Is Medifast a Cry Baby or a Corporate Bully?

This is the way corporate bullying works. Last Monday, September 30, 2013, I reported that Medifast (NYSE: MED), its former CFO, and the engagement partner who supervised its audits for its former accounting firm agreed to the entry of separate Cease-and-Desist Orders by the Securities and Exchange Commission for various violations of securities laws. On Wednesday, October 2, 2013, I received a letter from its lawyers with the following barely veiled threat, “…The Company, is not adverse to taking decisive action to redress false accusations against its business.”

Background

On September 19, 2013, Medifast (NYSE: MED) disclosed that on the previous day it consented to an entry of a Cease-and Desist Order and agreed to pay a $200,000 civil money penalty in connection with an "investigation" by the Securities and Exchange Commission into its improper financial reporting from 2006 to 2009. I reported that Medifast's press release and 8-K report made no mention that Brendan N. Connors, its former CFO and Marc G. Nochimson, the engagement partner who had supervised Medifast's audits for its former accounting firm, consented to the entry of separate Cease-and-Desist Orders which alleged improper conduct. Furthermore, I wrote that "I did not find any specific disclosure of the above referenced investigation in any of Medifast's previous filings with the S.E.C. I asked the company for an explanation via email, but it did not respond my request."

Therefore, I asked a reasonable question: "Was Medifast transparent with investors about an S.E.C. investigation?" based on underlying facts that were referenced in the S.E.C.’s three Cease-and-Desist Orders, Medifast’s S.E.C. filings and a certain press release). Medifast responded by having their lawyer Robert A. Giacovas send me a threatening legal letter. The letter cannot cite a single false or erroneous fact that it claims I published. Instead, it resorts to veiled threats, personal attacks, and innuendo in an attempt to distort the meaning of what I wrote and to bully me. [Read a copy of the letter from Robert A. Giacovas, Esq. here.]

Medifast's letter and my response

If I may be so bold as to summarize their lawyer’s letter, they are complaining that I “did not find any specific disclosure of the [SEC] investigation in any or Medifast’s previous filings with the S.E.C.” They claim “the Company cannot locate any email” from me asking them for an explanation. They requested that I forward them "the email that was supposedly sent to the Company and went unanswered." [Emphasis added.]

On September 20, 2013 at approximately 3:00 AM, I filled out an online inquiry for Medifast's Investor Relations Department:

Did Medifast make any PRIOR disclosure referenced in the 8-K report filed on 9/13/2013?
Here is the link:
http://www.sec.gov/Archives/edgar/data/910329/000114420413051618/v355486_8k.htm
I cannot find any disclosure by the company of the referenced SEC investigation PRIOR to the filing of the 8-K.
Please respond via email.

See the screen shot below (Click on image to enlarge it):

At about 3:01 AM ET, I received the following confirmation that my inquiry was received. See the screen shot below (Click on image to enlarge it):

In addition, on September 20, 2013 at 4:41 AM ET, I sent an email to Medifast’s Investor Relations Department which made the same request: [Read the full email here.].

Question: Did Medifast make any disclosure of the above referenced investigation into Medifast's financial reporting in its previous filings with the S.E.C.? I cannot find any reference to the above referenced investigation in any of Medifast’s filings with the S.E.C. prior to the filing of the 8-K report referenced above.

I’d appreciate a prompt answer to this question via email.

However, Medifast did not respond to me as of the time I published my blog 10 days later on September 30, 2013. If Medifast cannot find my online inquiry and email detailed above, I respectfully suggest that apparently either someone at the company is not being truthful to them or it has a problem with its information technology infrastructure.

Medifast's letter does not deny that it failed to report the existence of an S.E.C. investigation prior to the issuance of a Cease-and-Desist Order, press release, and 8-K filing. Instead, it explains that Medifast had no specific legal obligation to disclose such an investigation:

However, there is no statute, regulation, or rule that explicitly imposes an affirmative duty upon a public company to disclose the existence of an SEC investigation.

The letter says:

First, you state that you "did not find any specific disclosure of the [SEC] investigation in any of Medifast's previous filings with the SEC." The statement and your emphasis on the word "any" is clearly meant to convey that the Company has somehow not made proper disclosures to investors."

Apparently, the letter claims that I inferred that Medifast had broken the law by not reporting the existence of an ongoing investigation prior it consenting to the entry of a Cease-and-Desist Order. I made no such claim or inference. I asked a reasonable question: “Was Medifast transparent with investors about an S.E.C. investigation?” For example, many public companies report the existence of confidential S.E.C. investigations. Whether or not public companies should disclose the existence of ongoing S.E.C. investigations has been a matter of endless public debate. Therefore, even if we accept Medifast’s contention that by the letter of the law it was not required to report the existence of the S.E.C. investigation, it is still reasonable to ask a question about whether it was transparent with investors in communicating with them.

In addition, I reported that Medifast did not disclose in its press release and 8-K filing that its former CFO and the former engagement partner who supervised its audits also consented to the entry of separate Cease-and-Desist Orders. Their letter claims that I inferred that Medifast “purposely omitted mention of these other settlements." [Emphasis added]. As I detailed above, Medifast claimed that it had no specific legal obligation to report the S.E.C. investigation prior to it accepting the entry of a Cease-and Desist Order against it. Is Medifast now claiming it would have reported the other two Cease-and-Desist orders if they had known about them prior to its press release and filing of an 8-K report? If that is so, Medifast could have issued another press release and filed an amended 8-K report with the S.E.C. if it had chosen to do so. It did not.

The letter goes on to say that:

For your information, as a matter of policy, the SEC does not disclose the status of any investigations and settlement discussions with other potential parties (and it did not in this case).

The letter claims that:

The Company learned about details of those settlements at the same time as everyone else – when they were released by the S.E.C.

