PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MEMORANDUM
July 24, 2023
TO: Audit Committee of the Board of Directors, Verimark Hospitality Group Inc.
Diane Kowalski, Chair Reginald Faulkner, Member Sandra Yeung, Member
FROM: Howard Quinn, Responsible Partner, and Liam Donahue, Lead Associate
Calderwood & Harkness LLP 200 South Biscayne Boulevard, Suite 4400 Miami, FL 33131
RE: Investigation Scope Memorandum & Work Plan — Internal Investigation of Verimark Coastal Resorts LLC
MATTER NUMBER: 1021-00008
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I. Introduction and Purpose
This memorandum sets forth the scope, methodology, work plan, and staffing for the internal investigation that Calderwood & Harkness LLP ("C&H") has been retained to conduct on behalf of the Audit Committee (the "Committee") of the Board of Directors of Verimark Hospitality Group Inc. ("VHG" or the "Company"), a Delaware corporation publicly traded on the Nasdaq Stock Market (ticker: VMRK), with its corporate headquarters located at 4100 Bayshore Boulevard, Suite 1200, Tampa, FL 33611. The purpose of this memorandum is to provide the Committee with a comprehensive roadmap of the investigation, including its objectives, anticipated phases, timeline, staffing, budget, and key protocols, so that the Committee may evaluate and approve the proposed plan and provide any additional guidance at the outset of the engagement.
C&H's engagement was formalized pursuant to an engagement letter dated July 17, 2023, executed by Audit Committee Chair Diane Kowalski on behalf of the Committee. The engagement letter establishes the Committee as the client for purposes of the investigation, sets forth the terms of C&H's retention, and confirms the Committee's authority under VHG's Amended and Restated Bylaws and Audit Committee Charter to retain independent outside counsel and forensic advisors.
The investigation is being opened effective today, July 24, 2023, as marked by the issuance of document-preservation notices to VHG personnel. As discussed further in this memorandum, the document-preservation notices are being delivered today to all relevant custodians, and active evidence collection will commence immediately thereafter.
The investigation concerns potential irregularities at Verimark Coastal Resorts LLC ("VCR"), a Florida limited liability company and wholly owned subsidiary of VHG, with its principal office at 7820 Gulf Breeze Parkway, Suite 400, Destin, FL 32541. VCR operates VHG's resort-development division, which encompasses timeshare-interest sales, resort construction and management, and related hospitality services across properties located primarily in the Gulf Coast region of Florida. For fiscal year 2022 ("FY 2022"), VCR reported revenue of approximately $438.7 million, representing approximately 23.5% of VHG's consolidated revenue of $1.87 billion. Given the materiality of VCR's operations to VHG's consolidated financial results, the potential irregularities identified to date are significant and warrant thorough, independent investigation.
As set forth in detail below, the investigation will address two principal workstreams: (1) potential irregularities in VCR's revenue-recognition practices related to timeshare-interest sales, and (2) potential expense-reporting irregularities involving suspected fictitious vendor invoices and purchase orders at VCR. In addition, the investigation will encompass a broader assessment of VHG's and VCR's internal controls over financial reporting in the areas implicated by the suspected misconduct.
II. Background and Origin of the Investigation
A. HSA's Identification of Potential Material Weakness
On June 19, 2023, William "Bill" Gentry, CPA, lead engagement partner at Hargrove, Steen & Aldrich LLP ("HSA"), VHG's independent registered public accounting firm (101 East Kennedy Boulevard, Suite 3200, Tampa, FL 33602), communicated to VHG Chief Financial Officer Thomas Rhett Griffith and Audit Committee Chair Diane Kowalski that HSA had identified a potential material weakness in VCR's internal controls over financial reporting during the course of HSA's interim review of VHG's financial statements for the first fiscal quarter of 2023 (the 10-Q period ending March 31, 2023).
Specifically, HSA identified that approximately $9.8 million in timeshare-interest purchase deposits had been recorded as completed-sale revenue in Q1 2023, notwithstanding the fact that the applicable rescission periods had not expired before the close of the quarter. Under Florida Statute § 721.10, purchasers of timeshare interests are entitled to a rescission period of ten (10) calendar days following the execution of a purchase agreement, during which the purchaser may cancel the agreement without penalty and receive a full refund of all deposits. Revenue recognition for timeshare-interest sales under ASC 606 (Revenue from Contracts with Customers) generally requires that the seller have a legally enforceable right to payment and that the contract not be subject to unilateral cancellation by the customer. Where a statutory rescission right remains in effect, the sale has not been consummated for revenue-recognition purposes, and the deposit should be recorded as a liability (deferred revenue) until the rescission period has expired.
HSA's findings indicated that VCR's finance department had been booking timeshare-interest deposits as completed-sale revenue upon execution of purchase agreements, without regard to whether the ten-day rescission period had lapsed. HSA's preliminary assessment further suggested that this practice may not have been limited to Q1 2023 but may have extended to prior reporting periods. These findings raised substantial concerns about the integrity of VCR's revenue-recognition practices and about the adequacy of VCR's internal controls over financial reporting.
Mr. Gentry communicated HSA's findings to Ms. Kowalski and Mr. Griffith in a meeting held at HSA's Tampa offices on June 19, 2023. Following that meeting, HSA confirmed its findings in writing in a letter to the Audit Committee dated June 22, 2023, in which HSA indicated that it would need to consider the implications of the identified issues for its Q1 2023 interim review and for VHG's FY 2022 annual financial statements.
