Ubiquity, Inc. (OTCPK: UBIQ) was the subject of a prior SA article by Investor Protection Association (IPA) on December 18, 2014. In that article, IPA concluded that Ubiquity was being touted by various penny stock promoters in classic "pump and dump" fashion, and the shares were essentially worthless. This article addresses new issues presented by Ubiquity's recent SEC filings, missing SEC filings, executive compensation and related party transactions, audit-related issues, and recent litigation.
According to the cover page of the 10-Q filed on May 4, 2016 - a late filing which covered the quarter ended September 30, 2015 - Ubiquity had 220,316,435 shares of common stock outstanding at April 18, 2016. This is noted for purposes of allowing investors to confirm the market cap calculation in the bullet above. Also, this article makes extensive references to the following Ubiquity filings: the 10-K for the year ended December 31, 2014 (the "2014 10-K," available here); Amendment No. 1 to the 2014 10-K filed on April 30, 2015 ("Amendment No. 1," available here)'; Amendment No. 2 to the 2014 10-K filed on August 7, 2015 (incorrectly titled Amendment No. 1) ("Amendment No. 2," available here); and the 10-K for the year ended December 31, 2013 (the "2013 10-K," available here).
Recent Director and Officer Resignations, Disclosures and Their Import
On June 1, 2016, Webb Blessley resigned as a member of Ubiquity's board of directors. The Form 8-K filed on June 3, 2016 stated that all contracts between Mr. Blessley and Ubiquity were rescinded as of his resignation. Mr. Blessley's resignation letter was attached as an exhibit to the 8-K, and cited personal reasons for his resignation. This 8-K was amended on June 29, 2016 to include Mr. Blessley's resignation as Secretart and Treasurer.
On June 8, 2016, Christopher Carmichael resigned as CEO, and Nicholas Mitsakos, then the co-chair of the board, was appointed Interim CEO. Ubiquity's 8-K filed on June 9 stated that Mr. Mitsakos' appointment as Interim CEO was a "part of the corporate restructuring plan of Ubiquity, Inc." Mr. Carmichael continues as Chief Creative Architect and co-chairman of the board with Mr. Mitsakos. There was no indication that Mr. Carmichael's compensation was in any way reduced in connection with his relinquishing the CEO role.
On June 10, 2016, Greg Jones - who had joined the board only four months previously - resigned as a board member. No resignation letter was attached to the Form 8-K filed June 15 with respect to Mr. Jones' resignation. However, like the 8-K filed on June 9, the 8-K reporting Mr. Jones' resignation stated that the resignation was a "part of the corporate restructuring plan of Ubiquity, Inc."
Ubiquity issued a press release on June 7, 2016 (available here) which stated that it intends to spinoff Ubiquity Studios into a standalone company. I was unable to locate any other press release or disclosure filed with the SEC stating that Ubiquity had adopted a corporate restructuring plan. Investors are left in the dark about the parameters of the restructuring plan, when it was adopted, and its expected effect on operating expenses, among other things.
As Christopher Carmichael and Connie Jordan are husband and wife, and Nicholas Mitsakos is being paid $25,000 per month for his service as co-chair, the Ubiquity board now has no independent directors and no non-management directors. This may not be a significant concern for a company that never has had an audit committee or a compensation committee, but investors who own Ubiquity stock - and lenders to Ubiquity - will understand the import of the lack of independent directors when we examine below the amounts of executive compensation paid in 2014 and 2013. And we have no idea what Ubiquity paid in 2015 executive compensation as Ubiquity has thus far failed to file its 2015 10-K and its 2015 proxy statement.
Parenthetically, the Orange County Business Journal reported on June 9, 2016 that Mr. Mitsakos had been appointed interim CEO and also cited Mr. Carmichael as the source for a statement that Ubiquity "is searching for a permanent chief executive, as well as new board members with expertise in augmented reality, virtual reality and holography…" Thus, some would say that Ubiquity understands the independent director issue and is acting on it. That effort will face some real headwinds, however, as potential directors realize the extent of actual and potential contingencies facing Ubiquity profiled below under, "Just a Little Issue: Millions in Tax Withholdings," and "Noteholder Litigation is on the Upswing."
Amendment No. 2 to the 2014 10-K reported on page 30 that Mr. Blessley was the sole independent director of Ubiquity. This differs from the original 2014 10-K and Amendment No. 1, which stated that Nicholas Mitsakos and Mr. Blessley were independent directors.
Defining Nicholas Mitsakos as "independent" when the 2014 10-K and Amendment No. 1 were filed is erroneous, to put it mildly. Why? According to the 2014 10-K, Nicholas Mitsakos and Ubiquity had entered into a "Co-Chairman of the Board of Directors Retention Agreement" on March 22, 2013, and in an amendment to that agreement on December 31, 2013, Ubiquity agreed to pay him $25,000 per month plus his stock award. In other words, when Ubiquity filed the 2014 10-K on April 15, 2015, Nicholas Mitsakos was already due or had been paid $100,000 under the co-chairman of the board director retention agreement. This "oversight" is not one with which investors should feel comfortable.
Mr. William Zimmer filed a Form 3 on December 17, 2014 (available here) which reported his position as a director of Ubiquity. However, the 2014 10-K shows the directors as being Messrs. Carmichael, Mitsakos, and Blessley, and Ms. Jordan. The Director Compensation Table on page 26 of the 2014 10-K shows the same directors, but notes the resignation of James Nelson as a director in June 2014. Neither Amendment No. 1 nor Amendment No. 2 to the 2014 10-K reported Mr. Zimmer as a former director. Ubiquity never filed Form 8-Ks reporting the addition or resignation of Mr. Zimmer from the board of directors.
Yes, The CEO and Senior Executive VP Are Married
Connie Jordan is married to Christopher Carmichael. I will refer to Ms. Jordan as Mrs. Carmichael below. This is not in derogation of her maiden name, but instead is intended to allow investors to more easily see how their relationship affects Ubiquity's ownership and control, executive compensation, and related party transactions.
The 2014 10-K, Amendment No. 1, and Amendment No. 2 disclose the spousal relationship in a one sentence entry near the end of Item 10. However, an investor who did not read the entirety of Item 10 and who read only the names and biographies of the officers and directors might conclude that Mr. Carmichael and Ms. Jordan are no more than co-workers. The same goes for an investor who read the executive compensation disclosure. So Ubiquity met the letter of the law by making the required disclosure, but let's just say that it's definitely not a fact that is given its due.
Ubiquity's Late and Missing SEC Filings
Here is a list of Ubiquity's delinquent and missing SEC filings as of now (excluding any additional 8-K's which may not have been filed, such as one covering the restructuring plan and 8-K's disclosing waivers of the code of ethics):
Event or Period Covered
DEF 14A (Proxy Stmt)
2015 Annual Meeting
April 30, 2015
Not filed to date
May 15, 2015
Nov. 16, 2015
Aug. 14, 2015
February 1, 2016
Nov. 14, 2015
May 4, 2016
March 31, 2016
Not filed to date
May 15, 2016
Not filed to date
2016 Annual Meeting
April 29, 2016
Not filed to date
Appointment of William Zimmer as a director
Note filed to date
Resignation of William Zimmer as a director
Note filed to date
Issuance of 500 shares of Series A Preferred Stock to Christopher Carmichael and Connie Jordan on March 6, 2015
March 12, 2015
Not filed to date
March 5, 2015
Not filed to date
Employment Agreement amendments of January 1, 2014 for Christopher Carmichael and
January 7, 2014
Not filed to date
Co-Chairman of the Board Director Retention Agreement of December 31, 2013 with Nicholas Mitsakos
January 7, 2014
Not filed to date
No 10-K has been filed for the 2015 year, meaning that filing is delinquent by almost three months. The failure to file the 2015 10-K is especially significant as the lack of audited financial statements deprives investors of information such as the 2015 net loss, 2015 financing transactions, and executive compensation during 2015. As outlined below, these issues were red flags in 2014 and are unlikely to have improved in 2015. However, Ubiquity's failure to file the 2015 10-K deprives investors of the information needed to make that judgment.
What Disclosures Were Given to Private Placement Investors?
According to the Statement of Cash Flows in the September 30, 2015 10-Q, Ubiquity raised over $4.2 million in the nine months ended September 30, 2015. That same 10-Q indicates that Ubiquity sold "approximately 55,164,252 shares of common stock for cash proceeds of $1,822,530" subsequent to September 30, 2015. Thus we know that in 2015 and up to an indeterminate date in 2015 or 2016, Ubiquity issued securities for a total purchase price of over $6 million. As Ubiquity had filed no registration statement, it follows that the entire $6 million was raised in private offerings.
