Securities Law Blog

An offshore insurance company located in Costa Rica has been simultaneously charged by the Securities and Exchange Commission (SEC) and by the U.S. Attorney’s Office for the Eastern District of Virginia and the Fraud Section of the Department of Justice’s Criminal Division. Provident Capital Indemnity, Ltd. (PCI), its president, Minor Vargas Calvo (Vargas), and its purported outside auditor, Jorge L. Castillo have been charged with conducting a massive life settlement bonding fraud.

PCI provides financial guarantee bonds on life settlements and claims to protect investors’ interests in life insurance policies by promising to pay the death benefit if the insured lives beyond his or her life expectancy. According to the complaint, PCI issued approximately 197 bonds backstopping numerous bonded offerings of investments in life insurance policies with a face value of more than $670 million, from at least 2004 to March 2010.

The SEC claims that Vargas and Castillo misrepresented PCI’s ability to satisfy its obligations under its bonds, made material misrepresentations about the assets that backed PCI’s bonds, PCI’s credit rating, the availability of reinsurance to cover claims on PCI’s bonds, and whether PCI’s financial statements had been audited.

According to the complaint, Castillo never conducted an audit of PCI but continued to issue clean audit reports at the request of Vargas. Castillo’s actions reportedly furthered the illusion that PCI had materially larger assets and greater financial resources to support its obligations.

The complaint alleges that PCI’s “audited” financial statements were provided to Dun & Bradstreet (D&B), which issued PCI a favorable rating of “5 A/S” based on PCI’s reported net worth. PCI then marketed itself as providing “successful customer satisfaction” and having “the ability to maintain one of the insurance industry’s lowest loss ratios,” based on the D&B rating.

The SEC Life Settlement Task Force released a report last year nothing that the market for life settlements has grown over the past decade and calling for greater regulatory coordination and investor protection.

NIC Inc., a Kansas-based company that manages government websites, and four current or former company executives were charged with failing to disclose to investors more than $1.8 million in perks paid to the former CEO Jeffrey Fraser over a six-year period.

According to the Securities and Exchange Commission (SEC), NIC’s public filings failed to disclose that it footed the bill for Fraser to receive more than $4,000 month to live in a ski lodge in Wyoming, for Fraser to commute by private aircraft to his office at NIC’s Kansas headquarters, vacations, Fraser’s flight training, hunting, skiing, spa and health club expenses, and day-to-day living expenses to name a few.

The SEC alleges that NIC and its executives “falsely represented to investors that Fraser worked virtually for free from 2002 to 2005, and then continued to materially understate the perks that Fraser received in 2006 and 2007.”

Fraser also reportedly charged living expenses on NIC credit cards and submitted expense vouchers falsely claiming personal items were business-related in order to have NIC pick up the tab, according to the complaint.

Also named in the complaint are current CEO Harry Herington, former CFO Eric Bur and current CFO Stephen Kovzan, who is also being charged separately.

The complaint alleges that Herington had been informed of problems with Fraser’s expense reports but failed to adequately address them. Herington also reportedly received information that NIC was paying for Fraser’s personal expenses and still reviewed or signed NIC’s public filings that failed to disclose Fraser’s perks.

The SEC claims that Bur was aware of the SEC’s rules requiring the disclosure of executive perks, yet he reviewed, signed or certified NIC’s public filings that failed to disclose Fraser’s perks. Bur also allegedly allowed NIC to pay Fraser’s expenses even though he was informed that Fraser was not submitting proper documentation.

According to the complaint, Kovzan authorized NIC’s payment of Fraser’s personal expenses and knew or was reckless in not knowing, that Fraser’s expenses were falsely characterized as business expenses. Kovzan allegedly prepared, reviewed or signed NIC’s proxy statements, annual reports and registration statements that underreported Fraser’s compensation.

NIC, Fraser, Herington and Bur agreed to pay a combined $2.8 million to settle the SEC’s charges. Fraser has also consented to an order barring his from serving as an officer or director of a public company. The SEC’s litigation against Kovzan is pending and seeks a permanent injunction, disgorgement, penalties, prejudgment interest, and an officer-and-director bar against Kovzan.

