Instead of investing the funds in the purchase of high-quality accounts receivable as promised in the indenture, however, the company “diverted the funds to healthcare providers, many of whom they owned in whole or in part, creating shortfalls in account balances,” added the Attorney General. In all, the NCFE sold $4.4 billion worth of notes to investors between May 1998 and May 2001. The SEC estimates that $2.5 billion of that total was linked to fraud.
The eight NCFE executives are accused of fabricating data in regulatory reports, double-counting money by moving it back and forth between funds, making other false statements, and loading false data into the accounting systems to conceal the shortfalls. The trio of auditors was accused by the SEC of being aware of the possible fraud and not taking appropriate action. None of the auditors were charged in federal court — rather, their deeds were cited in an SEC administrative proceeding. The reason for that, says Robert Burson, an SEC attorney involved in the case, is SEC enforcement attorneys were seeking only a practice bar in this case, not disgorgement or fines.
The securitization agreements required an annual audit of NCFE’s consolidated financial statements. And Harbrecht and Spires admitted to the SEC that the company’s purchased receivables were one of the most significant areas of the 2000 audit. NCFE had $2.3 billion of receivables outstanding at the end of 2000, which represented 81 percent of the company’s $2.9 billion of total assets.
Nevertheless, the SEC says Harbrecht and Spires never obtained “sufficient competent evidential matter” supporting the supposed purchase of the receivables. As a result, the auditors failed to discover that NCFE’s receivables included a significant amount of ineligible, or low quality, assets.
The SEC charged that Harbrecht and Spires also devised inadequate internal-control tests, failed to design substantive audit procedures, and did not deem the “collectibility” of the receivables a significant issue, because they believed that the indenture provisions were being followed. For example, the pair assumed that only low-risk borrowers were allowed into the program, and that any receivables older than 180 days were replaced. Neither assumption turned out to be correct, however.
Similarly, the SEC asserted that because Southworth conducted the PwC audit of NCFE, he knew about the “widespread violations of the indenture agreements and also should have recognized the threats those violations posed to the noteholders’ interests.” In fact, Southworth stated in a June 1999 memo to NCFE management that there was a need to meet with the securitization trustees and investors to discuss several open issues, including not forcing providers to repurchase all receivables that have aged past 180 days, as per the indenture; inaccurately aged receivables being included on the report to investors; and ineligible receivables brought on as collateral.
In July Jon A. Beacham, one of the eight NCFE executives indicted on criminal charges, pleaded guilty to charges of securities fraud in the U.S. District Court in Ohio. Beacham was the director of securitizations at NCFE and was responsible for raising money from investors. He faces a maximum of 10 years in prison and a maximum fine of $500,000. The remaining seven defendants are slated for trial on November 5.