Question: Exactly what disclosure was provided to the investors who purchased Ubiquity securities during this period? Per the prior section, we know that Ubiquity had failed to file a significant number of SEC filings in 2014 and 2015. As you will see below, we also know:
- that Amendment No. 2 contained disclosure of an accounting restatement not disclosed in the 2014 10-K, the 2014 quarterly filings, and Amendment No. 1.
- that Amendment No. 2 also disclosed for the first time a material contingency related to the Carmichaels being paid by Ubiquity in 2013, 2014 and 2015 as consultants rather than as employees, even though they were executive officers of Ubiquity.
- That executive compensation and related party transaction disclosures covering 2013 and 2014 trigger many unanswered questions and unreconciled differences.
- That Mr. and Mrs. Carmichael took voting control of Ubiquity on March 6, 2015 in a transaction not disclosed for approximately six months.
I cannot, unfortunately, describe the extent to which Ubiquity may have disclosure liability related to the $6 million raised, as I am not privy to what disclosures were provided to the investors. However, I can point to an example of Ubiquity's Share Purchase Agreement filed under cover of an 8-K on November 25, 2014 (available here). That agreement was with KBM Worldwide, Inc., a New York investor identified incorrectly as "Worldwide, Inc." in the 8-K but correctly identified in the Exhibits to the 8-K. The Share Purchase Agreement:
- Contains a Ubiquity representation and warranty stating, "The Company [Ubiquity] has timely filed all reports, schedules, forms, statements and other documents required to be filed by it with the SEC pursuant to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "1934 Act").... As of their respective dates, the SEC Documents complied in all material respects with the requirements of the 1934 Act and the rules and regulations of the SEC promulgated thereunder applicable to the SEC Documents, and none of the SEC Documents, at the time they were filed with the SEC, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. None of the statements made in any such SEC Documents is, or has been, required to be amended or updated under applicable law (except for such statements as have been amended or updated in subsequent filings prior the date hereof). As of their respective dates, the financial statements of the Company included in the SEC Documents complied as to form in all material respects with applicable accounting requirements and the published rules and regulations of the SEC with respect thereto." [Emphasis added]
- Contains a Ubiquity covenant stating, "So long as the Buyer beneficially owns the Note, the Company [Ubiquity] shall comply with the reporting requirements of the 1934 Act; and the Company shall continue to be subject to the reporting requirements of the 1934 Act." [Emphasis added]
If similar representations, warranties and covenants were included in securities purchase agreements through which the $6 million was raised, Ubiquity's board and management team should be extremely concerned about the implications of those provisions - and investors may have recourse against Ubiquity for its failure to comply with those representations, warranties and covenants. The SEC also will be very interested in disclosures not made, or not made timely, to private placement investors who provided over $6 million to Ubiquity in 2015 and perhaps into 2016.
Executive Compensation: The Sky's The Limit
According to Amendment No. 2 to the 2014 10-K, Mr. and Mrs. Carmichael (Connie Jordan) received combined total compensation of over $4 million in 2014. Sadly for them, that number reflected a decrease from 2013's combined total compensation of $7.99 million.
To be fair, the bulk of the total compensation was paid through option awards to Mr. and Mrs. Carmichael, and many of those options are now worthless given Ubiquity's stock price decline. However, the Carmichaels' combined salaries and bonuses still topped $1.3 million in 2014 and $1.0 million in 2013.
To put this in context, Ubiquity reported in Amendment No. 2 that it had at December 31, 2014:
- $389,280 in current assets
- $3.5 million in current liabilities
- $602,077 in stockholders' equity
and for 2014 had:
- $67,835 in total revenues - a decrease of 66% from 2013
- an operating loss of over $24 million
- used cash in operating activities of $7.8 million
I do not claim expertise in compensation matters, but if I were a Ubiquity investor I would be wondering why Ubiquity paid Mr. and Mrs. Carmichael so handsomely in 2014 and 2013. More to the point, I would wonder what financial or key performance indicators supported the salaries and bonuses paid. This would be even more important to me if, for example, I had purchased Ubiquity stock ((i)) on June 17, 2014 when the last sale price was $7.15 per share; ((ii)) on October 1, 2014 when the last sale price was $5.45 per share; or ((iii)) on December 31, 2014, when the last sale price was $.68 per share.
Put another way, it seems there is a very significant disconnect between Ubiquity's 2014 financial performance and stock performance, on the one hand, and the 2014 compensation paid to Mr. and Mrs. Carmichael. Again, without an audit committee or compensation committee, it appears to me that Mr. and Mrs. Carmichael have enjoyed wide latitude when it comes to their compensation. As discussed below, the same conclusion can be drawn from related party transactions with Mr. Carmichael's children and transactions between Ubiquity and its other officers.
Mr. and Mrs. Carmichael may defend their compensation by pointing out that their compensation was paid in accordance with employment agreements executed or renewed in June 2013 and March 2012, respectively. This argument, however, fails to take into account two important facts.
First, the employment agreements were executed with Ubiquity Broadcasting Corporation (UBC, the predecessor) at a time when Mr. and Mrs. Carmichael comprised 50% of the board of UBC. Likewise, when the employment agreements with Mr. and Mrs. Carmichael were amended to increase the Carmichaels' base salaries by 25% and 26%, respectively, on January 1, 2014, the board was then 50% controlled by Mr. and Mrs. Carmichael. In addition, Nicholas Mitsakos had by then become a management director, if you will, as a result of Ubiquity having agreed the day before to pay him $25,000 per month. Board approval of the Carmichaels' amendments to their employment agreements was assured, however onerous their terms.
The second important fact is that the terms were indeed onerous, in my view. The following extracts are from the descriptions of the March 1, 2015 amendments to their employment agreements in the 2014 10-K and its amendments. Commencing March 1, 2015, Mr. Carmichael:
"will receive three and a half percent (3.5%) of gross revenue from any and all corporate activities worldwide and a two and a half percent (2.5%) gross override of the book value derived from all cashless transactions. All cashless transactions are paid out as common stock."
And, in addition, commencing March 1, 2015, Mrs. Carmichael:
"will receive one and a half percent (1.5%) of gross revenue from any and all corporate activities worldwide and a three percent (3%) gross override of revenue resulting from the successful patent prosecution, litigation, settlement or actions taken by the company."
Summing up, Ubiquity is obligated to pay out a total of 5% of its gross revenue from corporate activities worldwide to Mr. and Mrs. Carmichael, not to mention 2.5% of cashless transactions in stock, and 3% of "revenue" from patent litigation. One can only hope that whoever prepared these amendments knew enough about GAAP that the amendments did not use the term "revenue," as patent litigation will not result in recognition of "revenue" unless the company is in the business of patent litigation.
Investors have no way of knowing how the amendments to the employment agreements defined "revenue" or "corporate activities worldwide," however, because Ubiquity never filed copies of the March 1, 2015 employment agreement amendments, or the prior employment agreement amendments of January 1, 2014, with the 2014 10-K, its amendments, or in Form 8-Ks (that were required under Item 5.02). The exhibits to Amendment No. 2 , for example, include the Carmichaels' employment agreements as Exhibits 10.1 and 10.2. Footnote references to these exhibits cite the original employment agreements filed in an 8-K of September 27, 2013.
The exorbitant cash, stock and "revenue" share compensation paid to the Carmichaels, and the $300,000 annual payment to Nicholas Mitsakos, are emblematic of a company with no compensation committee, no audit committee, and (as of now) no independent directors. (Note: Ubiquity stated in the so-called Super 8-K filed on September 27, 2013 that, "We intend, however, to establish an audit committee and a compensation committee of our Board in the future following the Share Exchange." As this was almost three years ago, you can see that "in the future" must be a very flexible term indeed.) If I was a Ubiquity shareholder, which fortunately I am not, I would find these self-interested transactions offensive and outrageous. And the fact that these arrangements have never been properly disclosed only increases the level of concern.
The Carmichaels Are Paid Commission-Type Compensation
To add icing on the cake, consider the following disclosure from page F-13 of the 2014 10-K:
"The Company's CEO and Senior Executive Vice President receive percentages of 5% and 1.5% for all monies obtained through capital raises, respectively. During the years ended December 31, 2014 and 2013, the CEO earned bonuses from capital raises of $403,010 and $230,563, respectively. During the years ended December 31, 2014 and 2013, the Senior Executive Vice President earned bonuses from capital raises of $120,943 and $39,168, respectively. The Company accounts for the bonuses as offsets to the proceeds raised due to the individuals involvement in obtaining the investments."
