Wednesday, March 31, 2010

Did InterOil Commit Securities Fraud?

In the latest salvo of its battle to expose fraud, deceit, and misconduct by InterOil (NYSE: IOC) and its CEO Phil Mulacek, Fraud Discovery Institute sent former LA Times investigative reporter, now an iBusiness Reporting blogger, William Lobdell to a Texas courthouse to pour "thousands of pages of legal documents" and discovered even more damaging information of an ongoing pattern of deceit involving the company and Mulacek. William Lobdell's detailed blog report can be read here.

iBusiness Reporting is a division of Fraud Discovery Institute (co-founded by convicted felon, now fraud fighter Barry Minkow). Both Lobdell and Minkow publicly acknowledge holding short positions in InterOil securities.


Possible Securities Fraud

Separate and apart from new information discovered by Minkow and Lobdell, this blog has uncovered troubling false and misleading disclosures by InterOil in filings with the Canadian Securities Commissions and the Securities and Exchange Commission that violate securities laws in both countries. Certain disclosures by InterOil in financial reports conflict with disclosures uncovered in two separate court cases, as detailed below.

Zeigler Litigation

For example, in June 2009, this blog exposed how InterOil filed a false SEC form Regulation D claiming it paid no fees for a $95 million private placement of convertible debt in 2008.

In a July 2009 blog post entitled, "InterOil, John Thomas Financial, and Clarion Finanz: Anatomy of a Stock Market Manipulation Scheme," I provided detailed evidence of a stock market manipulation scheme involving InterOil, John Thomas Financial, Clarion Finanz AG, and banned stock promoter Carl Caserta. I believe that they conspired to raise the stock price of InterOil's shares to force the conversion of certain outstanding convertible debt to common stock.

InterOil's material omission of fees in its SEC form Regulation D filing later enabled it to conceal in other filings John Thomas Financial's role in helping the company raise money from investors.

That deception enabled John Thomas Financial analyst Wayne Kaufman to appear on CNBC and recommend InterOil's stock without accurately disclosing his company's conflict of interest from his company's prior investment banking relationship with InterOil. Afterwards, John Thomas Financial heavily promoted Wayne Kaufman's CNBC appearance to pump InterOil stock to its customers without disclosing its prior investment banking relationship with InterOil. Over the next couple of weeks, InterOil shares rose dramatically and the company was able to force the conversion of its debt to equity.

A joint investigation with Fraud Discovery Institute, securities litigator Howard Sirota, and this blog found Court documents in the Zeigler litigation that revealed the payment of undisclosed fees by InterOil to Clarion Finanz AG, headed by Carlo Civelli who controls a major stake in InterOil. Originally InterOil was dealing directly with John Thomas Financial in helping it raise funds for its $95 million private placement of convertible debt securities.

However, that relationship was papered over to instead make it look like John Thomas Financial was working for Clarion. In other words, InterOil deliberately set up Clarion to act as a buffer between the company and John Thomas Financial. In any case, InterOil disclosed no fees paid to Clarion or indirectly paid to John Thomas Financial in its SEC form Regulation D filing and later filings. Therefore, both Clarion's and John Thomas Financial's role in helping InterOil obtain financing was concealed.

In addition, those Court documents revealed that InterOil was still doing business with banned stock promoter Carl Caserta, after the company lied to the New York Times by telling them that it stopped doing business with Caserta.

In other words, InterOil told one story to investors (no fees paid to raise $95 million of convertible debt in SEC form Regulation D) and while its internal company documents told a conflicting story to the Court (investment banking fees paid). (Full details here.)

Nikiski Partners Litigation

Likewise, former LA Times investigative journalist now working for Fraud Discovery's iBusiness Reporting blog uncovered a similar scheme by CEO Phil Mulacek in an ongoing Court battle between him and InterOil's original seed money investors. Those investors are alleging that Mulacek and various entities under his control defrauded them.

