Category: Fraud

The One with the Inflated Loan Values

The Securities Exchange Commission followed up on whistleblowers’ complaints against TCA Fund Management for inflating the value of the assets in its Global Credit Master Fund. In January, investor redemption requests exceeded the liquidity of the fund and it eased operations.

The SEC complaint against TCA Global alleges that TCA was booking fees before they were received.

The SEC claims that TCA was booking loan fees as revenue at the non-binding term sheet stage, instead of when the loan closed. The SEC also claimed that the TCA was booking investment banking fees at the time the firm was engaged and not when the fee was earned . TCA would only be paid if a transaction closed. According to the SEC complaint these practices resulted in over $155 in improperly recognized revenue.

As for the value of the TCA assets, the SEC called it “grim.”

“For 2017 and 2018, the Funds’ auditor issued a qualified opinion with respect to Master Fund’s income and assets, including, for 2018, a qualified opinion with respect to 89% of Master Fund’s NAV. By May 2019, Master Fund had only 5% of its assets in cash, with most of the balance of the assets consisting of amounts owed to Master Fund on loans to thinly capitalized borrowers, a substantial amount of which are in default.”

Strangely, however, the SEC complaint does not accuse TCA of overstating its assets. The whistleblowers accuse the firm of not writing down asset value. I’m not sure why the SEC pulled its punch on the valuation issue.

The other issue that the SEC did not highlight in its complaint is that TCA would likely have been receiving excessive fees from the fund based on the inflated values. I assume the fee had some basis on NAV. With the NAV inflated, the fees would have been inflated.

According to the NBC News story, the problems first surfaced in a 2016 SEC exam. TCA had restated some values as a result of the process. The whistleblowers stepped up when they felt the SEC has missed the full extent of the fund’s misconduct.

Of course, we haven’t heard TCA’s side of the story. I’m just looking at this as a compliance lesson.

Valuation should be the number one issue for compliance in funds with illiquid assets. They are harder to value so more effort should be put into making sure the values can be justified.

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SEC Going After COVID-19 Fraud

There is no greater villain right now that fraudsters trying to profit from the COVID-19 pandemic. The Securities and Exchange Commission is more than willing to go after these bad guys.

Trading Suspension

According to speech last week by Steven Peiken, the SEC’s Co-Chief of Enforcement,  the SEC has suspended trading in the securities of more than 30 issuers as a result of questions about the adequacy and accuracy of coronavirus-related information since early February. .

Do you have masks?

Praxsyn Corporation claimed to be able to obtain large quantities of N95 masks used to protect you from COVID-19. The SEC suspended trading in the company’s shares. It turns out that that Praxsyn had been offered millions of masks from a Mexican company. Turns out the masks were no good.

Do you have test kits?

Applied BioSciences Corp. issued a press release on March 31 stating that it had begun offering and shipping supposed finger-prick COVID-19 tests to the general public that could be used for “Homes, Schools, Hospitals, Law Enforcement, Military, Public Servants or anyone wanting immediate and private results.”

No. The SEC charged that the tests were not intended for home use by the general public and could be administered only in consultation with a medical professional. The SEC further charged that Applied BioSciences had not shipped any COVID-19 tests as of March 31. And furthermore, the SEC charged the company for failing to disclose that the tests were not authorized by the U.S. Food and Drug Administration.

The SEC suspended trading in the company’s securities and is seeking relief.

Do you have a fever?

Turbo Global claimed to have a multi-national public-private partnership to sell thermal scanning equipment to detect individuals with fevers. In a press release with its supposed corporate partner, Turbo claimed the technology is 99.99% accurate.

Turbo Global had no agreement to sell the product, there was no partnership involving any government entities, and the CEO of Turbo Global’s supposed corporate partner did not make or authorize the statements attributed to him. 

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The One with the Fake Pot Ownership

With the growth of marijuana businesses across several states, many see it at a sector ripe for investment with the possibility of big returns. While states approve the sale of marijuana, it’s not entirely legal. Federal law still lists it as a controlled substance. That makes banking difficult and oversight difficult for investors. It also makes it a target for less than scrupulous middlemen.

That’s where we find Guy Griffitthe and Robert Russell. Mr. Russell and his wife had created a company in Washington that held a license to grow marijuana under the state’s recreational cannabis laws.