Those statements raise another reasonable question. Their letter is silent on whether Medifast knew that its former CFO and the engagement partner who supervised its audits were being simultaneously investigated by the S.E.C. Is Medifast inferring that it did not know that the S.E.C. was investigating its former CFO and the engagement partner who handled its audits until after it learned that they consented to the entry of Cease-and-Desist Orders? If Medifast did know that its former CFO and the engagement partner were being investigated by the S.E.C., wouldn't its lawyers be in contact with their lawyers to monitor the ongoing investigation? Again, these are reasonable questions based on the information presented.

Furthermore, Medifast, its former CFO, and the engagement partner who supervised its audits for its former accounting firm all consented to Cease-and-Desist Orders on the same day: September 18, 2013. The respective Cease-and Desist Orders entered against all three parties contain sequential Securities Exchange Act of 1934 file numbers, sequential Accounting and Auditing Enforcement Release numbers, sequential Administrative Proceeding file numbers, and sequential URLs to access them on the internet. A day later, on September 19 at around 9:19 AM Medifast issued a press release which reported its Cease-and-Desist Order, but omitted reference to the other two orders. Its 8-K filing with the S.E.C., which also omitted reference to the other two Cease-and-Desist Orders, was accepted by the S.E.C. later that same day at 4:59 PM. Based on that sequence of events, it’s a reasonable question to ask why Medifast did not disclose the two Cease-and-Desist Orders in its initial press release and 8-K report. In any case, as I suggested above, Medifast could have issued a new press release or filed an amended 8-K report disclosing the other two Cease-and-Desist orders if it chose to do so. It did not. There still remains a reasonable question to ask about whether Medifast was transparent in communicating with investors even if Medifast complied with S.E.C. reporting requirements on this issue. [Cease-and-Desist against Medifast, Cease-and-Desist against Brendan Connors, and Cease-and-Desist against Marc Nochimson]

What further amuses me about Medifast's bullying is their lawyer's apparent blundering. For example, the letter states:

Your post, which begins with the question – “Was Medifast transparent with investors about an S.E.C. investigation?” – then contains a number of statements that answers the question in the affirmative, thereby raising specter of some improper conduct by Medifast surrounding the entry of a cease and desist order with the Securities and Exchange Commission (“SEC’). [Emphasis added.]

Apparently, the letter erroneously claims that I answered my own question “in the affirmative” which means that I implied that Medifast engaged in proper conduct while it goes on to erroneously claim that I answered the question in the negative, meaning that Medifast engaged in improper conduct. I'm confused by their language. A company can follow the letter of the law and still not be transparent as I understand the term to mean. In any case, I did not say that Medifast was transparent or that it was not transparent. I simply asked a reasonable question about whether Medifast was transparent with investors and published the underlying facts accurately to help readers reach their own conclusion.

The letter references a certain defamation lawsuit Medifast brought against "...your friend and twice convicted felon Barry Minkow and (others)." I thought Minkow was a friend, but he is no longer a friend anymore and he has not been a friend for years. In any case, Medifast's defamation lawsuit against Barry Minkow was dismissed, although it is appealing the ruling. (See 10-Q report - Contingencies on page 14.)

Finally, Medifast requested that “And if you are truly interested in full transparency, you should publish this letter for your readers.” Well, I am interested in transparency. I made an upload of their letter available in the first paragraph of this blog, provided links to it several times above, and it can be uploaded here, too. In the spirit of the First Amendment to the Constitution of the United States, I welcome the debate. Back in 2012, I defended a government employee's right to free speech after he was fired for saying personal insults about me:

When Antar was asked about the critique of his talk and Mr. Kaplan’s firing his reaction was, “He has every right to voice his opinion of me. It was wrong for the City of Philadelphia to fire him for what he said about me."

In my humble opinion, Medifast appears to be thin-skinned. They are acting like crybabies. However, Medifast, like me has a constitutional right to the freedom of speech. Their opinions like mine here have a right to be heard. However, I will not allow them to bully me.

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic 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 want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

There is a saying, "It takes one to know one." I've done professional work for the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify fraud and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. Recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud.

I do not own any Medifast securities long or short.

If You Question Medifast's Revenue Accounting, Expect a Subpoena Rather Than a Rebuttal

Rather than respond to my Open Letters to the Securities and Exchnage Commission raising serious questions about Medifast's (NYSE: MED) compliance with Generally Accepted Accounting Principles (GAAP) and SEC Topic 13 governing revenue recognition, the company has decided to subpoena me as a third party witness in its ongoing litigation with Fraud Discovery Institute, co-founded by convicted felon turned successful fraud buster Barry Minkow.

Starting in January 2009, Fraud Discovery Institute released a series of detailed investigative reports alleging potentially serious improprieties concerning Medifast's business model, marketing practices, and financial disclosures to investors in reports filed with the SEC. In addition, Barry Minkow openly disclosed that he has held a short position in Medifast securities, hoping to profit from the decline in the company's stock price (perfectly legal).

In February 2010, Medifast filed a multi-million dollar lawsuit alleging defamation by Fraud Discovery Institute, its co-founder Barry Minkow, pyramid scheme expert Robert L. FitzPatrick, acclaimed forensic accountant and book author Tracy Coenen, best-selling author and former investigative journalist William Lobdell (who now writes for iBusiness Reporting, a blog funded by Fraud Discovery), and an anonymous Yahoo massage board poster. The defendants have since filed, what is known as, Anti-Slapp motions claiming that Medifast is attempting to limit their First Amendment right of free speech under the United States Constitution.

Back in 2007, Fraud Discovery alleged fraud at Usana (NYSE: USNA) and the company sued Minkow for libel. All the libel counts were thrown out by a federal judge who then ordered Usana to pay Minkow’s legal fees. Likewise, the defendants are confident that Medifast's lawsuit will be dismissed, too.

Rather than provide any detailed rebuttal of Fraud Discovery's allegations, Medifast CEO Michael C McDevitt has resorted to personal attacks against Minkow:

We believe most everything he says to be false and made for his own personal gain. He is a liar and can't be trusted.

