Since the market crisis enforcement officials have heard repeated calls to prosecute not just companies but high ranking corporate officials. While the Commission brought a series of market crisis actions against firms and individuals, as part of the new “get tough” policy individuals will be a focus. Now the agency has brought actions involving an issuer and eight officers and directors, including the chairman of the audit committee, the CEO, the CFO and the corporate controller. SEC v. AgFeed Industries, Inc. (M.D. Tenn. Filed March 11, 2014); In the Matter of John A. Stadler, Adm. Proc. File No. 3-15782 (Filed March 11, 2014); In the Matter of Clayton T. Marshall, Adm. Proc. File No. 3-15783 (Filed March 11, 2014).
The actions centers on a years long financial fraud at AgFeed Industries, Inc., a firm which was the product of a merger in September 2010 of U.S. and China based entities. AgFeed was a publicly-traded hog and feed production company based in Tennessee but with most of its operations in China. The business plan for the merged firms called for the company to raise additional capital and become a modern hog production firm.
The financial fraud traces to 2008. During that period six defendants were key officers: Junhong Xiong was the CEO from late 2006 through early 2011; Junhong Xiong was an accountant at the company from mid-2008 until early 2009 when he became CFO, a position he held until late 2010; Songyan Li was the chairman of the firm from late 2006 through early 2011; and Shaobo Ouyang was an accountant and comptroller from late October 2009 through mid-2013 (“initial officers”).
Approximately $57 million was raised in three registered offerings by the firm in early 2008. The proceeds were used to acquire hog farms in China. By June 2008 the initial officers began cooking the books, inflating revenue through a variety of methods. Fictitious accounting entries were made. Those included, for example, fake entries for sales of pigs. Prices were also inflated by manipulating the weight of the hogs. As the fraud continued the initial officers took steps to conceal it from the company and the auditors. A parallel set of books was created so that there were “real” books and “fake” books.
In late 2010 and in early 2011 Messrs. Xiong, Jin and Li left the firm. Edward Pazdro and K. Ivan Gothner, both of whom are also defendants, joined. Mr. Pazdro, a CPA, became CFO beginning in November 2010, a post he held through mid- July 2011. Mr. Gothner joined earlier, becoming the Chair of the board’s audit and compensation committees beginning in December 2009, posts he held for two years (together the “new officers”).
By early 2011 the new officers leaned the company had two sets of books. They obtained a USB drive that contained a partial set of the real and fake books recorded on it. Mr. Ouyang, after inquiry, admitted his role in the fraud.
By June 2011 in-house Chinese counsel provided the new officers with a memorandum statingthat the accounting fraud was wide spread and confirming the information on the thumb drive – there were two sets of books. The memorandum also noted that Messrs. Xiong and Jin had directed the fraud and that Mr. Xiong had ordered the destruction of the second set of books. The memorandum was based on interviews and documents.
In the summer of 2011 the two new officers – defendants Pazdro and Gothner – were implementing the plan to expand the firm into a modern hog producer. Funds were being raised to implement that plan. The proper steps to disclose the fraud were not. The auditors and disclosure counsel not told the most significant evidence about the fraud, although there were reports of a whistleblower. Key management personnel were not informed. Representations were made to counsel that a third-party expert had been engaged to analyze the USB drive when in fact no expert had been retained. The new CFO, who had to execute a certification, was not informed. Critical follow-up investigation was not undertaken. These failures resulted in false filings regarding the financial condition of the company being made with the Commission.
In December 2011 AgFeed finally disclosed that accounting improprieties had occurred at the firm. Now all of the executives have left the firm which has filed for bankruptcy. The complaint alleges violations of: Exchange Act Sections 10(b), 13(a), 13(b)(2), 13(b)(5), control person liability under Section 20(a) and false certifications under Rule 13a-14; Securities Act Section 17(a); and Sarbanes-Oxley Section 304(a). The action is in litigation.
Mr. Stadler, who served as chairman and interim CEO from February 2011 until December 2011, settled with the Commission. He consented to the entry of a cease and desist order based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). He also agreed to the entry of an order prohibiting him from serving as an officer or director of a public company and directing that he pay a civil penalty of $100,000. Mr. Stadler agreed that in any other proceeding he will not claim credit for the payment of the civil penalty.
Mr. Marshall, who served as a divisional chief financial officer of firm from mid-2011 through August 2012, also settled with the Commission. The Order alleged violations of Securities Act Section 17(a)(2) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding he consented to the entry of a cease and desist order based on Securities Act Section 17(a) and the Exchange Act Sections cited in the Order. He also agreed to be denied the privilege of appearing or practicing before the Commission as an accountant for a period of five year after which he may request reinstatement. The question of financial remedies will be considered at a later date. The Commission’s press release states that he is cooperating with the agency.