Part 1: Understanding round-tripping in the capital markets

By Christine Duhaime | August 6th, 2022

Part 1

SEC files rare round-tripping enforcement action against Canadian issuer

We tend to think of round-tripping as tax evasion round-tripping tied to FDI, where investments are routed through a no tax jurisdiction before being reimported into the economy of origin as FDI. Mauritius comes to mind, because billions of dollars are round-tripped there every year, from India and emerging nations of Africa. The FATF has cautioned Mauritius about this type of activity.

But before there was sophisticated tax-evasion round-tripping, local capital markets had their own version of round-tripping, with new public companies inflating sales or revenues, to increase valuations to sell stock and dump it on unsuspecting investors. Round-tripping is as old as the capital markets themselves but for some reason, in the last 50 years, it has rarely been prosecuted.

That is until recently when the Securities and Exchange Commission (“SEC“) filed a handful of enforcement actions specifically addressing round-tripping, some involving Canadians.

Round-tripping is frequent and yet so infrequently addressed in the law, that we’ve decided to cover it in a two part series.

In Part 1, here, we discuss what round-tripping is and a recent SEC enforcement action. In Part 2, we explore the world’s most famous round-tripping case involving a mysterious man from Asia named Hady Hartanto.

What is round-tripping?

Round-tripping is a scheme involving financial transactions of public companies. It literally means money that went around and ended up at the same place (it went around in a circle), but deceptively, so that it appears to those not-in-the know that new money came in, when the same money re-enters an issuer. A round-trip involves several financial transactions, and combined, we use the term round-tripping.

Round-tripping happens frequently enough with little issuers – they do it to inflate their sales and revenues artificially to deceive banks, investors and analysts. Issuers may also round-trip to obtain a loan from a financial institution, and insiders sometimes take money from an issuer and circle it around to acquire securities using the issuer’s own money (instead of their own).

In terms of money laundering, round-tripping usually goes hand-in-hand with trade-based money laundering. To round-trip to deceive, the issuer has to fabricate invoices and sales to move the money, and that part of round-tripping is trade-based money laundering. The underlying crime is fraud (fraudulent financial statements, false documentation to obtain credit, etc.), and the proceeds are proceeds of crime, and thus the financial transactions are laundered funds.

SEC case involving round-tripping

In June, the SEC filed a claim against Mark Korb (“Korb“), the CFO of a Canadian issuer called Petroteq Energy Inc. (“Petroteq”), listed on the TSXV, OTC and Frankfurt exchanges. The CEO of Petroteq was Aleksandr Blyumkin (“Blyumkin”). 

Korb was charged by the SEC with multiple failures to disclose material information to investors, including executive compensation, related party transactions and mining rights.  

Failures to Disclose Related Party Transactions

In 2013, business associates of Blyumkin began buying shares of Petroteq, accumulating 8.96% of Petroteq’s shares and as a result of owning that amount of securities, became its control person (the “Control Group”).

That Control Group acquired mining rights from third parties on certain federal land leases in Utah for $275,000 and then flipped the mining rights to Petroteq for $23.8 million, meaning that the issuer’s own control person entered into a non-arms length deal and made over $23 million. Petroteq filed a Form 10-K, that was certified, which failed to disclose that the transaction was a related party transaction with its control person, and that the Control Group had an interest in the transaction.

Money From Acquisition of Mining Rights Round-Tripped

Petroteq acquired the mining rights in two transactions from the Control Group.  In the first transaction, Petroteq acquired a 50% interest from Vendor A for $10.8 million, satisfied with a $1.8 million cash payment and the remainder in Petroteq shares. It then acquired the remaining 50% interest from Vendor B for $13 million, satisfied with payments in cash and Petroteq shares. 

Most of the $1.8 million cash that Petroteq paid to Vendor A for mining rights was returned (round-tripped) to Petroteq and to Blyumkin. Blyumkin directed that $1.4 million paid by Petroteq be wired to two companies in the Control Group.  These two companies then wired $1.39 million back to Petroteq to buy its shares. The result was that the same money came in, went out and came back in. Issuers cannot round-trip in this manner.

There is a lot more to the civil case against Korb than round-tripping, including in respect of related party disclosure, which can be read here, and it is highly recommended for Vancouver CFOs and auditors.

Criminal round-tripping

Round-tripping can be dealt with criminally as well.

In USA v. Vitaly Fargesen and Igor Palatnik (involving the cannabis issuer Canadian CanaFarma), two CanaFarma control persons were charged for raising money from investors on false statements, lying about having cannabis facilities and creating bogus deals to round-trip money around to create fake revenue for the issuer. They were hoping that by round-tripping using fake deals for technology, the stock price would increase and because they were the control persons, their stock holdings would be more valuable and they could cash out.

The auditor signed off on round trip transactions but likely was not aware of round-tripping risks or how to detect them.

YouTube Channel of SAExploration

In another case, USA v. Whiteley, the CFO of SAExploration, a well-known public oil and gas company was charged for round-tripping $12 million through several companies to create the illusion of having sales on the books in order to qualify for a corporate loan. In doing so, he certified to false financial statements which were filed with the SEC. The CFO pled guilty to securities and wire fraud and at his plea hearing, stated that he understood that he faced a 90 year jail sentence.

Stay tuned for Part 2, where we review the most famous round-tripping case involving a mysterious man from Asia.

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