Category: Fraud

The One with The Fake Ron Stenson

Some of the things that catches my attention with frauds and Ponzi schemes are the steps that the fraudsters will take to cover up the fraud and how they think they will escape from the fraud unscathed. The recent charges against Jeremy Drake caught my attention because of the steps he took.

The Securities and Exchange Commission has filed the charges, but Mr. Drake has not yet had a chance to refute them. I’m just using the allegations as a way to help me (and maybe you) better understand how frauds evolve.

According to the complaint, Mr. Drake worked as a registered investment adviser representative. He managed to convince a professional athlete and his wife to become his clients. (I poked around, but couldn’t find out who.) The relationship started off with a standard 1% fee.

In 2012 Mr. Drake told them they were entitled to a VIP discount on the fee. I assume (1) his clients pressed him on fees, (2) his firm did not agree to the discount, and (3) Drake lied to keep them as clients. He fed them some gobbledygook about how they were getting credits in their account from the brokerage. I can only assume that he thought he could eventually convince his firm to give the discount.

But there was no discount. The client met with Mr. Drake a year later and he once again spewed out the discounted rate. He documented the fraud by sending fake account statements stating that the clients had paid “net” rates of 0.177% and 0.15%, resulting in “net” fees of $44,994 and $34,737. They had in fact paid a 1.0% rate in both accounts, resulting in actual fees paid of $280,349 and $231,889.

At this point, you may expect that the firm could have spotted Mr. Drake’s fraud. The rep is sending the account statements instead of them coming from the custodian.

A year later, the same discussion over fees happened again and more fake documents were sent. The client’s wife first language was not English, so perhaps Mr. Drake thought he could use the language barrier to keep the fraud going. The client’s wife’s assistant was the translator.

In 2016 with a new assistant and a new accountant, the client pressed Drake again. Drake continued with the lies and fake documents. The fraud was not holding together and they pressed Drake on the fee discount. To bolster the fraud, Drake created a false persona named “Ron Stenson” whom he held out as an employee of “Charles Schwab Advisor Services” who could help explain the fee credit. He pressed a colleague into the role of Ron Stenson to answer phone call inquiries.

At this point Mr. Drake realized he couldn’t keep the fraud going. The accounts were short almost a million dollars in the fees the firm was taking compared to what he was telling the clients. I scratch my head wondering how Mr. Drake was going to get out of this. I have to assume that he hoped the firm was going to grant the discount at some point.

Should Mr. Drake’s firm caught some of this activity through email monitoring? Maybe. I’m skeptical of the effectiveness of email monitoring. It’s full of false positives, causing compliance to stare at a lot of stuff instead of spending time looking at other areas.

Theoretically, Mr. Drake’s clients should have been getting account statements directly from the  third-party custodian. That should have shown actual fees deducted and the actual positions held by the client. That is one of the key pillars of the custody rule. The client should be able to verify an advisor’s work by getting the account statement directly from the custodian or getting statements that have been vetted through a third-party auditor.

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The One With The Fake Cancer Detection

The product sounds great: “The Gold Standard to monitor metastic breast cancer. Our Serum-2 test provides a more accurate representation of HER-2 status, facilitating more appropriate treatment strategies.” NanoMolecularDX is “executing a commercialization strategy” for this test and others.  In July is closed on $1 million of seed funding.

I’m an advocate for cancer research and raising money to fight cancer, so this sounds like a good thing. It also has an affiliated entity, MetaboRX that is a “preclinical stage biopharmaceuticals enterprise based on pioneering research in fatty acid metabolism.”

So why did NanoMolecularDX list as its general character of business “serving food; restaurant” on its filing with the Massachusetts Secretary of the Commonwealth? And why did MetaboRX list as its general character of business “serving food; restaurant” on its filing with the Massachusetts Secretary of the Commonwealth

The Securities and Exchange Commission also wants to know. The SEC filed a complaint against NanoMolecularDX  and its manager, Patrick Muraca.

