Securities Industry Commentator by Bill Singer Esq

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Former CEO And CFO Of Public Telecommunications Company Charged In Manhattan Federal Court With Scheme To Defraud Investors / Defendants Charged with Concealing Company's Deteriorating Financial Condition and Embezzling Company Funds (DOJ Release)

SEC Charges Executives of Network Infrastructure Company With Accounting Fraud (SEC Release)

Former Banker Sentenced to Prison for Role in Movie Financing Fraud Scheme, Falsely Applying for COVID-19 Loans (DOJ Release)

South Florida Man Pleads Guilty to Multi-Million Dollar Investment Scam Targeting the Elderly, Spending Investor Money on Gambling, Jewelry, and Luxury Vehicles (DOJ Release)

Two South Bay Residents Plead Guilty to Securities Fraud / Defendants Admit Illegally Transferring, or Using, Insider Information for the Purpose of Trading Infinera Securities (DOJ Release)

Texas Man Pleads Guilty to $1.5 Million Investment Fraud Scheme / Admits Defrauding KC Brothers, Who Also Pleaded Guilty to Fraud Scheme (DOJ Release)

SEC Charges Virginia Man with Manipulating Microcap Stock (SEC Release)

SEC Charges Securities Fraud Recidivist in Real Estate-Related Scheme (SEC Release)

FINRA Censures and Fines Laidlaw and Fines and Suspends a Principal for Supervisory Lapses 

In the Matter of Laidlaw & Company (UK) Ltd. and John Coolong, Respondent (FINRA AWC)

SEC Awards Over $1.2 Million to Whistleblower

Order Determining Whistleblower Award Claim

I. SEC Awards 30% of Sanctions to Whistleblower

Order Determining Whistleblower Award Claim 

II. SEC Awards 30% of Sanctions to Whistleblower

Order Determining Whistleblower Award Claim 

FINRA Arbitrators Directly Nullify Indirect Non Solicitation Agreement  (BrokeAndBroker.com Blog)

Wasted Time By FINRA Regulatory Notice (BrokeAndBroker.com Blog)

FTE was a telecommunications company based in Naples, Florida and Manhattan.  As of December 2017, its stock traded on the NYSE American market.  From 2014 to 2019, PALLESCHI was the chairman of FTE's Board of Directors and its Chief Executive Officer.  LETHEM served as FTE's Chief Financial Officer from 2014 through 2019.

Fraud with Respect to Convertible Notes

From 2016 to early 2019, PALLESCHI and LETHEM caused FTE to issue approximately 70 notes with a total principal balance of more than $22 million to private lenders that the lenders could convert to FTE's common stock, either upon demand or upon default.  Issuers of such convertible notes must recognize on their financial statements liabilities and expenses that arise from the notes' conversion features.  PALLESCHI and LETHEM caused FTE to recognize only the principal amounts and resulting interest expense on the company's books but not the substantial liabilities and expenses arising from the notes' conversion features.

In furtherance of the scheme, PALLESCHI and LETHEM took several steps to conceal the notes' conversion features:

Rather than provide FTE's accountants and auditors with copies of the actual convertible notes, the defendants created fake notes with the same lenders, principal amounts and other terms as the convertible notes and gave the fake notes to the auditors and accountants.  PALLESCHI and LETHEM created more than 35 such fake notes with a total principal balance of more than $14 million. 

PALLESCHI and LETHEM also created fake resolutions of FTE's Board of Directors that purportedly authorized the company to issue the convertible notes on which they forged the Directors' signatures.  The defendants then provided these forged Board resolutions to FTE's lenders. 

On four occasions in June 2017, LETHEM forged the signature of a representative of FTE's transfer agent on letters that he provided to lenders.  The transfer agent kept records of who owned FTE's stock and held stock shares that the company had not yet issued.  The forged letters purported to confirm that the transfer agent would hold a sufficient number of shares of FTE's stock in reserve to pay a convertible lender in case the lender decided to convert a convertible note into FTE stock.  These letters protected convertible lenders by ensuring that enough shares of FTE's stock would be available to pay off the convertible notes.  Convertible lenders generally required their borrowers to provide them with such letters before funding a convertible note.