B. Audit Committee Action
Upon receiving HSA's communication, the Audit Committee took immediate steps to address the identified concerns. Ms. Kowalski convened a special meeting of the Audit Committee on June 26, 2023, at which the Committee discussed HSA's findings and received a preliminary briefing from VHG's General Counsel, Patricia Navarro. Ms. Navarro reported that she had conducted a limited, preliminary inquiry into the matters identified by HSA, and that her initial review had surfaced additional concerns beyond the revenue-recognition issues, specifically relating to expense-reporting irregularities at VCR, as discussed further below.
On July 10, 2023, the Audit Committee met again in executive session, without VHG management present, and resolved to retain independent outside counsel to conduct a full internal investigation into the matters identified by HSA and the additional concerns surfaced by Ms. Navarro. The Committee determined that the investigation should be conducted under the direction and control of the Committee, independent of VHG management, and that the investigation team should include both outside counsel and an independent forensic accounting firm retained under the direction of counsel.
On July 17, 2023, the Audit Committee formally engaged Calderwood & Harkness LLP to conduct the investigation, with Diane Kowalski executing the engagement letter on behalf of the Committee. The Committee selected C&H based on the firm's recognized expertise in internal investigations, white-collar defense, and SEC enforcement matters, and its experience with complex accounting-fraud investigations in the hospitality and real estate sectors.
In addition to the revenue-recognition concerns identified by HSA, the investigation will also examine indications of expense-reporting irregularities at VCR, which surfaced during the preliminary inquiries conducted by VHG General Counsel Patricia Navarro. Ms. Navarro's preliminary review identified several vendor invoices and purchase orders in VCR's records that appeared to be associated with entities that could not be independently verified as legitimate vendors. The nature and extent of these expense-reporting concerns are discussed in greater detail in Section III.B below.
C. Subjects of the Investigation
Based on the information available to date, three VCR employees have been identified as subjects of the investigation:
Garrett W. Daskine — Division President, VCR. Mr. Daskine is a 17-year VHG veteran who has served as Division President of VCR since 2016. In that capacity, he oversees all aspects of VCR's resort-development operations, including sales, finance, construction, and property management. Mr. Daskine is suspected of directing the premature revenue-recognition practices identified by HSA and of approving fictitious vendor invoices to conceal personal expenses. Mr. Daskine has retained Merritt & Dunleavy LLP (James Corwin Merritt) as individual counsel. C&H has been in communication with Mr. Merritt regarding the investigation and Mr. Daskine's status as a subject.
Nicole Prescott — Vice President of Finance, VCR. Ms. Prescott is a 9-year VHG veteran who has served as VCR's VP of Finance since 2019. She reports directly to Mr. Daskine and is responsible for overseeing VCR's financial reporting, budgeting, and accounting operations. Ms. Prescott is suspected of implementing the revenue-recognition scheme by booking timeshare-interest deposits as completed sales before the statutory rescission periods expired and by directing VCR's accounting staff to record the deposits as revenue in VCR's general ledger. Ms. Prescott has retained Langford Pace LLP (Candace O'Brien Langford) as individual counsel.
Ryan Mateo Serrano — Controller, VCR. Mr. Serrano is a 5-year VHG veteran who has served as VCR's Controller since 2020. He reports to Ms. Prescott and is responsible for day-to-day accounting operations, including accounts payable, purchase-order processing, and vendor management. Mr. Serrano is suspected of creating fictitious capital-improvement purchase orders and vendor invoices to funnel reimbursements for personal expenditures through VCR's accounts-payable system. Mr. Serrano has retained Coletti & Ruiz PA (Marco A. Ruiz) as individual counsel.
The identification of Daskine, Prescott, and Serrano as subjects is based on the information available at this early stage of the investigation. As the investigation progresses, additional individuals may be identified as subjects, and it is possible that individuals currently designated as subjects could be reclassified based on the evidence developed. C&H will keep the Committee informed of any changes to the subject designations.
III. Scope of the Investigation
A. Revenue-Recognition Irregularities (Workstream 1)
The first principal workstream of the investigation will focus on whether VCR prematurely recognized revenue from timeshare-interest purchase deposits by recording such deposits as completed-sale revenue upon execution of purchase agreements rather than upon expiration of the statutory ten-day rescission period prescribed by Florida Statute § 721.10. This workstream will address the following specific issues:
Magnitude and Duration. The investigation will seek to determine the magnitude and duration of any premature revenue recognition at VCR. Based on the information currently available, the initial focus of the revenue-recognition analysis will cover four fiscal quarters: Q3 FY 2022 (quarter ending September 30, 2022) through Q2 FY 2023 (quarter ending June 30, 2023). This time period encompasses the quarter in which HSA first identified the potential material weakness (Q1 2023) as well as the two preceding quarters and the most recently completed quarter. Depending on the evidence developed, the scope may be expanded to cover earlier reporting periods.
Properties Affected. The investigation will identify the VCR properties at which revenue-recognition irregularities occurred. Based on preliminary information, two properties are of particular concern:
• Coral Dune Resort & Residences — 14200 Emerald Coast Parkway, Destin, FL 32541 (Phase III timeshare units). Coral Dune is VCR's flagship timeshare property, and Phase III timeshare sales commenced in early 2022. Preliminary information suggests that a significant volume of premature revenue recognition occurred in connection with Phase III sales.
• Palmetto Bluff Club — 3950 Longboat Key Drive, Sarasota, FL 34228 (Phase II timeshare units). Palmetto Bluff Club is VCR's second-largest timeshare property by revenue, and Phase II timeshare sales commenced in mid-2022.
Other VCR properties may be implicated as the investigation develops, and C&H will expand its analysis as warranted.