“According to the SEC’s complaint, Patrick Muraca established two pharmaceutical development companies and raised nearly $1.2 million by representing to investors that their money would be used to develop products to detect cancer and other diseases. The SEC has traced the flow of investor funds into Muraca’s personal bank account and alleges that at least $400,000 has been used to pay rent for the restaurants and fund other purchases by Muraca, including payments to a casino, automotive shop, and cigar shop.”

According the SEC complaint Mr. Muraca used the money he raised for personal expenses: mortgage, groceries, and gas. He also used $45,000 of the investors’ money to pay the rent and expenses for his fiancee’s restaurant business. Once that went out of business he spent another $30,000+ to start a new restaurant.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Muraca.

“As alleged in our complaint, we’re intervening to protect investors because Muraca has veered from his stated intentions and has been using their money for purposes other than the fight against cancer and other diseases.” – Paul Levenson, Director of the SEC’s Boston Regional Office

Great job by the SEC’s Boston Office to identify the fraud and shut it down before Muraca was able to scam any more investors.

What compliance lessons can we learn from the case?

Corporate filings do matter. Any investor could have pulled up the filing Massachusetts filing and noticed that strange purpose. I generally don’t find the filings with the secretary of state to be incredibly useful. But sometimes you do find a red flag like this to stop you in your tracks.

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As I mentioned above, I’m raising money for the Dan-Farber Cancer Institute for the Pan-Mass Challenge. 100% of your donation is passed through to DFCI. I’m riding my bike for three days and 250+ miles. I appreciate the generous support I have received from so many of the readers of Compliance Building. You can donate through any of the links below.

Thank you,
Doug

 

The One With The Floundering Hedge Fund

I’m a local homer, so fraud cases in Massachusetts catch my attention, especially when they involve private funds. The case of the floundering hedge fund, MC2 Capital, founded by Yasuna Murakami, is the usual example of greed and failure to acknowledge one’s mistakes.

Mr. Murakami had big dreams and in the glory days of 2007 thought he could graduate from business school and start a hedge fund. According to the order from the Massachusetts Secretary of State, he had no professional experience trading securities.

He convinced a business school classmate who had been working at Bear Stearns in 2007 to join with him to form MC2 Capital. They were able to raise $3.6 million. The fund was supposed to focus primarily on small to medium cap US stocks with an emphasis on value-oriented investments. However, in reality it had no strategy and had significant holdings in extractive industries and used margin loans for its trading.

It should come as no surprise that inexperienced managers with no strategy lost a great deal of money for the fund investors. By August 2011, the fund had only $33,577.51 in net equity. MC2 lied to investors and covered up the losses. Investors got fake K-1s and account statements.

The trading losses did not deter them. They started a second fund, and then a third fund for Canadian investments.

For the Canadian investments, MC2 managed to eventually link up in 2011 with a successful Canadian asset management firm and fund manager who agreed to run the investments for 70% of the fund fees. That firm cancelled the arrangement in 2015. To make up for the loss, MC2 made up a fake firm as the replacement asset manager.

By the end of 2016, the combined worth of all three funds was less than $10,000. Yet, MC2 told one if its investors that its investment was worth over $4.5 million, with a year to date gain of 18.7%.

It should come as no surprise that some of the investor money was not just lost in trading, but ended up directly in Mr. Murakami’s pocket.

As you might expect, MC2 was using new investor money to pay redemption requests. MC2 turned into a Ponziu scheme.

The Massachusetts fraud case did not pull in the other MC2 partner, Avi Chait. The SEC action does and implicates Mr. Chait in the wrongdoing. It may be that Mr. Chait was not aware of Mr. Murakami’s wrongdoing. The SEC complaint has this quote from Mr. Chait to Mr. Murakami, “I am trying to sell a fund that I know nothing about at all.” It all became too much for him in 2016 and Mr. Chait redeemed his interest and his relatives’s interest, pocketing the fake returns.

The SEC swooped in May, after Massachusetts has already brought its action in January and fund investors had brought their suit in November.

