for the Northern District of Illinois, Eastern Division on February 22, 2011, the FTC charged that the defendants advertised nonexistent sales jobs with “good pay” and benefits on CareerBuilder.com and other online job boards, that their telemarketers falsely told consumers that the company recruited for Fortune 1000 employers and that they had a unique ability to get the consumers interviewed and hired. The FTC also alleged that the defendants charged fees they said covered background checks and other services, and often overcharged, taking $97 from consumers who had agreed to pay $29 or $38. Further, the defendants allegedly charged some consumers recurring fees of $13.71 or more per month without their consent.

According to other documents filed in the court, the defendants’ actions generated more than 17,000 complaints to law enforcement agencies, online forums, and job boards, and defrauded consumers of at least $8 million. (CareerBuilder.com dropped the company from its website due to complaints.) The court temporarily halted the defendants’ deceptive practices, froze their assets, and put the company into receivership.

See http://www.ftc.gov/opa/2011/03/emptypromises.shtm for information about other enforcement actions brought through “Operation Empty Promises.”

March 12th, 2011|Categories: Commercial Transactions Due Diligence|Tags: |

Uncovering hidden assets

Exactly what is a hidden asset? Several business reference books define it a valued asset that is not listed on the balance sheet of its owner or beneficiary, and/or is moved or transferred with the intention to defraud, hinder or delay discovery by anyone classified as a creditor. Just about any type of asset can be hidden, including real property, jewelry, stocks, bonds, vehicles, aircraft, watercraft, and the most liquid of all assets – money.

Many hidden assets, such as those existing in corporate holdings, various trusts, family-limited partnerships, limited liability companies, charitable foundations, real estate, lawsuit payouts, judgment awards, and vehicle, aircraft and watercraft ownership, can be found through searches of public records. Comprehensive searches of media sources can provide further details about these assets and also supply clues to funds from royalties, contracts, patents, inheritances and other distributions.

The hardest of all hidden assets to reach — and those not reported in public records — are held outside of the United States. Various Caribbean and other island nations, and certain European enclaves are laden with “wealth preservation strategies” that offer secrecy-ruled offshore accounts and asset protection trusts (OAPTs) that keep the creditors away. Financial experts and fraud examiners say that OAPTs are especially popular hideouts because the “hider” can make himself or herself the beneficiary of these trusts, and thus protect the money from third-party claims, consistent with foreign laws which do not recognize the American “fraudulent transfer” concept. OAPTs are nearly impossible to collect against, even with a valid judgment from the U.S. While information for such assets is not publicly available, media reports about mode of living and certain activities can provide indications of possible concealed assets abroad.

March 10th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , |

Wall Street firms slow in reporting infractions to FINRA

The Financial Industry Regulatory Authority (FINRA), Wall Street’s self-reporting system that allows investors to vet stockbrokers and other financial professionals, says that it has a persistent problem with financial firms not reporting infractions properly or in a timely manner.

FINRA, which shares oversight of Wall Street with federal agencies such as the Securities and Exchange Commission (SEC), requires financial firms to disclose employee infractions within 30 days. Those records, ranging from serious criminal offenses to minor customer complaints, are then entered into a database known as the Central Registration Depository. Individual investors use the 30-year-old system to check out a stockbroker’s history, including employment, criminal records and client lawsuits. Institutions use the database to investigate job candidates.

FINRA depends on Wall Street, which finances its operations, to update the records. But dozens of new cases show that critical information is missing, out of date or erroneous. And Wall Street has a checkered history of reporting infractions by brokers. When regulators last cracked down on disclosure violations in 2004, the sweep ensnared nearly 30 securities firms. At the time, the National Association of Securities Dealers, FINRA’s predecessor, fined brokerage firms a collective $9.2 million for failing to report customer complaints and criminal convictions properly. That same year, Morgan Stanley was hit with a $2.2 million penalty, the largest ever levied against a firm for disclosure issues, for failing to appropriately report 1,800 incidents of customer complaints and other problems. In 2010, the regulator suspended 56 brokers for failing to report previous infractions, up from 34 in 2006. Annual fines rose to $2 million from $1.6 million over the same period.

In one of the most prominent cases in 2010, FINRA fined Goldman Sachs $650,000 for failing to disclose that a trader, Fabrice P. Tourre, and another employee had received an SEC “Wells” warning that the agency was considering an enforcement action against them. Tourre was the only individual named in the SEC fraud case against Goldman Sachs last year, which accused the investment bank of misleading investors about subprime mortgages. Tourre purportedly was ”principally responsible” for marketing the bonds. Goldman, without admitting or denying any wrongdoing, settled the SEC’s charges in July 2010 for $550 million – one of the largest fines ever paid by a Wall Street firm. The charges against Tourre are pending.

Also in 2010, FINRA fined Citigroup $150,000 for filing inaccurate disclosures regarding about 120 brokers who had been fired or resigned after being accused of theft or fraud. In its disciplinary action, FINRA said that Citigroup ”hindered the investing public’s ability to access pertinent background information.” It fined JPMorgan Chase $150,000 for similar violations in 2009.

FINRA soon will face another test. Policy makers are considering whether to expand its responsibilities, giving the regulator oversight of tens of thousands of investment advisers, on top of the 600,000-plus brokers it already under its purview.

March 2nd, 2011|Categories: Commercial Transactions Due Diligence|Tags: , , |

Tyson Foods charged with violations of the Foreign Corrupt Practices Act

 

The Securities and Exchange Commission (SEC) today charged Tyson Foods Inc. with violating the Foreign Corrupt Practices Act (FCPA) by making illicit payments to two Mexican government veterinarians responsible for certifying its Mexican subsidiary’s chicken products for export sales.

The SEC alleged that Tyson de Mexico concealed the improper payments by putting two veterinarians’ wives on its payroll but they performed no work for the company. The spouses were later removed from the payroll and their payments were processed with invoices issued for “services.” Tyson de Mexico paid the veterinarians, who were responsible for certifying Tyson’s chicken products for export and served as official Mexican government veterinarians at Tyson facilities, a total of $100,311. It was not until two years after Tyson Foods officials first learned about the subsidiary’s illicit payments that its counsel instructed Tyson de Mexico to cease making the payments.

The SEC further charged that in connection with these improper payments, Tyson Foods failed to keep accurate books and records and failed to implement a system of effective internal controls to prevent salary payments to phantom employees and the payment of illicit invoices. The improper payments were recorded as legitimate expenses in Tyson de Mexico’s books and records, and included in Tyson de Mexico’s reported financial results for fiscal years 2004, 2005 and 2006. Tyson de Mexico’s financial results were, in turn, a component of Tyson Foods’ consolidated financial statements filed with the SEC for those years.

Without admitting or denying the SEC’s allegations, Tyson Foods consented to the entry of a final judgment ordering disgorgement plus pre-judgment interest of more than $1.2 million and permanently enjoining it from violating the anti-bribery, books and records, and internal controls provisions of the FCPA. The proposed settlement is subject to court approval.

In a related criminal action announced today, the Department of Justice (DOJ) charged Tyson Foods with conspiring to violate the FCPA and violating the FCPA. The DOJ and Tyson Foods agreed to resolve the charges by entering into a deferred prosecution agreement. Tyson Foods also agreed to pay a $4 million criminal penalty.

February 12th, 2011|Categories: Commercial Transactions Due Diligence|Tags: , , , |
© 2012- SCHERZER INTERNATIONAL | ALL RIGHTS RESERVED
Go to Top