The Foreign Corrupt Practices Act has always been a law much broader than its name suggests. Sure, the FCPA contains anti-bribery provisions which concern foreign bribery. Sure, the FCPA’s books and records and internal controls provisions can be implicated in foreign bribery schemes.
However, the fact remains that most FCPA enforcement actions (that is enforcement actions that charge or find violations of the FCPA’s books and records and internal controls provisions) have nothing to do with foreign bribery and these provisions are among the most generic legal provisions one can possibly find.
Case in point is this recent SEC enforcement action against Medallion Financial Corp., a Delaware company headquartered in New York, NY, and its President and Chief Operating Officer, Andrew Murstein of New York, NY, with illegally engaging in two schemes in an effort to reverse the company’s plummeting stock price.
As stated in the SEC’s release:
“According to the SEC’s complaint, Medallion’s core business was making loans backed by taxicab medallions to taxicab owners and operators. However, the popularity of ride-sharing companies like Uber and Lyft led to a decline in the value of taxicab medallions and of Medallion’s stock price. Murstein and Medallion allegedly directed two separate schemes to inflate the company’s stock price, in part with the help of California-based media strategy company, Ichabod’s Cranium, Inc., and its owner, Lawrence Meyers, both of whom were also charged by the SEC with fraud.
The complaint, filed in federal district court in Manhattan, alleges that Murstein and Medallion engaged in illegal touting by paying Ichabod’s Cranium and others to place positive stories about the company on various websites, including Huffington Post, Seeking Alpha, and TheStreet.com. With Murstein’s knowledge, Meyers and others created fake identities so their opinion pieces would appear credible to potential investors. The complaint further alleges that Medallion and Murstein fraudulently increased the carrying value of Medallion Bank (the Bank), a wholly owned subsidiary of Medallion, to offset losses relating to the taxicab medallion loans. The complaint alleges that when the existing valuation firm refused to cave to Murstein’s pressure to increase the Bank’s valuation, Murstein fired the firm and hired a new firm to provide an inflated valuation of the Bank.
The SEC’s complaint charges Murstein and Medallion with violating the antifraud, books and records, internal controls, and anti-touting provisions of the federal securities laws.”
Under the heading “Books and Records and Internal Controls Violations,” the complaint alleges:
“Medallion Financial was required to make and keep books, records and accounts, which accurately reflect the values of its assets.
Medallion Financial was also required to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things transactions are executed in accordance with management’s general or specific authorization, and that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP. To this end, Medallion Financial was required to establishing procedures designed to prevent errors and irregularities.
Medallion Financial’s internal accounting controls were not properly designed to implement an appropriate valuation methodology and procedures to value Medallion Financial’s loans or the Bank consistent with GAAP. In particular, Medallion Financial’s valuation procedures did not adequately take into account the decline in the value of medallions. Furthermore, Medallion Financial did not have sufficient internal accounting controls to analyze the application of the valuation techniques being used in the valuations of the Bank to ensure they were being done on a consistent basis. And Medallion Financial’s documentation concerning its valuation decisions and reporting disclosures was inadequate.
During 2016, both Medallion Bank and Medallion Financial had loans that were collateralized by taxi medallions in both New York and Chicago. In addition to loans collateralized by medallions, Medallion Financial also owned some Chicago medallions outright. In 2016, the value of medallions was declining precipitously, but the drop was particularly significant in the Chicago medallion market.
As of September 30, 2016, the Bank and Medallion Financial valued Chicago medallions at twice their market value. Medallion Financial and Murstein knew that Medallion Financial was valuing the Chicago medallions at twice the market value because they closely monitored transactions occurring in the market place. As Medallion Financial and Murstein were aware, sufficient and readily available comparable sales data suggested that Chicago medallions had a value of $65,000 each as of September 30, 2016.
Murstein signed a valuation memo provided to the Auditor on November 9, 2016, that stated that the average sales price of a Chicago tax medallion in November 2016 was $64,700. Murstein was also aware that a comparable bank had already reduced the value of its Chicago medallions to $60,000 each based on reports it had received from an investor analyst firm.
Despite the data points cited in its valuation memo indicating a fair value of less than $120,000 each and sales transactions indicating an even lower value, Medallion Financial valued the Chicago taxi medallions it owned at $120,000 each. Medallion Financial and Murstein simply disregarded all comparable sales when calculating the fair value of the Chicago medallions in an effort to avoid materially impacting Medallion Financial’s financial statements.