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The One With The Options Pricing Theft

Some financial fraud is easy to spot. Some is hard to spot. Some I barely understand. Kevin Amell was very clever in hiding his alleged fraud and I’m not sure I understand exactly how he pulled it off.

Mr. Amell was a fund manager at Eaton Vance for its Risk-Managed Diversified Equity Income Fund. The fund used options to hedge some of its positions and Mr. Amell had some responsibility for the purchase or sale of call options. According to the complaint, on at least 265 occasions, Mr. Amell pre-arranged the purchase or sale of call options between the Fund’s brokerage accounts and his personal brokerage account at prices that were disadvantageous to the Fund and advantageous to Amell. He generated almost $2 million in profits for himself.

Mr. Amell carried out the fraud by placing orders in his personal brokerage accounts to buy specific options at a specific price and at the same time placed orders on behalf of the funds to sell the same options at the same price. He took advantage of the trades with wider spreads and exploited the spread. The fund order was just outside the midpoint of the spread so the market would not take the trade. He took the trade in his personal account and then sold for the difference in the market.

It seems like one of those frauds where the scammer just takes a little bit each time.

One thing hanging out there for me, from a compliance perspective, is how did he get caught.

He did not report the account to Eaton Vance and did not tell the brokerage that he was an employee of Eaton Vance. That means it would be hard for the firm to find the fraud. He clearly violated the firm’s policies.

In paragraph 28 of the complaint, the SEC notes that the initial brokerage account he used for the fraud was closed by the brokerage. I assume the broker’s compliance noted something was fishy. Mr. Amell opened an account at a different broker-dealer and resumed the fraud for another year. Perhaps that second brokerage noted the weird trades and decided to report it to the regulators instead of just closing the account.

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Slapping Down Investment Research Website

The Securities and Exchange Commission took the “extreme step” of warning consumers that articles on the internet may not be objective and independent. They sent up a warning signal to deceptive promoters by announcing enforcement actions against 27 individuals and entities behind various alleged stock promotion schemes that left investors with the impression they were reading independent, unbiased analyses on investing websites while writers were being secretly compensated for touting company stocks.

From the cases, it  looks like the SEC found a rat’s nest of stock promotion companies, wiling to say great things about public companies in exchange for a fee. In total the SEC filed fraud charges against three public companies, seven stock promotion or communications firms, two company CEOs, six individuals at the firms, and nine writers.

In one case, the person engaged in the business of providing stock promotion services to publicly-traded issuers, and directed the publication on investment websites of over 400 articles about its issuer clients and the clients of an affiliated promotional services company.

“Despite being paid for their work, the writers failed to disclose their compensation in the articles and therefore misrepresented the nature of their relationship with the clients to the investing public.”

This included violating the terms on some major investment websites like SeekingAlpha and Motley Fool. Each of these require a disclaimer that the writer had not received compensation for an article.

The charges are all for fraud, deception or omitting material facts in violation of several securities laws.

The cases don’t address the line between lawfully promoting a company as part of public relations and fluff pieces that the SEC is concerned about here. It appears that the writers and scheme purposefully tried to look like impartial investors promoting their favorite stocks and doing so in places that expect impartial articles.

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The One About The Defrauding Pastor

When you run across someone trying to get you to invest risk-free with a high annual return, you know you have run into a fraudster. Unless god is on the side of the investment, there is no such thing as a high-rate, risk-free return.

Apparently, Larry Holley, the pastor of Abundant Life Ministries in Flint, Mich., thought he could cloak his securities in god’s will and pass them off to parishioners.

According to the SEC complaint, Holley and his associate Patricia Enright Gray, used faith-based rhetoric, with references to scripture and biblical figures to pitch fraudulent promissory notes from a real estate company. From February 2015 until recently, approximately 83 individuals invested with pair.

Holley labeled his church as a “place of provision” and “distributors of knowledge, wisdom, wealth & substance.” To be fair to the pastor, it looks he and the church had spent time buying and fixing up homes for those in need. It just seems he crossed the line at some point.