Rescission-Period Analysis. The investigation will assess whether timeshare purchasers exercised their statutory rescission rights after revenue had already been booked, and whether the resulting revenue reversals were processed in the same quarter in which the rescission occurred or were delayed or deferred to subsequent quarters. If rescission-related reversals were systematically deferred, this would have created a persistent overstatement of revenue that carried forward across reporting periods, potentially compounding the impact on VHG's consolidated financial statements.
Rescission Rate. C&H and Crestline will evaluate VCR's rescission rate during the investigated period. Preliminary indications suggest that VCR's rescission rate during the period under review was approximately 14.3%, which is elevated compared to an industry average of approximately 11% for comparable Florida timeshare properties. The higher-than-average rescission rate, when combined with premature revenue recognition, would have amplified the magnitude of the overstatement, as a greater proportion of prematurely recognized revenue would ultimately have been reversed.
Individuals Involved. The investigation will determine the identities of the individuals who directed, implemented, or were aware of the premature revenue-recognition practices. The investigation will seek to determine, among other things, whether the premature recognition was the result of a deliberate scheme directed by senior VCR personnel, whether it reflected a misunderstanding or misapplication of applicable accounting standards, or whether it was attributable to deficiencies in VCR's internal controls.
ASC 606 Compliance. The investigation will analyze VCR's timeshare-interest revenue-recognition practices for compliance with ASC 606 (Revenue from Contracts with Customers). ASC 606 establishes a five-step model for recognizing revenue from contracts with customers, including the identification of performance obligations, the determination of the transaction price, and the timing of revenue recognition. The analysis will focus on the extent to which VCR's practices were consistent with the requirements of ASC 606 as applied to timeshare-interest sales, including the treatment of statutory rescission rights as variable consideration or contract-modification provisions.
Financial Statement Impact. The investigation will assess the impact of any overstatement on VHG's consolidated financial statements, including:
• FY 2022 consolidated revenue ($1.87 billion as reported);
• FY 2022 consolidated net income ($142.3 million as reported);
• Q1 FY 2023 interim financial statements (10-Q period ending March 31, 2023);
• Q2 FY 2023 interim financial statements (10-Q period ending June 30, 2023); and
• Any prior periods to which the scope may be extended.
SOX Implications. The investigation will evaluate the implications of any revenue-recognition irregularities for VHG's obligations under the Sarbanes-Oxley Act of 2002 ("SOX"), including:
• Section 302 (CEO/CFO certifications), which requires the CEO and CFO to certify that the Company's financial statements fairly present, in all material respects, the financial condition and results of operations of the Company, and that the signing officers are responsible for establishing and maintaining internal controls; and
• Section 404 (internal controls over financial reporting), which requires management's annual assessment of, and the independent auditor's attestation to, the effectiveness of the Company's internal controls over financial reporting.
If the investigation determines that a material misstatement exists in previously filed financial statements, VHG may need to consider the advisability of restating such financial statements, and the Committee will need to assess the implications for prior SOX certifications executed by VHG's CEO and CFO.
B. Expense-Reporting Irregularities (Workstream 2)
The second principal workstream of the investigation will focus on whether VCR personnel created fictitious purchase orders and vendor invoices for purported capital-improvement work at VCR properties and directed payments to entities controlled by or affiliated with VCR executives or their associates. This workstream will address the following specific issues:
Fictitious Vendor Activity. The investigation will seek to determine whether purchase orders and vendor invoices in VCR's accounts-payable records correspond to legitimate capital-improvement work performed at VCR properties or whether they are fictitious. VHG General Counsel Patricia Navarro's preliminary inquiry identified several vendor invoices that appeared to be associated with entities that could not be independently verified as legitimate construction or design vendors.
Vendor Entity Identification. The investigation will identify the vendor entities to which payments were directed and determine their beneficial ownership. Preliminary information suggests that at least three vendor entities may warrant particular scrutiny:
• Gulf Standard Contracting LLC ("GSC") — a Florida limited liability company believed to have been registered within the last two years. Preliminary inquiry has not identified any independent online presence, contractor licensing, or verifiable business operations for GSC.
• Clearwater Design Collective Inc. ("CDC") — a Florida corporation. Preliminary inquiry has similarly failed to identify any independent business operations, portfolio, or client references for CDC.
• Suncoast Property Services LLC ("SPS") — a Florida limited liability company. Preliminary information suggests that SPS may share a registered agent or principal office address with one or more of the investigation subjects or their family members.
C&H will conduct corporate formation and registration searches with the Florida Division of Corporations and other relevant jurisdictions, and will analyze beneficial ownership, registered agent information, and officer/director filings for each suspected entity.
Aggregate Amount and Time Period. The investigation will determine the aggregate amount of improper payments, the time period over which they occurred, and the number of fictitious transactions. Preliminary indications suggest that the suspected expense-reporting irregularities may have occurred over a period of approximately 24 months, from approximately July 2021 through June 2023. The aggregate amount of payments to the three identified vendor entities during this period has not yet been quantified but is expected to be material at the divisional level.
Fund Tracing. C&H and Crestline will trace fund flows from VCR to the suspected vendor entities and from the vendor entities to end uses, to determine whether payments were diverted for the personal benefit of VCR executives or their associates. This analysis will involve the review of bank records, cancelled checks, wire transfer confirmations, and other transactional documentation, and may require the issuance of subpoenas or other compulsory process to obtain records from third-party financial institutions if such records cannot be obtained voluntarily.
