Category: Fraud

All You Wanted to Know About SEC Remedies

Steven Peikin, Co-Director of the SEC’s Division of Enforcement gave an encyclopedic description of the Remedies and Relief in SEC Enforcement Actions at PLI’s White Collar Crime symposium. The speech was meant to address the effectiveness of enforcement actions. He wanted to point out that the number of enforcement actions or the total amount of penalties are not good metrics for assessing the work of the enforcement division.

The speech looked at all of the remedies available and how they address the mission of the Securities and Exchange Commission.

Undertakings – Specifically target and attempt to address specific risks

He gave the example of Tesla and Elon Musk. The undertaking to control Musk’s corporate communication was to address the “the potential harm to investors caused by Musk’s communication practices and a lack of sufficient oversight and control of those communications.”

Bars and Suspensions – serve a critical prophylactic function

They preserve the integrity of the markets and protect investors by limiting the activity of known bad actors by removing them from the industry or preventing them from serving as officers or directors at public companies.

Penalties – serve as a deterrent

“Penalties are one of the primary enforcement tools we have to incentivize regulated entities to remain in compliance with the rules that protect investors.”

Disgorgement – Even where a defendant “cooperates and agrees to meaningful undertakings, it should not be entitled to keep its ill-gotten gains, which we are often in a position to restore to harmed investors.”

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If Your Clients Are Going to Lose Money Anyway, Why Not Just Steal It?

Say you run a trading platform and lots of your traders lose money. Why not just take their money for yourself instead of them losing it to the market?

For one, that’s stealing.

But apparently that didn’t stop Jeffrey Goldman, Naris Chamroonrat, Christopher Eikenberry, Ran Armon, Adam Plummer, and Yaniv Avnon from doing just that.  They set up Nonko Trading as a purported offshore proprietary trading firm. It was organized to cater to U.S.-based day-traders, but evading the U.S. Broker-Dealer registration and regulatory requirements.

The Nonko group interviewed traders first. They targeted traders that appeared inexperienced or unsophisticated. Instead of providing these traders with access to a live securities trading platform, the Nonko team provided them with training accounts that merely trading.  When these traders sent funds to Nonko to place securities trade orders, the orders were never actually sent to the markets. Instead, the Nonko team simply pocketed the traders’ money.

Their theory is that the traders won’t notice that you stole their money if they were going to lose it anyway. If you’ve see The Producers you know how this works. Your targets won’t know you’ve stolen you money if the targets thought they lost it.

If a trader stated to make money, they moved that trader from the simulation on the TRZ platform to the live NTRD version of the platform.

The Nonko crew apparently left a trail of messages pointing out their misdeeds”

the current frame work [sic] now with TRZ is that we interview the
traders first and make sure they are complete newbs before putting
them on TRZ, while at the same time, we have a close watch to see
which account is starting to make money, at any point in time they
start to show signs of profitablity [sic] we quickly switch them
over to a NTRD account (live)
with this new platform, we will use the same process but as we
expect to have smaller deposits and more new accounts, we will
have to figuire [sic] a more stricter way to flag “game” accounts,
we havent [sic] gotten that far yet

The Nonko Group lured day traders by offering high margin limits (20:1) and small commissions. They also put together written TRZ Guidelines on which traders should be selected for the fraudulent TRZ platform.

During the initial phases of the training accounts scheme, Goldman commented to Chamroonrat on Skype: “trz group down 3k…every trader down. How come part of me feels good and part of me feels bad?!?!??”

You feel bad, because you’re stealing their money.

In The Producers, the scheme goes awry when the production makes money. For Nanko, it went wrong when a newbie trader on the TRZ version called the underlying provider for technical help. The help desk was confused that the trader thought his simulation was real. Once the provider saw the problem it emailed all of the TRZ traders telling them it was just a simulation.

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Broken Windows at Wells Fargo

Getting a free meal is one of the few perks of staying late at the office for many financial services firms. The firm is willing to pay some set amount if the employee stays after some deadline. Most figure that the person is going to be more productive if he or she is not starving.

I initially found it strange that Wells Fargo fired a dozen employees of the Wells Fargo Securities division for violating the policy.