PALLESCHI and LETHEM lied repeatedly to FTE's auditors by falsely denying that the company had issued convertible debt.  In April 2018, LETHEM falsely denied to the auditors that FTE had issued two specific convertible notes.  Three days later, both PALLESCHI and LETHEM repeated this false denial to the auditors in a management representation letter related to the audit of FTE's 2017 year end financial statements.  PALLESCHI and LETHEM also falsely denied to the auditors in April 2018 and again in November 2018 that a $1.4 million note FTE had entered into in April 2018 was convertible.  When the auditors asked to see a copy of the $1.4 million note, LETHEM falsely claimed that his sole electronic copy of the note was lost because the electronic file had become corrupted.  When the auditors continued to ask for the note, LETHEM concealed that he had the note all along by sending the note to a company attorney and arranged for the attorney to send it back to him.  LETHEM then forwarded the attorney's email to a company Director, who forwarded it to the auditors with the notation that "[the attorney] found the note!"  When the auditors then asked that the attorney review her files for other notes, LETHEM and the attorney falsely responded that the attorney did not know of, or possess, additional convertible notes.

As a result of this fraud with respect to convertible notes, the defendants caused FTE to understate its debt derivative liabilities and warrant derivative liabilities and to fail to recognize losses on conversion derivative liabilities and losses on issuance of notes in 2017 and 2018.  For example, FTE's year end 2017 financial statements understated FTE's debt derivative liabilities by $48 million and warrant derivative liabilities by $16 million.  FTE also failed to recognize a $35 million loss on conversion derivative liabilities and a $42 million loss on issuance of notes for the year ending 2017. 

Fraudulent Revenue Recognition

PALLESCHI and LETHEM also caused FTE to recognize more than $13 million in fraudulent revenue:

This fraudulent revenue included more than $10 million in "unbilled" revenue that the defendants represented FTE had earned from services it had supposedly provided to a large customer that would not yet accept bills for those services.  FTE never provided any such services.

In addition, the defendants caused FTE to recognize approximately $2.6 million as an account receivable for which there was no support.  When FTE's auditors said that the account receivable should be written off, PALLESCHI and LETHEM  created a fake email from a representative of the customer saying that the customer would "expedite payments" for more than $1.5 million for projects completed by FTE in 2016 and 2017.  The defendants caused this fake email to be sent to FTE's auditors so that FTE could continue to recognize the receivable. 

PALLESCHI and LETHEM caused FTE to recognize another $600,000 in accounts receivable for work the defendants falsely claimed FTE performed.  When FTE's auditor sought confirmation of this account receivable from the customer, LETHEM gave the auditor the name and email address of an FTE director who also was an employee of the customer.  PALLESCHI and LETHEM then attempted to persuade the FTE director to sign the confirmation but the director refused to do so.  LETHEM then emailed PALLESCHI in part "should I just send plan b?"  Later that day, LETHEM emailed PALLESCHI an audit confirmation containing the director's forged signature.  A few days later, LETHEM emailed the auditor a confirmation containing the director's forged signature.

As a result of the defendants' fraudulent recognition of revenue, FTE's financial statements overstated the company's accounts receivable by between 18% and 120% for each of the quarters in 2017 and 2018 and by approximately 477% for 2016.

Embezzlement of Corporate Funds

PALLESCHI and LETHEM also embezzled corporate funds.  This embezzlement included payments for private jet use, luxury automobiles, personal credit cards, unauthorized wire transfers and stock issuances.  PALLESCHI and LETHEM used a bank account in the name of another entity to hide their diversion of corporate funds. 