Other than say that Fraud Discovery's allegations are false in its lawsuit and the press, Medifast has yet to provide a detailed line-by-line rebuttal of any allegation made in Minkow's reports. Minkow has asked for such a rebuttal and offered to correct any possible errors. What's Medifast afraid of?

Instead, Medifast has complained to the SEC and the regulator is now probing Minkow. Portfolio.com columnist Gary Weiss asked:

What in heaven’s name is the SEC thinking? Is it completely out to lunch?”

Weiss continues:

What is going on here? Well, I think what we may be seeing is a repeat of the Einhorn fiasco, and then some.

Both Einhorn and Minkow are short-sellers, profiting from their probes into the finances of companies. Short-sellers provide an undeniable benefit for the markets and perform a function that the SEC often fumbles: Shorts, and whistleblowers like Antar, police the financial statements of companies, providing a skeptical view of stocks that they believe are overvalued or otherwise flawed. Antar takes pride in the accounting goofs and crookedness that he has brought to the SEC’s attention, directly and through his blog.

SEC investigations are like unguided missiles. In case after case, the SEC usually ends up clearing whistleblowers like Minkow and Einhorn and finding securities violations committed by complaining companies.

The same happened with Overstock.com. The SEC cleared independent research firm Gradient Analytics and short seller Copper River Management, formerly Rocker Partners. Overstock.com and its CEO are under current investigation by the SEC as a result of GAAP violations exposed in this blog that caused the company to restate its financial reports for the third time in three years. (Read Richard Sauer's book entitled, "Selling America Short: The SEC and Market Contrarians in the Age of Absurdity.")

For Minkow to be wrong, Medifast has to prove that it is right and that's where the real fun begins. Medifast will have to put up or shut up and risks the SEC possibly finding Minkow's allegations of improprieties are correct.

In my case, Medifast remains strangely silent in responding to questions raised in my open letters to the SEC about the company's compliance with accounting rules governing revenue recognition. It looks like the folks at Medifast have no balls.

Likewise, I filed a whistleblower tip to the SEC and the regulator assures me that they will investigate Medifast's revenue accounting practices. I even got a thank you letter!

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 in cold-blood for fun and profit, and 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.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.

Recently, I exposed financial reporting violations by Overstock.com (NASDAQ: OSTK) as an independent whistleblower. The Securities and Exchange Commission is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

In addition, the SEC is now investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them about the company's inventory accounting practices.

I do not own Overstock.com or Bidz.com securities long or short. My exposure of confirmed financial reporting violations by Overstock.com and possible financial reporting violations by Bidz.com was a freebie to securities regulators to get me into heaven, though I doubt that I will ever get there.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

In the past, I was compensated by Fraud Discovery Institute to do certain research on InterOil and Medifast's auditors. However, I do not own InterOil or Medifast securities long or short. Fraud Discovery Institute, co-founder, Barry Minkow has publicly disclosed that he has held short positions in InterOil and Medifast securities. However, I am unaware if he has any position in InterOil or Medifast at this time.

I posted this open letter on my blog simply because I could - for fun and enjoyment. In America, even convicted felons like me have rights under the First Amendment to the US Constitution. If anyone has any complaints, please ask your elected officials to change the Constitution, feel free to complain to the SEC, take other legal measures, or rant, yell and scream. I personally don't give a damn.

Barry Minkow Gives Medifast the Middle Finger

If Medifast (NYSE: MED) thought that a lawsuit and complaints to the Securities and Exchange Commission against certain critics would get them to back down and retreat from criticizing the company, they are badly mistaken. This morning, Fraud Discovery Institute co-founder Barry Minkow effectively gave Medifast the middle finger by releasing a very detailed and potentially devastating report by pyramid scheme expert Robert L. FitzPatrick detailing additional allegations of potentially serious improprieties concerning Medifast's business model, marketing practices, and financial disclosures to investors in reports filed with the SEC. (Robert L. FitzPatrick’s 18 page report can be downloaded here).

Note: Convicted felon Barry Minkow (co-founder of Fraud Discovery) has publicly disclosed holding short positions in Medifast securities. As a successful fraud investigator, Minkow has uncovered over $1.8 billion of fraud involving over twenty companies and has received an official commendation from the FBI for his work in uncovering crime. Minkow and I are close personal friends and I do research work for Fraud Discovery on InterOil and Medifast's auditors, but I do not own any securities in InterOil or Medifast, long or short.

FitzPatrick’s report alleges that Medifast has a "troubled history" of "making false and misleading claims regarding its products" and takes aim at the company's Take Shape for Life (TSFL) division, which is responsible for Medifast's recent growth in revenues and profits. Fraud Discovery's press release alleges that Medifast's TSFL division is effectively a multi-level marketing scheme involving:

... pyramid-style selling - is unsustainable and will lead to a revenue trajectory similar to other multi-level marketing companies: dizzying initial expansion followed by lackluster revenue or worse.....

[Snip]

Despite heady starts, revenues from multi-level marketing companies usually slow or fizzle out all together because the business model relies mostly on an endless recruitment of independent salespeople, most of whom make little or no money.

[Snip]

"Only a business model that relies on recruitment of new sales associates by promising income in a down economy - and not the sales of its product - can explain Medifast's revenue anomaly and more importantly, that deviation from the norm is unsustainable and can't continue because Medifast will not be able to keep recruiting a large army of sales associates."

While Medifast sells hope to new sales associates (most of whom lose money), in 2009 Medifast insiders dumped $11.5 million of company stock and just a few days ago, Shirley MacDonald, wife of Medifast Executive Chairman Bradley T. MacDonald dumped 133,402 company shares and pocketed $4.69 million.

