Category: Fraud

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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Trustee Charged As A Failed Gatekeeper

When a fraud is uncovered, the Securities and Exchange Commission not only wants to get the fraudsters, it also wants to get those who should have stopped the fraud: the gatekeepers. Recently, the SEC has brought charges against a fund administrator and fund auditors. The latest is a case against

Château de Crécy-la-Chapelle: Gate

The Securities and Exchange Commission announced that a subsidiary of Oklahoma-based BOK Financial Corporation agreed to pay more than $1.6 million to settle charges that it concealed numerous problems and red flags from investors in municipal bond offerings to purchase and renovate senior living facilities. According to the SEC’s order, BOK Financial failed in its gatekeeper role as indenture trustee and dissemination agent for the bond offerings.

In a case brought last year, the SEC filed charges against Christopher F. Brogdon for dozens of municipal bond and private placement offerings in which investors supposedly earn interest from revenues generated by the nursing home, assisted living facility, or other retirement community project supported by their investment. But Brogdon secretly commingled investor funds instead of using the money to finance the project described to investors in the disclosure documents for each offering and diverted investor money to other business ventures and personal expenses.

According to the SEC’s order, BOK Financial, and a former senior vice president at the bank, Marrien Neilson, became aware of numerous red flags:

  • Brogdon was withdrawing money from bond offering’s reserve funds and failing to replenish them.
  • He had failed to file annual financial statements for the bond offerings.
  • The nursing home facilities serving as collateral for one of the bond offerings had been closed for years.

But Neilson allegedly warned others that disclosing red flags could impair future business and fees from Brogdon, upset bondholders, and cause regulatory issues for bond underwriters. So Neilson and BOK Financial decided not to inform bondholders as required.

BOK Financial settled the charges. Neilson is challenging the charges, so we only have the SEC’s side of the story.

Neilson was the primary recipient of bonus compensation awarded on the basis of the fees paid to BOKF for the Brogdon Bond Offerings. She also received bonus compensation for other bond offerings that financed the sale of Brogdon-owned nursing homes and assisted living facilities to third parties. The SEC charged that she knew or recklessly disregarded that Brogdon was supposed to make disclosures to the bondholders about the red flags.

In the SEC Order, there are numerous emails showing Neilson in a poor light:

“In a March 1, 2010 email to one of Brogdon’s assistants regarding late debt service payments for an offering, Neilson states that the late payment put her “in an extremely awkward position” because “the Reserve Fund has previously been used and not replenished and I did not call a default.” In the same email, Neilson states that “[b]ondholders are going to want to know why we don’t used [sic] the Reserve Fund.” Neilson also states that “we need to disclose the other Reserve funds if they are not replenished,” asking Brogdon’s assistant “if you want a list of them and how much?”

I assume Brogdon was trying to keep his enterprise afloat and Neilson was helping him kick the can down the road. Perhaps a little more debt can buy a little more time to get cash flow positive. That didn’t happen and the debt facilities finally went into default and bankruptcy.

The gatekeeper should have stopped the fraud. Instead, it helped with a dozen more offerings expanding the scope of the fraud.

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Château de Crécy-la-Chapelle: Gate by Baishiya 白石崖
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When Is Fraud Just A Breach Of Contract?

If you are going to originate some shady mortgages, maybe you shouldn’t nickname the program the “hustle.” If you package up the mortgages and sell them as good mortgages, it would seem you are committing fraud. But maybe not.

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It may come as no surprise that the company running the “hustle” was Countrywide. According to Countrywide, the High Speed Swim Lane or HSSL (or hustle) was an automated program created to improve loan quality by limiting the number of people who processed loans. According to the government, the Hustle program was meant to churn out home loans, rewarding employees for speed rather than quality and removing financial penalties that employees could incur for making bad loans. In the end Countrywide made $165 million from the program while Fannie Mae and Freddie Mac had net losses of $131 million.

Countrywide had a contract with Fannie Mae and Freddie Mac to sell Acceptable Mortgages. As you might expect, the Hustle mortgages did not all meet the Acceptable Mortgage standard, so it was delivering some sub-standard mortgages under the contract.