Wells Fargo has been in the news for all the wrong reasons. My first reaction is that it was taking the broken windows approach: target small crimes to create an sense of order and compliance as a deterrence to bigger problems. What could be a smaller crime than ordering a free dinner before the 6:30 dinner policy time? You get hungry at 6:15 and order, knowing that it will take time to get delivered and that you are planning to work for another few hours.

Did Wells Fargo really bring down the hammer for ordering dinner early?

I don’t think so.

The employees that were fired were accused of altering their receipts to show an order time in compliance with the policy. The headlines were missing the point.

Wells Fargo fired a dozen employees for forgery. It was stupid forgery. These bankers could afford the $20 for dinner. Something was wrong with the culture if employees feel that forgery is acceptable.

If you remember back to the bigger problems at Wells Fargo, employees were forging account opening documents to meet their sales quota. That is clearly a bigger problem than the $20 dinner receipt. But a financial firm cannot tolerate any level of forgery.

The fired employees must feel stupid. Losing a job over not wanting to pay for cheap sushi is a terrible way to start a career.

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2018 Global Study on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners

Study 2,690 cases of occupational fraud over 18 months and you may see some trends. The Association of Certified Fraud Examiners conducted a survey of its 41,000+ certified fraud examiners to collect data on the single biggest fraud case they investigated from January 2016 to October 2017.

The study identified six behavioral red flags that have consistently been common in each of its studies (ranked by prevalence):

  1. Living beyond means (41%)
  2. Financial difficulties (29%)
  3. Unusually close association with vendor/customer (20%)
  4. Control issues/ unwillingness to share duties (15%)
  5. Divorce or family problems (14%)
  6. “Wheeler-Dealer” attitude involving shrewd or unscrupulous behavior (13%)

According to the report, the fraudster displayed at least one of these red flags in 86% of the cases and displayed more than one in 50% of the cases.

The other piece of data that jumped out at me was that employees who been with their company longer stole more. Setting the line at five years of tenure at the job, those with more stole a median of $200,000 and those with less stole $100,000.

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The One With the Whale Whisperer

Often there is little new to discover and learn from in securities fraud charges. The fraudster may or may not have started with good intentions. Regardless, the fraudster takes the investors’ money and spends it on things it was not supposed to be spent on. But I could not help but take a closer look at the securities fraud case where the fraudster is identified as the “whale whisperer.”

At first, I thought the case might have involved JP Morgan’s London Whale who lost the firm $6.2 billion. But it turned out to be a much more colorful character.

Paul Gilman is a New Age composer, rock music producer, and filmmaker. He made a film about using music to communicate with ocean mammals. He apparently had some solid technical skills and upgraded the sound systems for the Houston Astros and the Texas Rangers at their stadiums. He leveraged that into convincing investors to give him more capital for more installations.

He had some idea that he could use sound to lower the viscosity of oil, allowing it to flow through pipelines more efficiently. (That sounds like a evil villain plan to gain entry to an industry, then decimate others with soundwave technology.) He convinced investors to give him capital to test and develop this purported technology.

I don’t know if Mr. Gilman thought he could expand his stadium sound business and develop his oil viscosity sound system or whether he started out intending to steal people’s money. He did not agree to the charges and pleased the Fifth Amendment.

Regardless of his original intent, he did what most frausters do in the end. He spent investors’ money on his own needs instead of the company needs. The SEC points out that he spend the investors’ money on designer clothing, travel and dining, rent and home furnishings, and cash withdrawals at casinos.

In the complaint, the SEC piles on and tells the stories of a nurse in Dallas, a church minister in Tennessee and psychology professor in Houston who “invested” money in Gilman’s enterprises.

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HoweyCoins – The ICO I Have Been Waiting For

Initial coin offerings have been a new wave of financing.. and scams. One offering that you should look at for some lessons about coin offerings is the soon to be released Howey Coin.

HoweyCoins are the cryptocurrency for the travel industry. According to the white paper, HoweyCoins partner agreements lock in an average initial discount of 30% for airfare and 42% for hotel room rates for all HoweyCoin-denominated transactions. The agreements are not final, but once the offering is complete, they will be revealed.