Medifast Filed Lawsuit

In February 2010, Medifast filed a multi-million dollar lawsuit alleging defamation by Fraud Discovery Institute, its co-founder Barry Minkow, pyramid scheme expert Robert L. FitzPatrick, acclaimed forensic accountant and book author Tracy Coenen, best-selling author and former investigative journalist William Lobdell (who now writes for iBusiness Reporting, a blog funded by Fraud Discovery), and an anonymous Yahoo massage board poster.

In an open letter Medifast Board Chairman Bradley T. MacDonald and Chief Executive and CFO Michael S. McDevitt, I suggested that they grow some hair on their chests and "stop acting like whining cry babies to investors, securities regulators, and now, the federal courts." I noted that:

...lawsuit reads like a cheaply produced late-night infomercial for insomniacs, rambles about the purported "health" benefits of Medifast products, and rants that Fraud Discovery Institute's reports are false. To support your claims of defamation, the lawsuit refers to self-serving claims on Medifast's website and disclosures in SEC filings which certain Defendants allege are false and misleading.

The defendants have since filed, what is known as, Anti-Slapp motions claiming that Medifast is attempting to limit their First Amendment right of free speech under the United States Constitution (Details here and here). In her blog, Tracy Coenen noted:

SLAPP stands for Strategic Lawsuit Against Public Participation.  It’s basically when a big company tries to shut up a little guy with expensive litigation. In my opinion, Medifast sued me and others in an attempt to get us to stop publicly analyzing or criticizing the company and it’s multi-level marketing business model.

In filing an anti-SLAPP motion, we are essentially asking the court to rule in our favor and in favor of free speech. Consumers should have the right to discuss, analyze, and criticize companies without the fear of expensive lawsuits.

In 2008, Fraud Discovery and Minkow won a similar Anti-Slapp motion filed by USANA (NASDAQ: USNA) and they were awarded legal fees to reimburse them for defending that company's frivolous lawsuit.

Responding to Medifast's recent lawsuit against himself, FitzPatrick wrote in his report that:

Medifast has recently characterized inquiries and critical examinations of its business model and marketing tactics as “attacks.” It has sought to silence me and others by means of a lawsuit in which Medifast has accused me of defamation, vilified my character, publicly denigrated my credentials and sought to silence me and others. This lawsuit has had a chilling effect on my willingness to continue to report and has created fear and concern for those I might collaborate with. It has inhibited communications and placed a financial and administrative burden on me that interferes with continued research and writing.

However, because truth is an absolute defense and my speech involves issues of public interest, I refuse to be bullied from accurate reporting. Of even greater importance is that one of the goals of my research and writing is to provide findings of fact to governmental agencies responsible for protecting consumers from companies involved in questionable business practices. Producing accurate information on multi-level marketing schemes that may prove valuable to regulatory agencies such as the FTC, SEC or state attorneys general and which may lead to governmental actions in consumer protection is a compelling reason for my continuing to investigate, analyze and produce reports such as this one. [Emphasis added.]

Whistleblowers like Minkow, FitzPatrick, Coenen, and Lobdell have the balls that certain simpletons and pussies working at the SEC simply don't have. The SEC needs more knowledgeable and hard working people like Richard Simpson, who successfully prosecuted the Crazy Eddie fraud and is now lead counsel in the SEC's cases against Goldman Sachs (NYSE: GS) and Sponge Tech (NASDAQ: SPNG).

Instead, there are certain rogue elements within the SEC who would much rather intimidate or ignore whistleblowers such as David Einhorn, Harry Markopolos, and others. Those naughty elements reward whistleblowers by biting the hand that feeds them. It seems that no good deed goes unpunished by the SEC, while the regulator continues to allow many corporate miscreants to go unpunished, too.

I'll have more to say about that issue, soon.

Written by:

Sam E. Antar

Recommended Reading:

TheStreet.com: SEC Doesn't Deserve to Exist by Gary Weiss

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 am planning to go straight to hell for my unforgivable crimes. However, certain other corporate miscreants won't meet me there due to indifference, incompetence, laziness, and a lack of balls by certain pussies and rogue elements working at the SEC.

Barry Minkow has publicly disclosed that he holds a short position in Medifast securities. From time-to-time, I do research for Fraud Discovery Institute on certain companies, such as InterOil and Medifast's former auditors. However, I do not own InterOil or Medifast securities long or short.

iBusiness Reporting is a division of Fraud Discovery.

Are InterOil's Auditors Capable of Finding Fraud in Plain Sight?

Fraud Discovery Institute (co-founded by convicted felon turned fraud buster Barry Minkow) is putting PricewaterhouseCoopers (PwC), InterOil's (NYSE: IOC) auditors, on notice that they must look out for possible fraud by the company as required by Statement of Auditing Standards No. 99. Fraud Discovery released a video to provide a road map to PwC "in an attempt to give investors clearer picture of the inside workings of the controversial company." Minkow believes that InterOil is "a financial crime in progress." In addition, former LA Times investigative reporter William Lobdell, who now writes for Fraud Discovery's iBusiness Reporting blog, issued a report detailing a "troubling pattern of behavior" by InterOil since its founding in 1997.




However, I am skeptical about PwC's capability to find any fraud at InterOil based on my prior experience with them as the auditors of Overstock.com (NASDAQ: OSTK) another scam company investigated in this blog. I correctly identified certain GAAP and SEC disclosure violations by Overstock.com and PwC still certified the company's financial reports as being in compliance with GAAP and SEC rules. A year later, Overstock.com admitted to those same GAAP and SEC disclosure violations exposed in my blog and restated its financial reports to correct its violations.

Both Barry Minkow and William Lobdell have publicly disclosed holding short positions in InterOil securities. I do research for Fraud Discovery on InterOil and I do not own any securities in InterOil, long or short. More disclosure at the bottom of this blog post.

