Category: Fraud

The One with Failing to Meet Investment Criteria

Knight Nguyen Investments raised millions from its retail investor clients to invest in securities that met the firm’s investment criteria: 

(a) always allocate “secured” capital to attract at least 10% returns, and would select entities 

(b) with taxable income to support returns and that often do over $10 million of revenue;  

(c) that are already making money and not dependent on investor funds; and  

(d) that have financials that have been audited by KNI.    

Instead, the firm put its clients into extremely risky investments that did not meet the stated investment criteria. Instead, the firm invested its clients’ capital into high risk or fraudulent companies that, in most cases, were owned, controlled, or associated with principals of the firm. 

One was investments in promissory notes issued by a Seychelles-based company that was purportedly involved in the purchase and sale of gold from a Lebanese refinery. The company later defaulted on the notes and the firm’s clients lost their capital.  

Another was a Florida bioscience company that purportedly held patents for peptides that have potential applications ranging from cancer and burn treatments to crop solutions. The investment was speculative and did not meet the investment criteria, because the company de minimis revenues, its financials were not audited, and it was not actually offering secured investments. 

A Texas widow lost her entire $30,000 retirement investment. A Nevada individual lost his entire $92,000 retirement portfolio. A Kansas veteran and military professor, who was months away from retirement, lost almost all of his $320,000 retirement savings. An Alabama retiree lost $105,000. A retiree in Houston who had been seriously injured at work, and feared she could never work again, was seeking safety and income from her investments. Instead, says the SEC, she lost her entire $75,000 retirement portfolio. The SEC mentions others who lost between $30,000 and $150,000 their retirement accounts.

There looked to be a lot of other shenanigans going on at the firm. The big one problem the SEC hung its charges on was how the actual investments differed from the promised investment criteria.

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The One with the Pre-IPO Shares

Peter Quartararo met with potential investors and told them that he had access to “pre-IPO” stock in Peloton, WeWork, and Airbnb.  

The first potential investor was an acquaintance that had done a favor for Mr. Quartararo. He offered to let the investor buy the shares in WeWork and AirBnB at his cost, with was less than $2.00. That investor wrote a check for $96,000 to Quartararo’s firm, Private Equity Solutions, with the notation “Stock Purchase IPO.” 

A few weeks later, Quartararo came back to this investor with access to pre-IPO shares in Peloton. That investor wrote a check for $71,000. That investor shared the opportunity with some friends and Mr. Quartararo also sold them some shares. In all, Quartararo raised $436,000 from this pool of investors. 

After Peloton and AirBnB had their public offerings of shares, the investors began asking for the shares to be sold and the profits sent to them. Mr. Quartararo kept putting them off.  

According to the Securities and Exchange Commission and the Nassau County District Attorney, Mr. Quartararo never had access to the shares in those companies. Instead, Mr. Quartararo pocketed the cash and used it for personal purposes, including to buy a Maserati. 

If the investors had checked the BrokerCheck system, they would have seen that he was barred from acting as a stockbroker. The bar was imposed in 2013 because Mr. Quartararo stolen money from a client. He had a prior history of other misdeeds before  being barred.  

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The One That is a Hollywood Story

Zach Horwitz was struggling actor using the stage name “Zach Avery.” His IMDB entry lists him in minor parts in mostly bad movies. His biggest movie role is an uncredited part as a medic in Brad Pitt’s “Fury.” 

Mr. Horowitz couldn’t figure out how to get rich and famous, but he did hatch a plan to get rich.  

Mr. Horwitz told investors that he had acquired and distributed dozens of cheap films including titles such as “Active Measures,” “Ruin Me” and “Slasher Party.” He produced contracts signed by HBO or Netflix executives showing he was doing business with the streaming platforms. He paid great returns to his early investors.  

Those early investors were mostly college friends. Those friends  offered the opportunities to their friends and family members to enter into loans with Mr. Horowitz’s production company. That lead to larger investors making loans. 

One investor urged his partners to finance deals more films.  “This is the goose that lays the golden egg guys, lets just hope they keep coming month after month.”  He brushed off his partners’ annoyance at Mr. Horwitz for refusing to let them see his business records. “If anything not sending us financials proves to me even more that they are not desperate, they don’t need our money.” 

As you might expect, Mr. Horowitz was not sending financials because it was a massive fraud. The documents were fake. He had not purchased any films and had no connection to the streaming platforms for distribution. Those early returns to investors were paid with money received from later investors. The classic Ponzi scheme. 

Maybe he was a better actor than the studios gave him credit. He managed to raise $690 million dollars from investors by convincing them his production company was real. That must take some acting skill.  

It looks like Mr. Horowitz will end up famous for his fraud. Whatever riches he briefly held have evaporated as the fraud came to an end.  

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The One With the Lack of Write-Downs

I think many frauds start with a failure to recognize mistakes. Yes, it’s hard to tell your investors that you lost some of their money. It makes it harder to attract new investors and additional investments. It gets really hard to do that when you go to jail.