[M]ichael Palleschi and David Lethem, the former CEO and CFO respectively of FTE, directed the company to issue approximately $22.7 million in convertible notes with short-term maturities, steep interest rates, and market-price-based formulas for conversion into shares.  As alleged, Palleschi and Lethem misled in-house accounting personnel and FTE's outside auditor about certain material terms of the notes, which were not properly accounted for or disclosed in FTE's financial statements.  The complaint also alleges that Palleschi and Lethem inflated FTE's revenue by directing FTE to improperly recognize revenue and related accounts receivable for nonexistent construction projects.  According to the complaint, Palleschi and Lethem misappropriated millions of dollars of company funds to pay for personal expenses, including luxury car leases, private jet services, and unauthorized salary increases.

[B]enjamin McConley and Jason Van Eman, held themselves out as film producers and financiers.  In those roles, McConley and Van Eman allegedly offered to provide financing to investors and producers seeking funds to produce motion pictures, theater performances, and for other projects.  The indictment charges that McConley and Van Eman promised the victims that, in exchange for the victims' cash contributions, McConley would "match" the contributions and use the combined funds to secure financing from financial institutions in South Florida and elsewhere. 

In furtherance of the scheme, McConley and Van Eman recruited Rafael, a then bank employee, to deceive victims about the security of their funds, it is alleged.  During the course of the scheme, McConley and Van Eman repeatedly directed Rafael to falsely assure victims that their contributions or loans had been "matched" as promised in the funding agreements, say the court documents. 

According to the indictment, victims sent tens of millions of dollars to accounts controlled by the defendants based on these false representations and promises.  In truth, the schemers never "matched" the victims' contributions as promised in the funding agreements.  Instead, they stole the victims' money by transferring the funds to their personal and corporate bank accounts, often within days of the victims' contributions or loans, according to the court documents. 

Following his indictment and guilty plea in Case No. 19-CR-20447, Rafael submitted several applications to various banks for Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL).  In those applications, he concealed the fact that he had previously pled guilty in Case No. 19-CR-20447. 

[G]rossman admitted that from September 2014 through April 2018, he raised approximately $2.4 million in investor funds for his company, Dragon-Click Corp., by soliciting investments from elderly retirees nationwide.  Grossman told potential investors that Dragon-Click was developing an internet application that would revolutionize internet shopping by allowing a user to upload a photograph of any item the user wanted to purchase, identify all retailers offering that item for sale, provide price comparisons for that item across retailers, and provide a link to retailers' websites where the user could purchase the item.  Grossman admitted that he solicited funds by falsely telling potential investors they would double, triple, or quadruple their investments, and that Dragon-Click was on the verge of being sold to a large technology company, such as Google, Apple, or Amazon, for over $1 billion.  He concealed from investors that, prior to raising funds for Dragon-Click, he had been permanently barred by the Financial Industry Regulatory Authority ("FINRA") from acting as a broker-dealer or associating with any broker-dealer firm, and that he had been permanently banned from commodities trading by the U.S. Commodity Futures Trading Commission ("CFTC"). 

Grossman admitted that he falsely told investors that their investment money would be used to complete the technological development of the Dragon-Click internet application, to pay legal fees related to the patent application process, and to close the sale of the application to a large technology company.  But rather than using investors' money for any legitimate business purpose Grossman admitted that he misappropriated investors' funds for his own personal use.  Specifically, Grossman admitted that he spent $1.3 million of investors' money on gambling, diamond jewelry, luxury cars, home mortgage payments, tuition payments for his children's private school education, and other personal expenditures.  For example, Grossman's unlawful expenditures included a McLaren MP4-12C, a Chevrolet Corvette, and a 4.81 carat diamond ring.

[A]ccording to Brown's plea agreement, Brown admitted that, between 2011 and 2017, he was employed as a Senior Revenue Manager at Infinera Corporation ("Infinera"), a Sunnyvale-based technology company. Infinera's common shares were registered pursuant to Section 12(b) of Securities Exchange Act of 1934 and publicly traded on the NASDAQ Stock Market under the ticker symbol INFN. During Brown's employment at Infinera, he was regularly privy to material nonpublic information about Infinera's financial performance and financial projections. Beginning in or about April 2016 and continuing until the termination of his employment from Infinera in November 2017, Brown admitted that he regularly shared material nonpublic information that he obtained during his employment with Wylam. Brown admitted he knew Wylam intended to, and did, use the material nonpublic information to purchase Infinera securities in advance of Infinera's quarterly public earnings announcements.

