SEC Files Financial Fraud Action “Caught on Camera”

Using images satellite images of largely vacant land parcels, the Commission filed a financial fraud action against four former officers of Mexico’s once largest home builder, Desarrolladora Homex, T.C.V. or Homex. The photos are of land tracts where the company claimed to have built homes fr om which revenue was recognized – no homes, no sales, no revenue. The four former executives named as defendants are: Gerardo de Nicolas Gutierrez, CEO; Carlos Javier Monctezuma Velasco, CFO; Bamon Lafarga Batiz, controller and administrative and accounting officer; and Noe Corrales Reyes, manager in the operations department. Each defendant is a resident of Mexico. SEC v. de Nicolas, Civil Action No. 1:17-civ-2086 (S.D. Cal. Filed Oct. 11, 2017).

Homex, based in Culiacan, Sinaloa, Mexico, was at one time known as Mexico’s largest home builder. The firm specialized in constructing affordable, middle-class homes in Mexico. Its ADRs were listed for trading on the NYSE from 2004 through 2014. Its shares were also listed on the Mexican Stock Exchange or BMV. During that period the firm’s shares were controlled by the De Nicolas family. Gerardo de Nicolas served as CEO until his resignation in May 2016 in the wake of an announcement regarding the staff’s investigation. The firm’s CFO also resigned at that time.

The company prepared its financial statements during the period applicable here in accord with Mexican Financial Reporting Standards or MFRS. For 2012 the Homex used International Financial Reporting Standards or IFRS. In its annual report on Form 20-F for 2010 and 2011 the company prepared a reconciliation.

Revenue recognition policies at the firm – the central issue here – specified that Homex recognize revenue from a home sale only if specific criteria were met. Essentially “control” of the home had to be transferred to the buyer and it had to be probable that Homex would receive the economic benefits associated with the transaction.

During the period here the firm maintained an internal system called Sistema Integral de Administration or SIA wh ere accounting entries were recorded. The firm’s CEO strictly limited employee access to the system. Beginning in 2010 false manual entries for home sales and the related revenues and expenses were entered into the system. This materially inflated the financial results of the firm. For example, in 2010 the firm reported revenue of $18,465 million on the sale of 44,347 units. In fact revenue was only $6,456 million for 16,077. The numbers for 2011 and 2012 were inflated in a similar manner. These entries were made by Defendants Lafarga, Corrales and at lest one other Homex employee acting at the direction of Mr. Lafarga.

The fraudulent entries were tracked on manually created spreadsheets prepared by Mr. Lafargat at the direction of Mr. Corrales. These spread sheets were maintained outside the firm’s accounting systems. To conceal the manually-entered fictitious revenue numbers another employee, acting at the direction of Mr. Lafarge, manually entered corresponding false cost-of-sales and inventory information. The firm recognized revenue and expenses from homes that were never built. The fraudulent nature of the entries was readily apparent from an inspection of sites were the homes supposedly were built. For example, satellite images taken in March 2012 of one project for which revenue was recorded shows that hundreds of the units had yet to be built. A photo of the satellite image is attached to the complaint and the Litigation Release.

Key to maintaining the fraud was the creation of cash flow, generated from fictitious receivables. When Homex built and sold a home the purchase price was typically financed by a mortgage from one of two large Mexican Government-backed lending institutions. Homex usually received the loan proceeds from the lender within weeks. During the waiting period the company carried the expected payment from the lender on its books as an account receivable. Most of those receivables were fictitious since the sales were fictitious.

Defendants de Nicolas and Moctezuma caused the firm to enter into non-recourse factoring agreements with a group of at least thirteen banks to monetize its receivables. Since the sales were largely false, the factoring agreements were also false, although they were certified by the CEO and CFO of the company. All of the false financial information was reflected in filings made with the Commission and certified by the CEO and CFO.

By no later than June 2012 Homex was aware of the staff’s investigation. Nevertheless, the conduct continued. Eventually the firm tumbled into the Mexican equivalent of bankruptcy. Its CEO and CFO resigned; its shares were delisted but continue to be quoted on OTC Link. Shareholder value was essentially wiped out. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The complaint is pending. See Lit. Rel. No. 23964 (Oct. 11, 2017).

Previously, the company settled with the Commission. SEC v. Desarrolladora Homeex S.A.B. de C.V., Civil Action. No. 3:17-00432 (S.D. Cal. Filed March 3, 2017). To resolve the action the company consented to the entry of an injunction based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). The company did not agree to pay disgorgement, prejudgment interest or a penalty. The Commission considered the cooperation of the new management of the firm and the fact that what the press release calls “critical information” was furnished to the staff during its investigation as well as the continuing cooperation of the company. The Commission suspended trading in Homex shares.