As you can see, Mr. and Mrs. Carmichael were paid over $500,000 in bonuses in 2014 and $269,731 in 2013 for their roles in raising capital for Ubiquity - that was then used to pay their combined cash salaries of over $800,000 in 2014 and over $1 million in 2013. Percentage payments such as these eliminate the safe harbor that otherwise exists to exempt officers and directors from the broker-dealer registration requirements. Accordingly, in my view, Mr. and Mrs. Carmichael are liable for acting as unregistered broker-dealers, having received percentage payments based on capital raised by Ubiquity in 2014 and 2013.
Other Carmichael Compensation Issues
Parenthetically, I note that the Summary Compensation Table on page 22 of Amendment No. 2 does not show any bonus amounts paid to Mr. and Mrs. Carmichael in 2013. (The disclosure does show the 2014 bonuses of $403,009 (one dollar off from the footnote disclosure) paid to Mr. Carmichael and the $120,943 bonus paid to Mrs. Carmichael.) This raises another unanswered question: did Mr. and Mrs. Carmichael receive total 2013 cash compensation of $1,092,970, or did they actually receive the capital raising bonuses of $269,731 in 2013 that were not disclosed in the Summary Compensation Table, thus increasing their total combined 2013 compensation to $1,362,701?
Whatever the answer to the foregoing question, I would be remiss if I failed to note one other important element of executive compensation. According to Item 13 in Amendment No. 2, Mr. and Mrs. Carmichael also received combined annual salaries of $380,000 from Sponsor Me, Inc. ("SME"), an affiliate VIE that was consolidated with Ubiquity in Amendment No. 2.
The SME salaries are listed separately from the salaries and bonuses paid to Mr. and Mrs. Carmichael by Ubiquity in the table on page 27 of Amendment No. 2. Although it appears that the SME salaries were accrued and not actually paid, disclosure in footnote 1 to the table on the bottom of page 27 states that SME paid $59,850 in benefits for Mr. and Mrs. Carmichael in 2013. The Summary Compensation Table on page 22 of Amendment No. 2 has blanks under "All Other Compensation" for 2013 for Mr. and Mrs. Carmichael. This clearly indicates the $59,850 is not included in All Other Compensation disclosure.
So perhaps the question above should be reframed to this: did Mr. and Mrs. Carmichael receive $1,092,970 in 2013 compensation or did they receive $1,422,551 in 2013 compensation?
I realize some of you may feel this analysis is overdone, but take a moment to consider materiality: the difference between the reported 2013 compensation and what Mr. and Mrs. Carmichael may have actually received is 30% of their reported cash compensation. That is material, without a doubt.
One last point: was the SME compensation paid to Messrs. Carmichael and Garrison (the CFO), and Mrs. Carmichael - whether benefits and/or salary - subject to disclosure in Ubiquity's related party transaction section of the 2013 10-K? The answer lies in the nature of the relationship. Disclosure at the time of the SME acquisition indicates SME was then 67% owned by Messrs. Carmichael and Garrison and Mrs. Carmichael, based on the share exchange ratio. Page 9 of Amendment No. 2 states that their collective ownership was 80% of SME.
As Mr. Garrison was CEO and Mrs. Carmichael was a director of SME (see page 9 of Amendment No. 2) and Messrs. Carmichael and Garrison and Mrs. Carmichael were controlling shareholders of SME, every transaction and payment above the materiality threshold in 2014 and 2013 between or among Ubiquity and SME, and SME and the Ubiquity officers in question, should have been disclosed in the 10-K, Amendment No. 1, and Amendment No. 2 pursuant to Item 404 of Regulation S-K. For smaller reporting companies, the materiality threshold is the lesser of $120,000 or one percent of the average of the smaller reporting company's total assets at year-end for the last two completed fiscal years. For Ubiquity, that number would have been $82,589 in 2014, and $91,385 in 2013 (using the corrected amounts of total assets for 2014 and 2013 in Amendment No. 2). I believe this standard was not met by Ubiquity, although the disclosure is so opaque that perhaps they have an argument for having done so.
Speaking of Materiality and Missing SEC Filings...
Item 406 of Regulation S-K requires companies - including smaller reporting companies - to disclose any waiver of the company's code of ethics in either an Item 5.05 Form 8-K or on the company's website. If the company chooses website disclosure, it is required to state in its most recently filed 10-K that the company intends to disclose waivers on the website and the website address. In Amendment No. 2, I searched the terms "ubiquitycorp.com" (the Ubiquity website address), "waiver" and "code of ethics." Ubiquity discloses that it has a code of ethics on page 21 of Amendment No. 2, but does not provide the address of its website or any intent to disclose waivers of the code of ethics in Amendment No. 2. That leaves 8-K disclosure as the only method by which Ubiquity could have disclosed waivers of its code of ethics following its filing of the Form 8-A on October 3, 2014. If you search all Forms 8-K filed by Ubiquity in 2016, 2015, and in 2014 following October 3, 2014 (available here), you will find that Ubiquity has not filed a single Item 5.05 Form 8-K during these periods.
The disclosure requirement in Item 406 of Regulation S-K applies to the company's "principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions." Thus we know that transactions with Messrs. Carmichael and Garrison (at a minimum) were covered by the disclosure requirement in Item 5.05 of 8-K, if the transactions involved, among other things, the "ethical handling of actual or apparent conflicts of interest..." (quoted from Item 406(b)(1) of Regulation S-K).
Ubiquity may argue that it did not waive the code of ethics when it entered into the universe of related party transactions with Messrs. Carmichael and Garrison (see "Ubiquity's CFO: Millions in Credit Card Charges and More" below). A waiver is defined in Instruction 2 to Item 5.05 of Form 8-K as the "approval by the company of a material departure from a provision of the code." How the board could have approved the significant number of related party transactions with Messrs. Carmichael and Garrison that exceeded the materiality threshold for Ubiquity without waiving the code is definitely an issue. But even if the board did not feel a waiver was necessary, Item 5.05 of Form 8-K states that the company must disclose a waiver or implicit waiver of its code of ethics. An "implicit waiver" is defined as "the registrant's failure to take action within a reasonable period of time regarding a material departure from a provision of the code of ethics that has been made known to an executive officer..."
It is a matter of opinion as to which transactions with Messrs. Carmichael and Garrison involved a waiver or implicit waiver of the code. However, when analyzing this issue, investors would do well to focus on the material related party transactions with Messrs. Carmichael and Garrison disclosed in Amendment No. 2's Note 8 to the financial statements, Note 10 to the financial statements (Employment Agreements), and "Transactions with Related Persons" in Item 13. With Mr. Carmichael receiving over $400,000 in 2014 bonuses based on capital raised by Ubiquity during this period, and SC Business (owned by Mr. Garrison) having charged millions of dollars on Ubiquity credit cards in 2014 (a portion of which was paid by SC Business to SME), it seems Ubiquity should have filed a number of Item 5.05 8-K's in at least 2014 or early 2015. To the extent additional related party transactions with Messrs. Carmichael and Garrison exceeded the materiality threshold in 2015 or 2016 (up to the date of Mr. Carmichael's resignation as CEO in June, although he continues to be co-chair of the board), those transactions also should have been disclosed in an Item 5.05 8-K.
Just a Little Issue: Millions in Tax Withholdings
The IRS and the State of California might be interested in the following disclosure, which appeared for the first time in Amendment No. 2 to the 2014 10-K. This disclosure has been updated in the three 2015 10-Q's since filed by Ubiquity. Quoting from the 10-Q for the period ended September 30, 2015, as filed on May 4, 2016:
"The Company's Chief Executive Officer and Senior Executive Vice President are paid as consultants and thus the required payroll taxes are not withheld and remitted to the appropriate taxing authorities. The Company issues these individuals 1099s which represent amounts paid to them. In connection with this, the Company accrues estimated taxes and penalties due to taxing authorities in which would be potentially due if the taxing authorities were to require the Company's to pay if the individuals were deemed employees. The Company accrues the taxes at the time in which the amounts payable to the individuals is recorded. See Note 8 for discussion related to compensation either paid and/or accrued for related parties. As of September 30, 2015 and December 31, 2014, total amounts accrued related to potential payroll taxes and penalties were $844,453 and $890,623, respectively." [Emphasis added]
From this disclosure, we know that Ubiquity did not withhold federal and California payroll taxes from amounts paid to the Carmichaels at least during 2014 and in the first nine months of 2015. According to Amendment No. 2, the accrual for unpaid payroll taxes and penalties for 2013 was an additional $730,069. So we know that Ubiquity failed to withhold from the Carmichaels' compensation in 2013, 2014, and 2015.