Statement of Auditing Standards: Consideration of Fraud in a Financial Audit

According to SAS No. 99, "The cornerstone of an effective antifraud environment is a culture with a strong value system founded on integrity." Unethical behavior by company management is considered a red flag for possible fraud and auditors are required to increase the scope of their audits to detect potential fraud to insure that financial reports are free from material errors. Fraud Discovery Institute's InterNoOil.com website and its iBusiness Reporting blog have published many reports detailing a troubling pattern questionable behavior by InterOil management.

Forensic accountants look for a "pattern of inconsistent and conflicting disclosures" in investigating fraud at public companies, like InterOil. Likewise, PricewaterhouseCoopers is required by SAS No. 99 to look at "inconsistent and conflicting disclosures" to determine if InterOil is committing fraud, such as those described below.

Previous examples of a "pattern of inconsistent and conflicting disclosures" by InterOil

In my June 2009 blog post entitled, "InterOil, John Thomas Financial, and Clarion Finanz: Anatomy of a Stock Market Manipulation Scheme," I detailed how InterOil filed a false report with the Securities and Exchange Commission claiming that the company paid no fees for a private placement $95 million convertible debt offering. However, documents submitted in another court case reveal that Clarion Finanz (a major shareholder of InterOil) had in fact received $5.7 million in fees, contrary to InterOil's SEC filings.

In March 2010, William Lobdell went to a Texas courthouse to examine documents filed in a litigation by the original investors of InterOil against CEO Phil Mulacek alleging fraud by him dating as far back as 1997 (Details here, here, and here).

In another blog post, entitled, "Did InterOil Commit Securities Fraud?" I detailed how CEO Phil Mulacek made sworn statements in that court case which conflicted with InterOil's financial disclosures to investors. In his sworn court testimony, Mulacek claimed that a $50 million judgment against InterOil would bankrupt the company, while InterOil's financial disclosures to investors claimed that a judgment in excess of $125 million would have a material adverse impact on the company.

Under SAS No. 99, "Misrepresentation in or intentional omission from the financial statements of events, transactions, or other significant information" is considered "relevant to the auditor's consideration of fraud." In both of the situations cited above, InterOil told one story to investors in its SEC filings and financial reports and its management told a conflicting story to the courts in sworn statements. If one story is true, the other story simply cannot be true. In each of the cases cited above, InterOil misrepresented or omitted material information in its financial reports to investors, as evidenced by its management's conflicting disclosures to the courts.

Based on InterOil's conflicting disclosures, PwC is required to investigate such irregularities under SAS No. 99, as part of its audit of the company. However, I am skeptical of PwC's auditing abilities and it's capability to uncover any fraud committed by clients such as InterOil. So far, they seem to have ignored significant management integrity issues at InterOil, like the two issues detailed above.

Why I am skeptical about PwC's capability to find fraud at InterOil

PwC was Overstock.com's auditors from 1999 to 2008. During that period, every initial financial report for every reporting period issued by Overstock.com and reviewed or audited by PwC violated Generally Accepted Accounting Principles (GAAP) or some other SEC disclosure rules. Overstock.com CEO Patrick Byrne blatantly lied to investors over a ten year period about the company's financial performance, internal controls, and compliance with GAAP and other SEC disclosure rules.

Starting in February 2009, I wrote a series of blog posts correctly identifying certain GAAP violations by Overstock.com in 2008 and prior years. Both Overstock.com and PwC ignored my requests for them to correct those GAAP violations and restate the company's financial reports. Patrick Byrne responded by orchestrating a smear campaign to discredit me and other critics who agreed with my findings, while PwC improperly certified the company's financial reports as being in compliance with GAAP.

In March 2009, Overstock.com hired Grant Thornton to replace PwC as its auditors. In September 2009, the SEC started investigating Overstock.com's accounting irregularities that were pointed out in my blog. In November 2009, Overstock.com fired Grant Thornton after they agreed that I correctly identified certain GAAP violations and wanted the company to restate its financial reports. PwC still stuck to its guns and claimed that Overstock.com did not violate GAAP.

In December 2009, Overstock.com hired KPMG to replace Grant Thornton. In February 2010, Overstock.com finally admitted that the company violated GAAP and restated its financial reports to correct GAAP violations, previously identified by me. I was right and Overstock.com and PwC was wrong.

Overstock.com's financial reports that were audited by PwC were restated three times in ten years and every single audit report issued by PwC was wrong. PwC ignored serious management integrity issues at Overstock.com and I have no reason to believe that they will address any management integrity issues at InterOil.

A "troubling pattern of behavior" by InterOil

William Lobdell's latest report details even more questionable behavior by InterOil's management team. Lobdell cites "InterOil’s 12 years of hyping gas and oil fields in Papua New Guinea" and points out that InterOil still has no proven commercially exploitable reserves to date. Lobdell lists ten wells that InterOil hyped to investors, only to abandon them later on.

Many short sellers, including Minkow and Lobdell, are skeptical of InterOil's claimed estimates of contingent resources (not proven reserves). Lobdell examined the track record of GLJ Engineering, a firm hired by InterOil in 2009 to estimate its oil and gas resources. He found three major blunders by GLJ in the past and questioned the reliability of their reports on InterOil.

Then, Lobdell details how InterOil was apparently shopping for a favorable engineering report on its reserves before the company hired GLJ:

InterOil’s Netherland Sewell report is MIA.

GLJ's past mistakes might not be that much of an issue if it weren't for the "Case of the Missing Netherland Sewell Report."

In March 2007, InterOil CEO Phil Mulacek told attendees at a Raymond James conference in Orlando, Florida that three "world-class" firms were in the process of performing reserve analysis on InterOil gas fields. Mulacek named one firm, the iconic Netherland Sewell, stating that InterOil had hired the company, according to a reliable source.

This news of an imminent evaluation from Netherland Sewell was frequently mentioned in fawning investor reports by Raymond James and on blogs and message boards promoting InterOil.

But the report never came.