This is a can’t miss investment opportunity. HoweyCoins are officially registered with the U.S. government and will trade on an SEC-compliant exchange where you can buy and sell them for profit. According to the ICO team, they “forecast a minimum growth rate of between 7% to 15% annualized, making HoweyCoins attractive for long-term investment. In addition, HoweyCoins can serve as a GUARANTEED hedge against inflation and market loss.”

…

Hopefully, you have noticed a few things that might make you not click on the the button to buy the HoweyCoins. Bonus points if you recognized “Howey” as the seminal court case that sets the test for whether an investment is a security. Hopefully you noticed the “registered with US government” as red flag that this company is doing something wrong with this offering. Of course the high returns, and guarantee of success are hallmarks of problematic offerings. But if not, go ahead and click on the button.

This is a new type of performance education by the Securities and Exchange Commission. Clearly, the SEC is focused on the fraud and securities-law violations of coin offerings. If you are involved in such an offering, you should be worried. The SEC spent some time, money and energy on putting together the HoweyCoins website. You can be certain that the SEC is devoting much more time, energy and money into investigating ICO fraud and securities law violation.

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Fraudulent Coin Offerings

I’ve been highly critical of cryptocurrency. It doesn’t act like a currency: people are not using it to actually buy goods and service (at least not legal goods and services).  The world of coin offerings has been the wild west. In many instances, the sponsors are just ignorant of the securities law implications of their coin offering structures. Others are scams or turn quickly into scams.

The most recent coin offering to come crumbling down is the CTR Token sponsored by CentraTech. The SEC charged Sohrab Sharma and Robert Farkas with masterminding the fraudulent Initial Coin Offering.

What was the case for using Centra? I read through the whitepaper and it’s full of nothing. There is some nonsense abut currency conversion and storing coins in the Centra Wallet. As near as I can tell the only thing Centra Token did was get the boxer Floyd Mayweather to endorse it.

Centra Tech claimed that it was producing a debit card backed by Visa and MasterCard that would allow you to instantly convert hard-to-spend cryptocurrencies into U.S. dollars.  The SEC alleges that Centra had no relationships with Visa or MasterCard.

Sharma and Farkas stated that funds raised in the Initial Coin Offering would help Centra Tech build a suite of financial products. This turned it into a securities offering because the offering claimed that token holders would be paid “rewards” of 0.8% of the total revenue that Centra earned from Centra Card transactions. That makes the ICO a securities offering.

This goes back to the Howey definition of a “investment contract” as “investment in a common enterprise with the expectation of profit to be derived through the essential managerial efforts of someone other than the investor.” If it meets the definition of “investment contract” its a security.

“Endorsements and glossy marketing materials are no substitute for the SEC’s registration and disclosure requirements as well as diligence by investors.” – Steve Peikin, co-director of the SEC’s Division of Enforcement.

My Favorite part of the fraud is the use of fictional executives. “Michael Edwards” was listed as the Chief Executive Officer and Co-Founder of Centra, with an impressive LinkedIn profile. He had an M.B.A. from Harvard University and an extensive career in banking, most recently as a Senior VP at Wells Fargo. Edwards was not a real person. A photo of Edwards used in an early version of Centra’s website was that of a Canadian professor of Physiology and Pathophysiology with no relationship to the company. Later versions of the marketing materials included instead a picture of one of Defendant’s relatives purporting to be of “Edwards.”

The big surprise is that it took the SEC this long to build a case. The New York Times put together a profile of the company in October that was full of red flags.

Several weeks ago Sharma and Farkas received subpoenas from the SEC about the Centra ICO.  I would assume that they realized their time was short. According to the SEC’s complaint, Farkas made flight reservations to leave the country around April 1. That must be what put the SEC and the Department of Justice on an accelerated schedule. Farkas was arrested before he was able to board his flight.  Sharma was also arrested.

As of March 30, Centra’s bank accounts were depleted and most of its employees had been terminated according to the SEC complaint.

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Use of Data in Proving Fraud

The Securities and Exchange Commission’s case against Robert Magee and Valor Capital was a straight forward cherry picking case. What caught my eye was the data and statistical analysis that the SEC used to prove its charges.

Magee was doing the wrong thing by order block trades in an omnibus trading account and then allocating the trades to his personal account and client accounts at the end of the day. That procedure is ripe for compliance failure without a preset decision on who gets the trades. The concern will always be that the securities that increased during the day will be allocated to favored accounts and those that went down would be allocated to others.