When faced with Federal income tax and Social Security tax that is not withheld or paid, the IRS will assess the company's share of "un-withheld" and unpaid taxes against "responsible persons" of the company. The IRS calls this a Trust Fund Recovery Penalty (TFRP), a somewhat misleading term because unpaid income taxes comprise part of the amount due. The IRS states that a person will be liable for the TFRP if the person is "responsible" - that is, the person had a duty to account for, collect, and pay over the trust fund taxes to the government, and (ii) "willfully" failed to collect or pay over trust fund taxes to the government.
The persons who are exposed to the Trust Fund Recovery Penalty are listed in Part 5, Chapter 17, Section 7 of the Internal Revenue Manual (accessible here). Those persons include officers, directors, and even shareholders or another corporation that was responsible for the willful failure to collect, truthfully account for, or pay trust fund taxes. According to the U.S. Supreme Court, responsible persons include those who are responsible to perform any of the three enumerated duties - collect, truthfully account for, and pay over taxes. Slodov v. United States, 436 U.S. 238, 250 (1978).
"Willfulness is present if the responsible person had knowledge of a tax delinquency and knowingly failed to rectify it when there were available funds to pay the government." Gephart v. United States, 818 F.2d 469, 475 (6th Cir.1987). Since the disclosure of the delinquency first appeared in Amendment No. 2 filed on November 16, 2015, it is clear that Messrs. Carmichael, Garrison, Blessley and Mitsakos, and Mrs. Carmichael, knew of the tax delinquency as of sometime prior to November 16, 2015. As a practical matter, I suspect these persons knew of the delinquency well before this time.
As noted previously, the Statement of Cash Flows in the September 30, 2015 10-Q stated that Ubiquity raised over $4.2 million in the nine months ended September 30, 2015. That same 10-Q indicated that Ubiquity sold "approximately 55,164,252 shares of common stock for cash proceeds of $1,822,530" subsequent to September 30, 2015. Thus, it seems clear that Messrs. Carmichael, Garrison, Blessley and Mitsakos, and Mrs. Carmichael, knowingly failed to rectify the delinquency when funds were available. Worse for them, the TFRP is not dischargeable in personal bankruptcy proceedings - not that these folks are facing such an event.
So if Mr. and Mrs. Carmichael are later determined to be employees of Ubiquity, the company is liable for - as of September 30, 2015 - over $2.4 million in unpaid withholding taxes and penalties. And since this practice likely continued to date, it would not be surprising if the TFRP liability for these responsible persons now exceeds $3 million or more.
Just How Much Are We Talking About?
The non-withholding was first disclosed after Ubiquity's prior auditor resigned in April 2015. The then-new auditor, Harley Moore Accountancy Corporation, was only required to consider the impact of amounts not withheld in 2014 and 2013 as their audit report covered only those two years. Key questions:
1. Did this practice begin at Ubiquity in 2013, or did it also occur in UBC (the predecessor) in 2010, 2011 and/or 2012?
2. If this practice occurred in UBC, did it also occur in Sponsor Me, Inc.?
3. If so, for how many years?
Although we do not know the answers to these questions, the IRS and the California EDD will certainly seek to get to the bottom of this. If one speculated that this practice went on for a number of years in multiple entities, the total amount at issue with the IRS and California might exceed $4 or $5 million (after reducing this liability for forgiven SME salaries discussed below and associated payroll taxes). When I mentioned above that new directors might have concerns about contingencies, this is one that will likely scare the you-know-what out of any potential new directors. I know it would definitely scare me. Conversely, Mr. Blessley might think about coming back in as a director to help clean up this mess, as I believe he is going to face potential TFRP liability by virtue of serving on the board during the years he was a board member. Likewise, if Mr. Mitsakos thinks about walking away from Ubiquity, his potential TFRP liability may incline him to stick around. Like it or not, TFRP liability is like an anchor - a very, very heavy one.
Side note: Can officers of a corporation - think Mr. and Mrs. Carmichael - also be independent contractors? A great article on this topic was written in 2011 by Robert S. Schriebman, an attorney who is a California Bar certified specialist in tax law, which you can find here. I contacted Mr. Schriebman and he provided me consent to include the quotes below from the article. As Mr. Schriebman's article likely appeared contemporaneously or shortly after its copyright date, the Ubiquity directors certainly should have known how at least one very well-qualified California tax attorney viewed the issue in 2012 and thereafter.
You will see that Mr. Schriebman concludes:
"If you are an officer of a small corporation or LLC, you are by law deemed to be a 'statutory employee.' You must have federal and state employment and withholding taxes taken from your paycheck; the employer - the corporation or LLC - must pay the employer's portion of these taxes as well…Is it possible to be both an officer and an independent contractor? Not likely. The overwhelming majority of people who work as officers of a corporation or an LLC are deemed to be employees under the law. That's what being a "statutory employee" is all about. Both California and federal law say you must be an employee." [Emphasis added]
"When the EDD [California Employment Development Department] selects your company for audit and demands the production of your 1099s for the past three years, you can count on an assessment for unpaid employment and withholding taxes, several levels of penalties, together with interest on both the tax and penalty portions. Taking a 1099 as a corporate officer is just flat out wrong. You do so at [y]our peril." [Emphasis added]
These quotes summarize an accomplished tax attorney's point of view, although many of you would say that common sense tells you an officer is an employee. I have little doubt that Mr. and Mrs. Carmichael will want to argue this point, as the alternative - for them and their fellow officers and directors - will be an enormous bill for taxes and penalties owed to the Federal government and California.
Investors will want to focus on two points when evaluating this issue: (1) the actual exposure for unpaid withholding and penalties is unknown, as it is unclear how long the Carmichaels claimed "consultant" status and for which entities that status was claimed, and (2) the failure to disclose these contingent liabilities in the original 10-K and Amendment No. 1, as well as the failure to disclose this information in prior filings that are implicated once the period of non-withholding is known.
As an aside, one wonders how Messrs. Garrison, Blessley, and Mitsakos will feel once they realize the extent of their possible exposure to TFRP liabilities.
And Shareholders Get No Say on Pay
The bylaws of Ubiquity were apparently those of the predecessor shell company, Fermo Group, Inc. I base this conclusion on Ubiquity's Amendment No. 2 to the 2014 10-K, which discloses that the company's bylaws were filed as an exhibit to the S-1 (filed by Fermo) on February 27, 2012. Those bylaws indicate in Article II, Section 1, that the annual meeting of shareholders is to be held on "January 31 of each year."
Ubiquity did not become subject to Section 12(g) until the filing of the Form 8-A on October 3, 2014. Therefore, Ubiquity was not required to file proxy statements, information statements, or even notices of annual meetings with the SEC until after that date.
Since the filing of the 8-A, Ubiquity has failed to hold a 2015 annual meeting of shareholders and a 2016 annual meeting of shareholders. That the 2016 annual meeting was not held is unsurprising given the fact that Ubiquity has yet to file audited financial statements for 2015. Nonetheless, Ubiquity's failures to hold 2015 and 2016 annual meetings have deprived investors of their only opportunities to express their displeasure concerning executive compensation.
By Ubiquity violating its own bylaws, to say nothing of state law, Ubiquity has avoided putting a "say-on-pay" resolution up for a shareholder vote. Smaller reporting companies such as Ubiquity have been subject to the "say-on-pay" and "say-on-frequency" votes since shareholder meetings held on or after January 21, 2013. Ubiquity was not subject to the proxy rules until October 3, 2014, which is why - to date - it has "only" failed twice to file a proxy statement (Schedule 14A) and hold annual meetings. So while the Carmichaels and Nicholas Mitsakos continue to collect or accrue their cash, stock and (in the case of the Carmichaels) percentage compensation, shareholders are left to count their losses.
Shareholders: Why Worry About Annual Meetings? You Are Outvoted Anyway!
Shareholders who reviewed the 10-Q covering the quarter ended March 31, 2015 were in for a big surprise. Filed approximately six months late, this 10-Q contained the following disclosure on page F-15 under "Preferred Stock":
"In February 2015, the board of directors approved the designation of 500 shares of preferred stock, par value $0.001 per share, of the Company as Series A Preferred Stock. The Series A Preferred stock receive no dividends or liquidation preferences. Each share is entitled to the equivalent of 1,000,000 votes of common stock.