About 17 months later, Mulacek indicated in a conference call to investors that an international firm hired by InterOil would finish its reserve analysis report by the end of October 2008.

Again, the report never came.

So what happened to the Netherland Sewell report? Netherland Sewell nor InterOil will comment. And since InterOil is never shy about releasing good news, this should be worrisome to investors.

In the balance of his report, William Lobdell takes issue with InterOil's hype on the company's long term viability. He analyzes how InterOil is running out of cash and questions and other roadblocks facing the company in the future.

Closing comments

I cannot understand how auditing firms like PwC with their access to a company's books and records can miss red flags and financial reporting violations correctly pointed out by outsiders such as short sellers like Barry Minkow and William Lobdell and independent whistleblowers like me. Unlike us, PwC seems to be incapable of finding fraud, even fraud in plain sight .It seems that the reliability of PwC's audit reports is nothing more than pot luck in most cases.

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 Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway.

I do research on InterOil for Fraud Discovery Institute. However, I do not own any InterOil securities, short or long.

I plan on meeting corporate miscreants, such as fifth rate crooks like Patrick Byrne, in hell. In addition, it is likely that InterOil CEO Phil Mulacek may join Patrick Byrne and me in hell, too. We will all fry together.

Open Letter to Morgan Stanley "Research" Analyst Evan Calio: About Your Seriously Flawed Report on InterOil

To Morgan Stanley "Research" Analyst Evan Calio:

Evan Calio

Back in the day as the criminal CFO of Crazy Eddie, some of our staunchest defenders were gullible Wall Street research analysts like you. Even as events were imploding around us, we could count on gullible and naive research analysts to pump up the price of Crazy Eddie shares, as the Antar family continued to unload stock and pocket millions of dollars in ill-gotten gains.

Like those research analysts back in the day, your recent deluge of Morgan Stanley (NYSE: MS) "research" reports seem to be more interested in defending your past hype of InterOil (NYSE: IOC), rather than accurately communicating to investors the potential substantial material adverse financial risks facing the company in the very near future, as InterOil insiders are dumping shares.

The issue is not whether the Todd Peters case will be ultimately settled or goes to trial. The case may or may not be settled or go to trial. As I will detail below, the Morgan Stanley "research report" bearing your name seems to have no issue with InterOil and its CEO Phil Mulacek making conflicting disclosures to investors and the Courts.

Your reports do not accurately consider both InterOil's and Mulacek's disclosures about the potential material adverse financial impact of the Todd Peters litigation on InterOil that is scheduled for trial in October 2010, barring a settlement. Is success that is based on either a company or its CEO to lying to investors or the Court a business plan that you endorse for your investors?

InterOil and Phil Mulacek's Potential Legal Issues

Recently, former LA Times reporter William Lobdell wrote a series of reports in iBusiness Reporting* that provides details of serious fraud allegations made in an ongoing court case by the original investors in InterOil against company CEO Phil Mulacek. Those investors are alleging that Mulacek and various entities under his control defrauded them. (Details in iBusiness Reporting: here, here, and here).

Note: iBusiness Reporting is a division of Fraud Discovery Institute which was co-founded by convicted felon, turned fraud fighter Barry Minkow. Both William Lobdell and Barry Minkow have publicly disclosed holding a short position in InterOil securities. My disclosure is at the end of this blog post.

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 Todd Peters lawsuit and any potential liability or other economic consequences effecting InterOil. However, the Bankruptcy Court Judge dismissed the bankruptcy attempt by Mulacek, ruling that it was filed in "bad faith" as argued by the investors.

In attempting to throw Nikiski into bankruptcy, Mulacek testified in various Court hearings. According to the December 30, 2009 Bankruptcy Court transcript, Attorney Thomas M. Kirkendall said:

InterOil CEO Phil Mulacek under fire

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.

The Thomas Peters lawsuit is currently scheduled for trial on October 18, 2010. In recent weeks, certain InterOil insiders seem to be hedging their bets by dumping over $10 million in company shares prior to the scheduled trial date, barring a settlement of the said action.

Morgan Stanley Defends InterOil

Right after William Lobdell reported about the above litigation affecting both InterOil and Phil Mulacek, you issued a barrage of "research reports" defending its previous guidance on InterOil and hyping the company's future prospects. In particular, the March 29, 2010 "research report" takes issue with Lobdell's reporting of the litigations.

Your research report starts off with the usual reference to Barry Minkow and William Lobdell holding short positions in InterOil and reference to Minkow's criminal past (like Morgan Stanley has no past and present legal problems itself):

What Happened Late Last Week? Negative claims regarding IOC’s management, resources and valuation (addressed below) began Wednesday evening with two stories circulating similar negative claims. These general claims have been made before over the past year and we believe they remain incorrect. On Thursday, after these stories, IOC was up in down energy tape (unclear why). On Friday, IOC gapped lower, trading on high volume (8.4MM shares) on the back of a negative claim made by the Fraud Discovery Institute and iBusiness Reporting. Both the Fraud Discovery Institute and iBusiness Reporting are entities affiliated with Barry Minkow, a convicted felon for securities law violations who publicly states it holds short positions of stocks it is “investigating” (it is “investigating” IOC).

There is no secret about the relationship between Fraud Discovery, Barry Minkow, and William Lobdell. Both Minkow and Lobdell have publicly stated holding short positions in InterOil securities. Minkow is very vocal and makes no excuses about his past criminal misdeeds, having written several books about it, discussing it openly in the media, and disclosing it on his website.

Since Minkow's past seems to concern you, consider InterOil's covert relationship with Carl Caserta, who in 1991 was barred by the Securities and Exchange Commission from “association with any broker, dealer, or investment advisor.”

According to a 2007 New York Times article, Caserta "stopped working for InterOil in 2005." InterOil Director Gaylen J. Byker claimed that that the company was "not aware of Mr. Caserta’s history when he was retained." Anesti Dermedgoglou, Vice President Investor & Public Relations, claimed that he "was not aware that the firm had hired Mr. Caserta."

