Category: Fraud

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.

Sources:

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.

Sources:

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.

Sources:

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. “

Sources:

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.

Sources:

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

Sources:

Cryptocurrency Problems Roundup

Crypto Currency can be a Commodity

A federal judge in Massachusetts agreed with the Commodity Futures Trading Commission’s view that virtual currencies are commodities under the Commodity Exchange Act and subject to federal regulation. See CFTC v. My Big Coin Pay, Inc., (D. Mass. Sept. 26, 2018). The CFTC sued a virtual currency company and several affiliated companies and individuals alleging fraud and misappropriation in the sale of the virtual currency “My Big Coin.” The CFTC claims that defendants perpetrated the fraud by falsely representing to purchasers that My Big Coin was “backed by gold,” could be used anywhere Mastercard was accepted, and was being “actively traded” on several currency exchanges.

My Big Coin Pay is the second federal court decision to embrace that virtual currencies are commodities under federal law. In CFTC v. McDonnell, (E.D.N.Y. Mar. 6, 2018), the court found that the term “commodity” encompasses virtual currency “both in economic function and in the language of the statute” because virtual currencies are “‘goods’ exchanged in a market for a uniform quality and value.”

Unregistered national securities exchange

The SEC brought its first enforcement action against a cryptocurrency trading platform for operating as an unregistered national securities exchange. EtherDelta is an online platform for secondary market trading of ERC20 tokens used by Etherium based crypto. Over an 18-month period, EtherDelta’s users executed more than 3.6 million orders for ERC20 tokens, including tokens that are securities under the federal securities laws. Almost all of the orders placed through EtherDelta’s platform were traded after the Commission issued its 2017 DAO Report, which concluded that certain digital assets, such as DAO tokens, were securities and that platforms that offered trading of these digital asset securities would be subject to the SEC’s requirement that exchanges register or operate pursuant to an exemption. EtherDelta offered trading of various digital asset securities and failed to register as an exchange or operate pursuant to an exemption.

The Environment

If you’re an environmentalist you also need to think about the energy of cryptocurrency mining. The amount of energy required to “mine” one dollar’s worth of bitcoin is more than twice that required to mine the same value of copper, gold or platinum.

You Can’t Hide Overseas

The Tezos blockchain project established a Swiss non-profit stiftung to oversee the ICO and control the proceeds. No surprise that the ICO was bad for those who bought and they a class action. The court found the tokes to be securities. The meant the sale was an unregistered security transaction. The only question was whether the ICO and its sponsors were subject to US securities laws.  The court listed several factors that contributed to its determination that the sale of Tezos tokens had occurred in the United States, including that:

  • US investors bought Tezos tokens
  • a website that sold the tokens was hosted in the US and run by a person located in the US
  • marketing efforts targeted US residents
  • payments made in Ether for the Tezos tokens were validated by a network of Ethereum nodes clustered more densely in the US than in any other country.

Unregistered Broker-Dealer

The Securities and Exchange Commission imposed sanctions against TokenLot LLC, an “ICO Superstore,” for its sales of digital tokens to the general public through a website. The SEC found that TokenLot acted as unregistered broker-dealers in violation of Section 15(a) of the Securities Exchange Act of 1934 and engaged in unregistered securities offerings in violation of Section 5 of the Securities Act of 1933.

Summary

It’s clear the SEC and CFTC have some easy targets in ICOs and their sponsors. I expect there are many more cases in the pipelines.

Sources:

Blockchain Exchange Commission

Worried about the security of your cyptocurrency? How about having the Blockchain Exchange Commission protect you.

It won’t.

According to a complaint filed by Securities and Exchange Commission, Reginald Ringgold is a founding member of this very prestigious-sounding, regulatory-sounding Blockchain Exchange Commission. According to it’s LinkedIn page:

The mission of the [Blockchain Exchange Commission] is to protect investors; and assist in maintaining fair, orderly, and efficient markets within the Blockchain Digital Asset Space. The [Blockchain Exchange Commission] strives to promote a market environment with Decentralized Governance and reliance on distributed ledgers rather than internal ledgers that can exploit the public’s trust.

You might want to compare that to the What We do Page on the SEC’s website:

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

Even more fun, the BEC lists it’s address on LinkedIn as 100 F Street NW in Washington D.C. You may know that better as the SEC headquarters.

It looks like the BEC has cleaned up its website, removed its claims of investor protection and stated its address in San Diego.

The information about the BEC came out in an SEC complaint against Blockvest and its founder, the same Reginald Ringgold.

“Don’t look for the needle in the haystack…just buy the whole haystack.” – Reginald Ringgold

The SEC won’t approve Bitcoin ETFs, so Blockvest is creating a token as a fund. The offering is some pool of something that does something, blockchain, blockchain… The whitepaper is a bunch of nonesense.

The Securities and Exchange Commission obtained an emergency court order to halt a planned initial coin offering of Blockvest, which falsely claimed that it was approved by the SEC. The order also halts ongoing pre-ICO sales.

There is no bigger red flag than stating that an offering is approved by the SEC.

Sources:

“Crypto is the Mother of All Scams”

It looks like the testimony will not be subtle at the Senate Banking Committee today entitled: Exploring the Cryptocurrency and Blockchain Ecosystem.

Peter Van Valkenburgh, Director Of Research at Coin Center, spends his time trying to explain blockchain by calling it decentralized computing. I’m going to guess that his presentation falls on ears that have no idea what he’s talking about.

Nouriel Roubini, Professor of Economics at the Stern School of Business at New York University, is much less subtle. He titles his testimony:
Crypto is the Mother of All Scams and (Now Busted) Bubbles While Blockchain Is The Most Over-Hyped Technology Ever, No Better than a Spreadsheet/Database.

Actually calling this useless vaporware garbage a “shitcoin” is a grave insult to manure that is a most useful, precious and productive good as a fertilizer in agriculture.

He goes on to attack the premise of cryptocurrency. Financial crises happened before fiat currencies and central banking. There were many bubbles and busts before central banking. We all note tulipmania. He takes the position that central banking helps avoid currency runs that occur when a bubble bursts. It may be hard to make this point when the wounds of the 2008 financial crisis still feel fresh.

Professor Roubini also points out the environmental consequences of cryptocurrency. He cites a figure of $5 billion a year spend on energy costs.

My personal take on bitcoins and other cryptocurrency is that they have been a boon to criminals and money laundering. The loose attitude for the exchanges on reporting suspicious transactions has been a boon for moving illegal money around from person to person and laundering it back into the legitimate money system.

Then add in the pump and dump mechanisms of other smaller coin ecosystems, you have fraudsters getting money from ICOs. More money when they fraudulently prop them up, then use them to transmit the proceeds outside the legitimate banking system.

Last night, the International Monetary Fund warned that cryptocurrencies “could create new vulnerabilities in the international financial system.” Cryptocurrency valuations crashed as a result.

You can also add in the “whales” of Bitcoin when talking about stability. Thirty-two Bitcoin wallets collectively own about 1 million bitcoin (i.e 5% of all bitcoins). Five of those wallets are lost. The owner lost the private key and cannot access the accounts. That represents 212,000 coins worth about $1.3 billion. That to me, is an incredible concentration in ownership that can’t lead to anything good.