Originally, the investors sued InterOil, Mulacek, and Nikiski Partners, which is controlled by Mulacek (Todd Peters, et. al. v. Phil Mulacek et. al.). Mulacek attempted to throw Nikiski into bankruptcy (in re Nikiski Partners, Ltd.) to derail the investor's lawsuit. In that case, Mulacek's and his attorneys made claims to the Court that conflict with InterOil's disclosures to investors, as I will detail below.

Last week, Fraud Discovery went public with its investigation and issued a press release and Lobdell published a blog report detailing their findings. Below is an excerpt from Fraud Discovery's press release summarizing Lobdell's report:
...William Lobdell details stunning allegations made by about 20 original investors in what is now InterOil. Among the claims: InterOil CEO Phil Mulacek forged documents, secretly created a shadowy Bahamian company, and ignored "crippling conflicts of interest" in order to enrich family, friends and himself.
So desperate was Mulacek to evade the consequences of his actions relating to a case going to trial this May that he filed bankruptcy for a company he controls in what seems an attempt to derail the lawsuit, which is asking up to $1.3 billion in derivative or stockholder claims.

In one candid admission, Mulacek and his attorneys testified that even a $50 million judgment for the plaintiffs would be "devastating" to InterOil. The bankruptcy testimony also showed the precarious financial condition of InterOil, with $60 million in cash and massive amounts of money needed to drill wells ($1 billion), construction of a pipeline ($900 million) and the building and construction of a liquefied natural gas (LNG) plant ($5-7 billion).

To date, InterOil hasn't found any commercial oil or gas.

Federal Judge Marvin Isgur ruled that Mulacek had filed the bankruptcy in "bad faith" and the executive's credibility was "diminished" by building a key argument for bankruptcy upon a lie.

Note: Bold print and italics added by me.
If even a $50 million judgment would be "devastating" to InterOil and a favorable verdict by the Plaintiff's against Mulacek would threaten InterOil's licenses for drilling on Papua New Guinea land as claimed by Mulacek's attorneys, you would never know it from the company's filings with the Canadian Securities Commissions and the Securities and Exchange Commission.

Let's review InterOil's financial reporting disclosures.

InterOil Disclosures

While the Todd Peters litigation had been going on, InterOil did not even disclose it in its 2005 and 2006 Annual Information forms. In 2007, InterOil finally disclosed the litigation but said that "management does not believe the litigation will have a material adverse effect on the Company or its subsidiaries." (See InterOil 2007 Annual Information page 50.)

In its 2008 Annual Information form, InterOil provided more details of the actual allegations in the Todd Peters litigation:
Plaintiffs contend that the defendants, including the Company, breached their fiduciary duties to the plaintiffs as part of these transactions and also assert claims for knowing participation in a breach of a fiduciary duty, common law fraud, fraudulent inducement, statutory fraud, securities fraud, breach of contract, investor oppression and conspiracy. Plaintiffs are seeking actual damages of up to $118,068,759.00 and unspecified punitive damages, attorneys’ fees, expenses and court costs, an accounting and access to books and records. The Company and other defendants are vigorously contesting the matter. Management does not believe the litigation will have a material adverse effect on the Company or its subsidiaries. (See InterOil 2008 Annual Information page 43.)
Note: Bold print and italics added by me.
Finally, in its 2009 Annual Information form, InterOil disclosed that:
If, however, plaintiffs are successful in obtaining a favorable verdict, actual  damages could exceed $125,000,000.  Plaintiffs also seek unspecified punitive damages, attorneys' fees, expenses and court costs.  The case is set for trial beginning in October 2010. The Company and other defendants are vigorously contesting the matter. If however, plaintiffs succeed in obtaining a judgment in the amount they seek, it could have a material adverse effect on the Company or its subsidiaries. (See InterOil 2009 Annual Information page 43.)
Note: Bold print and italics added by me
.For fiscal year 2007, InterOil reported a net loss of $28,912,908 and shareholder's equity of $96,098,569 and claimed that "management does not believe the litigation will have a material adverse effect on the Company or its subsidiaries."