The government claims fraud and Countrywide claims that it was merely a breach of contract.

A jury ruled in favor or the government and the judge ordered $1.27 billion in penalties. The Second Circuit overturned that decision and the judgment. It was was merely a breach of contract.

The Second Circuit phrased the question like this:

“B’s Fraud theory is that A knowingly and intentionally provided substandard widgets in violation of the contractual promise—a promise A made at the time of contract execution about the quality of widgets at the time of future delivery. Is A’s willful but silent noncompliance a fraud—a knowingly false statement, made with intent to defraud—or is it simply an intentional breach of contract?”

The law does not permit a fraud claim merely on a contractual breach. Fraud turns on the parties intention when the contractual obligations and representations were made. The party claiming fraud need to prove that the other party had fraudulent intent at the time the party entered into the contract.

So to prove fraud, the government would need to prove that Countrywide did not intent to perform its obligations when it entered into the contract.

[T]he Government has never argued—much less proved at trial—that the contractual representations at issue were executed with contemporaneous intent never to perform, and the trial record contains no evidence that the three Key Individuals—or anyone else—had such fraudulent intent in the contract negotiation or execution. Instead, the Government’s proof shows only post-contractual intentional breach of the representations. Accordingly, the jury had no legally sufficient basis on which to conclude that the misrepresentations alleged were made with contemporaneous fraudulent intent

This is a fairly arcane area. The court agrees with this arcane assessment. I think the decision also hinges on the way the contract was structured. The contract did not call for a restatement of the representations when each mortgage was delivered. Many contracts are structured with the restatement of representations to avoid this arcane treatment.

It does not mean that Countrywide is off the hook. It’s still liable for damages from the contractual breach. It does mean that Countrywide did not commit fraud under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and is not liable for the ensuing civil penalties.

The big loser in this was Ed O’Donnell. He was the whistleblower in this case. He is doing okay. He had already been awarded $58 million as a result of the $16.65 billion that Countrywide paid for the contractual breaches and mortgage securities fraud. I assume he would have been eligible to get a chunk of the $1.27 billion fine in this case.

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SEC Charges Fund Administrator as a Failed Gatekeeper

The Securities and Exchange Commission charged Steven Zoernack and his firm EquityStar Capital Management with fraud for stealing investor money and hiding his criminal past. The SEC brought fraud charges against ClearPath Wealth Management and its principal, Patrick Evans Churchville, for operating a fraudulent scheme that resulted in at least $11 million in losses to investors. One thing in common between the two firms was that both used the same fund administer.

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SEC investigations found that Apex Fund Services missed or ignored clear indications of fraud while record-keeping and preparing financial statements and investor account statements for funds managed by ClearPath Wealth Management and EquityStar Capital Management.

This is another case of the SEC charging a gatekeeper for failing to identify and stop fraud.

The SEC’s order finds that in regard to ClearPath Apex failed to act appropriately after detecting undisclosed brokerage and bank accounts, undisclosed margin and loan agreements, and inter-series and inter-fund transfers made in violation of fund offering documents. Apex failed to correct previously issued accounting reports and capital statements and continued to provide materially false reports and statements to the funds’ independent auditor. Apex should have known that ClearPath would use Apex’s false reports to communicate financial positions and performance to the ClearPath funds’ investors.

The SEC’s order finds that in regard to EquityStar and Zoernack, Apex accounted for more than $1 million in undisclosed withdrawals as receivables owed to the funds, despite no evidence that it was able or willing to repay the withdrawals. Apex confronted Zoernack about the withdrawals and concluded he was unlikely to repay the funds. But Apex still did not properly account for Zoernack’s withdrawals even as they started to consume a significant portion of the funds’ assets. Apex sent monthly account statements to investors that it knew or should have known materially overstated the investors’ true holdings in the funds.

Apex was a failed gatekeeper. The SEC will bring charges for not taking appropriate steps. In this case, Apex knew its reports were false and still sent them to investors or to the funds knowing that they would be given to investors.

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Château de Crécy-la-Chapelle: Gate by Baishiya 白石崖
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