According to the SEC complaint, Russell cut a deal with Griffithe to offer a stake in his marijuana growing business. That was the first problem.

Under the Washington law for marijuana businesses, ownership is tightly controlled and regulated. Russell couldn’t sell an ownership interest without approval from the state Liquor and Cannabis Board. According to the complaint, Russell and Griffithe tried to structure it as a right to receive profits and not an ownership interest. I don’t think it worked.

That didn’t seem to stop Griffithe from selling interests in the company that bought the interest in the marijuana growing company. The pitch was that the investment would help the marijuana grower to expand by providing capital for equipment, land and physical facilities.

The next problem is that Griffithe didn’t register the securities for sale and didn’t make sure the sale was happening within an exemption. He used a website and openly advertised the sale of the securities.

The third problem was that they spent most of the $4.85 million they raised on non-business purchases. The SEC loves to list out the extravagant purchases made by fraudsters with their ill-gotten cash. This was no exception.

  • 2008 Bentley Continental
  • 2012 Mercedes Benz C Class
  • 2013 Ford Mustang (I’ll assume this was a Boss 302 or Shelby GT500 model)
  • 2015 Porsche Panamera
  • $250,000 towards a 65-foot Pacific Mariner yacht

The final straw was that the marijuana growing business was not actually profitable. According to the SEC, it never made a profit. Meanwhile Griffithe’s marketing material proclaimed a 40% profit margin. They faked the profitability by using some of the investor paid-in capital to make distributions. That turned it into a Ponzi scheme.

Fraudulent investment activity in marijuana business has become so widespread that the SEC has published an Investment Alert: Marijuana Investments and Fraud.

This case points out one of the shortcomings in that SEC alert. It fails to point out the very common limitation on changes of ownership in marijuana businesses. Even if the investment is legitimate, the likely requirement of approvals for the acquisition and later sale will have a big impact on the investment.

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The One with the Fake ComplianceGuard

Compliance; solve it with the blockchain. Operational due diligence; solve it with the blockchain. Shortcomings of separately managed accounts; solve it with the blockchain. Financial audits; solve it with the blockchain.

Shaun MacDonald, managed to squeeze $30 million in ICO funding from investors for his idea to create ComplianceGuard, a blockchain based tool for funds, and a blockchain terminal, crypto-focused version of the ubiquitous Bloomberg Terminal. According to the SEC complaint, the tools were not in production. That and other materially false and misleading statements were made in the illegal sale of securities that was the ICO.

The first problem is that Shaun MacDonald is really Boaz Manor. In 2010, Mr. Manor pleaded guilty in Ontario, Canada to the crimes of laundering the proceeds of a crime and disobeying an order of a court. Both charges related to the 2005 collapse of the hedge fund firm Portus Group. Mr. Manor darkened his hair, grew a beard, and used aliases to hide his identity and conceal the fact that he had served a year in prison.

It started with ComplianceGuard. A box-shaped device that was supposed to do something compliance-y. It was enough to convince people to give him $775,000 through a token offering. It looked something like this. The whitepaper is full of great compliance-related themes. But I don’t see any actual description of a solution to those compliance requirements

Mr. Manor managed to put the device in the hands of a few hedge funds. But according to the SEC complaint, none of them actually used it. It basically functioned as an extra electronic hard drive for the storage of manually entered transaction data. None of the funds paid for the devices.

Then the company pivoted harder to blockchain with the blockchain terminal. That caught the attention of token purchasers and the company raised $30 million.

Clearly, it was more sexy than compliance.

The company actually made a product and sent it to to funds for use. It’s not clear than anyone actually used those terminals or even if they did anything useful.

I’m going to guess that the ICO fundraising was better than the terminals.

In the end, the SEC has all of the alleged fraud. But it also has the fraud of the disguised Mr. Moran.

On top of that, it has a claim for the unregistered sale of securities. The company did file a for Form D for 506(c) offering. But that form of offering requires you to take reasonable steps to verify that the purchaser is an accredited investor. The SEC claims that those steps were not taken.

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Is Fraud Contagious Among Financial Advisors?

Yes.

Perhaps it’s useful to have some data behind that “yes.”