Individual Responsibility. The investigation will identify the individuals who authorized, created, or processed the fictitious purchase orders and invoices. Based on the information available to date, Mr. Serrano, as VCR Controller, had primary responsibility for the accounts-payable process, including the creation and approval of purchase orders and the processing of vendor invoices. The investigation will also examine the roles of Mr. Daskine and Ms. Prescott in the approval chain for capital-improvement expenditures.
C. Broader Internal Controls Assessment
In addition to the two principal workstreams described above, the investigation will encompass a broader assessment of the adequacy of VHG's and VCR's internal controls in the areas implicated by the suspected irregularities. Specifically, the investigation will:
• Evaluate the adequacy of VHG's and VCR's internal controls over revenue recognition, including controls relating to the timing of revenue recognition for timeshare-interest sales and the processing of rescission-related revenue reversals;
• Evaluate the adequacy of VHG's and VCR's internal controls over vendor approval, including the procedures for onboarding new vendors, verifying vendor legitimacy, and maintaining the approved vendor list;
• Evaluate the adequacy of VHG's and VCR's internal controls over purchase-order authorization, including segregation-of-duties requirements, approval thresholds, and documentation requirements; and
• Evaluate the adequacy of VHG's and VCR's internal controls over expense reimbursement, including the procedures for reviewing and approving employee expense reports and corporate credit card statements.
The internal controls assessment will determine whether VHG's existing compliance policies and procedures were circumvented by the individuals involved in the suspected irregularities or whether design deficiencies in the controls themselves permitted the irregularities to occur without detection. The assessment will also determine whether the potential material weakness identified by HSA in Q1 2023 extends to additional control areas beyond those initially flagged by HSA.
D. Boundaries of the Investigation
The Committee should be aware of the following boundaries and limitations on the scope of the investigation:
• The investigation is directed by and reports exclusively to the Audit Committee. C&H's client is the Audit Committee, not VHG management or any individual officer, director, or employee of VHG or its subsidiaries. All strategic decisions regarding the investigation will be made by the Committee, upon the advice of C&H.
• The investigation is limited to matters arising out of VCR's resort-development operations, as described in Sections III.A and III.B above, unless evidence developed during the investigation reveals irregularities in other VHG business units. If such evidence surfaces, C&H will promptly notify the Committee and seek direction regarding any expansion of scope.
• The investigation does not encompass VHG's tax positions, employee benefits programs, or environmental compliance matters, unless such matters are directly implicated by the revenue-recognition or expense-reporting findings. C&H does not anticipate that these areas will be implicated, but will monitor for any such connections as the investigation progresses.
• The investigation is an internal investigation conducted under the direction of the Audit Committee through its outside counsel. It is not a government investigation, and C&H does not have subpoena power. If compulsory process becomes necessary to obtain documents or testimony from third parties who are not employees or agents of VHG, the Committee may need to consider alternative mechanisms, such as referral to regulatory authorities or initiation of civil litigation.
IV. Investigation Methodology
A. Document Collection and Review
1. Document Preservation
Document-preservation notices are being issued today, July 24, 2023, to ensure the preservation of all potentially relevant documents and electronically stored information ("ESI"). Two categories of preservation notices are being issued:
• Company-Wide Preservation Notice. A general preservation notice will be issued to all VHG officers and relevant corporate personnel, directing them to preserve all documents and ESI relating to VCR's operations, including revenue recognition, timeshare-interest sales, expense reimbursements, capital-improvement expenditures, vendor relationships, and internal controls. The notice will be distributed via email from VHG General Counsel Patricia Navarro, under the direction of C&H, and will be accompanied by detailed instructions regarding preservation obligations.
• Targeted Preservation Notice. A targeted preservation notice will be issued directly to identified VCR custodians, including the three investigation subjects (Daskine, Prescott, and Serrano) and other identified VCR finance and operations personnel. The targeted notice will contain more specific preservation instructions tailored to the types of documents and ESI that each custodian is likely to possess.
Preservation obligations will cover all documents and ESI relating to VCR revenue recognition, timeshare-interest sales, expense reimbursements, and capital-improvement expenditures from January 1, 2021 forward. The January 1, 2021 date is selected to provide a reasonable lookback period that encompasses the full suspected period of expense-reporting irregularities (July 2021 to present) with a six-month buffer, as well as the period preceding the suspected revenue-recognition irregularities (Q3 FY 2022 to present).
The preservation notices will instruct custodians to take affirmative steps to preserve all responsive materials, including but not limited to emails, text messages, instant messages, voicemails, calendars, financial records, contracts, purchase orders, invoices, memoranda, presentations, spreadsheets, and any other documents or ESI in electronic or hard-copy form. Custodians will be directed not to delete, destroy, alter, or remove any potentially responsive materials, and will be instructed to suspend any routine document-destruction procedures that might affect relevant materials.
2. Custodian Identification
Eleven (11) custodians have been preliminarily identified for potential document collection. These custodians include:
1. Garrett W. Daskine — VCR Division President
2. Nicole Prescott — VCR VP of Finance
3. Ryan Mateo Serrano — VCR Controller
4. Thomas Rhett Griffith — VHG CFO
5. Patricia Navarro — VHG General Counsel
6. Six (6) additional VCR finance, operations, and sales personnel whose identities will be confirmed following initial scoping interviews and a review of VCR's organizational chart and reporting lines
Based on our preliminary assessment, we anticipate collecting documents from eight (8) of the eleven (11) identified custodians. The remaining three (3) custodians will be subject to further assessment based on initial evidence, and collection from those custodians will be undertaken only if warranted by the evidence developed during the early phases of the investigation. This tiered approach is designed to balance thoroughness with cost efficiency and to avoid unnecessary disruption to VHG's operations.