Martin Silver was the co-founder, managing partner, and chief operating officer of the International Advisory Group LLC. The firm was an investment adviser that specialized in trade finance lending—risky loans to small- and medium-sized companies in emerging markets. The firm also sponsored three private funds to invest in the trade finance loans.

One of the funds had assets of about $300 million. The firm learned that a South American coffee producer had defaulted on a $30 million loan. Fearing that existing investors would flee the fund and that ongoing fundraising efforts would suffer if the loss were disclosed, Silver decided to conceal the loss by incorrectly valuing the loan on the fund’s books. Later, he replaced the defaulted the loan with fake loans to prop up the value of the fund after auditor inquiries.

Then, a second loan in the fund’s portfolio defaulted. Silver continued his actions of not writing down the value of the loan and eventually replacing it with fake loans.

Eventually, faced with liquidity demands for redemptions, Silver formed the second and third funds to buy the fake loans from the initial fund. Eventually, the schemes collapsed and charges were brought.

Of course the scheme collapsed. You can never find the out-sized returns to make up for the big loss.

Mr. Silver pled guilty to one count of conspiracy to commit investment adviser fraud, securities fraud, and wire fraud, which carries a maximum sentence of five years in prison; one count of securities fraud, which carries a maximum sentence of 20 years in prison, and one count of wire fraud, which carries a maximum sentence of 20 years in prison.

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Subscription Credit Facility Fraud

Lots of private equity funds use a line of credit to fund acquisitions. It’s quicker to draw on the line than to call equity from investors. That line of credit is secured by the capital commitments to the private equity fund. Later the private equity fund calls the capital for the acquisition and pays down the line of credit. According to a criminal complaint a private equity fund manager is accused of forging subscription documents and an audit letter to get a line of credit.

JES Global was registered with the Securities and Exchange Commission as an Exempt Reporting Adviser. Its principal, Elliot Smerling, committed blatant fraud. It may have future implication for private funds and the work that will go into setting up a credit facility.

Elliot Smerling had an empire of private equity funds and reportedly lived a lavish lifestyle, with homes in Florida, New York and Brazil with a collection of luxury cars. Smerling is accused of committing fraud to keep his complex financial operation afloat, according to the criminal charges.

He set up a credit facility with Silicon Valley Bank for one of his funds. He handed the bank two subscription agreements. One purported a $45 million commitment from a New York University endowment and a second purported to be $40 million from an investment manager. The criminal complaint did not identify the two purported investors. Smerling is also accused of submitting a forged audit letter and a falsified bank statement showing a wire transfers from the purported investors.

According to the criminal complaint, Smerling produced fake documents. The University endowment has no record of the document or the wire and the signature does not match the CIO of the endowment. The investment manager has no record of the document or the wire and the signature does not match. The audit firm named on the audit letter was not engaged by Smerling or the fund. The address on the letterhead of the audit letter is an address that the firm has not operated at for several years.

This is the first time that I’ve heard of subscription facility fraud. I expect that there may be changes to the lending process

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Affiliate Funds Shuffling Funds

George Heckler, of Charleston, South Carolina, operated a decade-long fraud through three private hedge funds, Cassatt Short Term Trading Fund LP (Cassatt), CV Special Opportunity Fund LP (CV Special), and Conestoga Holdings LP (Conestoga). This fraud caught my attention because my brother and mom both live in South Carolina.

Heckler’s initial fund was Conestoga, which was formed in 1998. Unfortunately, the fund had a big investment in an illiquid investment and that investment went south, resulting in millions of dollars in losses.

Rather than admit to the problem, Heckler raised new cash to pay off Conestoga investors looking to exit. He raised the additional funds, in part, to repay the Conestoga investors. He convinced a fund administrator to help him with the fraud. He used the Cassat and CV Special capital raises to pay off investors in Conestoga. He falsely stated in those fund financial statements that the funds were properly invested.

Although Heckler has not agreed to the SEC charges, he did plead guilty to the criminal charges brought by the Department of Justice.

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A Shot of Tequila and Pilfered Investor Funds

Joseph Cimino wanted to make a great tequila and needed capital to make it happen. He raised almost $1 million and got 6 Degree tequila into production. Unfortunately, he apparently lied to his investors in raising the capital and then stole almost half of that capital.

Cimino created a 40-page booklet providing sales and expense forecasts and describing 6 Degree’s product and business plan. This booklet reported 2015 sales of approximately $260,000 and a net profit of approximately $40,000. But 6 Degree did not launch its operations until the spring of 2016, so those numbers were entirely fictitious.

In another example, Cimino gave a potential investor a financial update showing sales of over 800 cases in Puerto Rico, when the truth was less than 200 cases in sales. Puerto Rico was one of the few places 6 Degree was sold. In another report, Cimino falsely represented in an investor report and quarterly profit and loss statement that the company’s year-to-date sales totaled 3,410 cases, when its actual sales totaled only 350 cases.  

When he wasn’t lying to his investors and potential investors about the company’s results, he was allegedly stealing money from the company. He transferred approximately $472,000 from the company to his personal accounts. 

