Category: Fraud

Yet Another ICO Scam

With Bitcoin hitting stratospheric pricing levels, there are scams aplenty trying to cash in on tulip-mania around Bitcoin. This chart from the Wall Street Journal says it all.

Of those trying to cash in, I’m sure some actually have legitimate business purposes and are trying to find new ways to operate financial systems. But many are just scams trying to fool some people out of cash. The latest scammer is PlexCoin. The SEC filed a complaint for an emergency action to freeze the scammers assets and stop selling any more.

Dominic Lacroix, and his company, PlexCorps, were running an initial coin offering of its PlexCoin. It launched the ICO on August 6.

PlexCorps claimed that if you invested $100 USD into PlexCoin at the ICO, you would obtain 769.23 PlexCoin, with an estimated value of $1,353, a return on your investment of 1354% “in 29 days or less”. It’s unclear how they reached the value of “$1.76 per PlexCoin”.

It wasn’t clear what was behind the PlexCoin or who was behind it. That didn’t stop ten of thousands of investors from plowing $15 million into the company.

It turns out that one of the people behind PlexCorps is Dominic Lacroix. In July, the Autorité des marchés financiers (AMF), Quebec’s chief financial regulator, had issued orders prohibiting Lacroix and several associated companies from promoting “any form of investment” to investors in Quebec and operating an investment scheme from within the province, even if it was targeted solely at investors who did not live in Quebec. Lacroix had several previous problems with the Quebec financial regulators.

According to the SEC complaint, the ICO of PlexCoin was an offering of securities.

PlexCoin, like Bitcoin has limited utility. There is no argument that crypto-currencies are growing in value. The problem is that even though there is value being created, it’s not being used as a currency very much. Rightly so. It makes poor economic sense to use a rapidly rising commodity to pay for a transaction if you have alternatives.

I think it is a commodity and not a currency. Theoretically, you could pay for your groceries with gold if the store was willing to accept the gold. Like a commodity, the commodity future exchanges are going to start trading on Bitcoin futures. The CBOE starts on December 11, following by the CME on December 18. It will be interesting to see whether some short selling will put pressure on BitCoin’s rise in value.

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The Pot of Gold at the End of the Rainbow

With all of the SEC enforcement actions, it takes something related to my area or a quirk to catch my attention. The fraud that caught my attention this morning was a hedge fund manager claiming he no longer needed income and instead wanted to help friends and charitable causes. He told investors that his 20% of the trading profits would fund his wife’s charitable organization for abused women and children, The End of the Rainbow Foundation in Colorado.

Running a hedge fund for charity sounds nice. I’m not sure I’ve heard that happening. It didn’t in this case. Michael Anderson, the hedge fund manger, talked 18 investors into giving him $5.3 million to “invest.”

He didn’t.

He suffered $600,000 in trading losses, used some of the investor money to redeem investors based on falsified returns, and pilfered at least $2.3 million.

The SEC got wind of the problems in early 2017 and launched an investigation and hoped to shut down the fraud.

Whatever thread Mr. Anderson had been hanging on to justify his fraud snapped. He was found dead in his garage with his ATV running and filled with carbon monoxide. According to the SEC complaint, a few weeks before his death, Mr. Anderson hired an attorney to help him draft a sworn confession, admitting to defrauding Rainbow Partners’ investors, fabricating their account statements, making Ponzi payments, and misappropriating investors’ funds. The confession also stated that he controlled all aspects of Rainbow Partners’ business and was wholly responsible for the transactions. This was an attempt to isolate his wife from the fraud.

According to another action, Mr. Anderson was also involved with another investment firm, BigHorn Wealth. It also sounded sketchy, with a promotion that it went to cash at then end of each day. That strategy makes it easy to hide trading account balances from investors. It turns out that BigHorn had taked a big position in an exchange-traded gold fund and had lost $2.4 million in that fund.