Holley allegedly told prospective investors that as a person who “prayed for your children,” he was more trustworthy than a “banker” with their money. He held financial presentations masked as “Blessed Life Conferences” at churches. As part of the presentation he asked congregants to fill out cards with information on their finances and he promised to pray over the cards.

Apparently, he turned over the financial information to Gray for the hustle and she would have a on-on-one meeting to help them become millionaires. During the consultations, Gray showed prospective investors a large book filled with photographs of what she represented to be some of real estate company’s properties, testimonials from satisfied investors and copies of checks paid to investors.

The real estate company, Treasure Enterprise, did exist and did own some real estate. The company did not invest the money fast enough or profitably enough to meet the payments on the promissory notes. Perhaps the goal was legitimate at first. (I don’t know.) When Treasure missed its investment marks, Holley and Gray could have broken the news to investors. Instead, it looks like they increased their fundraising efforts to cover the shortfall. (Which of course just increases the shortfall.) The pair used payments of the fresh capital to payoff earlier investors in exchange for dropping their complaints to regulators.

As of February 2017, Treasure was past due on approximately 51 promissory notes for 43 investors, totaling nearly $2 million.

The State of Michigan had caught up with them before the SEC. The Michigan Department of Licensing and Regulatory Affairs used a cease and desist order in August for selling unregistered securities, from acting as unregistered agents and from making false or misleading statements in the offer and sale of securities. Unlike the SEC, Michigan can put them in jail.

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The SEC Is Using Satellites To Hunt For Fraudsters

I did not find the headline to be remarkable: SEC Charges Mexico-Based Homebuilder in $3.3 Billion Accounting Fraud. The subtitle caught my attention:

SEC Uses Satellite Imagery to Crack Case

We learned from the Rajaratnam insider trading case that the SEC was using wire taps and informants as part of its securities fraud investigations. The SEC is clearly stepping up a notch by using satellites to hunt for fraudsters.

The Securities and Exchange Commission caught Mexico-based homebuilding company Desarrolladora Homex S.A.B. de C.V. in a lie and forced it to admit that it had reported fake sales of more than 100,000 homes during a three-year period. From at least 2010 through 2013 Homex improperly recognized billions of dollars of revenue by systematically and fraudulently reporting revenue from the sale of tens of thousands of homes annually that it had neither built nor sold.

This all comes to late for investors in Homex. Its securities were, until April 2014, dually listed on the New York Stock Exchange and the Mexican Stock Exchange. In 2013 Homex had begun defaulting on its debt obligations and repeatedly failed timely to file quarterly and annual reports with the SEC. In April 2014, Homex filed for the Mexican equivalent of bankruptcy reorganization.

Homex’s Real Estate Project 877 (named “Benevento” and located in the Mexican state of Guanajuato) is illustrates the fraud. Homex’s senior management identified Benevento to the SEC as one of the Company’s top ten real estate development projects by revenue. Homex provided Benevento’s project plan (identifying the location, block and lot number of each planned housing unit), and details (by block, lot number, sale price and sale date) of the Benevento sales that Homex had included in its financial statements. These documents stated that all of Benevento’s planned units had been built and sold, and that Homex had recognized and reported that revenue by December 31, 2011.

However the SEC pulled up satellite images taken in March 2012 that reveal that hundreds of those very same Benevento units remained unbuilt.

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The SEC Is Serious About Protecting Seniors

It was a real estate fraud action that caught my eye, but the victims that kept me reading. The Securities and Exchange Commission filed charges against Paul Garcia and his fund management company, Caliber Capital, for defrauding investors.

Since it was a real estate fraud, it caught my eye. But I didn’t have to dive into the murky waters of what is a security and what isn’t a security. Garcia is alleged to be selling interests in a fund and then not using the money as he said he would. I don’t see any argument that passive interests in an investment fund could be anything other than securities.

Mr. Garcia enticed investors to invest in a golf course purchase and shuffled money to keep things going. Things did not go well and Caliber Partnership filed for bankruptcy in January 2016. The lender foreclosed and the investors are likely left with no assets from the partnership. Even with the underlying asset being real estate, it does not change the nature of the interests.

