Category: Fraud

Investment Fraud and Online Dating

Most good financial advisers will tell you that referrals are their best source of business. The same is true for fraudsters. Affinity fraud is just using a network to funnel new “investors” into a fraud. The Boston office of the Securities and Exchange Commission brought charges against an alleged fraudster using an unusual network.

The word Fraud appearing behind torn brown paper.

The SEC alleges that Thomas J. Connerton told investors that his company, Safety Technologies LLC, was developing a material to make surgical gloves better resistant to cuts or punctures. He claimed that several major glove manufacturers wanted the technology and Safety Technologies was on the brink of imminent deals that would result in large payouts for investors in his company. But no deals have ever been anywhere close to materializing.

Instead, the SEC alleges that Connerton has been emptied the company’s bank accounts for his own expenses. Those expenses include a $20,000 for an engagement ring for his latest online date.

She is also an investor.

Of the 50+ investors in the company, six are women Connerton met through online dating. There are 14 others who are family or friends of those women. A third of his “investors” and half of the money are tied to Connerton’s online dating activities.

And you thought your ex had problems.

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A Chairlift to Securities Fraud

The Securities and Exchange Commission brought charges against the owners of Jay Peak resort in Vermont’s Northeast Kingdom just as ski and snowboard season is winding down. The Miami-based ownership was allegedly using fraudulent EB-5 offerings to raise money and take a bit off off the top for themselves.

jay peak logo

Jay Peak is wonderful mountain for snowsports, but you need to spend quite a lot of extra time getting there. Historically, there was not much at the mountain except for the mountain. Lately, the resort has added a hotel and an indoor water park. According to the SEC, the owners were involved in some shenanigans when raising money for these improvements.

The EB-5 Visa program allows an immigrant and family to live or work or retire in the United States. It requires investment in an enterprise that creates jobs for US citizens. The minimum amount of money to invest is $500,000 for an investment in a rural or high unemployment area. The EB-5 immigrant investor visa program is intended to attract foreign capital into the US and create jobs for American workers.

The Jay Peak program, combined with a similar strategy at nearby Burke Mountain and a biotech research building, was one of the biggest projects to be financed in this way.

According to the SEC complaint, the problem started with the purchase of the ski mountain. The head of the company, Ariel Quiros commingled funds from two separate investment programs to help fund the acquisition. Inexplicably, investor money was deposited in a brokerage account and Mr. Quiros arranged for margin loans and cross-collateralized the accounts across investment programs.

The final straw appears to be the biotech building. The offering documents misrepresented that there was FDA approval in place. The SEC also alleges that Quiros pocketed some of the investor money.

The SEC complaint is full of charges of mismanagement, theft and fraud.

I fear that the result will be a terrible blow to Jay Peak. I assume that half-completed projects will sit decaying in the ground for years, if not decades. The resort itself will not have the capital to operate well.

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Racing, Compliance and Cheating

With the Boston Marathon on Monday, the legend of Rosie Ruiz comes up as one of the most infamous sports cheats. Races have since added controls, but cheaters still look for ways around the controls.

Rosie Ruiz, center, is helped by Boston police after winning the women's division of the Boston Marathon, April 21, 1980. Ms. Ruiz had a partial unofficial time of 2 hours, 31 minutes, and may have broken the women's record set in 1979. (AP Photo)

For those of you not familiar with the history of the Boston Marathon, Rosie Ruiz was declared the winner of the 1980 Boston Marathon with a time of 2:31:56. At that time, it was one of the fastest female marathon runs. Currently, the female elite runners leave before the men. In 1980, women were back in the pack and harder to track.

Now, racers have a timing chip that notes when the athlete passes certain points in the course. It makes it harder to cheat because you need to figure a way to get the chip to each of those points.

According to a recent article in the New York Times on an ironman athlete, the athlete tried to circumvent the system by claiming that her timing chip fell off. The general rule for most races is that if you don’t finish with your timing chip, you don’t get a finishing time. She plead for reinstatement, and had her time reinstated. That also made her the winner of her division.