It turns out that Carl Caserta continued his relationship with InterOil. In 2008, Carl Caserta helped InterOil raise $95 million in a private placement of convertible debt securities.

Emails obtained by me and turned over to FINRA show Carl Caserta as a party to various emails discussing details of the transaction with InterOil CEO Phil Mulacek and John Thomas Financial CEO Thomas Belesis.

InterOil filed a false Form D with the Securities and Exchange Commission claiming it was paying no sales commissions or finder's fees in connection with the offering, when, in fact, the company previously agreed to pay such commissions and fees. InterOil's concealment of such fees enabled John Thomas Financial to hype InterOil shares on CNBC and to investors without disclosing its investment banking relationship with the company.

As of July 2009, Carl Caserta still had an available, current, and active email address (carl.caserta@interoil.com) at InterOil.

Legal Claims

Your Morgan Stanley "research report" discusses the "legal claims" involved in the Todd Peters litigation and the Nikiski bankruptcy:

Legal Claims. The legal claims relate to two actions: (1) claims made by Plaintiff in a legal filing in 2008 in litigation between Phil Mulacek, Chairman and CEO of IOC, and early stage investors in certain refining equipment of predecessors to IOC (Peters vs. Mulacek) over ownership interests in IOC stock, and (2) a Bankruptcy court ruling and selected findings/statements (In re Nikiski Partners). We believe that both cases pose immaterial risks to IOC and reporting of selected facts in Plaintiff’s filings and statements from Bankruptcy action can be misleading. IOC has likely reached a similar conclusion, as it has not reserved any contingent liabilities.

[Snip]

Damages sought in the case vary depending on IOC’s share price; however, in the most recent AIF, the company states that actual damages could exceed $125MM. Plaintiffs also seek unspecified punitive damages, attorneys’ fees, expenses and court costs. The case is set for trial in October 2010.

The Judge already ruled that the Nikiski bankruptcy case was filed in "bad faith" and that case was dismissed. Mulacek put Nikiski into bankruptcy to avoid a material adverse financial exposure for InterOil. That material adverse financial exposure for InterOil still remains in the Todd Peters case, contrary to your claim that "both cases pose immaterial risks to IOC."

InterOil's financial disclosures contradict your Morgan Stanley "research report" claim there is no potential material adverse financial exposure to InterOil, arising from the Todd Peters litigation. 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.) [Emphasis added.]

However, your Morgan Stanley "research report" failed to alert investors that InterOil's own disclosures say investor claims in the Todd Peters case, "could have a material adverse effect on the Company or its subsidiaries."

While it is true that InterOil has "not reserved any contingent liabilities", the company disclosed a loss contingency exceeding "125,000,000." At this time, InterOil simply does not have the resources to reserve for a contingent liability exceeding "125,000,000." As of December 31, 2009, InterOil reported an unrestricted cash balance of only $46,449,819. The company's net working capital (which includes restricted cash of $22,698,829) was only "$114,535,654." InterOil would require "substantial third party financing" as revealed in the Bankruptcy Court transcript quoted below:

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.

Are you saying that Mulacek and his attorneys lied to the Bankruptcy court and we should not accept their representations to the Court as facts? If Mulacek and his attorney did in fact lie to the Bankruptcy Court, are you comfortable with the CEO of a public company, like InterOil, making false representations to the Court so long as it favorably impacts the company? Is that a business plan that you endorse for your investors reading your supposed "research" reports?

Your "research report" claims that:

Legal Actions and Statements are Not New News. The litigation is not “new,” has been under way for a number of years and has been disclosed in each IOC’s last 3 annual information forms (2007, 2008 and 2009). The act of highlighting the plaintiff’s claims (from a July 2008 court filing) and selected judicial statements in various transcripts (from a December 2009 hearing), in a sensationalistic and one-sided manner, was “new.”

While it is technically correct that the Todd Peters litigation is not "new" you seem to miss the main point of William Lobdell's report about InterOil's and Mulacek's conflicting disclosures. According to InterOil's disclosures detailed above, "...actual damages could exceed $125,000,000....." and "it could have a material adverse effect on the Company or its subsidiaries." As of December 31, 2009, InterOil reported a cash balance of only $46,449,819 and the company's net working capital (which includes restricted cash of $22,698,829) was only "$114,535,654."

What is new is that the Bankruptcy Court transcript says, "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...without substantial third party financing." As you noted above, "The case is set for trial in October 2010."

If Phil Mulacek was truthful to the Bankruptcy Court and did not commit perjury by lying under oath, InterOil failed to disclose that even a "$50 million judgment" could have a "material adverse financial effect" on the company. The company's disclosures said that a judgement exceeding "125,000,000" could have a "material adverse financial effect" on the company.

Did CEO Phil Mulacek lie to the Court and commit perjury or did InterOil lie to investors and commit securities fraud? Take your choice! In any case, lies to one venue or another don't seem to bother you or Morgan Stanley, as long as your "research reports" can keep hyping InterOil to its uninformed investors.

Your Morgan Stanley "research report" goes on to say that:

Even if Meritorious, Limited Impact to IOC. The civil case is primarily against Phil Mulacek who, directly and indirectly, owns more than 5MM shares of IOC. The value of these shares, even off Friday’s lows is likely sufficient to cover any liability.

Your claim that "Even if Meritorious, Limited Impact to IOC" conflicts with Bankruptcy Court transcripts that reveal:

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...without substantial third party financing.

In addition, your claim conflicts with InterOil's disclosure that:

...actual damages could exceed $125,000,000.

[Snip]

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.

Here again, the Morgan Stanley "research report" fails to consider both InterOil and Mulacek's representations to investors and the Courts.