There was also $1 million wired to purchase bars of gold around the time of his confession. That 53 pounds of gold has not been recovered.

It sounds like Mr. Anderson had a tangled web of investment firms and control, some of which sustained losses, and he raised funds to redeem investors to keep his facade of success in place. He tried to save his wife from the fraud.

Perhaps he stashed those gold bars for her at the end of the rainbow.

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The One with the Deceptive Investment Description

Augustine Capital Management did many things wrong while managing its Augustine Fund. One highlight or the misdeeds is using fund assets to make conflicting transactions without notifying investors.

The fund charged the salaries of two principals, Thomas F. Duszynski and John T. Porter, as fund operating expenses. According to the fund documents, the management fee was supposed to compensate Augustine for its  “overhead and expenses in managing the Partnership.” The manager could charge  “operating expenses” to the Fund, a term defined by the PPM to include communication costs, brokerage commissions, legal, accounting, and auditing fees. The fund documents did state that the Fund would pay salaries, healthcare, or rent for the manager. But they made the Fund pay for it anyhow.

It’s not that a manager is not allowed to charge those expenses to the fund. It just has to be disclosed to investors so they know what they are paying for.

In the same light, you need to disclose your investments to the fund investors. Augustine chose to hide a related-party transaction. Augustine had made an investment in FT Investing. However, Duszynski and Porter held an interest in FT. Then they bought out the Fund’s investment in FT at a loss. After the sale, they had the Fund make $600,000 in loans to FT, with no documentation. Duszynski and Porter’s original ownership in FT had been funded by a loan from the Fund.

Nothing in the Fund documents allowed personal loans to the management company or its employees/owners. The Fund had no board of advisors or other mechanism to approve of the related-party transactions. They failed to accurately describe the transactions to Fund investors.

Augustine Fund formerly held an investment in FT Investing, LLC. This investment was liquidated in December 2013. When the original investment was made, the Fund also made an interest-bearing loan to one of its co-investors in FT Investing. This loan is on track to be fully repaid on its maturity date in December 2014.

This description was misleading because it did not reflect the conflict with the loan: that the loan was made to Duszynski, a principal of the fund manager. Additionally, it misrepresented the loan’s repayment status, because Duszynski had not begun repaying the loan.

“Reasonable investors would have considered it important both that the Fund’s monies were used to make a substantial personal loan to a director of the general partner without the investors’ consent, and that the director defaulted on the loan.”

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Hoodoo Spells Fails to Ward Off the Feds

According to the SEC Complaint and Criminal Complaint, Dawn Bennett lived the life a classic ponzi schemer who got in over her head and continued to lie and cheat, perhaps hoping to find a way out. The story caught my attention for two reasons. The first was the implication that Ms. Bennett used a voodoo spell to ward off attorneys from the Securities and Exchange Commission. The second was reference to an influential blog post.

To prove how egregious her fraud was, the criminal complaint highlight two well-worn stories of fraud. One was that she defrauded elderly investors. To prove that point, there are several emails in the criminal complaint that tell the sad story of elderly investors sending all of their retirement savings to Ms. Bennett for investment in her company.

The second story is that of a luxurious lifestyle. To prove that point, there is a picture of her large collection of shoes taken during the FBI search of her home.

The criminal complaint notes that Ms. Bennett had read a blog post on whether a note is a security. Based on that blog post, she changed her documents in an attempt to make them look more like a loan than a security. The blog post sounded familiar: “Is A Promissory Note A Security?” I searched Compliance Building and found this blog post: Is a Note a Security? I was ready to be self congratulatory and tout my influence. But a quick internet search found a more likely blog post: Is Our Promissory Note A Security? by A. O. Headman. It’s also much better written. <sigh>

But there was still the voodoo to keep my attention. The FBI agents found Ms. Bennett’s freezer to be full of unusual jars.