On March 6, 2015, the Company issued the CEO and the SEVP 250 shares each of Series A Preferred Stock. In connection with this issuance, the Company valued the shares at $295,918. The shares were valued under the provisions ASC 820 Fair Value Measurements taking into account the control premium associated with the voting provisions of the Series A. The Company expensed the value of the Series A upon issuance as there were no additional performance requirements." [Emphasis added]
The upshot is that Mr. and Mrs. Carmichael now have complete voting control over Ubiquity, as 500 shares of preferred stock carry the equivalent voting rights of 500,000,000 shares of preferred stock. So although Mr. Carmichael resigned as CEO, he and Mrs. Carmichael can vote him back in as CEO at their discretion - as they comprise 2/3rds of the board of directors and hold voting rights to 516.5 million shares of common stock via their owned shares (see notes 4 and 6 to security ownership table on page 26 of Amendment No. 2) and the preferred stock voting rights. Other shareholders hold a paltry 190,000,000 shares or less, so the Carmichaels will outvote them every time.
It is interesting that the issuance of preferred stock to Mr. and Mrs. Carmichael was undisclosed in a Form 8-K and surfaced only months after the board authorized the issuance of the shares. In a transaction of this magnitude, the 8-K which Ubiquity should have filed was required to cite events under:
- Item 1.01 (entry into a material definitive agreement outside the ordinary course of business, which was the subscription agreement with the Carmichaels)
- Item 3.02 (unregistered sales of equity securities)
- Item 3.03 (material modifications to the rights of security holders)
- Item 5.01 (change in control)
- Item 5.03 (amendments to the articles of incorporation, which in this case would have included the Certificate of Designation of preferred stock which was required to be filed with the Nevada Secretary of State; see, e.g., certificate of designation filed as Exhibit 3.1 to Form 8-K of Drone Aviation Holding Corp. on June 3, 2015)
- Item 9.01 (exhibits consisting of the certificate of designation and the subscription agreement with Mr. and Mrs. Carmichael)
Because the preferred stock was issued to Mr. and Mrs. Carmichael, each of them had to recuse themselves from the board's vote on such issuance. Shareholders therefore know that Messrs. Mitsakos and Blessley were the directors who approved the preferred stock issuance (unless one abstained and one voted in favor).
In reviewing Ubiquity's filings with the Nevada Secretary of State, I noted that the only filing made by Ubiquity, Inc. with the Secretary of State in 2015 was the "annual list" of officers and/or directors. Thus, I believe there is some question of whether the failure to file the Certificate of Designation invalidates any action taken to date in reliance on the voting rights of the preferred stock - if any such action has been taken. This might include, for example, shareholder approval (if required) of the Sponsor Me, Inc. acquisition, which closed on March 31, 2015.
Although Mr. and Mrs. Carmichael should have recused themselves from any vote (director or shareholder) on the SME acquisition, if Mr. Blessley and Mr. Mitsakos were also shareholders of Sponsor Me, Inc. (the opaque disclosure merely says Sponsor Me "has a similar shareholder group including the Company's CEO and EVP," see Note 1 on page F-4 of March 31, 2015 10-Q), then there was no disinterested director who could have approved this acquisition. And if there was no disinterested director who could have approved the acquisition, then all Ubiquity's non-interested shareholders should have been afforded the opportunity to vote on the related party acquisition. As we know, shareholders were not asked to approve or disapprove this related party acquisition at any time.
Side note: Mr. Carmichael filed a Form 13D on December 3, 2014 reporting his and Mrs. Carmichael's ownership of Ubiquity and the ownership of a related trust and LLC. No amended 13D was ever filed by Mr. Carmichael reporting the issuance of the Series A preferred stock to himself and Mrs. Carmichael, nor was their taking of voting control via the preferred stock issuance ever disclosed through an amended 13D.
Ubiquity's CFO: Millions in Credit Card Charges and More
A good place to begin this topic is to examine what Ubiquity's CFO, Brendan Garrison, has been up to using his consulting company, SC Business. According to Amendment No. 2, page F-12, SC Business charged Ubiquity $28,758 for consulting work in 2014 and $8,000 for consulting work in 2013. Questions: Why would the CFO of a public company charge his employer consulting fees on top of his salary? How could the board justify authorizing these transactions given that the CFO owes a fiduciary duty of loyalty to Ubiquity?
But this gets better. According to Amendment No. 2, Ubiquity had a receivable of $437,812 at the beginning of 2014 from SC Business, Mr. Garrison's company. During 2014, SC Business charged over $2.6 million on Ubiquity credit cards - in order to "assist the Company [Ubiquity] in accessing its credit card lines (as provided by the Carmichael family…)." [Emphasis added] From the $2.6 million in charges, SC Business paid $1.673 million back to Ubiquity, paid $738,000 to SME, and deducted over $75,000 for PayPal fees. (SME is Sponsor Me, Inc.)
The table on page 26 of Amendment No. 2 ties out the SC Business transactions with two line items. The second line from the bottom is entitled, "Receivable from SC Business." For 2014, this line item totals $1,279,681. That amount is, however, footnoted with the following:
"The substance of this receivable is that it is due from SME based on the balance being related to amounts remitted from Ubiquity to SME. See note 2 for related elimination of the related balance upon the acquisition of SME."
An educated guess would say that this disclosure means SC Business owes nothing to Ubiquity. But the last line item of the table is titled, "Amounts remitted to SME…" and that amount is listed as $609,897. Investors should be forgiven if they concluded that SC Business must owe Ubiquity the difference between the $1,279,681 listed as a receivable from SC Business and the $609,897 that is acknowledged as being an obligation of SME. Surely some entity owes Ubiquity $669,784, doesn't it?
The answer to this question is "maybe not." Consider the following sentence on page F-22 of Amendment No. 2:
"In addition, in connection with the transaction [the acquisition of SME by Ubiquity], the Company forgave notes accounts/receivables due from Sponsor Me and SC Business, Inc." [Emphasis added]
Interestingly, the amount of the debt forgiven to SC Business (as well as SME) is not disclosed. I base this statement on a search of the terms "forgive," forgave," and "cancelled" in Amendment No. 2 and the March 31, 2015 10-Q. However, Ubiquity is careful to disclose the exact amount of accrued salary (and related payroll taxes) forgiven by Mr. Garrison of $247,022 in connection with the acquisition of SME by Ubiquity. The apparently different disclosure standards used by Ubiquity are emblematic of the issues surrounding this company.
Since Ubiquity now consolidates SME with Ubiquity's financial statements, the forgiveness of SME receivables may not be a real issue. That said, to the extent that SME is a "black box" and it is not currently possible to know how the loans or advances from Ubiquity or SC Business were spent by SME in 2013 and 2014, the question of the amount of the notes and/or accounts receivable that were forgiven may turn out to be quite material to Ubiquity investors.
Summing Up SC Business
So in summary, here is what investors see: Mr. Garrison is the CFO of Ubiquity, a public company. Mr. Garrison's company, SC Business, charged Ubiquity "consulting fees." In addition, SC Business used a Ubiquity credit card to charge $2.6 million in 2014 and $1.862 million in 2013 (page F-12 of Amendment No. 2). A material portion of the funds arising from the charges was then paid over to Ubiquity, SME and, apparently, SC Business retained a portion of those funds (hence the receivable). Questions:
· Why didn't Ubiquity use its own credit cards? In other words, what business purpose was served by having SC Business use Ubiquity's credit cards?
· Why didn't Mr. Garrison act in his capacity as CFO of Ubiquity when making charges to Ubiquity's credit cards? How did he sign the charge slips - in the name of SC Business or simply "Brenden Garrison"?
· What was charged on credit cards that resulted in millions of dollars in charges? Assuming these were cash advances, which entity paid the interest charges? Or were the balances paid off in full each month?
· Did SC Business mark up the "PayPal fees" charged to Ubiquity?
· Why didn't the Carmichael family simply loan money to SME instead of using Ubiquity's credit cards and SC Business as conduits?
· Why didn't the Carmichael family guarantee credit cards in the name of SME to allow SME to directly access funds through those credit cards? If SME was unable to secure its own credit cards with a Carmichael family guarantee, why would Ubiquity have considered SME to be a good credit risk?
· Who was looking out for Ubiquity's interests if the Ubiquity directors were all shareholders of SME?
Until there is an SEC investigation of Ubiquity, investors are unlikely to learn the answers to these questions. But anytime investors see financing transactions using constructs that don't have a clearly enunciated business purpose - think Enron - investors should cast a jaundiced eye on those constructs. And when the CFO of a public company is in the eye of this hurricane, far more questions need to be asked and answered.