In looking at running portion of the race course, it seems clear that the course failed in having enough timing checkpoints. The course consisted of two laps, with several points that a cheater could cut across the route.

The other element helping to catch cheaters is the prevalence of spectators that can provide meaningful race data. We all have mini-computers in our pockets with phones that accurately capture time and location. Race officials were able to identify the time and place of the athlete on certain parts of the course that did not match her claimed performance based on spectator images.

Officials should not have had to rely on extrinsic data. There should have been more timing mats. Race officials should not have allowed reinstatement of her time. They should particularly not allowed reinstatement when it gave the athlete a win in her division.

Controls are in place to prevent cheating, allowing circumvention of the controls is a compliance failure by the race officials. It takes well-deserved recognition from the athletes who followed the rules.

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Videogame Failure and Securities Fraud

As a Red Sox fan, Curt Schilling is an iconic player to me, leading the team to break the curse of the Bambino. I don’t think that leads to him being a successful entrepreneur or video game developer. Nonetheless, he invested a great deal of his own wealth and raised a big pile of capital to create 38 Studios and start production of a massive multi-player video game. Despite his greatness as a pitcher, he was not able to close the deal and publish the game. The company folded and laid off its employees.

Now the Securities and Exchange Commission has brought charges of securities fraud in connection with the raising of capital.

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Rhode Island was looking to bring jobs to the state and lured 38 Studios to relocate to the Ocean State. The Rhode Island Economic Development Corporation agreed to issue bonds and raise $50 million of capital for 38 Studios through a $75 million offering. The remaining $25 million was for offering expenses and a reserve fund.

The EDC hired Wells Fargo as the placement agent to sell the bonds. However, Wells Fargo had already been hired by 38 Studios to raise capital. According to the SEC complaint, the bond offering documents should have disclosed more about Wells Fargo’s role and how much it was getting paid.

The other problem was that the bond offering was not enough money to finish production of the video-game.  The original projection was for the full $75 million to go to 38 Studios. By only getting $50 million, it had a capital shortfall. It would run out of money by the end of 2011. According to the SEC complaint, the offering documents should have disclosed this shortfall and did not.

38 Studios managed to last longer than projected. It did not default on the bond payments until the Spring of 2012. Then it filed for bankruptcy in June 2012.

The SEC does not spell it out, but clearly the myth of Curt Schilling was the selling point for the deal. Wells Fargo’s ability to sell the bonds was based on the myth of Curt Schilling.

The ability of 38 Studios to successfully produce a videogame was a myth. The job creation behind the bond offering was myth. According to the SEC suit and various other lawsuits it looks like a lot of people thought they could make money from the myth of Curt Schilling.

The first tenet of our securities laws is disclosure. Making money from the myth is not inherently illegal. Failing to disclose is.

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Phishing for Losses

You’re security is only as secure as your employees. I was struck by this when I received an email from the head of my firm wanted to discuss a wire. I was being subject to a phishing attack.

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I think we all see this often. Personally, I always find it curious when a bank sends me an email with a a warning about my account. I’m not worried since I don’t have an account at that bank. Of course that also leads to me ignoring emails from my own bank.

I pay a bit more attention when the CEO sends me an email.

Email business scams may caused more than $2 billion in losses over the last two years.

It’s not just advisers or fund managers that need to worry. At least one publicly listed company has suffered a loss from this scam. The company had to admit in it’s quarterly report that $46.7 million had gone missing.

As good as a firm’s systems may be to deter external threats and hackers, it’s the social engineering attacks at a firm that are becoming more successful.

Convincing an employee to authorize a wire takes less technical skill than hacking into a firm’s network. It all starts with a simple email.

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The Good, Bad and the Ugly of Lending

In browsing through the Wall Street Journal I ran into three stories side by side:

Each is a different side of specialty loans.

Cash in the grass.

The Ezubo fraud story caught my attention first. That is a lot of money for a Ponzi scheme. There is no proof that it is actually a fraud at this point. But employees of legitimate companies do not generally bury the firm’s accounting books in a field.

I found the LendingClub loan story to be interesting because the loans were sold at premium to the outstanding balance. The buyer thought it would get its money back and then generate more revenue through those borrowers.