The FBI agents found documents with instructions on how to place individuals under hoodoo spells. (Hoodoo is the less religious take on Voodoo.) The jars contained identifying information for the SEC attorneys that were investigating Ms. Bennett and I suppose other items that were part of the hoodoo spell. The FBI believes it was the beef tongue shut up hoodoo spell that involveds beef tongue and had-written notes.

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The One With A Cascade of Bad Choices

Rusty Tweed may have been trying to make good investments for his clients. He knew a guy that had a new quantitative trading strategy for blue chip stocks. Rusty raised money form his clients to invest with the quant manager.

Problems started right at the beginning, according the complaints filed by FINRA and the Securities and Exchange Commission.

Tweed could not open the brokerage account because of financial arbitration complaints against him. Instead of opening the account, he created a feeder fund to invest in a master fund that would be invested by the quant manager.

Tweed raised $1,635,000 from 23 of this clients. However, the PPM for the fundraising failed to disclose the fees charged by the quant manager. FINRA also decided that Tweed should have disclosed that he had to set up the feeder/master structure because of the disciplinary problems. I guess that it did not work in the real world.

The quant manager’s strategy apparently didn’t work and Tweed withdrew the money. That quant strategy was theoretical and based on backtested performance. The strategy was still in the testing mode when Tweed made the investment.

After the quant strategy, Tweed sent the cash to QAMF as a replacement master fund. Tweed failed to update the PPM to describe this new strategy and apparently failed to tell his existing investors about the change. QAMF was also more expensive, taking a 3.5% annual fee and 20% of the profits.

Six months later, Tweed felt that QAMF was under-performing and asked for a return of capital. QAMF was willing to return 2/3 of the capital, but 1/3 was invested in an illiquid asset. That turned out to be an investment in a gold venture in Ghana. Rather than being honest with investors, Tweed merely told them that the “the money was locked up for another year.” QAMF transferred the investment directly to Tweed’s fund.

Tweed failed to write down the value of the Ghana gold for two years and then only partially. Tweed has not recovered anything from that investment.

A year later, still stuck with gold investment, the principal behind QAMF was arrested for bank fraud charges and plead guilty.

Of the 2/3 returned to Tweed’s fund, he caused $200,000 to be invested in a software company owned by a friend that was to pay 18% interest quarterly. None of the interest was paid, nor was the loan re-paid before the software company went into bankruptcy. Tweed never disclosed the bankruptcy filing to fund investors.

Tweed had issued financial statements to investors that showed positive returns. Tweed allowed investor redemptions at the inflated values. One of those was Tweed’s profit sharing plan, benefiting Tweed and his employees. Tweed began to prioritize redemptions over others, allowing his family members to redeem.

Tweed was hit by a state regulator with a deficiency letter for failing to issue audited financial statements.

The SEC commenced an examination of the investment advisory firm that Tweed was associated with. During the exam, the IA’s CCO discovered Tweed’s misconduct. The CCO ordered corrective action be taken. According to the SEC’s complaint, that corrective action was incomplete and failed to fully disclose the problems.

That is a long list of poor decisions and misconduct piled on top of poor decisions and misconduct.

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The First Ever Cryptocurrency Back By Real Estate

The First Every Cryptocurrency Back By Real Estate, REcoin, is a big scam. At least according to the Securities and Exchange Commission.

Several weeks ago the SEC posted an Investor Bulletin in Initial Coin Offerings. In the bulletin, the SEC raised the issue that an initial coin offering could easily be considered an offering of securities, which would require compliance with the securities laws. The SEC warned that fraudsters had begun using ICOs as fraudulent investment schemes.

It seems easy to paste together some mumbo-jumbo to make it sound like the blockchain could be something useful and disrupt an industry. You can add dash of hope for the conspiracy freaks by noting the ICO is free from government fiat and the Federal Reserve. Add in the lure of big profit. Then rope in the suckers.

You can see all of that in the white paper for REcoin.