3. Collection and Processing
C&H will retain Triton discovery Solutions Inc. ("Triton"), located at 500 Seventh Avenue, 14th Floor, New York, NY 10018, as the e-discovery vendor for the investigation. Triton will provide hosting, processing, de-duplication, de-NISTing, and review-platform services. Triton is a nationally recognized e-discovery firm with extensive experience in complex internal investigations and SEC-related matters. C&H has worked with Triton on numerous prior matters and is confident in Triton's capabilities, security protocols, and cost structures.
C&H is in the process of finalizing a Master Services Agreement ("MSA") with Triton, which is expected to be executed by August 1, 2023. The MSA will set forth the terms of Triton's engagement, including data security requirements, chain-of-custody protocols, and confidentiality obligations.
Based on preliminary estimates of custodian email volumes and the scope of financial records maintained at VCR, the estimated document collection for this investigation is approximately 1.2 million documents, encompassing emails, email attachments, financial records, contracts, purchase orders, invoices, and other ESI. The actual volume may vary depending on the number of custodians from whom collections are ultimately made and the date range of the collection.
Following collection, all documents will be processed through standard e-discovery protocols, including de-duplication (removal of exact duplicate documents across custodians) and de-NISTing (removal of system files and other non-responsive file types based on the National Institute of Standards and Technology hash-value library). These processing steps are expected to reduce the document population significantly before review commences.
4. Document Review
C&H will employ a TAR 2.0 (Technology-Assisted Review) predictive-coding workflow to prioritize and expedite the review of the collected documents. TAR 2.0 is a continuous active learning methodology in which a machine-learning algorithm is trained on the review team's coding decisions in real time, allowing the system to progressively prioritize the most likely responsive documents for human review. This approach is widely accepted in the e-discovery field and has been endorsed by courts in numerous jurisdictions as a defensible and efficient methodology for document review.
Based on the anticipated document collection of approximately 1.2 million documents, and after application of TAR, de-duplication, and de-NISTing protocols, the estimated review population is approximately 347,000 documents. This estimate is preliminary and may be adjusted as the TAR model is trained and refined during the review process.
All document review will be conducted by C&H attorneys, including associates and contract attorneys operating under C&H's direct supervision. Quality-control sampling protocols will be implemented to validate the TAR results and ensure the accuracy and completeness of the review. Specifically, C&H will employ statistical sampling of documents scored as non-responsive by the TAR algorithm to verify that the recall rate meets an acceptable threshold (targeted at 80% or above).
A detailed E-discovery Protocol and TAR Methodology Memorandum will be prepared by the C&H team, with a target completion date of early August 2023. This memorandum will document the TAR methodology in sufficient detail to support its defensibility in any subsequent proceeding, including any SEC inquiry or litigation.
All documents identified as potentially subject to the attorney-client privilege, the work-product doctrine, or any other applicable privilege will be segregated and logged. A final privilege log will be prepared at the conclusion of the investigation, documenting all documents withheld or redacted on privilege grounds, including the basis for the privilege assertion.
B. Witness Interviews
1. Interview Protocols
All witness interviews will be conducted by C&H attorneys using standardized protocols designed to protect the attorney-client privilege and to ensure the accuracy and completeness of the information obtained. Each interview of a VHG or VCR employee will begin with the administration of an Upjohn warning, advising the interviewee of the following:
• C&H represents the Audit Committee of the Board of Directors of VHG, not any individual officer, director, or employee of VHG or its subsidiaries;
• The attorney-client privilege belongs to VHG and may be waived only by VHG (through the Audit Committee or the Board of Directors), not by the individual interviewee;
• The content of the interview is confidential and should not be disclosed by the interviewee to any other person, including other VHG or VCR employees, without the prior approval of C&H;
• The interviewee is expected to cooperate with the investigation and to provide truthful and complete responses to C&H's questions; and
• The interviewee has the right to retain personal legal counsel at his or her own expense.
The Upjohn warning script will be finalized and distributed to all members of the investigation team by mid-August 2023. All interviews will be memorialized through detailed attorney memoranda prepared by the C&H attorney conducting the interview. Interviews will not be audio- or video-recorded unless the Committee specifically directs otherwise.
For interviews of subjects who have retained individual counsel, the interviews will be scheduled in coordination with subjects' counsel, and subjects' counsel will be permitted to attend the interviews. C&H will provide reasonable advance notice of the interview topics and any documents that will be presented to the subject during the interview.
2. Planned Interview Schedule
The investigation will involve approximately 18 to 22 interviews covering an estimated 15 to 18 unique witnesses. The interview schedule is organized into three phases, designed to ensure that C&H has a sufficient evidentiary foundation before conducting subject interviews.
Phase 1 Interviews (August 2023): Non-Subject, Foundational Interviews. The first phase of interviews will focus on non-subject witnesses who can provide background information regarding VCR's operations, financial reporting practices, and internal controls. These interviews are designed to establish a foundational understanding of the matters under investigation before more targeted, evidence-driven interviews are conducted. Phase 1 interviews will include:
• William "Bill" Gentry, CPA (HSA engagement partner) — Mr. Gentry will be interviewed in an informational capacity regarding HSA's identification of the potential material weakness, HSA's observations regarding VCR's revenue-recognition practices, and any other relevant information developed during HSA's Q1 2023 interim review. Because Mr. Gentry is not an employee of VHG, this interview will not be conducted under Upjohn warnings. Target date: mid-August 2023.
• Thomas Rhett Griffith (VHG CFO) — Mr. Griffith will be interviewed regarding his oversight of VCR's financial reporting, his interactions with VCR finance personnel (including Prescott and Serrano), and his knowledge of VCR's revenue-recognition practices and expense-reporting procedures. Target date: late August 2023.