The liar loans are a vestige of the housing boom when lenders were underwriting loans on value and not the borrowers’ ability to repay the loan. There is some need for these products for borrowers whose income is hard to document. But largely they are known as liar loans for poor documentation and cheating on behalf of the borrower. I though they had gotten buried in hole, never to be seen again.

It’s the liar loans and the Ezubo loan that are most alike. The loans (or “loans” in the case of Ezubo) are driven by lender demand. It’s Wall Street banks that are looking for pools of liar loans. In Ezubo’s case its the small investors looking generate returns for peer-to-peer loans. In neither case is an increase in loans being driven by legitimate consumer demand. Its lenders searching for yields.

The LendingClub loans are driven by consumer demand. These loans are also better documented and have credit worthy borrowers. The story states that the average FICO score was about 700.

Good documentation and controls generated the best returns. I think that makes any compliance professional happy.

It’s Hard to Tell What the Next Form of Cheating Will Look Like

One of the problems with compliance is that the fraudsters seem to be one step ahead of the regulators. The regulators try to push out rules to prevent bad behavior. Regulators look at their charges to find cheating. But the cheaters are often one step ahead. We saw this in professional cycling over the weekend.

Femke Van den Driessche

Professional cycling has been rife with cheating throughout its history. It’s a brutal sport so contenders are always looking for a little edge to get them to the finish line first.

Of course, there was Lance Armstrong and the doping of the 1990s. Cycling was not alone. Baseball had its own issues at the same time. Regulators seem to have caught up with cheaters, flushing a lot of the doping out.

This weekend regulators found a new kind of cheating.

Race officials found a motor in the bike of Belgian cyclist Femke Van den Driessche. Yes, a motor. In her bike frame.

A rumor about motor doping popped up last year. During the 2015 Tour de France race officials checked several bikes, but never found anything. It seemed like a possibility that battery technology could catch up to make a motor and power sources small enough to fit unnoticed in a bike frame. The key would reducing the weight so that whatever power was generated would not be overcome by the additional weight of the machinery.

Apparently that time has come. Although Ms. Van den Driessche denies she cheated:

“I didn’t know anything about it. I don’t know how that bike got there. I was surprised to see that bike standing there. It’s not my bike. There’s been a mistake.”

Incidentally, Van den Driessche’s brother Niels is currently suspended for doping.

Regardless of whether she cheated, it is clear that the technology is here. Regulators will have a new round of checks on race winners, looking at their bikes as well their blood.

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Shkreli Gets His Holiday Gift… Handcuffs

One of the most hated men in American business was grabbed by the FBI and put in handcuff. The Securities and Exchange Commission slapped a “me too” suit on him as well. Martin Shkreli did the perp walk last week for running a ponzi scheme.

shkreli

Shkreli became the face of what is wrong with the American health industry when he jacked the price of treating a life-threatening parasitic infection from $13.50 a tablet to $750.

With his engorged wallet he spent $2 million to purchase the sole copy of Wu Tang Clan’s latest album. To prove that it was just an expensive trinket, he claimed to have not listened to it.

That all just makes him gross, but not a criminal.

But it turns out that he got there through running a ponzi scheme. He pulled off the rare ability to exit from a ponzi scheme.

The vast majority of ponzi schemes collapse under the weight of promised payouts exceeding the inflow from new investors. The original investment scheme fails and the sponsor is scrambling to find anything that might work to score the redemptive returns. Given that the supply of capital is significantly smaller, the returns need to be astronomical.

Skreli had lost all of his investors’ money. He had just settled a FINRA Arbitration over naked short-selling that took the last few dollars out of his hedge fund accounts.

He started MSMB Capital, a hedge fund company, in his 20s and drew attention for urging the Food and Drug Administration not to approve certain drugs made by companies whose stock he was shorting. The strategy did not work.

Nonetheless he send a message out to investors that he had doubled their money.

Mr. Shkreli started Retrophin, which also acquired old neglected drugs and sharply raised their prices. The company was wildly successful and went public.

