Case Study # 3:  Private Placement Due Diligence and Fraud Investigation

The Client:  A publicly traded company in the beverage industry.  The company had been created by a reverse merger with a privately held company with a public shell.  As a result of the reverse merger,  the owner of the privately held company became the largest shareholder in the company, but was not in a position of majority ownership

The company was in the middle of attempting to complete the acquisition of two (2) privately held companies and attempting to meet the Form 10 reporting requirements for its listing on the Pink Sheets.

The Task:  Oversee the completion of the two (2) acquisitions and the operations of the finance department.  Additionally the company was seeking to raise expansion capital.

Issues:  It was soon discovered that the financial statements of the company were fraudulent, and that significant fraud was being perpetrated by the largest shareholder in the company.

Coral Capital Partners was retained to provide Chief Financial Officer (CFO) services and membership on the board of directors.  A member of Coral’s management was appointed Chief Financial Officer (CFO) of the company and as a member of its board of directors.  It was soon discovered that the two (2) privately held companies were on the verge of terminating their acquisition agreements due to delays in closing the transactions. Efforts were immediately made to get the two (2) acquisitions back on track and ready for closing.

As the work on the acquisitions was nearing completion it was discovered it was not possible to verify the assets and equipment the company claimed to have in warehouse storage.  An investigation revealed that the company’s financial statements were fraudulent, and that the company’s auditor was not registered with the Public Company Accounting Oversight Board (PCAOB) as had been represented.

Further investigation revealed that the largest shareholder of the company had been involved in scheme whereby he had formed a privately held company with a similar name to the public company’s name and had been privately selling shares in the private company (after it had merged with the public company) to investors while misleading them into believing that they were purchasing shares in the public company.  It was further discovered that the largest shareholder had been using the proceeds from these stock sales for his own personal use.

Plan of Action:

Coral Capital Partners and CEO of the company notified the investment bank not to proceed with its capital raise for the company.

Coral Capital Partners along with the CEO of the company conducted an initial investigation on the activities of the largest shareholder. The investigation lasted approximately 2 weeks.  During the course of the investigation it was learned that several of the entities with which the company had signed agreements and contract with were essentially shell companies controlled by either the largest shareholder or his wife.

The initial findings were reported to the board of directors.  Within days of the report 2 members of the board of directors with previous business relationships to the largest shareholder immediately resigned, leaving the three (3) remaining directors to address the issues.

The company attempted to reach a settlement agreement with the largest shareholder (who did not have majority control) that would see an unwinding of the merger with the private company controlled by the largest shareholder.  The proposed unwinding of the merger would have resulted in a cancellation of the shares issued to the company’s largest shareholder and a return of the private company to this shareholder.

Despite its best efforts the company could not reach a settlement agreement with its largest shareholder.  It is believed he was fearful of having to explain the unwinding of the merger to the investors whom he had sold shares in the privately held company to. As a result,  the company notified the two (2) privately held companies it would be unable to complete their acquisitions.  It subsequently ceased operations and filed the appropriate notifications with Securities Exchange Commission (SEC).


Despite the disappointment of being unable to reach an agreement with the largest shareholder an unfortunate situation was prevented from being dramatically worse.  The uncovering of the fraud and its subsequent investigation resulted in termination of the two (2) acquisition, which if they had been completed could have subjected the company and its management to extension litigation and legal liability.  Additionally had the capital raise been completed,  the company, its management, and the investment bank could have been subject to extensive litigation and legal liability.  Furthermore by making the appropriate notifications to the SEC,  the company limited its exposure to potential regulatory actions.

The appropriate handling of the investigation and its subsequent reporting successfully limited the legal exposure of those who were not involved in the fraud perpetrated by the largest shareholder of the company.  A failure to have done so could have resulted in significant financial loss and career damage to the company’s officers and directors who were not involved in the fraud.  In over three (3) years since the fraud was originally discovered and reported not a single lawsuit has been filed against the company or its former management.