For fiscal year 2008, InterOil reported a net loss of $11,797,077 and shareholder's equity of $227,133,927 and acknowledged that "Plaintiffs are seeking actual damages of up to $118,068,759.00 and unspecified punitive damages, attorneys’ fees, expenses and court costs." However, InterOil still claimed that "management does not believe the litigation will have a material adverse effect on the Company or its subsidiaries."

For fiscal year 2009, InterOil reported a net profit of $6,082,627 and shareholder's equity of $441,976,093. InterOil bragged, "The 2009 year is the first recording an annual net profit." This time InterOil disclosed that "actual  damages could exceed $125,000,000.... If however, plaintiffs succeed in obtaining a judgment in the amount they seek, it could have a material adverse effect on the Company or its subsidiaries." (Source: See InterOil News Release dated March 1, 2010.)

That same year, InterOil made the Guinness Book of World Records for its claimed “world-record” gas flow from a certain natural gas well owned by the company.

InterOil CEO Phil Mulacek under fire
Mulacek's Financial Disclosures in Court Transcripts

According to the December 30, 2009 Bankruptcy Court transcript Attorney Thomas M. Kirkendall said:
InterOil, as Mr. Mulacek testified that InterOil wouldn't even be able to pay a $50 million judgment, much less a 100 million or several hundred millions or a billion-dollar judgment, as the Peters group is seeking, without substantial third party financing.
Compare InterOil's Financial Disclosures with CEO Phil Mulacek's Court Disclosures

As of December 31, 2009 InterOil's shareholder equity was reported at $441,976,093 compared to $227,133,927 at the end of 2008. InterOil reported a 2009 net profit of $6,082,627 compared to a 2008 net loss of $11,797,077. As I detailed above, that same year InterOil made the Guinness Book of World Records for its claimed “world-record” gas flow from a certain natural gas well owned by the company and the company reported its first annual operating profit.

In its 2009 Annual Information, InterOil claimed that a judgment exceeding $125,000,000 and not less than $125,000,000 "could have a material adverse effect on the Company." However, Mulacek told the Bankruptcy Court that InterOil couldn't even pay a $50 million judgment without substantial third party financing.

The fact that InterOil cannot even satisfy a $50 million judgment "without substantial third party financing" is a "material adverse event" and that threshold should have been clearly disclosed by the company in its 2009 Annual Information. Instead, InterOil's 2009 financial disclosures mislead investors into believing that a possible judgment exceeding $125,000,000 "could have a material adverse effect on the Company or its subsidiaries."

In 2008, when InterOil was in a far worse financial condition than in 2009, the company reported a 2008 net loss of $11,797,077 compared to a 2009 net profit of $6,082,627. The company's 2008 shareholder's equity was $227,133,927 compared to $441,976,093 in 2009 or about 50% less equity. InterOil claimed that the "Plaintiffs are seeking actual damages of up to $118,068,759.00 and unspecified punitive damages, attorneys’ fees, expenses and court costs." In fact, InterOil had not yet made it into the Guinness Book of World Records.

Yet, with its far worse financial condition reported in 2008 compared to 2009, InterOil claimed that "management does not believe the litigation will have a material adverse effect on the Company or its subsidiaries." InterOil gave no indication that a even a $50 million possible judgment could have a "material adverse effect" on the company.

Conclusion

The main issue is that InterOil financial disclosures conflict with and are inconsistent with disclosures in either internal company documents or representations by its CEO Phil Mulacek found in two separate Court cases. That is out and out fraud!

Whether or not InterOil eventually settles the Thomas Peters litigation, the company and Phil Mulacek have to answer for false, misleading, and conflicting disclosures to investors. Securities regulators have been notified.

Written by:

Sam E. Antar

Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes, simply because I could.

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

I do not own any InterOil securities, long or short. However, I assisted Fraud Discovery Institute (co-founded by convicted felon, turned fraud fighter Barry Minkow) in researching InterOil. Barry Minkow and William Lobdell (iBusiness Reporting) have publicly stated that they have held short positions in InterOil securities.

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