According to Wylam's plea agreement, Wylam admitted that between April 2016 and November 2017, he obtained material nonpublic information about Infinera, and then engaged in transactions in Infinera securities. Wylam admitted that he obtained this material nonpublic information directly from Brown. As with Brown, Wylam admitted Infinera's common shares were registered pursuant to section 12(b) of Securities Exchange Act of 1934 and publicly traded on the NASDAQ Stock Market under the ticker symbol INFN. Wylam acknowledged the gross gains he made from trading based on material nonpublic information belonging to Infinera that he received from Brown amounted to approximately $999,959.

The plea agreements further revealed the steps Brown and Wylam took to conceal their actions and relationship. Both men admitted to having begun using the messaging application WhatsApp to communicate with each other because of its encrypted communications and as an extra measure to conceal the facts that Brown was providing Wylam with material nonpublic information and that the two were friends. Both men admitted that Wylam also "unfriended" Brown on Facebook to achieve these ends.

[N]guyen admitted that he engaged in a fraud scheme from April 2018 to August 2019 in which he proposed an opportunity for high net worth individuals to invest in the purchase, refurbishing, and sale of used oil equipment. He told Phillip Hudnall of Lenexa, Kansas, and his brother, Brian Hudnall, of Kansas City, Missouri, that profit from these transactions would be three to five times the amount of the investment. Brian and Phillip Hudnall raised money from investors based upon these representations from Nguyen.

For example, Brian Hudnall wire transferred $415,000 to Nguyen between May 3 and Sept. 19, 2018, for the purchase, refurbishment, and shipping of the oil equipment. Brian Hudnall wire transferred an additional $80,000 to Nguyen on Feb. 26, 2019. Phillip Hudnall transferred $1,075,000 to Nguyen between April 15 and June 17, 2019, for the purchase, refurbishment, and shipping of the oil equipment.

Nguyen admitted that he did not use any of the monies for the purchase, refurbishment, and shipment of used oil equipment, but instead spent the money on personal expenses.

Phillip and Brian Hudnall pleaded guilty in June 2020, in separate but related cases, to their roles in the investment fraud scheme and await sentencing.

Phillip Hudnall told investors that his company, BirdDog Business Group, LLC, had completed two successful transactions - a $244,000 loan and a $490,000 loan, both of which had been repaid with an interest rate of 30 percent. In fact, no prior completed transactions occurred and no monies were received from the sale of any oil equipment including any principal or interest. To support the false claim, Phillip Hudnall requested that Brian Hudnall create documents as proof of the prior successfully completed transactions. Brian Hudnall wrote two checks on the bank account of his business, DonDon LLC, which was closed. Brian Hudnall also created a fraudulent memorandum to support the false claim.

Phillip Hudnall told investors their funds would be used to purchase specific pieces of oil equipment for refurbishment and resale. Persons invested approximately $3.6 million for the purpose of purchasing specific pieces of oil equipment. Phillip Hudnall and another person also obtained a loan from a bank in Pittsburgh, Pennsylvania, for approximately $1.3 million to finance the oil equipment scheme. Most of the money raised from investors, however, was spent on personal expenses.

[U]sing an internet chat application, Muller repeatedly instructed an associate when and how to submit buy and sell orders for EMSF shares, using several brokerage accounts the associate controlled at multiple broker-dealers, in order to reach the price and liquidity levels Muller wanted. This manipulative trading activity allegedly distorted the true value of EMSF shares as well as the actual market interest in EMSF, and operated as a fraud on the investing public. According to the complaint, from June until September 2015, Muller received compensation from the associate as well as payments from another entity trading EMSF shares, totaling over $300,000. During the same period, at least 1,500 retail accounts, including over 300 individual retirement accounts, invested over $1 million in EMSF stock. The complaint further alleges that after the defendant stopped manipulating the stock, EMSF's stock price fell and those investors who still held the stock lost value.