The SEC ran the numbers to prove its point.

From July 2012 to January 2015, Magee’s personal accounts posted first-day profits of 0.876%. Those were 459 trades of which 376 were profitable on the first day.

Meanwhile, the client accounts posted a -2.309% return on the first day during roughly the same period. Those were 1,365 trades of which only 219 were profitable on the first day.

Of course, the disparate results could be based on good luck. The SEC ran some stats and found that the probability that disproportionate allocation of favorable trades was due to chance was less than one in 100,000 during one period and less than one in a trillion during another period.

Valor’s brokerage firm terminated its relationship because it suspected the cherry-picking. The subsequent brokerage firm did the same. The third brokerage firm did not permit the use of an omnibus account to execute trades. The Texas state securities regulator reprimanded and fined Magee in August 2016 for no pre-allocating block trades.

According to the SEC’s press release, this is the fourth action arising out of an enforcement initiative to combat cherry-picking led by the SEC’s Los Angeles Regional Office and supported by the agency’s Division of Economic and Risk Analysis.  The previous actions were against Jeremy Licht of JL Capital Management, Gary Howart of Howarth Financial, and Joseph B. Bronson of Strong Investment Management.

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Pump and Dump Cryptocurrency

Cryptocurrency is a lawless land.

Ten days ago, the Securities Exchange Commission and the Commodities and Futures Trading Commission issued a joint statement on virtual currency:

“When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws. The Divisions of Enforcement for the SEC and CFTC will continue to address violations and bring actions to stop and prevent fraud in the offer and sale of digital instruments.”

Take a look at BigPump.org. Go ahead and take a look. I’ll wait.

“We do pumps…. Big pumps.”

Right there on a public website, the group advertises its strategy for pumping and dumping cryptocurrency. It came to my attention through an article by Paris Martineau:
Inside the Group Chats Where People Pump and Dump Cryptocurrency.

I was skeptical that a strategy that was so brazenly illegal would be so easy to spot. So being skeptical, I dug into the underlying information. There it was, publicly displaying a pump and dump scheme.

In their defense, they claim their pumping schemes are fair. Of course, there is also a note that premium pumps will be coming soon. I have to assume that those premium pumps are less fair to those outside the premium group.

It does not take much to find examples of pump and dump. Look at this chart for the Crave cryptocurrency.

Some people made a bunch of money by rallying interest in this cryptocurrency and selling at the top before the price.

That is not the way a price chart for any “currency” should look. It’s not the way chart should look for any investment.

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Compliance Lessons From Star Wars – Lies

With the pending release of Episode VIII – The Last Jedi, I’m joining Tom Fox in tying compliance and the Star Wars franchise together in posts this week.

I’ve always been trouble by the lie from Obi Wan Kenobi to Luke Skywalker:

“Darth Vader betrayed and murdered your father.”

It’s the little lies that lead to bigger lies and bigger problems. Some of the ponzi schemes I see start with a sponsor telling a little lie about performance results. Then the sponsor is trapped chasing those untrue returns. That leads to bigger lies and bigger problems as the deficit between actual results and fictional results grow.

We saw the little lie growing with Bernie Madoff. Decades ago he missed his returns and lied about them. At some point he just gave up and didn’t pretend to chase the returns anymore. That became to a multi-billion dollar deficit between actual results and the fictional results he told investors.

Plenty of ponzi schemes are formed as frauds from the outset as a way to separate people from their money.  They start off with outlandish returns and promises of guaranteed results. There is a subset of these frauds that had started out with good intentions but misstep into these little lies that lead to downfall.

Obi Wan’s lie to Luke sends Luke into an ill-chosen battle with Darth Vader. Luke is seeking revenge for the death of his father. Things don’t go well for Luke in a battle against one of the fiercest warriors in the galaxy.

The cynic in me might point out that the lie was not intentional. Behind-the-scenes lore of the Star Wars franchise tells us that the plot turn in Empire Strikes Back, and told further in Episodes II and III, may not have been envisaged when Star Wars was made. For the pure of heart, we can assume the Kenobi was just trying to protect Luke from the truth.