When a fraud is uncovered, the Securities and Exchange Commission not only wants to get the fraudsters, it also wants to get those who should have stopped the fraud: the gatekeepers. The SEC recently brought a case against an investment advisory firm and its CEO for fraudulently inflating the values of investments in the portfolio of a private fund they advised so they could attain unearned management fees. The SEC also brought a companion case against the fund’s external auditors
Chris Yoo and his firm agreed to settle fraud charges related to his failure to inform clients that they received significant fees when referring clients to invest in the fund. In addition to failing to disclose the conflict, beginning in 2011, Yoo directed the firm to withdraw purported fees that were based on fraudulently inflated investment values or were otherwise disproportionate from the fund’s actual profits. Yoo falsely claimed that the fund owned an asset that had appreciated to approximately $2 million in value. In reality, the fund owned an entirely different asset that was worth less than $200,000. As a result of Yoo’s false claim, the fund’s financial statements materially overstated the fund’s investment values. As a result of the inflated values, they withdrew nearly $900,000 in purported fees to which they were not entitled.
The SEC thought the external auditors should have caught the fraud if the auditors had properly conducted a GAAP audit.
Raymon Holmdahl and Kanako Matsumoto worked for Peterson Sullivan LLP and served as the leads on the audit of Yoo’s fund.
“Holmdahl and Matsumoto did not uncover the fraudulent activity because they failed to properly verify the fund’s assets despite having reason to question Yoo’s valuations,” said Erin E. Schneider, Associate Director for Enforcement in the SEC’s San Francisco Regional Office.
Holmdahl and Matsumoto took over the audit work after the previous auditor resigned because it disagreed with the valuation of a particular security. The old auditor could not find enough evidence of the existence of the asset or its valuation. Holmdahl and Matsumoto failed to get third party verification.
Yoo’s fund claimed to own shares in “Prime Pacific Bank” that were illiquid. The fund used a model to claim a price of $3.22 a share, more than triple the $1 purchase price. In reality, the fund owned shares in “Prime Pacific Financial Services” that traded at price between $0.27 and $0.70 during the relevant period. A third party verification should have caught this name mistake.
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