• Margaret "Meg" Calder (VHG CEO) — Ms. Calder will be interviewed regarding her general oversight of VCR's operations, her interactions with Mr. Daskine, and her knowledge of the matters under investigation. Target date: late August 2023.
• Additional VHG corporate and VCR operational personnel — Additional foundational interviews will be scheduled as identified during the initial scoping phase, including interviews of VCR sales personnel, VHG internal audit staff, and VHG corporate accounting personnel.
Phase 2 Interviews (September – October 2023): Subject Interviews. The second phase of interviews will focus on the three identified subjects of the investigation. Subject interviews will be scheduled after sufficient document review has been completed to allow informed questioning. The ordering of the subject interviews is preliminary and may be adjusted based on the evidence developed during Phase 1:
• Ryan Mateo Serrano (VCR Controller) — Mr. Serrano's interview will focus on his role in creating and processing purchase orders and vendor invoices, his knowledge of the vendor entities GSC, CDC, and SPS, and his understanding of VCR's revenue-recognition practices. This interview will be coordinated with Marco A. Ruiz at Coletti & Ruiz PA.
• Garrett W. Daskine (VCR Division President) — Mr. Daskine's interview will focus on his oversight of VCR's financial reporting, his role in directing revenue-recognition practices, his approval of capital-improvement expenditures, and his knowledge of the vendor entities at issue. This interview will be coordinated with James Corwin Merritt at Merritt & Dunleavy LLP.
• Nicole Prescott (VCR VP of Finance) — Ms. Prescott's interview will focus on her implementation of VCR's revenue-recognition policies, her supervision of Mr. Serrano, her review and approval of vendor invoices and purchase orders, and her communications with HSA during the Q1 2023 interim review. This interview will be coordinated with Candace O'Brien Langford at Langford Pace LLP.
Phase 3 Follow-Up Interviews (November – December 2023). As warranted by emerging evidence, follow-up interviews will be conducted with key witnesses, including both subject and non-subject witnesses. Follow-up interviews may address newly discovered documents, forensic accounting findings, or inconsistencies identified between witness testimony and documentary evidence. The total number of follow-up interviews will depend on the evidence developed during Phases 1 and 2.
C. Forensic Accounting Analysis
C&H has retained Crestline Forensic Advisory LLC ("Crestline"), located at 1330 Avenue of the Americas, 28th Floor, New York, NY 10019, as the forensic accounting advisor for the investigation. Crestline has been retained under the Kovel doctrine, at the direction of the Audit Committee through C&H, to ensure that Crestline's work product is performed at the direction of counsel and is protected by the attorney-client privilege and the work-product doctrine. See United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).
Crestline's engagement number for this matter is CFA-VHG-2023-0089. The engagement partner is Douglas Reinhardt, CPA, CFF (Certified in Financial Forensics), a nationally recognized forensic accounting expert with more than 25 years of experience in financial-fraud investigations. The senior manager assigned to the engagement is Priya Venkatesh, CPA, who has extensive experience in revenue-recognition analysis and fund-tracing in the hospitality and real-estate sectors.
The Kovel retention letter was executed on July 21, 2023, establishing that Crestline's work product is performed at the direction of, and for the benefit of, C&H in its capacity as counsel to the Audit Committee. The retention letter confirms that Crestline will not independently communicate its findings to any party other than C&H, and that all communications between Crestline and C&H are privileged.
Crestline's scope of work will encompass three principal areas:
Revenue-Recognition Analysis. Crestline will reconstruct VCR's timeshare-interest sales transactions for Q3 FY 2022 through Q2 FY 2023, on a transaction-by-transaction basis where feasible. The analysis will determine the timing of deposit receipts versus rescission-period expirations for each identified transaction, quantify the aggregate overstatement of revenue by quarter, and evaluate the compliance of VCR's revenue-recognition practices with ASC 606. Crestline will also analyze VCR's rescission data to determine the rate at which purchasers exercised their rescission rights and the timing and accuracy of revenue reversals for rescinded transactions.
Expense-Reimbursement Analysis. Crestline will trace payments from VCR to the suspected shell entities (GSC, CDC, and SPS) and from those entities to their end uses, to determine whether payments were diverted for the personal benefit of VCR executives or their associates. This analysis will involve the review of bank records, purchase orders, invoices, cancelled checks, wire transfer records, and other transactional documentation. Crestline will also analyze the purported scope of work described in the vendor invoices and purchase orders and determine whether it corresponds to any actual capital-improvement work performed at VCR properties. Where possible, Crestline will identify the ultimate disposition of funds paid to the suspected entities, including any transfers to personal accounts or expenditures on personal goods or services.
Internal Controls Testing. Crestline will assess VCR's internal controls over revenue recognition, vendor approval, and purchase-order authorization, including the design and operating effectiveness of key controls. This assessment will inform the investigation's conclusions regarding whether the suspected irregularities were facilitated by control deficiencies or by the circumvention of otherwise adequate controls.
Crestline has been retained on a flat-fee basis of $1.15 million, with overage provisions applicable above 4,500 professional hours at a blended rate of $375 per hour. The flat-fee arrangement provides the Committee with cost predictability while preserving Crestline's flexibility to deploy additional resources if the complexity of the analysis requires it.
V. Investigation Phases and Timeline
The investigation is organized into four phases, as summarized below. The timeline is preliminary and may be adjusted based on the volume and complexity of the evidence developed, the availability of witnesses, and any unforeseen developments.