As a public company, Retrophin can’t pay off Mr. Shkreli’s disgruntled hedge fund investors. But fiduciary obligations were apparently not important to him and he caused the company to write the checks.

Retrophin’s board fired Mr. Shkreli a year ago. Last month, it filed a complaint in Federal District Court in Manhattan, accusing him of using Retrophin as his personal piggy bank to pay back disgruntled investors in MSMB Capital.

The DOJ and SEC piled on and brought their own suits.

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Twitter for Stock Manipulation

Twitter is stream of random thoughts, news, insightful commentary, boring stories, humor, sadness, food pictures, hate, love, and cat pictures. The internet as a whole. At least a few traders have used Twitter as stock pricing indicator. Theoretically, that means stories could be planted that would move the stock price of a company. One trader tried to do so under false pretenses and is now subject to civil charges by the Securities and Exchange Commission and criminal charges by the Department of Justice.

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James Alan Craig set up a few Twitter accounts. One was modeled after Muddy Waters Research, the influential equity research company. Another was modeled after Citron Research, another influential securities research firm. In each case he stole the firm’s logo to use on the Twitter accounts.

On Jan. 29, 2013, Craig used a Twitter account to send a series of tweets that falsely said Audience, Inc. was under investigation. Audience’s share price plunged and trading was halted before the fraud was revealed and the company’s stock price recovered. On Jan. 30, 2013, Craig used another Twitter account to send tweets that falsely said Sarepta Therapeutics, Inc. was under investigation. Sarepta’s share price dropped 16 percent before recovering when the fraud was exposed.

false tweets

Craig used his girlfriend’s brokerage account to buy the companies’ shares at depressed prices, hoping to sell them later after they rebounded. He was a terrible trader and missed the low prices. He bought $13,000 worth of stock in the companies, but made less than $100 of profit.

However, there was substantial short term damage to the targeted companies. The stock drop erases $1.6 million of shareholder value for at least a short time. There was enough of an impact that the NASDAQ halted trading in one of the companies.

It’s hard to believe that an unverified Twitter account that is poorly used could dupe the market into thinking that the claims were true. But I may be underestimating how much traders are using Twitter algorithms in their trading strategy. Craig’s accounts had very few followers and brief histories. Most people would discount the quiet tweeting from such an account. The algorithms did not.

For a few tweets and $100 of profit Craig faces a maximum prison sentence of 25 years, a fine of $250,000, penalties and restitution. Of course that is only if the US authorities can get their hands on him. His whereabouts are unknown.

If the case ever makes it to trial, it would be an interesting legal examination of the intersection of social media an securities fraud.

I don’t think I could be convicted of securities fraud for standing on a street corner and telling everyone that passes that Company X is a fraud and subject to upcoming charges. I didn’t think the same would be true if I did the same thing on Twitter. But maybe I’m wrong.

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Failing the Family

Some Securities and Exchange Commission cases catch my attention because of their headlines or their focus on a real estate investments. The case against Lee Dana Weiss caught my attention because it was from my home town.

newton mass

The story is one of alleged self-dealing and failure to disclose conflicts. In a complaint filed in U.S. District Court for the District of Massachusetts, the SEC alleges that Family Endowment Partners LP and its owner, Lee Dana Weiss, of Newton, Massachusetts, urged their clients to invest more than $40 million in illiquid securities issued by several related companies without disclosing that Weiss had an financial interest in the investments.

 

This was not the first round of trouble for Mr. Weiss and Family Endowment. In April, they lost an arbitration and had to repay $48 million to clients. The firm had recommended a series of private investments in a company that owned a Polish tobacco company and patents on a cigarette filter that it claimed would revolutionize the tobacco industry. Not only was it a sketchy investment, but apparently Mr. Weiss had an undisclosed performance interest in the success of the company.

Browsing through the Form ADV, you can see that it is filled with subsidiaries and the multiple hats that Mr. Weiss was wearing.  Given all of the existing disclosures, it seems that it should have been easier to include the additional disclosures that would have helped his case.

Given that Mr. Weiss had an ownership interest, and not just an incentive payment, the principal transactions rule would apply requiring explicit consent by the advisory client.

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