Former CEO and CFO of public telecommunications company charged in Manhattan Federal Court with defrauding investors | USAO-SDNY

Audrey Strauss, United States Attorney for the Southern District of New York, and William F. Sweeney Jr., Deputy Director in Charge of the New York Bureau of the Federal Bureau of Investigation (“FBI”), today announced the the unsealing of an indictment in Manhattan federal court accusing MICHAEL PALLESCHI, the former Chief Executive Officer of FTE Networks, Inc. (“FTE”), and DAVID LETHEM, the former Chief Financial Officer of FTE, of conspiracy, securities fraud and wire fraud, improperly influencing the conduct of an audit and aggravated identity theft. These charges stem from the defendants’ years-long scheme to inflate FTE’s revenues, conceal liabilities and expenses, and embezzle company funds. PALLESCHI was arrested this morning in the Northern District of New York and will be presented today in this district. LETHEM was arrested this morning in the Middle District of Florida and will be presented in that district today.

U.S. attorney Audrey Strauss said, “When corporate executives sell their company’s stock to the public, they are responsible under federal law for disclosing full and accurate financial information to investors. of their business. Palleschi and Lethem instead chose to lie about FTE’s finances to make the company appear financially sounder than it was, thereby defrauding FTE’s shareholders and lenders. Instead of being upfront with their investors, Palleschi and Lethem took the easy way out of making money by obscuring FTE’s true financial health with fake documents and signatures. This office is committed to ensuring the integrity of our capital markets through the rigorous enforcement of federal securities laws.

FBI Deputy Director William F. Sweeney Jr. said, “Concealing a company’s true finances from investors is not just unscrupulous business practice, but in the case of Palleschi and Lethem, as we claim today, this amounts to a federal crime. Financial fraud schemes are all too common, and in order to maintain investor confidence, we must hold accountable those who commit them.

According to the indictment unsealed today in Manhattan federal court:[1]

FTE was a telecommunications company based in Naples, Florida and Manhattan. Since December 2017, its shares have been trading on the American market NYSE. From 2014 to 2019, PALLESCHI was Chairman of the Board of FTE and its Managing Director. LETHEM held the position of Chief Financial Officer of FTE from 2014 to 2019.

Convertible Note Fraud

From 2016 to early 2019, PALLESCHI and LETHEM caused FTE to issue approximately 70 notes with an aggregate principal balance of over $22 million to private lenders which the lenders could convert into FTE common stock either on demand, or in case of default. Issuers of these convertible notes must recognize in their financial statements the liabilities and expenses that arise from the conversion features of the notes. PALLESCHI and LETHEM caused FTE to recognize only the principal amounts and resulting interest expense on the company’s books, but not the substantial liabilities and expenses arising from the conversion features of the notes.

In pursuit of the scheme, PALLESCHI and LETHEM took several steps to conceal the banknote conversion features:

Rather than providing FTE’s accountants and auditors with copies of the genuine convertible notes, defendants created fake notes with the same lenders, principal amounts and other terms as the convertible notes and delivered the fake notes to the auditors and accountants. . PALLESCHI and LETHEM have created over 35 such counterfeit notes with a total main balance of over $14 million.

PALLESCHI and LETHEM also created bogus FTE board resolutions that allegedly authorized the company to issue the convertible notes on which they forged the directors’ signatures. Defendants then provided these falsified board resolutions to FTE’s lenders.

On four occasions in June 2017, LETHEM forged the signature of a representative of FTE’s transfer agent on letters it provided to lenders. The transfer agent kept records of the owners of FTE shares and held shares that the company had not yet issued. The forged letters were intended to confirm that the transfer agent would hold a sufficient number of FTE shares in reserve to pay a convertible lender in the event that the lender decided to convert a convertible note into FTE shares. These letters protected the convertible lenders by guaranteeing that a sufficient number of shares of FTE would be available to repay the convertible notes. Convertible lenders generally required their borrowers to provide them with these letters before funding a convertible note.