Phase 1: Engagement, Scoping, and Document Collection (July 24 – August 31, 2023)
Phase 1 encompasses the initiation of the investigation, the establishment of foundational protocols, and the commencement of document collection and processing. Key activities during Phase 1 include:
• Issue document-preservation notices to all VHG officers and relevant VCR personnel (July 24, 2023, i.e., today).
• Finalize the custodian list and commence document collection from identified custodians, beginning with the three investigation subjects and the VHG CFO.
• Execute the Master Services Agreement with Triton discovery Solutions Inc. for e-discovery hosting, processing, and review-platform services (target: August 1, 2023).
• Prepare the E-discovery Protocol and TAR Methodology Memorandum, establishing the review methodology and quality-control protocols for the document review (target: early August 2023).
• Commence foundational witness interviews (Phase 1 interviews), including interviews of William "Bill" Gentry (HSA), Thomas Rhett Griffith (VHG CFO), and Margaret "Meg" Calder (VHG CEO).
• Evaluate whether to recommend that the Committee direct VHG management to place one or more of the investigation subjects on administrative leave pending the outcome of the investigation. This recommendation will be based on the risk of evidence spoliation, the potential for interference with the investigation, and the operational implications of the subjects' continued access to VCR systems and personnel.
• Coordinate with Westlake Burris & Holt LLP (Irene Castellanos, 600 Brickell Avenue, Suite 3100, Miami, FL 33131), VHG's outside securities counsel, regarding VHG's SEC disclosure obligations, including the potential need for a Form 8-K filing under Item 4.02 (Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review). The timing and content of any Item 4.02 filing will depend on the Committee's and HSA's assessment of the reliability of VHG's previously issued financial statements and related audit reports.
• Coordinate with HSA regarding the relationship between the investigation and HSA's ongoing audit activities, including the establishment of protocols for information sharing that preserve the privilege protections applicable to the investigation.
• Deliver the First Interim Status Report to the Audit Committee, with a target date of early September 2023.
Phase 2: Document Review and Analysis (September – October 2023)
Phase 2 encompasses the bulk of the document review and the commencement of forensic accounting analysis. Key activities during Phase 2 include:
• Commence the TAR 2.0 predictive-coding workflow and conduct the review of the estimated 347,000-document review population.
• Crestline commences forensic accounting analysis of VCR revenue transactions and expense records, including the transaction-level revenue-recognition analysis and the fund-tracing analysis for payments to suspected shell entities.
• Conduct subject interviews (Phase 2 interviews) with Serrano, Daskine, and Prescott, with respective individual counsel present. Subject interviews will be scheduled after sufficient document review has been completed to allow informed and effective questioning.
• Continue to identify and interview additional non-subject witnesses as warranted by the evidence developed during document review.
• Deliver the Second Interim Status Report to the Audit Committee, with a target date of late October 2023.
Phase 3: Follow-Up Interviews and Forensic Conclusions (November – December 2023)
Phase 3 encompasses follow-up interviews, the completion of forensic accounting analysis, and the preparation of analytical memoranda. Key activities during Phase 3 include:
• Conduct follow-up interviews as warranted by documentary and forensic evidence, including re-interviews of subjects and key non-subject witnesses.
• Explore potential cooperation arrangements with witnesses as appropriate. If any witness demonstrates a willingness to provide information that materially advances the investigation, C&H will consult with the Committee regarding the advisability and terms of any cooperation arrangement.
• Crestline completes forensic accounting analysis and delivers its findings to C&H. Crestline's deliverables will include detailed working papers and a summary memorandum setting forth the results of the revenue-recognition analysis, the expense-reimbursement and fund-tracing analysis, and the internal controls assessment.
• Complete the shell-entity analysis, including review of corporate formation records filed with the Florida Division of Corporations, beneficial ownership analysis, and transactional history for GSC, CDC, and SPS.
• Prepare a revenue-recognition analysis memorandum addressing VCR's compliance with ASC 606 and the implications of Florida Statute § 721.10.
• Prepare an expense-irregularity analysis memorandum addressing the findings regarding fictitious purchase orders, vendor invoices, and fund diversion.
• Deliver the Third Interim Status Report to the Audit Committee, with a target date of late November 2023.
• Prepare recommendations regarding personnel actions (including potential termination, referral for disciplinary action, or other measures) with respect to the investigation subjects and any other individuals implicated by the evidence. Target for delivery of personnel-action recommendations: mid-December 2023.
Phase 4: Final Report and Remediation Recommendations (January 2024)
Phase 4 encompasses the preparation and delivery of the Final Investigation Report and the formulation of remediation recommendations. Key activities during Phase 4 include:
• Preparation and delivery of the Final Investigation Report to the Audit Committee. The Final Report will set forth the investigation's findings of fact, the evidentiary basis for those findings, the investigation team's analysis and conclusions, and recommendations for remedial action. The Final Report will be a privileged document prepared by C&H at the direction of the Audit Committee.
• Preparation and delivery of a separate Remediation Recommendations Memorandum, addressing recommended enhancements to VHG's and VCR's internal controls over financial reporting, improvements to the Company's compliance program, strengthening of whistleblower procedures and reporting channels, and any other remedial measures that the investigation team deems appropriate.
• Target investigation close: early January 2024.
• Coordinate with Westlake Burris & Holt LLP regarding any amended SEC filings necessitated by the investigation's findings, including amended Forms 10-K and 10-Q and any restatement of previously issued financial statements. C&H will provide factual input to Westlake Burris as needed to support VHG's disclosure obligations, subject to the Committee's direction regarding the scope of any privilege waiver.