  • 100% (less the cost of maintenance) of proceeds from the sale of REcoin are invested in real estate
  • REcoin Trust guarantees 70% of the investors’ market value, against the US Federal Reserve’s 10%

The SEC alleges that REcoin misstated to investors that it had a “team of lawyers, professionals, brokers, and accountants” that would invest REcoin’s ICO proceeds into real estate. In fact none had been hired or even consulted.

REcoin was “backed by secure real estate investments in the world’s most advanced economies” and touted that the asset’s “security is ensured through the use of one of the soundest and most reliable currency backings there is: real estate.” REcoin never purchased any real estate, either before, during, or after the REcoin ICO, with the proceeds of the REcoin ICO or otherwise

REcoin misrepresented that it had raised between $2 million and $4 million from investors when the actual amount is approximately $300,000. Sadly, I suspect it has all been pilfered or misused. Investors who transferred funds to REcoin never received any form of digital asset, token, or coin, and no token or coin for REcoin has ever been developed.

I think there will be some interesting uses for the blockchain technology. None of them involve coins.

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By No One’s Math Is 50 Percent a Vast Majority

There is no place for hyperbole or fudging numbers in disclosure of investment returns. The Boston office of the Securities and Exchange Commission made that point with Aegerion Pharmaceuticals in its enforcement case.

According to the SEC complaint, Aegerion’s CEO said that the “vast majority of patients” who were given prescriptions for one of its drugs were taking the drug. However, the more accurate statement was that approximately 50% were taking it.

The problem was that in order to start the drug therapy, patients needed to maintain a low-fat diet and to seek regular liver monitoring. As for side effects, patients could experience nausea, vomiting, and stomach pain. Plus there was the enormous cost of the treatment: approximately $250,000 to $300,000 annually. Patients’ medical insurance may not agree to extend coverage.

Therefore, stock analysts covering the company were very focus on this conversion rate from prescription to treatment. On the first quarter 2013 earnings call, when asked about the conversion rate, Aegerion’s CEO said that the percentage of patients who did not convert: “[i]t’s a very small number. It’s not material.” On the second quarter 2013 earnings call, Aegerion’s CEO stated about the conversion rate: “We haven’t given that percent. It’s high. It’s very high.” He further asserted that the “vast majority of patients” who were given prescriptions actually followed through and began therapy.

I will be the first to admit that those are fuzzy statements. But I agree that saying “very high” or “vast majority” is far more than 50%. According to the SEC complaint, analysts plugged 85% or 90% into their financial analysis of the company.

Things began to fall part on the fourth quarter 2013 earnings call when Aegerion admitted that more patients were reluctant to start taking the treatment than previously anticipated. It was not until the third quarter 2014 earnings call that Aegerion was more exact and more accurate when it disclosed that the conversion rate was in the “range of 50%-60%.” It should be no surprise that Aegerion’s stock price plummeted on the next trading day after that call. Clearly, analysts thought the “vast majority” was much higher than 50%-60%.

“By no one’s math is 50 percent a vast majority,” said Paul Levenson, Director of the SEC’s Boston Regional Office.  “When companies publicly discuss their financial data, they must be truthful.  Whether they supply hard numbers or give broader descriptions, they cannot mislead investors.”

The SEC’s actions is just part of Aegerion’s problems. It also is pleading guilty to criminal liability under HIPPA and civil liability for make false claims to a federal program. In a deferred prosecution agreement to resolve the HIPAA violations, Aegerion admitted that it obtained patients’ personally identifiable health information, without patient authorization, for commercial gain. Under the civil false claims settlement, Aegerion is paying a civil penalty for false claims submitted to government healthcare programs arising from its promotion of its therapy without a proper diagnosis.

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The One with The Fake Ron Stenson

Some of the things that catches my attention with frauds and Ponzi schemes are the steps that the fraudsters will take to cover up the fraud and how they think they will escape from the fraud unscathed. The recent charges against Jeremy Drake caught my attention because of the steps he took.