Stephen G. Dimmock, William Christopher Gerken, and Nathaniel Graham looked at 477 financial firm mergers between 1999 and 2011 with multiple branch offices in overlapping cities. They used Form U4 to identify mass transfers of employees in the same city. They also used the disciplinary data from the U4 to measure misconduct in the newly merged offices where there had been overlapping offices. They could use the non-merged offices as control groups.

The study found evidence of co-worker influence on misconduct committed by financial advisors, controlling for merger-firm fixed effects and using changes to an advisor’s co-workers due to a merger. They determined that a financial advisor is 37% more likely to commit misconduct if his new co-workers have a history of misconduct.

Additional tests show that co-worker influence is asymmetric. There is evidence of contagion in misconduct, but no significant evidence of contagion in good conduct.

Bad seeds spread their badness.

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Live Well by Marking Up Your Assets

Live Well Financial found a great way to make money. Mark up your assets, gets loans on the inflated values, buy more assets, mark them up, gets loans on the inflated values, buy more assets, and so on and so on. But it’s only great until a lender wants its money back.

Live Well Financial, Inc., is (was?) a reverse mortgage originator and the owner of an investment portfolio of bonds. It’s CEO came up with scheme that he called, in his own words: “a self-generating money machine.”

The Securities and Exchange Commission didn’t like the scheme and brought charges. Live Well is disputing the charges. I’m taking the SEC’s charges at face value so that I (and also you) can see what the SEC doesn’t like.

Live Well used a lot of leverage, 80%-90% of the value of its bond holdings. With so much leverage, its banks would issue margin calls when the values decreased. Those values were determined by an unnamed third party pricing service who determined them independently.

To give some financial stability and to avoid margin calls, Live Well somehow convinced the Pricing Service to use the prices Live Well supplied to them. Of course, that stopped the pricing fluctuations and margin calls. It seems the lender were not informed of this change in pricing determination.

According to the SEC, Live Well abused that new pricing relationship by inflating the valuations. At times Live Well was able to obtain financing that exceeded the market value of the bonds. Live Well’s lenders thought that the Pricing Service independently determined the values of the bonds, and that the lenders were not aware that the Pricing Service had become a mere pass-through for Live Well’s purported valuations.

After Live Well began submitting its valuations to the pricing service, Live Well’s reported value of its portfolio grew from $71 million to $324 million after eight months, and then $570 million two months later. This growth was in part the result of new bond purchases that Live Well had made with loan proceeds without contributing its own capital.

It all came to a crashing end when Live Well’s lenders wanted to get repaid.

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Toga! Toga! Toga!

I grabbed the SEC case against Syed Arham Arbab for the headline and obvious jokes. Mr. Arbab is accused of running a fake investment scheme out of his college fraternity.

He formed a fund called Artis Proficio Capital Investments, LLC with a business address of 558 W. Broad Street, Athens, GA 30601. (Go ahead and clink on the address link. Yes, it’s a picture of the fraternity house at that address, complete with big Greek letters.)

According to the complaint, it’s a run-of-the-mill investment scam. Mr. Arbab never set up a custody account, never really invested the money and really made fake promises. Mr. Arbab had not settled with the SEC so we only have the Commission’s side of the story. He doesn’t think it’s over. Just like it wasn’t over “when the Germans bombed Pearl Harbor.”

Jeff

The other reason the case caught my attention because today would have been the birthday of my friend Jeff. We spent great years together in high school and college, and many great years thereafter.

We often called him Belushi because he was one of Jeff’s idols. There was some physical resemblance and lots of resemblance when it came to fun.

But cancer killed Jeff a few years ago. I raise money for cancer research in his memory. I’m riding almost 300 miles during the first weekend of August in the Pan Mass Challenge.

If you enjoy reading Compliance Building, please donate a few dollars. 100% of your donation goes to cancer research.

Thank you,
Doug

SEC Wins at SCOTUS

Can the Securities and Exchange Commission penalize an investment banker even though he did not “make” false statements? The SEC is claiming that his distribution of those false statements constituted a “device, scheme, or artifice to defraud” or an “act, practice, or course of business which operates . . . as a fraud or deceit” under subsections (a) and (c) of Rule 10b-5.

According to the Supreme Court, the answer is yes.

Francis Lorenzo was the director of investment banking at Charles Vista, LLC, a registered broker-dealer, and his client was Waste2Energy.