What caught my eye in the case was the SEC inclusion of one investor in particular in the press release and the complaint:

“The investors included an eighty two-year-old who invested $250,000 in Caliber.”

This may be a common tactic for the SEC to gain sympathy for the investors and to paint the alleged fraudster as being particularly sinister.

I went back to the SEC’s 2017 priorities. One of the priorities for examinations is senior investors and the issues around them. I expect we may see more SEC press releases mentioning the little old lady from Pasadena who got bilking by a fraudster.

If your investors include that little old lady from Pasadena, the SEC is going to use that fact.

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Wealth Building by Stealing From Your Investors

Jim Toner wants to help you get rich investing in real estate. He has a “simple 3 step method the ‘experts’ and ‘gurus’ don’t want you to know about creating lasting wealth with real estate…” According to an SEC complaint those steps are lying to investors, taking undisclosed fees, and pocketing some of the capital.

Mr. Toner consent to the court order, but did not admit or deny the allegations. We will have to rely on the SEC complaint and assume that the facts are mostly correct.

Mr. Toner’s main business is selling his instructions on how invest in real estate. On the side, he also solicits investments. Some of those investments in Arizona went bad and resulted in these SEC charges.

Mr. Toner pitched the investments as pooled investments in residential properties. He would manage and oversee renovations and then quickly resell the properties for a profit. Some of the investments were notes and some were partnership interests. He pulled together almost $1 million for three properties in Arizona.

He claimed he was the manager and would be running the deals. But he turned over control to an unnamed real estate broker who had already purchased two of the properties and sold them to the investors for “handsome profits” according to the SEC.

Mr. Toner claimed that he would be investing his own assets in the investments. According to the SEC complaint he told different investors different statements about how much he would be investing. The SEC claims he had no intention to make the investment. It points out that Mr. Toner was in protracted bankruptcy and had no assets to invest.

Lastly, Mr. Toner took management fees. In the offering documents, Mr. Toner would only be paid management fees after the partners received profits from the investments. He took $31,000 up front from the proceeds and received another $21,000 before the investors had realized any returns.

Later, as the investments were going poorly, Mr. Toner solicited another investor. Instead of adding this Investor B to the investor roll, he pocketed her $20,000. Given that the SEC is focusing on elderly investors, the complaint points out that Investor B was elderly.

At the end, Mr. Toner had raised almost $1 million from investors and ended up selling the properties for $256,000. Mr. Toner pocketed almost $70,000 through unauthorized management fees and theft.

He also failed to determine that the investors were accredited or told them to lie about being accredited.

This seemed like good wealth building for him, but not for his investors.

In the end, it was bad deal for him. Mr. Toner has to come up with over $500,000 in disgorgement and penalties.

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The Duchess and the Mouse Hole Cheat for Russian Athletes

Widespread cheating by Russian athletes has been uncovered. One of the key figures was Russian Dr. Rodchenkov who had breakthrough work on the detection of peptides and long-term metabolites of prohibited substances.

In the jargon of espionage, Dr. Rodchenkov was a double agent. While operating at the forefront of doping detection, he was secretly developing a cocktail of drugs with a very short detection window.

The doping was referred to as “Duchess.”

This was in connection with the mouse hole breach in the testing facility. In the dead of night, Russian officials exchanged the tainted urine from their athletes who had been doping with clean samples by passing them through a “mouse hole” drilled into the wall of the anti-doping lab.

The bottles were supposed to be tamper-proof. The Russian agents were able to open the tamper-proof bottles and replace the contents without detection. Upon closer inspection, investigators were able to identify bottles that were tampered with by identifying scratches on the inside of the bottle caps.

695 Russian athletes can be identified as benefiting from the manipulation to conceal potential positive doping controls. They have not yet been identified.

The reports reveals that the Russian Ministry of Sport manipulated the doping control process of the 2014 Sochi Games; the 2013 IAAF World Championships in Moscow; the 2013 World University Games in Kazan; and, put measures in place to circumvent anti-doping processes before the 2012 London Games.

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