Medallion Financial also failed to consider collateral value when calculating the value of its medallion-backed loans, contrary to fair-value accounting principles. As Murstein’s November 2016 valuation memorandum states, Medallion Financial calculated the value of loans at par (i.e., the amount of outstanding principal) so long as the loans were performing. Medallion Financial concluded that loans were performing if the loan payments were not more than ninety days past due and/or lacked other indicia of distress (such as bankruptcy of the borrower or troubled debt restructuring).
Given the significant decline in the value of medallions—the collateral for the loans—throughout 2016 and 2017, this valuation methodology did not approximate fair value. Medallion Financial nevertheless claimed that it reported its loans at fair value in its financial statements filed with the Commission.
Medallion Financial’s summary of significant accounting policies stated: “In determining the fair value [of the loans], the Board of Directors considers factors such as the financial condition of the borrower, the adequacy of the collateral, individual credit risks, cash flows of the borrower, market conditions for loans (e.g. values used by other lenders and any active bid/ask market), historical loss experience and the relationships between current and projected market rates and portfolio rates of interest and maturities.” (Emphasis added.)
Medallion Financial, however, failed to do such a fair value analysis, even when it was aware that both the “adequacy of the collateral” and “market conditions for loans” had deteriorated significantly. Importantly, Medallion Financial had sales data that showed the value of taxi medallions—the collateral that supported its medallion-backed loans—had declined in both of the company’s major markets, New York and Chicago. Between the end of 2014 and the end of 2017, New York medallion sales prices had declined by approximately 60 percent, and Chicago prices had declined by over 80 percent.
Medallion Financial and Murstein knew or recklessly disregarded that Medallion Financial was not carrying the medallion-backed loans at fair value but was instead significantly overvaluing the loans given their significantly increased risk profile. Medallion Financial’s reported aggregate loan-to-value ratios climbed to over 130%—meaning that the outstanding loan principal was substantially higher than the collateral value and indicating that the loan was significantly riskier. Medallion Financial and Murstein knew that other holders of medallion-backed loans had begun to mark their loans down to collateral value, even when those loans were less than 90 days past due. Medallion Financial knew that the loans were significantly riskier by 2016 and that market conditions had significantly worsened but failed to consider that changing landscape when calculating the value of its loans.
Another inaccuracy concerned the weighted average LTV ratio of the loan portfolio. The LTV ratio is material because it gives investors the ability to estimate the extent to which the loans are over- or under-collateralized. Under-collateralized loan portfolios are significantly riskier to the lender because there is not enough collateral to collect against if the debtors default on the loans. An LTV ratio greater than 100% indicates the portfolio is undercollateralized.
Medallion Financial made misleading statements regarding the method by which it calculated the LTVs for its loans in its 2017 financial statements. In both its 2016 and 2017 Forms 10-K, Medallion Financial claimed to calculate LTV ratios on a gross loan balance— meaning that the managed unrealized depreciation or allowance was not included in the calculation. The amount of managed unrealized depreciation on these loans during this time period was significant—approximately $63 million for both 2016 and 2017. For both 2016 and 2017, Medallion Financial claimed that the LTV ratios were approximately 130 percent.
In Item 1 of its Form 10-K for the year ended December 31, 2017, Medallion Financial claimed that its weighted average LTV of loans collateralized by taxi medallions was 131% compared to 129% at December 31, 2016. The Form 10-K stated that “[t]hese ratios also do not factor in the  unrealized depreciation on these loans of $62,723,000 and $63,252,000 as of December 31, 2017 and 2016, respectively.”
These statements were false and misleading. For the 2017 Form 10-K, Medallion Financial actually calculated the LTV on a net basis—meaning that the approximate $63 million in unrealized depreciation or allowance was included prior to calculating the LTV ratio.
Medallion Financial’s misstatement regarding LTV in its 2017 Form 10-K misleadingly gave the appearance that the LTV ratios remained stable, at approximately 130%, for the periods ending in 2016 and 2017.
If Medallion Financial had calculated the 2017 LTV ratio consistently with the 2016 LTV calculation, and in the way described in its 2017 Form 10-K, the LTV ratio would have been 155%. That increase in LTV ratio from approximately 130% in 2016 to approximately 155% in 2017—a significant increase in LTV ratio—would have shown the decline in the collateral supporting for Medallion Financial’s and the Bank’s loans during that time period.
As Medallion Financial’s President and Chief Operating Officer, and as head of the Investment Committee and Chief Credit Officer, Murstein knowingly or recklessly failed to ensure that Medallion Financial kept accurate books and records through the recording of inaccurate valuations for the Bank, the medallion-backed loans, Chicago medallions and LTV disclosures.
Medallion Financial failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that transactions were recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles. Murstein knowingly or recklessly aided and abetted Medallion Financial’s books and records and internal accounting controls violations.”