The Securities and Exchange Commission today charged the former CEO and CFO of FTE Networks Inc., a network infrastructure company formerly based in Naples, Florida, with conducting a multi-year accounting fraud. This 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, 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 shares. As alleged, Palleschi and Lethem misled in-house accounting personnel and FTE's outside auditor about certain material terms of the notes, which were not properly accounted for or disclosed in FTE's financial statements. 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. According to the complaint, Palleschi and Lethem misappropriated millions of dollars of company funds to pay for personal expenses, including luxury car leases, private jet services, and unauthorized salary increases.

"As alleged in our complaint, the defendants engaged in an egregious scheme to fraudulently inflate FTE's revenues to portray a false picture of the company's financial condition while misappropriating millions of dollars for their personal use," said Eric I. Bustillo, Director of the SEC's Miami Regional Office. "We are committed to holding accountable executives who provide the public with materially false financial reports and those who loot companies for their own personal gain."

The SEC's complaint charges Palleschi and Lethem with directly violating or aiding and abetting violations of antifraud, reporting, and proxy solicitation provisions of the securities laws. The complaint seeks permanent injunctions, penalties, and officer-and-director bars against Palleschi and Lethem, disgorgement and prejudgment interest, and a clawback of equity-based compensation paid to Palleschi during the alleged fraud.

Separately, the U.S. Attorney's Office for the Southern District of New York announced criminal charges against Palleschi and Lethem for related misconduct.

The SEC's continuing investigation is being conducted by Sagiv Edelman and Kathleen E. Strandell in the Miami Regional Office and supervised by Jessica M. Weissman and Glenn S. Gordon. The SEC's litigation is being led by Robert K. Levenson and supervised by Andrew O. Schiff. The SEC appreciates the assistance of the U.S. Attorney's Office for the Southern District of New York and the Federal Bureau of Investigation.

Required:

1) Identify the type of fraud committed by the CEO and CFO.

2) Discuss ways to mitigate the risk of fraud when those committing the fraud are at the very top of the organization; in this case, the CEO and CFO.

3) Discuss the organizational, cultural, and job security barriers to informing (whistle-blowing) the internal audit team that the CEO and CFO are committing fraud.

Answer rating: 100% (QA)

1 The type of fraud committed by the CEO and CFO in this case is accounting fraud They engaged in fraudulent activities to manipulate the companys financial statements including inflating revenues mis... View the full answer