Other Unanswered Questions
Another item that deserves investor attention is a parenthetical entry on the last line of the table. That reads as follows:
"Amounts remitted to SME (net of approximately $232,000(2014) of amount SME owed to SC Business)" [Emphasis added]
This language indicates that SME owed SC Business $232,000 that was apparently set-off against the remittance by SC Business to SME in 2014. The question: what exactly did SC Business do that generated a SME payable for $232,000? I might have been tempted to conclude that what was kept by SC Business related to accrued salaries owed by SME to Mr. Garrison at December 31, 2014, which totaled $247,022 (page F-13 of Amendment No. 2), but the accrued salary is described as forgiven by Mr. Garrison subsequent to year-end.
Footnote 1 to the table on the bottom of page 27 states that SME paid $61,875 in benefits for Mr. and Mrs. Carmichael in 2014. The disclosure on page 28 under "Sponsor Me, Inc.," which is duplicated on page F-13, reads slightly differently. That disclosure states:
"The Company's CEO, CFO and Senior Executive Vice Presidentreceive annual salaries of $200,000, $42,000 and $180,000, respectively, in connection with services performed for SME. As of December 31, 2014, amounts payable in connection with these salaries to the CEO, CFO and Senior Executive Vice President were $1,420,863, $247,022 and $1,151,065, respectively. Subsequent to year end all amounts, including accrued payroll taxes for which payroll wasn't paid, were forgiven, see Note 14 for additional information. During the years ended December 31, 2014 and 2013 the related officers received payments and benefits of $172,101 and $156,850, respectively." [Emphasis added]
So we know that Mr. and Mrs. Carmichael received from SME $61,875 in 2014 benefits. We also know that Messrs. Carmichael and Garrison, together with Mrs. Carmichael, received from SME a total of $172,101 in payments and benefits. If this is not read carefully, one might conclude that Mr. Garrison, the CFO, received the difference of $110,226. However, the language on page 28 says "payments and benefits" of $172,101. So, pick your poison: Mr. Garrison received $110,226 in payments and benefits, (ii) Mr. and Mrs. Carmichael received the $110,226 in payments (not benefits) that were notdisclosed in footnote 1 on page 27, or some combination of clauses and (ii). Add this to the list of Ubiquity compensation disclosure failures.
Summing Up Mr. Garrison
Mr. Garrison is Ubiquity's CFO, SME's CEO before SME was acquired by Ubiquity, and the owner of SC Business. As I look across the universe of transactions in 2013 and 2014 among Ubiquity, SME, and SC Business, I am astonished by the breadth and dollar value of these transactions, and the readily apparent conflicts of interest related to Mr. Garrison acting in multiple capacities of entities with objectives that certainly were not always aligned, e.g., Mr. Garrison charging Ubiquity credit cards in his capacity as SC Business instead of doing so as Ubiquity's CFO, and remitting proceeds to SME when the charges were made on Ubiquity cards. It is equally amazing that the Ubiquity board of directors was complicit in authorizing and approving these transactions.
I also get the distinct feeling that Mr. Garrison may have indirectly realized, retained, or charged material amounts through SME and SC Business that Ubiquity should have disclosed as compensation paid to Mr. Garrison in 2013 and 2014, at a minimum. Of course, this is only a feeling. If my feeling proves to be correct, I suspect that the dollar amounts involved may be material.
The SME Defense
I anticipate that the Carmichaels and Mr. Garrison will fall back on one principal defense in response to the issues I've raised on SME in this article. That defense will be based on this disclosure from page 9 of Amendment No. 2:
"On the Closing Date, Christopher Carmichael, Connie Jordan and Brenden Garrison, owning an aggregate of 39,625,000 shares of Sponsor Me, cancelled all of their shares in Sponsor Me and were not issued any shares of Ubiquity in the Acquisition. As a further condition to the Acquisition, Christopher Carmichael, Connie Jordan and Brenden Garrison waived accrued salary owed to them in amount of $1,420,864, $1,151,065, and $247,022, respectively, which amounts represented all accrued salary owed by Sponsor Me to those three individuals."
To put this in context, the 8-K covering the SME acquisition filed on April 3, 2015, stated that the SME shareholders were issued a total of 3,878,467 Ubiquity shares in exchange for the Sponsor Me shares. The key question is how many Sponsor Me shares were exchanged for the 3,878,467 Ubiquity shares? The answer appears in Section 3.2 of the Share Exchange Agreement filed as Exhibit 2.1 to the 8-K of April 3. That section states that there were 19,392,334 shares of Sponsor Me outstanding as of the agreement's date.
So, the exchange ratio appears to have been 1:5; that is, every five (5) Sponsor Me shares were exchanged for one (1) Ubiquity share. Applying this ratio to the 39,625,000 Sponsor Me shares owned by Mr. and Mrs. Carmichael and Mr. Garrison, this means that these three officers would have received a total of 7,925,000 Ubiquity shares if they had participated in the exchange. This is not an insignificant amount, as Ubiquity's closing stock price on March 31, 2015 was $.325 per share.
Against this, I would only point out that there are several questions that I would want answered before concluding that the Carmichaels and Mr. Garrison deserve kudos for their self-sacrifices in not taking the shares:
· How much of the license fees paid by Ubiquity and/or other entities were paid out by SME as compensation to the Carmichaels and Mr. Garrison since 2010?
· How much total compensation was paid by SME to the Carmichaels and Mr. Garrison since 2010?
· Were income taxes and Social Security withheld from all compensation paid to SME officers and statutory employees from 2010 through March 31, 2015? If not, did Ubiquity assume additional contingent liabilities in the Sponsor Me acquisition for unpaid withholding and penalties on what was actually paid out in compensation? If so, how much are those contingent liabilities?
· How much of the compensation paid to the Carmichaels and Mr. Garrison was disclosed by Ubiquity in 2013, 2014 and the three months ended March 31, 2015, knowing that the companies were under common control and that the Carmichaels and Mr. Garrison owned between 67% and 80% of Sponsor Me? (Source: page 9 of Amendment No. 2.)
· How much of the advances to SME made by Ubiquity, SC Business, Max Gan (another employee who used Ubiquity's credit cards and remitted proceeds to Ubiquity), and any other party were used to pay compensation and/or benefits to the Carmichaels and Mr. Garrison from 2010 until March 31, 2015?
· Exactly how much was forgiven by Ubiquity to SME and SC Business at the time Ubiquity acquired SME?
Investors can see where I am headed with these questions. I am not suggesting that the largess demonstrated by the Carmichaels and Mr. Garrison is unwelcome; however, investors deserve to know all relevant facts before making a judgment about this issue.
On the related issue of forgiveness of accrued salaries:
1. It is easy to set a very high salary bar and later forgive that which could not be paid.
2. As Mr. and Mrs. Carmichael and Mr. Garrison were accruing annual SME salaries of $200,000, $42,000 and $180,000, respectively, how much time did they devote to SME's business from the date of Ubiquity's becoming a public company via the Fermo Group merger (September 30, 2013) through March 31, 2015? Was the value of that time deducted proportionally from their salaries paid by Ubiquity during that time period?
3. How much were Mr. and Mrs. Carmichael and Mr. Garrison paid in salaries by Ubiquity Broadcasting Corporation from 2010 to the date of the merger with Fermo Group, Inc. (the shell)?
4. How many years' salaries did the SME accruals represent?
Per the above, investors need the facts before making a judgment on the forgiveness of salaries.
Side note: When the SME acquisition was agreed upon, it would be customary - especially in acquisitions involving related parties - for Ubiquity to have obtained a valuation of SME or a fairness opinion from an investment banking firm, or both. Neither the Share Exchange Agreement nor the 8-K makes any reference to a valuation or fairness opinion having been obtained by Ubiquity. No valuation report or fairness opinion was filed as an exhibit to the 8-K.
Without some documented and independent support for SME's value and/or the exchange ratio, I am much more inclined to look skeptically on the charitable gifts of stock and accrued salaries by Mr. and Mrs. Carmichael and Mr. Garrison. This also makes me wonder if the complexity of VIE accounting drove this transaction, rather than the value of SME's business.
Finally, if Ubiquity assumed any contingent liabilities when it acquired SME such as taxes, penalties, IP lawsuits, investor suits, etc., the assumption of those liabilities would definitely have impacted any SME valuation and should have been factored into the exchange ratio by the Ubiquity board. And if each Ubiquity board member was an officer, director or shareholder of SME, that raises the specter of conflicts of interest requiring a vote on the acquisition by the unaffiliated Ubiquity shareholders.
The Carmichael Family Issues
Having already addressed comprehensively the Carmichaels' executive compensation, I do not feel it necessary to belabor the Carmichaels' related party transactions much further. However, there is one exception that demands emphasis. If you read page 27 and page F-13 of Amendment No. 2, you will see that three children of Christopher Carmichael were paid compensation by Ubiquity in 2014 and 2013. In 2014, one of the children received approximately $8,353 in 1099 income, another received 1099 income of $21,876, and another received 1099 income of $45,837. Two of the children also received 1099 income of $24,853 and $34,460 in 2013.