The SEC's complaint alleges that Gordon sold investors interests in his company, Windy City Accelerated Returns Venture I, LLC, which he claimed would use investor funds to acquire stakes in other companies that operated lucrative rental properties near Chicago, Illinois. According to the complaint, Gordon told investors that these rental properties were "100% rented" and that he would further enhance their value by refinancing loans on the properties to get lower interest rates. Gordon also allegedly told investors that he would use their funds to renovate and update the properties, so that they could be leased at higher rates and ultimately sold at a premium. The SEC alleges that Gordon assured investors that these efforts would "conservatively" generate returns of 250% to 350% in three to five years.

According to the complaint, Gordon's representations were materially false and misleading. The complaint alleges that Gordon instead misappropriated most investor funds for unrelated expenditures and personal items such as luxury hotels, vacation rentals, gambling, and private school payments.

On February 7, 2012, FINRA accepted AWC No. 2009016306101 by which the firm consented to a censure and $65,000 fine for multiple violations, including for violations of NASD Rule 3010(b) and FINRA Rule 2010 occurring from January 1, 2009 to June 21, 2009. Specifically, the firm failed to establish, maintain, and enforce written supervisory procedures relating to the retention of business-related emails sent by its representatives from a Bloomberg terminal. 

On November 2, 2009, FINRA accepted AWC No. 2007007315501 by which the firm consented to a censure and $65,000 fine for multiple violations, including for violations of Section 17 of the Securities Exchange Act of 1934 (Exchange Act) and Exchange Act Rule 17a-4 and NASD Rules 3110, 3010(d), and 2110, occurring between June 1, 2006 and August 2, 2006. Specifically, the firm failed to retain business-related emails sent to and from non-Laidlaw email accounts used by Laidlaw representatives and failed to establish a system for supervisory review of those emails. 

From at least January 2015 through September 2015, Laidlaw failed to establish, maintain, and enforce a supervisory system, including written supervisory procedures, reasonably designed to achieve compliance with federal securities laws and FINRA rules prohibiting market manipulation. Laidlaw also failed to detect red flags of potential market manipulation. By virtue of the foregoing, Laidlaw violated FINRA Rules 3110 and 2010. 

During at least the same period, Laidlaw and Coolong failed to preserve and maintain certain books and records required by Section 17(a) of the Exchange Act and Exchange Act Rule 17a-4. Specifically, Laidlaw and Coolong failed to maintain numerous business-related text messages exchanged between firm personnel and customers. As a result, Laidlaw violated Section 17(a) of the Exchange Act, Exchange Act Rule 17a-4, and FINRA Rules 4511 and 2010, and Coolong violated FINRA Rules 4511 and 2010.  

During the relevant period, the firm's written supervisory procedures (WSPs) provided that "Laidlaw and its employees may not engage in manipulative activity to artificially affect the price of a security." The WSPs further stated that, "[m]atched trades where a person buys or sells a stock, with knowledge that a substantially offsetting transaction is going to be entered by someone, in order to mislead others about the extent of activity in, or the market for, a given stock is a form of market manipulation." The WSPs provided that "cross transactions on a frequent basis particularly in thinly traded securities may be an indicator of supporting the market." Laidlaw's WSPs prohibited matched trades and marking the close, and provided that cross trades could not be used to maintain or support the price of a security.

Respondent Laidlaw: Censure, $1.5 million fine, and an undertaking to certify that firm's supervisor system/written supervisory procedures has been enhanced as required.

Respondent Coolong: $15,000 fine and two-month suspension from association with any FINRA member firm in any Principal capacity.

considered that Claimant alerted the Commission to the securities law violations prompting the opening of a new investigation into the alleged conduct, participated in a voluntary interview with Commission staff, and provided documents and additional information that assisted the staff in its investigation, saving Commission time and resources.

• Securities Industry Commentator
• Bill Singer