Mr. Cimino is currently subject to civil and criminal charges by the Securities and Exchange Commission and Department of Justice. According to the statement of the FBI agent in the criminal complaint, Mr. Cimino admitted to at least some of the false claims. He does not admit to illegally taking the cash.

I assume that Mr. Cimino was initially just puffing the success of the company in order to entice investors. The classic, “fake it, ’til you make it.” The problem is that doing so in connection with raising capital, “faking it” is securities fraud. If you publish numbers in a fundraising document, you need to be able to substantiate that number. Moving the decimal point over is going to get you in trouble.

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Another Fake COVID Test Fraud

COVID vaccinations are continuing to roll out and we can hope to see an end to the pandemic. Regulators are continuing to roll out cases against people and companies that tried to illegally profit from the pandemic.

The latest case is against Arrayit Corporation, a life sciences company in Sunnyvale, California. Although a public company, the Securities and Exchange Commission had put a halt to the trading in its shares on public markets in 2015 because the company had failed to file annual reports with audited financial statements. The company failed to respond to auditors requests for information. That moved its share trading to the OTC pink sheets. 

The CEO of Arrayit, Rene Schena, and her brother Mark Schena, President of Arrayit, began telling investors that the reports were coming out and the company had some new revenue sources. 

In March of 2020 Arrayit began making statements to investors.

“Dear [investor], Confirming that we have a SARS-Cov-2 test and that the test is pending emergency approval.”

At that point Arrayit had no reagents needed for a test. Also, Arrayit had not actually applied for Emergency Use Authorization. 

Arrayit took it a step further and told investors that it had received more than 50,000 requests for its finger stick blood test. This was not true. As a result of the untrue or misleading statements Arrayit’s stock price traded up 50% and its volume increased 100%.

The SEC charged Arrayit, Rene Schena, and Mark Schena with fraud. Arrayit and Rene Schena have settled with the SEC. She will pay a $50,000 fine and is barred from acting as an officer or director. Mark Schena’s case is still pending. 

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Real Estate or the Lottery

Viktor Gjonaj thought he had figured out a way to make money. He was a commercial real estate broker and convinced members of his Albanian-American community in Detroit that he had lucrative real estate investment opportunities. He raised over $26 million.

Gjonaj had a promising plan. It involved lottery tickets instead of real estate. Gjonaj diverted his investors’ cash to playing the Michigan Lottery Daily 3 and Daily 4 games.

Maybe he had system that worked. He apparently won millions from the lottery. Unfortunately, it appears that he spent millions more buying the tickets. According to the complaints filed by the Securities and Exchange Commission and the US Attorney, Gjonaj was betting $1 million per week on the lottery using the money that was supposed to be put towards real estate investments.

His scheme unraveled. It appears that most of the investor money is gone. He is subject to lawsuits by his investors, an action by the Securities and Exchange Commission, and criminal charges from the US Attorney.

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Performance Advertising and the Funds That Weren’t There

Eric Malley decided that buying buy hundreds of luxury Manhattan residences on the cheap and leasing them to corporate tenants would be a great way to make money. He would let others in on his plan as investors. He created MG Capital Management Residential Fund III and raised $23 million from about 60 investors. It seemed successful enough that he launched a follow up Fund IV that raised $35 million.

You may be asking yourself: What about Fund I and Fund II?

The marketing materials for Fund III and Fund IV described very successful predecessor funds. In the Fund III PPM the outcome was described as

Fund I:
(1) raised $350 million of investor capital;
(2) earned a gross return on investment (ROI) of 38.99% and a net ROI of 30.81% during its six-year investment term from 2007 through 2013;
(3) outperformed the S&P 500 Index by 4.5-to-1; and
(4) sold its 74-property portfolio to two buyers for $750 million

and

Fund II:
(1) raised $55 million of investor capital in only 30 days; and
(2) achieved an average gross ROI of 38.06%,
cumulative unrealized gains on equity of 154.55%, and
a gross investment multiple of 2.55x.

In the complaint filed by the Securities and Exchange Commission, there is no evidence that these funds existed. Nor is there any evidence that MG controlled the $1.8 billion portfolio of real estate supposedly owned by the funds.

As for the Fund III and Fund IV, well, they did not perform well. According to the SEC complaint, Fund IV “earned $1.6 million in rent and incurred operating expenses of $8.3 million, resulting in net operating losses of approximately $6.7 million” and “$4.7 million in unrealized losses on portfolio investments, bringing Fund IV’s total net loss to approximately $11.4 million.”

As you might expect, MG is accused of illegally siphoning money from the funds. The SEC claims that (1) MG retained cash rebates from the sellers of the properties purchased by the funds and (2) charged the fund for unearned brokerage fees.

MG Capital and its principal Eric C. Malley are subject to civil charges by the SEC, criminal charges by the Department of Justice, and civil suits by investors. We haven’t heard their side of the story. Take the information above as a clear statement of what you should not do.

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