Your Morgan Stanley "research reports" highlights areas where you could be wrong. See below:

Where We Could Be Wrong
• Exploration failure. IOC is proving its resource base and any exploration failure will likely delay development and impact price.
• Failure to enter LNG JV. IOC is unlikely to be able to finance LNG development and its continued exploration program w/o partners.
• PNG risks. 100% of IOC’s operating assets are located in PNG.
• Failure to enter JV (LNG or liquid stripping) before potential 2H10 liquidity shortage forces additional capital raise.

In addition to your failure to address certain issues detailed above, you also failed to highlight that you could be wrong if the Todd Peters litigation does not settle and the Plaintiffs win a substantial monetary reward. As I detailed above, "Mulacek testified that InterOil wouldn't even be able to pay a $50 million judgment."

In your research report, you write:

Attacks are left to credibility. Media attacked have focused on management credibility.... We focus on what management has accomplished.....

So it's just fine with you that any public company and its CEO can lie to investors and the courts, if there is a the slightest hope that it can make money in the future? No wonder Wall Street remains a cesspool. I guess its all about making making money - our securities laws and justice system be damned.

Respectfully,

Sam E. Antar

PS: Please take note of my disclosure below. As a convicted felon and former CPA who trains law enforcement to identify and catch white collar criminals, I feel uniquely qualified to comment about moronic "research" analysts like you who don't care about management integrity issues.

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 in researching InterOil. Fraud Discovery co-founder Barry Minkow has publicly that he has held short positions in InterOil securities.

InterOil: Deal or No Deal? Does it Matter?

Fraud Discovery Institute (co-founded by convicted felon turned fraud fighter Barry Minkow) is skeptical about a report in the Sunday Chronicle in Papua New Guinea claiming that InterOil (NYSE: IOC) entered into a Preliminary Commitment Agreement with Mitsui for developing phase one of the Elk/Antelope LNG project, subject to final ratifications.

According to Fraud Discovery's press release:

Over the past year, media outlets—citing no or anonymous sources—have reported that no less than five companies appeared to be ready to ink deals with InterOil (NYSE: IOC) to help finance a liquefied natural gas (LNG) plant in Papua New Guinea, which InterOil estimates will cost up to $7 billion.

The media sizzle of “imminent” LNG partners mirrors an InterOil-style pattern of prematurely pumping up company “news” that never quite pans out.

[Snip]

“Getting a preliminary letter of intent from any one of these companies that contains multiple ‘outs’ for either party can be likened to getting a pre-qualifying letter from an online lender when attempting to secure financing for a home,” added Mr. Minkow.  “Funding a 6 billion dollar LNG plant is another matter entirely.”

In addition, InterOil and Mitsui have not made any official confirmation about the "Commitment Agreement."

Are InterOil's potential partners living on hope?

Many short sellers, including Minkow believe that InterOil is fraudulently reporting potential oil and gas reserve estimates to manipulate the market price of its shares. The company still has no proven reserves as defined by SEC disclosure rules. Business Insider cites another short seller who claims that InterOil's own geologists say that the company is "lying" to Wall Street about its oil and gas finds.

Does it really matter if InterOil has a deal?

In any case, whether or not InterOil has found a real partner does not mean any confirmation of its claimed oil and gas finds. Back in my criminal days at Crazy Eddie, we always thrived to do business with the biggest dopes on Wall Street and elsewhere. Gullible investors living on hope are a criminal's wet dream. If InterOil's oil and gas claims don't pan out, its partners and investors will be left holding the bag.

InterOil's suspicious "heads of state" deal, later no deal with Petromin and China National Offshore Corp

On April 16, 2009, Bloomberg reported that Petromin, InterOil, and China National Offshore Corp, also known as CNOOC, reached an "initial accord" on a "proposed liquefied natural gas project" in Papua New Guinea:

China National Offshore Oil Corp., the country’s biggest offshore petroleum explorer, agreed to work with InterOil Corp. on a proposed liquefied natural gas project in Papua New Guinea.

The initial accord commits the Chinese company, InterOil and the Papua New Guinea-owned Petromin PNG Holdings Ltd. to agreeing commercial terms for the financing of the government’s stake in the project, Petromin said today in an e-mailed statement.

[Snip]

“Both InterOil and Petromin have commenced discussions with a number of major oil and gas companies to bring in a strategic partner to the InterOil project who will underwrite the project,” Petromin Managing Director Joshua Kalinoe said in the statement. “The heads of agreement now allows China National Oil to participate in that process.”

Note: Bold print and italics added by me.

A Raymond James report citing the Bloomberg article claimed that InterOil confirmed a "signed" agreement with Petromin and China National Offshore Oil:

InterOil has confirmed to us that such an agreement was indeed signed, while underscoring its preliminary nature. The agreement was in fact signed earlier this week in conjunction with the visit to Beijing by PNG’s Prime Minister Sir Michael Somare. We would point out that this is not the first time a visit by Sir Michael to a major economy has led to heightened interest from a large international energy company in the development of PNG’s energy resources.

Conflicting report by InterOil

However, on April 20, 2009, Upstream reported that InterOil contradicted earlier reports it was involved in the agreement with Petromin and China National Offshore Corp:

Papua New Guinea's state-owned company Petromin said it has signed an agreement with China National Offshore Oil Corporation (CNOOC) on co-operating in Liquid Nuigini Gas' planned liquefied natural gas project.

Petromin said the heads of agreement also included gas reserves owner InterOil, but an InterOil spokesman said InterOil was not involved in the agreement; rather it was a direct arrangement between Petromin ands CNOOC.

Note: Bold print and italics added by me.

Will history repeat itself? Reports of a deal, afterwards, no deal? In any case, criminals love investors or partners living on hope. Prospective partners may end up with a lot less oil and gas than they bargained for.

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 in researching InterOil. Barry Minkow has publicly that he has held short positions in InterOil securities.

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. [Emphasis added.]

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.)  [Emphasis added.]

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.)  [Emphasis added.]

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.