On Sept. 19, 2013, GeoInvesting blew the whistle on L&L Energy (LLEN) in an incredibly detailed report that "ranked LLEN as bad or worse" than Longwei Petroleum (LPIH), a Chinese company that Nasdaq delisted after reviewing GeoInvesting's overwhelming evidence of fraud. LPIH's shares collapsed from over $2 to less than 10 cents.
I reviewed LLEN's SEC filings and discovered an important issue that GeoInvesting missed: On Dec. 10, 2012, LLEN borrowed $3 million from Phoenician Limited without disclosing the potentially highly dilutive convertible nature of the loan for over seven months. That's in violation of federal securities laws that require immediate disclosure of such potentially dilutive financings.
LLEN first mentioned the existence of the loan in a note to its fiscal 2013 Q3 10-Q (filed March 11, 2013). In the note, LLEN disclosed that it borrowed $3 million from an institutional investor at 12% interest:
The Company issued a Note to an institutional lender to borrow $3,000,000 loan with annual interest rate of 12%. This loan was collateralized by the loan from Bowie Resources LLC, which has more information on Note 25. (copied from Note 14, Other Payables)
LLEN then completely changed its description of this loan to a "Senior Secured Convertible Note" in Note 17 of its fiscal 2013 10-K (filed July 30, 2013):
On Dec. 10, 2012, the Company issued a Senior Secured Convertible Note (the 'Convertible Note') to Phoenician Limited ('Phoenician'), a Hong Kong company for $3,000,000 and warrants ('Investor Warrants') for a number of shares of the Company's common stock equal to 15% of the number of shares of common stock issuable under the Convertible Note, which was calculated at 290,323. The Convertible Note carries an interest rate of 12% and matures in 24 months from Dec. 10, 2012.
Both the Convertible Note and the Investor Warrants contain the same anti-dilution protection. If the Company, at any time or from time to time while the Convertible Note is outstanding, issues any common stock or common stock equivalent at a price per share that is less than the conversion price that entitle the holder thereof to acquire shares of common stock at a price per share that is less than the conversion price, then the applicable conversion price shall be adjusted to equal to the lower issuance price. The Convertible Note can be converted into shares of the Company's common stock at a conversion price $1.55.
Why did LLEN fail to disclose, for over seven months, that a $3 million note issued on Dec. 10, 2012, was in fact a convertible note, with warrants, and with reset provisions making it potentially highly dilutive? Seeking an explanation for LLEN's failed disclosure, I repeatedly confronted both LLEN's management and securities counsel via a series of emails and phone calls from Oct. 14-18, 2013.
On Oct. 16, LLEN V.P. Clayton Fong responded via telephone that:
The compliance issues around the disclosures were run by our lawyers, and what I am telling you is that we ran them by our lawyers and our lawyers were fine with the way it was disclosed and they don't see a problem with it. As far as we are concerned, we don't have a compliance issue.
Fong then recommended that if I still wished to challenge LLEN's disclosure I should contact Darrin Ocasio, LLEN's securities counsel at Sichenzia Ross Friedman Ference, who reviewed and approved of both the 10-Q and 10-K disclosures. Does that name sound familiar?
SRFF was also the SEC counsel to Longwei Petroleum. I doubt that many investors were aware that LLEN and LPIH shared the same SEC counsel. LPIH and LLEN also both engaged the same stock promoter (Redchip), boasted about having American CFOs, engaged the services of bottom tier auditors, and were spawned into public listings via reverse mergers.
Not surprisingly, SRFF failed to return any of my calls or emails. According to the following table from page 16 of the fiscal 2014 Q1 10-Q, Phoenician appears to have not yet converted any portion of its note into equity as of July 31, 2013 (activity during quarter = zero):
(Click to enlarge image)
Given the additional shares likely recently issued to Ironridge Global IV, under the terms of its potentially highly dilutive agreement, did Phoenician's conversion price reset to the lowest price of any shares issued during the recent decline in LLEN's share price? According to an email from LLEN's transfer agent, on Oct. 9, 2013 LLEN's outstanding share count had ballooned to 45,220,853. That's an increase of 6,835,803 shares from the 38,385,050 LLEN disclosed as of July 31, 2013, in its fiscal 2014 Q1 10-Q (just prior to the initial 2,588,888 million share issuance to Ironridge).
How many of these additional shares were issued to Phoenician? How many were issued to Ironridge? When will LLEN ever disclose this to investors? I warn that while LLEN management attempts to portray itself as shareholder-friendly, the repeated highly dilutive financings show that management places a very low value on its equity.
More importantly, management's failure to timely disclose the convertibility of the Phoenician financing appears to be an outright violation of federal securities laws. It's yet another reason why LLEN should be delisted from Nasdaq.