PALLESCHI and LETHEM repeatedly lied to FTE auditors by falsely denying that the company had issued convertible debt. In April 2018, LETHEM falsely denied to auditors that FTE had issued two specific convertible bonds. Three days later, PALLESCHI and LETHEM repeated this false denial to the auditors in a management representation letter relating to the audit of FTE’s 2017 year-end financial statements. PALLESCHI and LETHEM also falsely denied to auditors in April 2018 and again in November 2018 that a $1.4 million note FTE entered into in April 2018 was convertible. When auditors demanded to see a copy of the $1.4 million note, LETHEM falsely claimed that its only electronic copy of the note had been lost because the electronic file had been corrupted. When listeners continued to request the note, LETHEM concealed that he had the note all along by sending the note to a company lawyer and arranged for the lawyer to send it back to him. LETHEM then forwarded the lawyer’s email to a company director, who forwarded it to the auditors with the statement that “[the attorney] found the note! When listeners then asked the lawyer to review his records for other notes, LETHEM and the lawyer incorrectly replied that the lawyer did not know or own any additional convertible notes.

As a result of this convertible note fraud, defendants caused FTE to understate its debt derivative liabilities and warrant derivative liabilities and fail to recognize losses on conversion derivative liabilities and losses on equity. issuance of notes in 2017 and 2018. For example, FTE’s 2017 year-end financial statements understated FTE’s debt derivative liabilities by $48 million and warrant derivative liabilities by $16 million. millions of dollars. FTE also failed to recognize a $35 million loss on translation derivative liabilities and a $42 million loss on note issuance for the year ending 2017.

Fraudulent recording of income

PALLESCHI and LETHEM also led FTE to recognize over $13 million in fraudulent revenue:

This fraudulent revenue included more than $10 million in “unbilled” revenue that the defendants represented that FTE had earned from services it had allegedly provided to a large customer who would not yet be accepting bills for those services. . FTE has never provided such services.

In addition, defendants caused FTE to record approximately $2.6 million as an account receivable for which there was no substantiation. When FTE auditors said the accounts receivable should be written off, PALLESCHI and LETHEM created a fake email from a client representative saying the client would “expedite payments” for more than $1.5 million for the projects completed by FTE in 2016 and 2017. The defendants had this false e-mail sent to FTE’s auditors so that FTE could continue to recognize the debt.

PALLESCHI and LETHEM had FTE recognize an additional $600,000 in accounts receivable for work that the defendants falsely claimed FTE performed. When FTE’s auditor requested confirmation of this receivable from the client, LETHEM provided the auditor with the name and email address of a director of FTE who was also an employee of the client. PALLESCHI and LETHEM then tried to persuade the director of FTE to sign the confirmation, but the director refused to do so. LETHEM then emailed PALLESCHI part “should I just send plan b?” Later that day, LETHEM emailed PALLESCHI an audit confirmation containing the director’s forged signature. A few days later, LETHEM emailed the auditor a confirmation containing the director’s forged signature.

Due to defendants’ fraudulent recording of revenue, FTE’s financial statements overstated the company’s accounts receivable by 18% to 120% for each of the quarters of 2017 and 2018 and by approximately 477% for 2016.

Embezzlement of corporate funds

PALLESCHI and LETHEM also misappropriated corporate funds. This embezzlement included payments for the use of private jets, luxury automobiles, personal credit cards, unauthorized wire transfers and stock issuances. PALLESCHI and LETHEM used a bank account in the name of another entity to hide their embezzlement of corporate funds.

PALLESCHI, 46, of Naples, Fla.; and LETHEM, 62, of Fort. Myers, Florida is charged with 1) conspiracy to commit securities fraud, wire fraud, misrepresentation in SEC filings, and improperly influencing the conduct of audits, punishable by up to 5 years in prison; 2) securities fraud, punishable by up to 20 years in prison; 3) wire fraud, punishable by up to 20 years in prison; 4) improperly influencing the conduct of audits, punishable by up to 20 years in prison; and 5) aggravated impersonation, which carries a mandatory minimum sentence of 2 years in prison. The maximum potential sentences in this case are prescribed by Congress and are provided here for informational purposes only, as any sentencing of the defendants will be determined by the judge.

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Ms Strauss praised the FBI’s investigative work. Ms Strauss also thanked the U.S. Securities and Exchange Commission, which today filed a parallel civil action.

This matter is being handled by the Bureau’s Securities and Commodities Fraud Task Force. Assistant U.S. Attorneys Elisha Kobre, James McMahon and Negar Tekeei are charged with the prosecution.

The counts in the indictment are charges only and the accused are presumed innocent until proven guilty.

Sean B. Jackson