All three children are disclosed as receiving benefits from SME in 2014 and 2013. Those benefits totaled $40,343 in 2014 and $46,774 in 2013. This disclosure does not appear on page 27, but only on page F-13.
Conversely, the disclosure that appears only on page 27 of Amendment No. 2 is far different from that on page F-13. The disclosure on page 27 features substantially smaller amounts being expensed for two of the three children, and goes on to state that Ubiquity expensed "salary and personal expenses charged against his [her] salary" [Emphasis added] during the year in question.
This language led me to wonder if the Carmichaels had allowed Mr. Carmichael's children to use the Ubiquity credit cards to charge personal items. I suppose there may have been other ways that personal expenses were picked up by Ubiquity, but this disclosure concerns me. If the Ubiquity credit cards were used to pay any part of the childrens' personal expenses, this says more than I could ever say about the state of corporate governance at Ubiquity - and the culpability of the board of directors for this state of affairs.
A History of Late and Missing Form 3's - and Misleading Company Disclosures
On October 3, 2014, Ubiquity filed a Form 8-A by which it registered its common stock under Section 12(g) of the Exchange Act. It is that filing which subjected Ubiquity and its officers, directors, and control shareholders to the full range of Exchange Act reporting requirements. Prior to that time, Ubiquity was voluntarily filing Exchange Act reports, per Page 1 of the 2013 10-K, which had "checked the box" indicating that Ubiquity was not then required to file reports under Section 13 or 15(d) of the Exchange Act.
The general instructions to Form 3 state that the form must be filed by officers, directors and beneficial owners of 10% or more of the company's shares "no later than the effective date of the registration statement." Ubiquity registered its common stock on the Form 8-A which became effective on its filing date of October 3, 2014. Thus, the Form 3 filings were due on October 3, 2014. The table below shows the dates on which Ubiquity's officers and directors filed their Form 3's:
|Name||Position||Filing Date of Form 3|
|Christopher Carmichael1||President, CEO2 and Co-Chairman of the Board||December 2, 2014|
|Connie Jordan1|| |
Senior Executive Vice President of Intellectual Property and Director
|December 2, 2014|
|Brenden Garrison||Chief Financial Officer||December 2, 2014|
|Nicholas Mitsakos||Co-Chairman of the Board||December 10, 2014|
|Webb Blessley||Treasurer, Secretary and Director||December 2, 2014|
|William L. Zimmer||Director||December 17, 2014|
1 Christopher Carmichael and Connie Jordan are listed as husband and wife in this Form 3.
2 Christopher Carmichael resigned as CEO on or about June 9, 2016, at which time Nicholas Mitsakos was appointed Interim CEO. Christopher Carmichael remains as Co-Chair of the Board and Chief Creative Architect.
As shown in the table, the officers and directors filed their Form 3's approximately 60 to 70 days after the due date of such reports. In the 2014 10-K, the box on the cover page stating, "Indicate by check mark if disclosure of delinquent filers is not contained herein…" is checked "yes." Page 23 of the 2014 10-K states:
"Based solely upon a review of copies of such forms filed on Forms 3, 4, and 5, and amendments thereto furnished to us, we believe that as of December 31, 2014, our executive officers, directors and greater than 10 percent beneficial owners have complied on a timely basis with all Section 16(a) filing requirements."
A simple review of the Form 3's filed by Ubiquity's officers and directors would have revealed (as it did for the author) the falsity of the statement in the 2014 10-K. That false statement was repeated in Amendment No. 1 (page 24) filed on April 30, 2015, and Amendment No. 2 (page 22) filed on August 7, 2015. (Note that the cover page to Amendment No. 2 is incorrect also, referring to this filing as Amendment No. 1 beneath "Form 10-K/A," rather than Amendment No. 2.)
According to Note 9 to the financial statements contained in Amendment No. 2, Ubiquity granted 2,536,321 options during 2014. If any of these options were granted to officers and directors after October 3, 2014, then each officer and director failed to timely file a Form 4 during the remainder of 2014 related to the option grants. Likewise, the officers and directors failed to file any Form 4's in 2015 or in 2016 to date.
Ubiquity's board was expanded on February 1, 2016, by the appointment of Greg Jones to the board. At that time, Mr. Jones was issued 150,000 shares of restricted common stock pursuant to his director retention agreement. Mr. Jones never filed a Form 3 with the SEC.
Audit Firm Turnover and Dispute
As those of you who follow me know, as a professional I am reluctant to attribute the sins of clients to their professionals, and vice versa. However, I also believe in the maxim, "You are known by the company you keep."
Ubiquity's financial statements - actually then named Ubiquity Broadcasting Corporation - for 2013 and 2012 were audited by Silberstein Ungar, PLLC. Silberstein's audit report for these periods was dated April 15, 2014. Just over 90 days later, on July 24, 2014, Silberstein resigned as Ubiquity's auditor. At that time, Ubiquity appointed KLJ & Associates, LLC as the new auditor. (More on KLJ appears below.)
On June 6, 2016, the SEC filed a settled cease and desist action against Silberstein Ungar PLLC, Ronald N. Silberstein, CPA, Joel M. Ungar, CPA, Seth A. Gorback, and David A. Kobylarek, CPA. A copy of that action is available here. The introductory paragraph of the SEC order sums up this case:
"These proceedings arise out of deficient audits of financial statements of nine issuer clients by the Respondents, who issued audit reports that failed to comply with Public Company Accounting Oversight Board ("PCAOB") auditing standards. During the audits in question, each of the Respondents repeatedly engaged in improper professional conduct pursuant to Exchange Act Section 4C and Rule 102(e)(1) of the Commission's Rules of Practice that resulted in violations of applicable professional standards and demonstrated a lack of competence to practice before the Commission." [Emphasis added]
The nine issuers are not identified in the order, but seven of the nine issuers are Nevada corporations, like Ubiquity. The businesses of the issuers are described in the order, however, and therefore it is clear Ubiquity is not one of the issuers cited in the order.
The order indicates that Silberstein's client base was purchased by another accounting firm in July 2014, and that Silberstein was no longer performing audits of public companies. The order denies the firm and the individual defendants the right to appear or practice before the SEC, with a right on the part of the individual defendants to reapply after periods ranging from five years to three years.
The issues cited by the SEC in the order included the Silberstein firm's failure to perform analytic procedures (a basic audit procedure if there ever was one), failure to supervise, failure to document procedures, failure to perform engagement quality reviews, failure to comply with engagement quality review standards, and failure to examine journal entries, among other things.
These audit failures are significant, as reflected in the penalties agreed to in the cease and desist order. Naturally, one wonders if the audit failures Silberstein committed in the case of the nine issuers also might have occurred in the Ubiquity audits of 2013 and 2012. Many boards facing a situation such as this would seriously consider re-auditing the years in question, but I don't expect to see Ubiquity's board do so given Ubiquity's history of disclosure and governance failures.
Before I get to KLJ, allow me to touch on the second firm hired to audit Ubiquity's 2014 financial statements. That firm, Hartley Moore Accountancy Corporation, was engaged by Ubiquity on April 28, 2015. Hartley Moore resigned as Ubiquity's auditor on February 16, 2016. You can see the 8-K reporting the resignation here. Hartley Moore has apparently reorganized and some or all of its personnel are now affiliated with Hall and Company, Inc. It is not clear - nor has Ubiquity stated one way or the other - if the transition of personnel from Hartley Moore to Hall and Company had anything to do with Ubiquity's continuing failure to file its 2015 10-K and the 2015 audited financial statements.
The KLJ Situation
KLJ was engaged by Ubiquity to serve as its auditor on July 24, 2014, contemporaneous with Silberstein Ungar's resignation.
On April 15, 2015, Ubiquity filed the 2014 10-K. That filing included the report of KLJ dated April 15, 2015, and a typewritten signature of KLJ & Associates.
Less than a week later, Ubiquity filed an 8-K in which it reported that KLJ had resigned as Ubiquity's auditor on April 15, 2015. That 8-K also reported:
"KLJ did not issue an Auditors' Report for the fiscal year ended December 31, 2013 and did not issue an Auditors' Report to be relied upon for the fiscal year ended December 31, 2014, as discussed in further detail under Item 4.02."
