Category: Fraud

Use of Data in Proving Fraud

The Securities and Exchange Commission’s case against Robert Magee and Valor Capital was a straight forward cherry picking case. What caught my eye was the data and statistical analysis that the SEC used to prove its charges.

Magee was doing the wrong thing by order block trades in an omnibus trading account and then allocating the trades to his personal account and client accounts at the end of the day. That procedure is ripe for compliance failure without a preset decision on who gets the trades. The concern will always be that the securities that increased during the day will be allocated to favored accounts and those that went down would be allocated to others.

The SEC ran the numbers to prove its point.

From July 2012 to January 2015, Magee’s personal accounts posted first-day profits of 0.876%. Those were 459 trades of which 376 were profitable on the first day.

Meanwhile, the client accounts posted a -2.309% return on the first day during roughly the same period. Those were 1,365 trades of which only 219 were profitable on the first day.

Of course, the disparate results could be based on good luck. The SEC ran some stats and found that the probability that disproportionate allocation of favorable trades was due to chance was less than one in 100,000 during one period and less than one in a trillion during another period.

Valor’s brokerage firm terminated its relationship because it suspected the cherry-picking. The subsequent brokerage firm did the same. The third brokerage firm did not permit the use of an omnibus account to execute trades. The Texas state securities regulator reprimanded and fined Magee in August 2016 for no pre-allocating block trades.

According to the SEC’s press release, this is the fourth action arising out of an enforcement initiative to combat cherry-picking led by the SEC’s Los Angeles Regional Office and supported by the agency’s Division of Economic and Risk Analysis.  The previous actions were against Jeremy Licht of JL Capital Management, Gary Howart of Howarth Financial, and Joseph B. Bronson of Strong Investment Management.

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Pump and Dump Cryptocurrency

Cryptocurrency is a lawless land.

Ten days ago, the Securities Exchange Commission and the Commodities and Futures Trading Commission issued a joint statement on virtual currency:

“When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws. The Divisions of Enforcement for the SEC and CFTC will continue to address violations and bring actions to stop and prevent fraud in the offer and sale of digital instruments.”

Take a look at BigPump.org. Go ahead and take a look. I’ll wait.

“We do pumps…. Big pumps.”

Right there on a public website, the group advertises its strategy for pumping and dumping cryptocurrency. It came to my attention through an article by Paris Martineau:
Inside the Group Chats Where People Pump and Dump Cryptocurrency.

I was skeptical that a strategy that was so brazenly illegal would be so easy to spot. So being skeptical, I dug into the underlying information. There it was, publicly displaying a pump and dump scheme.

In their defense, they claim their pumping schemes are fair. Of course, there is also a note that premium pumps will be coming soon. I have to assume that those premium pumps are less fair to those outside the premium group.

It does not take much to find examples of pump and dump. Look at this chart for the Crave cryptocurrency.

Some people made a bunch of money by rallying interest in this cryptocurrency and selling at the top before the price.

That is not the way a price chart for any “currency” should look. It’s not the way chart should look for any investment.

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Compliance Lessons From Star Wars – Lies

With the pending release of Episode VIII – The Last Jedi, I’m joining Tom Fox in tying compliance and the Star Wars franchise together in posts this week.

I’ve always been trouble by the lie from Obi Wan Kenobi to Luke Skywalker:

“Darth Vader betrayed and murdered your father.”

It’s the little lies that lead to bigger lies and bigger problems. Some of the ponzi schemes I see start with a sponsor telling a little lie about performance results. Then the sponsor is trapped chasing those untrue returns. That leads to bigger lies and bigger problems as the deficit between actual results and fictional results grow.

We saw the little lie growing with Bernie Madoff. Decades ago he missed his returns and lied about them. At some point he just gave up and didn’t pretend to chase the returns anymore. That became to a multi-billion dollar deficit between actual results and the fictional results he told investors.

Plenty of ponzi schemes are formed as frauds from the outset as a way to separate people from their money.  They start off with outlandish returns and promises of guaranteed results. There is a subset of these frauds that had started out with good intentions but misstep into these little lies that lead to downfall.

Obi Wan’s lie to Luke sends Luke into an ill-chosen battle with Darth Vader. Luke is seeking revenge for the death of his father. Things don’t go well for Luke in a battle against one of the fiercest warriors in the galaxy.

The cynic in me might point out that the lie was not intentional. Behind-the-scenes lore of the Star Wars franchise tells us that the plot turn in Empire Strikes Back, and told further in Episodes II and III, may not have been envisaged when Star Wars was made. For the pure of heart, we can assume the Kenobi was just trying to protect Luke from the truth.

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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