SEC charges former CEO and CFO of FTE Networks, Inc with accounting fraud
Today, July 15, 2021, the Securities and Exchange Commission (the “SEC”) charged the former CEO and CFO of FTE Networks, Inc. (“FTE”), a network infrastructure company formerly based in Naples, Florida, with conducting a multi-year accounting fraud.
The alleged scheme involved inflating the company’s revenues for certain periods by as much as 108 percent, the misappropriation of millions of dollars of company funds for personal use, and concealing the then NYSE-listed publicly-traded company’s issuance of almost $23 million in convertible notes.
According to the SEC’s complaint, from 2016 to 2019, Michael Palleschi and David Lethem, the former CEO and CFO, respectively, of FTE, directed the company to issue approximately $22.7 million in convertible notes with short-term maturities, steep interest rates, and market-price-based formulas for conversion into FTE shares, either upon demand or upon default.
Palleschi and Lethem then took several steps to conceal the notes and their conversions, including:
- Rather than provide FTE’s accountants and auditors with copies of the actual convertible notes, the defendants created more than 35 fake notes from the same lenders, using the same terms, totaling $14 million, to the auditors and accountants.
- Palleschi and Lethem created fake resolutions of FTE’s Board of Directors that purportedly authorized the company to issue the convertible notes on which they forged the Directors’ signatures. The defendants then provided these forged Board resolutions to FTE’s lenders.
- On four occasions in June 2017, Lethem forged the signature of a representative of FTE’s transfer agent on letters that he provided to lenders. The transfer agent kept records of who owned FTE’s stock and held stock shares that the company had not yet issued. The forged letters purported to confirm that the transfer agent would hold a sufficient number of shares of FTE’s stock in reserve to pay a convertible lender if the lender decided to convert a convertible note into FTE stock. These letters protected convertible lenders by ensuring that enough shares of FTE’s stock would be available to pay off the convertible notes.
As a result of this fraud with respect to convertible notes, the defendants caused FTE to understate its debt derivative liabilities and warrant derivative liabilities and to fail to recognize losses on conversion derivative liabilities and losses on the issuance of notes in 2017 and 2018. For example, FTE’s 2017 financial statements understated FTE’s debt derivative liabilities by $48 million and warrant derivative liabilities by $16 million. FTE also failed to recognize a $35 million loss on conversion derivative liabilities and a $42 million loss on issuance of notes for the year ending 2017.
The complaint also alleges that Palleschi and Lethem inflated FTE’s revenue by directing FTE to improperly recognize revenue and related accounts receivable for nonexistent construction projects. In total, Palleschi and Lethem caused FTE to recognize more than $13 million in fraudulent revenue.
According to the complaint, the fake notes, forged documents and bogus accounting were all done so that Palleschi and Lethem could embezzle millions of dollars from the company.
This embezzlement included payments for private jet use, luxury automobiles, personal credit cards, unauthorized wire transfers and stock issuances.
Palleschi and Lethem also misappropriated company funds through unauthorized salary increases.
The SEC’s complaint charges Palleschi and Lethem with violating the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and the reporting provisions of Section 13(b)(5) of the Exchange Act and Rules 13a-14, 13b2-1, and 13b2-2 thereunder, and with aiding and abetting FTE’s violations of the reporting provisions of Exchange Act Section 13(a) and Rules 12b-20, 13a-1, 13a-11 and 13a-13 thereunder, and of the books and records and internal controls provisions of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). Palleschi is also charged with violating Section 304 of the Sarbanes Oxley Act of 2002 and the proxy solicitation provisions of Section 14(a) of the Exchange Act and Rules 14a-3 and 14a-9 thereunder.
Separately, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Palleschi and Lethem for related misconduct.
Audrey Strauss, the United States Attorney for the Southern District of New York, and William F. Sweeney Jr., the Assistant Director-in-Charge of the New York Office of the Federal Bureau of Investigation (“FBI”), unsealed an Indictment in Manhattan federal court.
Palleschi was arrested this morning in the Northern District of New York. Lethem was arrested this morning in the Middle District of Florida.
Palleschi, 46, of Naples, Florida; and Lethem, 62, of Ft. Myers, Florida, are charged with 1) conspiring to commit securities fraud, wire fraud, making false statements in SEC filings and improperly influencing the conduct of audits, which carries a maximum sentence of 5 years in prison; 2) securities fraud, which carries a maximum sentence of 20 years in prison; 3) wire fraud, which carries a maximum sentence of 20 years in prison; 4) improperly influencing the conduct of audits, which carries a maximum sentence of 20 years in prison; and 5) aggravated identity theft, which carries a mandatory minimum term of 2 years in prison.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.