The Securities and Exchange Commission today announced fraud charges and an emergency asset freeze against an Illinois-based transfer agent and its owner whose misappropriation scheme was exposed during an SEC examination of the firm.
Transfer agents are typically used by publicly traded companies or other issuers to keep track of individuals and entities owning their stocks and bonds. Transfer agents can record changes of ownership of securities, maintain issuers’ security holder records, cancel and issue securities certificates, and distribute dividends.
In a complaint unsealed today in the U.S. District Court for the Northern District of Illinois, the SEC alleges that IST Shareholder Services and Robert G. Pearson were misusing money belonging to their corporate clients and the clients’ shareholders in order to fund their own payroll and business obligations. Pearson admitted to the scheme during questioning by SEC examiners, and the agency subsequently filed an emergency action to obtain an asset freeze and place control of the firm under a third-party receiver appointed by the court.
IST Shareholder Services is registered with the SEC as a transfer agent under the name of Illinois Stock Transfer Company.
“Transfer agents perform a critical function in the securities markets and are entrusted with millions of dollars in client funds and securities,” said Tim Warren, associate director of the SEC’s Chicago Regional Office. “We allege that Mr. Pearson and IST committed a serious violation of that trust.”
According to the SEC’s complaint, Pearson misappropriated more than $1.3 million during the past two years from an IST bank account holding the funds of clients who use IST as a paying agent to make cash disbursements to shareholders. The account also holds money belonging to shareholders who sent IST dividend reinvestment checks in order to purchase additional securities. When reviewing account records, SEC examiners discovered several unusual transactions that appeared to be related to IST’s own payroll rather than transfer agent activities. When asked why it appeared that payroll payments were being made out of an account holding customer funds, Pearson initially said that the local suburban bank holding IST’s general operating account could not handle making direct deposits for payroll, so he utilized that account for the direct deposit function. When asked whether IST generated enough of its own revenue in the customer account to cover those payroll expenses without siphoning customer funds, he responded by saying “probably not.” In later interviews, it became clear that Pearson used funds from the account to meet payroll and payroll tax expenses because IST simply had not earned enough income to cover its business expenses. The income setbacks were attributed to a number of factors including the loss of several clients and unanticipated expenses related to the relocation of the office. Pearson claimed that he originally intended to repay the funds he took from the account, but lacked the funds to make full repayment in a timely manner.
The SEC’s complaint further alleges that under Pearson’s direction, IST committed multiple violations of the SEC’s transfer agent rules. IST failed to safeguard funds and securities and did not properly report lost and stolen securities. The firm did not file an accurate annual study and evaluation of internal accounting controls, and it failed to give notice of assumption and termination of transfer agent services.
The SEC’s complaint alleges that IST and Pearson violated Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5(a) and 10b-5(c). The complaint further alleges that IST violated Section 17A(d)(1) of the Exchange Act and Rules 17Ad-12, 17Ad-13, 17Ad-16, and 17f-1. The complaint charges Pearson with aiding and abetting those violations.
The SEC’s investigation was conducted by Tracy Lo and Steven Klawans of the Chicago Regional Office. The examination that led to the investigation was conducted by Antonita Caraan, Stephen Vilim, George Jacobus, Paul Mensheha, Laury Cornell, and Edwina Barlow. The SEC’s litigation will be led by Daniel Hayes.