The Securities and Exchange Commission (SEC) has obtained an emergency court order freezing the assets of SJK Investment Management LLC and its CEO Stanley Kowalewski. The investment advisor firm and its owner have been charged with defrauding investors in two hedge funds by secretly diverting millions of dollars to themselves through various transactions.

According to the complaint, since summer 2009 SJK and Kowalewski raised more than $65 million by marketing two hedge funds to various investors including pension funds, school endowments, hospitals and non-profit foundations. Kowalewski allegedly placed $16.5 million in a third fund, undisclosed to investors, and misused the investor’s money in various ways.

The SEC’s complaint stated that Kowalewski sold his personal home to the fund in early 2010 for $1 million more than he paid for it, and then continued to live in the house rent-free. Kowalewski is also reported to have used roughly $3.9 million of investor money to purchase a vacation home in South Carolina. Investor money was also allegedly used to pay personal expenses and SJK’s rent and other overhead for the company.

The SEC seeks permanent injunctions, disgorgement of ill-gotten gains with pre-judgment interest, financial penalties, and a financial industry bar against Kowalewski

Deutsche Bank AG has agreed to pay $553.6 million to settle a long-running probe over fraudulent tax shelters that allowed clients to avoid paying billions of dollars in U.S. taxes. The bank entered into a nonprosecution agreement with the U.S. Attorney’s office in Manhattan and the Internal Revenue Service to avoid being prosecuted for its participation in about 15 tax shelters involving more than 2,100 customers between 1996 and 2002, including shelters marketed by accounting firm KPMG LLP and the defunct law firm Jenkens & Gilchrist, P.C.

The investigation targeted aggressive, prepackaged tax shelters that the government believed were fraudulent, according to the agreement. The shelters at issue included “Blips”, or bond-linked issue premium structure; “Flips”, or foreign leveraged-investment program; and “OPIS”, or offshore portfolio-investment strategy.

Under the agreement, Deutsche Bank admitted that it knew or should have known that the transactions underlying the shelters were “intended to create the appearance of investment activity, but taxpayers were entering into these transactions for the primary purpose of avoiding taxes, as opposed to making profits on the transactions.”

The $553.6 million payment represents the total fees that the bank collected during the period, the taxes and interest the IRS was unable to collect, and a civil penalty of more than $149 million.

As part of its agreement, Deutsche Bank agreed not to be involved with any type of prepackaged tax products and to adopt an ethics and compliance program.

The New York State Attorney General has filed a lawsuit against Ernst & Young LLP, charging the accounting firm with helping Lehman Brothers Holding, Inc. “engage in accounting fraud involving surreptitious removal of tens of billions of dollars of fixed income securities from Lehman’s balance sheet in order to deceive the public about Lehman’s true liquidity condition.”

The lawsuit claims that for more than seven years Lehman engaged in “Repo 105” transactions. The transactions involved transfers by Lehman of fixed income securities to European counterparties in return for cash with the binding understanding that Lehman would repurchase the equivalent securities from these counterparties a few days later for more money. Lehman would then allegedly use the cash to pay down liabilities to appear financially healthier and mask debt from investors’ view by failing to disclose the obligation to repurchase the securities at a higher price.

According to the complaint, Ernst & Young was fully aware of Lehman’s fraudulent Repo 105 transactions, specifically approved Lehman’s use of them, and gave Lehman an unqualified audit opinion every year from 2001 to 2007. The lawsuit also alleges that Ernst & Young failed to object when Lehman misled analysts on its quarterly earning calls regarding its leverage ratios, and that Ernst & Young did not inform Lehman’s Audit Committee about a highly-placed whistleblower’s concerns about Lehman’s use of Repo 105 transactions.

The Attorney General is seeking the return of fees Ernst & Young collected for work performed for Lehman between 2001 and 2008, exceeding $150 million, plus investor damages and equitable relief.