The Securities and Exchange Commission has filed the charges, but Mr. Drake has not yet had a chance to refute them. I’m just using the allegations as a way to help me (and maybe you) better understand how frauds evolve.

According to the complaint, Mr. Drake worked as a registered investment adviser representative. He managed to convince a professional athlete and his wife to become his clients. (I poked around, but couldn’t find out who.) The relationship started off with a standard 1% fee.

In 2012 Mr. Drake told them they were entitled to a VIP discount on the fee. I assume (1) his clients pressed him on fees, (2) his firm did not agree to the discount, and (3) Drake lied to keep them as clients. He fed them some gobbledygook about how they were getting credits in their account from the brokerage. I can only assume that he thought he could eventually convince his firm to give the discount.

But there was no discount. The client met with Mr. Drake a year later and he once again spewed out the discounted rate. He documented the fraud by sending fake account statements stating that the clients had paid “net” rates of 0.177% and 0.15%, resulting in “net” fees of $44,994 and $34,737. They had in fact paid a 1.0% rate in both accounts, resulting in actual fees paid of $280,349 and $231,889.

At this point, you may expect that the firm could have spotted Mr. Drake’s fraud. The rep is sending the account statements instead of them coming from the custodian.

A year later, the same discussion over fees happened again and more fake documents were sent. The client’s wife first language was not English, so perhaps Mr. Drake thought he could use the language barrier to keep the fraud going. The client’s wife’s assistant was the translator.

In 2016 with a new assistant and a new accountant, the client pressed Drake again. Drake continued with the lies and fake documents. The fraud was not holding together and they pressed Drake on the fee discount. To bolster the fraud, Drake created a false persona named “Ron Stenson” whom he held out as an employee of “Charles Schwab Advisor Services” who could help explain the fee credit. He pressed a colleague into the role of Ron Stenson to answer phone call inquiries.

At this point Mr. Drake realized he couldn’t keep the fraud going. The accounts were short almost a million dollars in the fees the firm was taking compared to what he was telling the clients. I scratch my head wondering how Mr. Drake was going to get out of this. I have to assume that he hoped the firm was going to grant the discount at some point.

Should Mr. Drake’s firm caught some of this activity through email monitoring? Maybe. I’m skeptical of the effectiveness of email monitoring. It’s full of false positives, causing compliance to stare at a lot of stuff instead of spending time looking at other areas.

Theoretically, Mr. Drake’s clients should have been getting account statements directly from the  third-party custodian. That should have shown actual fees deducted and the actual positions held by the client. That is one of the key pillars of the custody rule. The client should be able to verify an advisor’s work by getting the account statement directly from the custodian or getting statements that have been vetted through a third-party auditor.

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The One With The Fake Cancer Detection

The product sounds great: “The Gold Standard to monitor metastic breast cancer. Our Serum-2 test provides a more accurate representation of HER-2 status, facilitating more appropriate treatment strategies.” NanoMolecularDX is “executing a commercialization strategy” for this test and others.  In July is closed on $1 million of seed funding.

I’m an advocate for cancer research and raising money to fight cancer, so this sounds like a good thing. It also has an affiliated entity, MetaboRX that is a “preclinical stage biopharmaceuticals enterprise based on pioneering research in fatty acid metabolism.”

So why did NanoMolecularDX list as its general character of business “serving food; restaurant” on its filing with the Massachusetts Secretary of the Commonwealth? And why did MetaboRX list as its general character of business “serving food; restaurant” on its filing with the Massachusetts Secretary of the Commonwealth

The Securities and Exchange Commission also wants to know. The SEC filed a complaint against NanoMolecularDX  and its manager, Patrick Muraca.