"During KLJ's audit of the Company's 2014 fiscal year and through the date of this Current Report on Form 8-K, there were the following disagreements with KLJ: (1) the valuation of certain intangible assets from the beginning of the fiscal 2014 through the year then ended; and (2) the filing of the Form 10-K for the fiscal year ended December 31, 2014 prior to receiving KLJ's consent (see Item 4.02). Except as discussed above in terms of the valuation of intangible assets and such effects on the 2013 and 2014 fiscal years, and the inappropriate filing of the 2014 Form 10-K, there were no 'reportable events' as that term is defined in Item 304(a)(1)(V) of Regulation S-K." [Emphasis added]
I cannot say that the scenario described - a client filing a 10-K prior to the accounting firm providing its consent to file - has never happened before. But in 35 years as a securities attorney, I remember reading of only one other instance where a company filed audited financial statements without the auditor's consent. While this may happen from time to time, I believe this situation is extremely rare. This scenario speaks volumes about governance, controls, and "tone at the top" among Ubiquity's executive officers who authorized and/or made the filing without KLJ's consent.
Management also stated in the 8-K reporting KLJ's resignation that, "As of the date of this filing, management does not believe there will be any significant differences between the Original Filing [the 10-K] and the Amended Filing [Amendment No. 2]."
This optimistic statement proved to be a bridge too far, as evidenced in Note 13 of the financial statement footnotes in Amendment No. 2, which is titled, "Re-Audited Balances." You can see this note on pages F-18 and F-19 of Amendment No. 2. Here is a small selection of the most material changes:
· Total assets decreased to $8.23 million from $16.14 million, or by 49%.
· Stockholders' equity fell from $12.44 million to $4.5 million, or by 63.5%.
· Net loss increased from $51.95 million to $55.66 million, or by 7.1%.
How management reached its conclusion that there would be no significant differences between the two filings is unknown. If anything, this demonstrates the difficulty a management team faces when announcing its expectations for future events. When changes range from 7% to 63.5%, you can bet that these changes will be considered to be significant by investors and the SEC.
Normally, a statement about management's belief that the two filings would contain no significant differences would appear alongside a "safe harbor" statement concerning forward-looking information and a reference to related meaningful cautionary language. This 8-K, however, failed to include the safe harbor statement and references to meaningful cautionary language, so this statement does not qualify for the Private Securities Litigation Reform Act safe harbor for forward-looking information. Like so many of Ubiquity's filings, omissions of required or protective information may later come back to haunt the board of directors and officers.
Noteholder Litigation is on the Upswing
Here is a timeline of legal proceeding disclosures in the filings listed below. Keep in mind that this disclosure may be incomplete due to the 2015 10-K and the March 31, 2016 10-Q having not been filed to date. However, to give credit where it is due, you will see that Ubiquity's 10-Q covering the September 30, 2015 (the last filed) includes updated legal proceedings disclosure through April 20, 2016. To limit the size of this list, it does not include each 10-Q filed during the period from March 31, 2014 through September 30, 2015.
· March 31, 2014 10-Q
- No legal proceedings disclosed.
· March 31, 2015 10-Q
o Four shareholders settle claims regard to failure of Ubiquity to remove restrictive legends from share certificates to enable sale pursuant to Rule 144. A second settlement followed approximately four months later related to additional share certificates. The shareholders later notified Ubiquity they intended to terminate the second settlement agreement because of failure to remove restrictive legends. Ubiquity discloses, "Since the Company was not current in its filings with the SEC it was unable to remove said legend. In light of the legal inability to satisfy that provision of the Second Settlement, the Company believes it can enforce the Second Settlement and that there is no material exposure to the Company."
o Typenex Co-Investment LLC files demand for arbitration concerning breach of terms of a convertible note. Principal amount of the note is undisclosed. Arbitrator issues injunction against Ubiquity " issuing any other convertible debt with a variable interest rate; (ii) paying any cash to the holders of any other convertible notes issued by the Company; and, issuing any additional shares of stock to the holders of any other variable interest rate convertible notes issued by the Company." Typenex seeks all available remedies.
o Ubiquity enters into forbearance agreement with Avant Garde, the landlord of its office space following late payment of rent in September 2015.
· September 30, 2015 10-Q
o Kay Strategies sues Ubiquity, its officers, and its directors for various violations of federal and state securities laws related to Kay Strategies buying Ubiquity restricted stock from a third party. This action was dismissed without prejudice.
o The Typenex arbitration is held and Typenex is awarded a net amount of $617,960.42. Typenex has filed to confirm the arbitration award, but Ubiquity intends to object to confirmation and object to continuation of the previously entered injunction.
o Landlord Avant Garde sues Ubiquity to recover office space. Ubiquity was defaulted in this suit when it "failed inadvertently to timely answer the unlawful detainer suit…" Ubiquity has paid an additional $150,000 security deposit while appeal is underway.
o On March 10, 2016, Vista Capital Investments sues Ubiquity for "breach of contract, unjust enrichment, declaratory relief, promissory estoppel, fraud, negligent misrepresentation and civil conspiracy" for failure to timely repay two promissory notes totaling $150,000 after Vista declared the notes due and payable when Ubiquity allegedly failed to make timely filings with the SEC. "Vista also seeks fraud damages against Chris Carmichael, the Company's [Ubiquity's] CEO, for allegedly representing that the Company [Ubiquity] would remain current in its SEC filings if the Loans were made."
o On March 15, 2016, Justin Keener sues Ubiquity for breach of contract arising out of Ubiquity's failure to repay a $300,000 convertible note.
o On March 28, 2016, Firstfire Global Opportunities sued Ubiquity for breach of a securities purchase agreement and a $140,250 promissory note. Firstfire's suit seeks a recovery of $304,889.
o On April 8, 2016, Brett and Mark Tomberlin sued Ubiquity over failure to pay promissory notes totaling $184,450.
o On April 20, 2016, R Squared Partners sued Ubiquity and Chris Carmichael related to non-payment of a net amount of $120,250 due under a promissory note and a purchase agreement. Claims include, "breach of contract, breach of the implied covenant, unjust enrichment, specific performance, fraud, negligent misrepresentation, and civil conspiracy." The suit seeks unspecified fraud damages against Ubiquity and Chris Carmichael, and alleges that R Squared has lost "not less than" $500,000.
Investors can see that there are several trends developing in the lawsuits recently filed against Ubiquity and Mr. Carmichael. These include:
· Failure to repay convertible notes when due
· Select suits contain fraud allegations against Ubiquity and Mr. Carmichael
· Failure of Ubiquity to remain current in its SEC filings, and damages related to that failure
The number of suits filed has likely increased since April 20, 2016, as additional convertible noteholders grew tired of waiting for repayment.
Faced with these and other suits, I can speculate that Ubiquity's board of directors will be in no hurry to bring Ubiquity current in its filings with the SEC. The reason is obvious: once Ubiquity is current, it could be faced with a tidal wave of conversions and stock sales by converting noteholders and holders of restricted stock (such as the four shareholders), which could conceivably drive Ubiquity's stock price to new lows.
However, given the nature of the allegations in a number of the suits filed in March and April 2016, many convertible noteholders may decide they will never convert - which would leave Ubiquity trying to figure out a way to repay millions of dollars in debt. Put another way, the carrot of conversion might be perceived as illusory, and an undesirable result for those already experienced in the ways of this management team.
Investors are not looking for guarantees when investing in a small public company such as Ubiquity. Rather, they are looking for a compelling business strategy and platform; a commitment to execute the strategy in the best interests of shareholders; a commitment to transparency; accurate and timely disclosure; reasonable compensation related to performance; excellence in corporate governance; accountability of officers to the board, and the board to shareholders; adherence to a code of ethics and waivers for related party transactions; use of raised capital to advance the company's best interests; and a fair shot at generating superior returns.
Instead of the foregoing, Ubiquity's investors have seen Ubiquity experience multiple and material disclosure failures; missing SEC and state filings; misleading SEC filings; executive compensation that seemingly knows no limits; extensive related party transactions with affiliates and family members; financing structures with no clear business purpose; tax issues caused by classifying executive officers as 1099 personnel; and lawsuits piling up as financing sources are not repaid. I don't believe Ubiquity investors have received what they deserve - and the responsibility for this falls squarely on the officers and board members, past and present, of Ubiquity during the relevant time periods.
Per Seeking Alpha policy, on June 11 I attempted to contact Mr. Mitsakos via the general mailbox (email@example.com) and through emails to four other email addresses at Ubiquity (including two of Mr. Carmichael's) that I obtained from a lawyer who is representing one of the plaintiffs that sued Ubiquity. All of those emails were returned to me as undeliverable due to a "temporary failure." I can only assume that Ubiquity has changed its email addresses and that the general mailbox was full. However, if Mr. Mitsakos would care to comment once he reads this, I invite him to do so.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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