VI. Staffing
A. Calderwood & Harkness LLP Investigation Team
The following C&H attorneys and professionals have been assigned to the investigation:
Howard Quinn will serve as lead investigation counsel, with primary responsibility for all Audit Committee communications, strategic direction of the investigation, witness interviews of senior personnel and investigation subjects, and overall management of the investigation team. Mr. Quinn has more than 28 years of experience in complex internal investigations, SEC enforcement matters, and white-collar defense, and has led investigations involving revenue-recognition irregularities, financial-statement fraud, and executive misconduct in publicly traded companies.
Conrad Ashby will provide partner-level support, with particular focus on privilege and work-product issues, remediation recommendations, and the interface between the investigation and VHG's ongoing compliance and audit activities. Mr. Ashby has extensive experience advising audit committees and boards of directors in connection with internal investigations and SEC proceedings.
Liam Donahue will manage the day-to-day activities of the investigation, including oversight of the document review, coordination with Crestline Forensic Advisory on forensic accounting analysis, preparation of analytical memoranda, and coordination with Triton discovery Solutions on e-discovery processing and production. Mr. Donahue will also participate in witness interviews alongside Mr. Quinn and will be responsible for drafting the interim status reports and the final investigation report.
Steven Hollander will support the document review, coordinate with Triton on e-discovery processing and TAR implementation, and conduct research related to the shell-entity analysis, including corporate-formation searches, beneficial-ownership tracing, and analysis of public records.
Additional paralegal support will be deployed as needed for document review, privilege logging, interview preparation, and administrative tasks. C&H will endeavor to staff the investigation efficiently and will keep the Committee informed of any changes to the staffing plan.
B. Crestline Forensic Advisory LLC
Additional Crestline staff will be deployed as needed based on the scope and complexity of the forensic accounting analysis. The blended rate for all Crestline personnel is $375 per hour, subject to the flat-fee arrangement described in Section IV.C above.
C. Triton discovery Solutions Inc.
Triton will provide e-discovery hosting, processing, TAR licensing, and production services for the investigation. Triton's estimated fees for the engagement are approximately $487,000, based on the anticipated document volume and the scope of processing and hosting services required. This estimate may be adjusted based on the actual volume of documents collected and the duration of the review. Triton's fees will be invoiced separately from C&H's legal fees and will be itemized in C&H's monthly billing statements.
VII. Coordination with Third Parties
A. Hargrove, Steen & Aldrich LLP (Independent Auditor)
C&H will establish protocols for coordination between the investigation and HSA's ongoing audit activities. The coordination is necessary because HSA's quarterly reviews and annual audit of VHG's financial statements will continue during the pendency of the investigation, and the investigation's findings will likely be relevant to HSA's assessment of VHG's internal controls and the reliability of VHG's financial statements.
C&H will prepare a letter to HSA documenting the coordination protocols, with a target date of early August 2023. The letter will address, among other things, the procedures for sharing factual information between the investigation team and HSA, the scope and limitations of any information sharing, and the measures that will be taken to preserve the privilege protections applicable to the investigation's work product. Information sharing will be structured to ensure that HSA receives the factual information it needs to fulfill its professional obligations while preserving the attorney-client privilege and work-product protections that attach to C&H's investigation activities.
HSA's June 19, 2023 communication regarding the potential material weakness will serve as a foundational data point for the investigation. C&H will request that HSA make available any additional working papers, correspondence, or other documentation relating to HSA's identification of the potential material weakness, to the extent that such materials can be shared without compromising HSA's independence or professional obligations.
B. Westlake Burris & Holt LLP (Outside Securities Counsel)
C&H will coordinate closely with Irene Castellanos and the securities team at Westlake Burris & Holt LLP ("Westlake Burris"), VHG's outside securities counsel, located at 600 Brickell Avenue, Suite 3100, Miami, FL 33131. The coordination with Westlake Burris is essential because the investigation's findings may have significant implications for VHG's SEC reporting obligations. Specifically, C&H will coordinate with Westlake Burris on the following matters:
• Form 8-K Filing Under Item 4.02. If the Committee and/or HSA conclude that VHG's previously issued financial statements should no longer be relied upon, VHG will be required to file a Form 8-K under Item 4.02 (Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review). Based on the information currently available, it is anticipated that an Item 4.02 filing may be necessary, and C&H and Westlake Burris are coordinating on the timing and content of any such filing. The anticipated filing date, if warranted, is mid-August 2023.
• Ongoing 10-Q and 10-K Disclosure Considerations. The investigation and its findings will need to be considered in connection with VHG's ongoing periodic reporting obligations, including the disclosure of the investigation in the risk factors, legal proceedings, and management's discussion and analysis sections of VHG's Forms 10-Q and 10-K.
• Potential Restatement. If the investigation determines that VHG's previously issued financial statements contained material misstatements, VHG may need to restate its FY 2022 annual financial statements (Form 10-K) and its Q1 and Q2 FY 2023 interim financial statements (Forms 10-Q). C&H will provide factual input to Westlake Burris to support the restatement analysis.
• SEC Interactions. If the SEC opens a formal or preliminary inquiry into the matters under investigation, or if VHG determines that a voluntary disclosure to the SEC is advisable, C&H will coordinate with Westlake Burris on the strategy for any interactions with the SEC, including the scope of any voluntary production and the handling of privilege issues.
C. Individual Counsel for Subjects
C&H will communicate with the individual counsel retained by the three investigation subjects regarding interview scheduling, document requests, and rights advisories. C&H has already established contact with each subject's counsel and will maintain ongoing dialogue as the investigation progresses:
• Merritt & Dunleavy LLP (James Corwin Merritt) — representing Garrett W. Daskine.