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Conspiracies To Commit Fraud: Steps To Counter

The transportation company Celadon recently admitted that its executives hid financial losses by lying to investors and falsifying books, records, and accounts to artificially inflate assets. Celadon was listed on the New York Stock Exchange (NYSE). The organization agreed to pay $42.2 million in corporate restitution for securities fraud.

Quality, a wholly-owned subsidiary of Celadon that leased trucks and trailers to truck drivers, grew rapidly from 2013 to 2016, but then began to struggle financially in 2016. According to court documents, Quality "owned a significant number of a truck models with mechanical issues, which many drivers did not want to lease." Many of Quality's trucks and trailers sat idle in 2016 but were overvalued by tens of millions of dollars on Quality's books.

In 2016, Quality engaged in several trades to get rid of its old, unused trucks. Celadon and Quality's senior management team schemed to avoid disclosing millions of dollars in losses from these trades by using invoices "inflated well above market value." As a result, they falsely reported inflated profits and assets on Celadon's financial statements to the investing public.

After public allegations of misconduct surfaced, senior managers approved a memorandum in December 2016 that falsely stated the trucks were purchased and sold at fair market value, and then lied to independent auditors investigating the allegations in 2017. Celadon's auditor withdrew its audit opinion for certain financial statements, which caused Celadon's stock prices to drop and investors to lose tens of millions of dollars.

Celadon entered into a deferred prosecution agreement that will delay securities fraud prosecution for five years to give Celadon time to demonstrate good conduct. As part of the agreement, Celadon will pay a $42.2 million restitution to the shareholder victims directly and proximately harmed by its fraud. It also agreed to "implement rigorous internal controls" and cooperate with the Justice Department's ongoing investigation.

Celadon no longer employs the executives who conspired to commit the fraud. It also created a new Chief Accounting Officer position that it filled with an experienced internal audit staff member. "Celadon Group, Inc. Enters into Corporate Resolution for Securities Fraud and Agrees to Pay $42.2 Million in Restitution" justice.gov (Apr. 25, 2019).

Commentary

Securities fraud occurs when members of an organization mislead shareholders, often for financial gain. If investors buy stock at inflated prices and then the prices drop drastically, as happened in this case, or the organization goes bankrupt, investors lose their investments.

In addition to criminal charges for securities fraud, shareholders can also sue for civil breach of fiduciary duties. Because of the potential for substantial financial losses resulting from securities fraud, organizations must take every measure to prevent it.

In the above matter, audits were performed, but management misled the auditors. As a result, the auditors withdrew their opinion, causing the stock price to tumble.

Organizations should use third-party auditors to protect investors. Auditors should not only audit finances, but also fraud risk management programs and practices to make sure they are effective.

Organizations should also have policies in place to reduce the risk of conspiracies to defraud the organization and to protect whistleblowers, including reporting mechanisms that encourage employees to report suspected misconduct.

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