Waste2Energy was trying to raise capital and Lorenzo was tasked with helping to sell $15 million of debentures. Lorenzo’s boss drafted the marketing emails that claimed Waste2Energy had $10 million in assets.

Dear Sir:

At the request of Adam Spero and Gregg Lorenzo, the Investment Banking division of Charles Vista has summarized several key points of the Waste2Energy Holdings, Inc. Debenture Offering.

…

Please call with any questions

Truly,

Francis V. Lorenzo Vice President – Investment Banking

Lorenzo had heard that the claim was incorrect and saw that the company had written off those assets in a public filing. Frank blamed his boss Gregg and others for the content of the email. They “made” the false statement. Frank merely delivered it. Frank was merely aiding and abetting, not the primary actor. Frank claims that he did not provide substantial assistance in the violation. He was merely the messenger.

The distinction is one of private party actions. The SEC can bring aiding and abetting claims, but not private plaintiffs.

The SEC thinks that knowingly distributing the false statements of others to sell an investment is a “device, scheme, or artifice to defraud” or an “act, practice, or course of business which . . . would operate as a fraud.” That makes Lorenzo a primary violator of the scheme liability provisions.

The SEC also sees the obvious loophole if it couldn’t penalize because the relevant person did not “make” the false statements. Those who distribute a statement with knowledge of its falsity would be held liable for aiding and abetting.

The Supreme Court took a pragmatic approach and agreed with the SEC.

“But using false representations to induce the purchase of securities would seem a paradigmatic example of securities fraud. We do not know why Congress or the Commission would have wanted to disarm enforcement in this way. “

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Shockingly, Hedge Fund That Promised No Losses Is Charged For Fraud

Joseph A. Meyer, Jr., and his Statim Holdings, Inc. offered investors in its Arjun private fund that investors would not lose money. The catch is that you can’t redeem from the fund for ten years or you forfeit 1/2 of your capital.

Of course the real catch is that Meyer a fraud. (At least according to the SEC and Georgia Secretary of State.)

According to the SEC complaint, Meyer created an Incentive Allocation on the books of Arjun. In profitable months, the Incentive Allocation would be a payable from Arjun to Statim. In unprofitable months, it would be a receivable due from Statim to Arjun. That allowed the Arjun NAV to remain stable.

Unfortunately, the fund documents only provide for a management fee. There is no disclosure of a performance fee.

The fund documents allowed LPs to borrow against their account. According to the SEC complaint, Meyer was in control of his father-in-law’s account and took a $4.3 million loan to pay down that incentive allocation receivable.

Arjun touted good results. But you can guess that they were not true. In 2015 and 2016, Meyer told prospective and existing investors that Arjun was mostly invested in US Treasury bonds. It hadn’t owned any treasury bonds since 2013.

In 2015, Arjun touted a 11.5% return. It actually had a loss of 7.7%.

If you look at the private fund reporting section of Statim’s Form ADV, you can see that Arjun was audited by Rubio CPA, PC, but the audited financial statements are not distributed to its investors. The Arjun fund agreement was amended in 2009 when the class structure was created and removed the requirement to deliver audited financial statements to investors.

The Custody Rule doesn’t care whether your fund documents require you to deliver audited financial statements. The LPs may not make you, but the SEC does. That’s there to protect investors against actions like this.

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Real Estate Cash Cow

With the Securities and Exchange Commission back up and running, we are seeing new enforcement actions coming out. A real estate fraud caught my attention.

The SEC charged Phillip Michael Carter, Bobby Eugene Guess and Richard Tilford with raising almost $45 million from over 270 investors by selling short-term, high-yield promissory notes issued by shell companies that were intentionally named to confuse investors.  

After reading the complaint, it seemed to me to be a run-of-the-mill real estate fraud. The promise was a low-risk investment backed by hard assets. The truth was a hit or miss collection or real estate assets, big commissions and pilfering of the funds for personal use.

The pitch likely had lots of red flags. The big one for me was that on of the main entities involved was called “Texas Cash Cow.” Investor gave the company placed almost $10 million with it. It turned out to be a cash cow for fraudsters instead of the investors.

Bank Note Save Cow Ceramic Piggy Bank Funny Money

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