“According to the SEC’s complaint, Patrick Muraca established two pharmaceutical development companies and raised nearly $1.2 million by representing to investors that their money would be used to develop products to detect cancer and other diseases. The SEC has traced the flow of investor funds into Muraca’s personal bank account and alleges that at least $400,000 has been used to pay rent for the restaurants and fund other purchases by Muraca, including payments to a casino, automotive shop, and cigar shop.”

According the SEC complaint Mr. Muraca used the money he raised for personal expenses: mortgage, groceries, and gas. He also used $45,000 of the investors’ money to pay the rent and expenses for his fiancee’s restaurant business. Once that went out of business he spent another $30,000+ to start a new restaurant.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Muraca.

“As alleged in our complaint, we’re intervening to protect investors because Muraca has veered from his stated intentions and has been using their money for purposes other than the fight against cancer and other diseases.” – Paul Levenson, Director of the SEC’s Boston Regional Office

Great job by the SEC’s Boston Office to identify the fraud and shut it down before Muraca was able to scam any more investors.

What compliance lessons can we learn from the case?

Corporate filings do matter. Any investor could have pulled up the filing Massachusetts filing and noticed that strange purpose. I generally don’t find the filings with the secretary of state to be incredibly useful. But sometimes you do find a red flag like this to stop you in your tracks.

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As I mentioned above, I’m raising money for the Dan-Farber Cancer Institute for the Pan-Mass Challenge. 100% of your donation is passed through to DFCI. I’m riding my bike for three days and 250+ miles. I appreciate the generous support I have received from so many of the readers of Compliance Building. You can donate through any of the links below.

Thank you,
Doug

 

The One With The Floundering Hedge Fund

I’m a local homer, so fraud cases in Massachusetts catch my attention, especially when they involve private funds. The case of the floundering hedge fund, MC2 Capital, founded by Yasuna Murakami, is the usual example of greed and failure to acknowledge one’s mistakes.

Mr. Murakami had big dreams and in the glory days of 2007 thought he could graduate from business school and start a hedge fund. According to the order from the Massachusetts Secretary of State, he had no professional experience trading securities.

He convinced a business school classmate who had been working at Bear Stearns in 2007 to join with him to form MC2 Capital. They were able to raise $3.6 million. The fund was supposed to focus primarily on small to medium cap US stocks with an emphasis on value-oriented investments. However, in reality it had no strategy and had significant holdings in extractive industries and used margin loans for its trading.

It should come as no surprise that inexperienced managers with no strategy lost a great deal of money for the fund investors. By August 2011, the fund had only $33,577.51 in net equity. MC2 lied to investors and covered up the losses. Investors got fake K-1s and account statements.

The trading losses did not deter them. They started a second fund, and then a third fund for Canadian investments.

For the Canadian investments, MC2 managed to eventually link up in 2011 with a successful Canadian asset management firm and fund manager who agreed to run the investments for 70% of the fund fees. That firm cancelled the arrangement in 2015. To make up for the loss, MC2 made up a fake firm as the replacement asset manager.

By the end of 2016, the combined worth of all three funds was less than $10,000. Yet, MC2 told one if its investors that its investment was worth over $4.5 million, with a year to date gain of 18.7%.

It should come as no surprise that some of the investor money was not just lost in trading, but ended up directly in Mr. Murakami’s pocket.

As you might expect, MC2 was using new investor money to pay redemption requests. MC2 turned into a Ponziu scheme.

The Massachusetts fraud case did not pull in the other MC2 partner, Avi Chait. The SEC action does and implicates Mr. Chait in the wrongdoing. It may be that Mr. Chait was not aware of Mr. Murakami’s wrongdoing. The SEC complaint has this quote from Mr. Chait to Mr. Murakami, “I am trying to sell a fund that I know nothing about at all.” It all became too much for him in 2016 and Mr. Chait redeemed his interest and his relatives’s interest, pocketing the fake returns.

The SEC swooped in May, after Massachusetts has already brought its action in January and fund investors had brought their suit in November.

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