Category: Fraud

Shkreli Gets His Holiday Gift… Handcuffs

One of the most hated men in American business was grabbed by the FBI and put in handcuff. The Securities and Exchange Commission slapped a “me too” suit on him as well. Martin Shkreli did the perp walk last week for running a ponzi scheme.

shkreli

Shkreli became the face of what is wrong with the American health industry when he jacked the price of treating a life-threatening parasitic infection from $13.50 a tablet to $750.

With his engorged wallet he spent $2 million to purchase the sole copy of Wu Tang Clan’s latest album. To prove that it was just an expensive trinket, he claimed to have not listened to it.

That all just makes him gross, but not a criminal.

But it turns out that he got there through running a ponzi scheme. He pulled off the rare ability to exit from a ponzi scheme.

The vast majority of ponzi schemes collapse under the weight of promised payouts exceeding the inflow from new investors. The original investment scheme fails and the sponsor is scrambling to find anything that might work to score the redemptive returns. Given that the supply of capital is significantly smaller, the returns need to be astronomical.

Skreli had lost all of his investors’ money. He had just settled a FINRA Arbitration over naked short-selling that took the last few dollars out of his hedge fund accounts.

He started MSMB Capital, a hedge fund company, in his 20s and drew attention for urging the Food and Drug Administration not to approve certain drugs made by companies whose stock he was shorting. The strategy did not work.

Nonetheless he send a message out to investors that he had doubled their money.

Mr. Shkreli started Retrophin, which also acquired old neglected drugs and sharply raised their prices. The company was wildly successful and went public.

As a public company, Retrophin can’t pay off Mr. Shkreli’s disgruntled hedge fund investors. But fiduciary obligations were apparently not important to him and he caused the company to write the checks.

Retrophin’s board fired Mr. Shkreli a year ago. Last month, it filed a complaint in Federal District Court in Manhattan, accusing him of using Retrophin as his personal piggy bank to pay back disgruntled investors in MSMB Capital.

The DOJ and SEC piled on and brought their own suits.

Sources:

Twitter for Stock Manipulation

Twitter is stream of random thoughts, news, insightful commentary, boring stories, humor, sadness, food pictures, hate, love, and cat pictures. The internet as a whole. At least a few traders have used Twitter as stock pricing indicator. Theoretically, that means stories could be planted that would move the stock price of a company. One trader tried to do so under false pretenses and is now subject to civil charges by the Securities and Exchange Commission and criminal charges by the Department of Justice.

twitterlogo

James Alan Craig set up a few Twitter accounts. One was modeled after Muddy Waters Research, the influential equity research company. Another was modeled after Citron Research, another influential securities research firm. In each case he stole the firm’s logo to use on the Twitter accounts.

On Jan. 29, 2013, Craig used a Twitter account to send a series of tweets that falsely said Audience, Inc. was under investigation. Audience’s share price plunged and trading was halted before the fraud was revealed and the company’s stock price recovered. On Jan. 30, 2013, Craig used another Twitter account to send tweets that falsely said Sarepta Therapeutics, Inc. was under investigation. Sarepta’s share price dropped 16 percent before recovering when the fraud was exposed.

false tweets

Craig used his girlfriend’s brokerage account to buy the companies’ shares at depressed prices, hoping to sell them later after they rebounded. He was a terrible trader and missed the low prices. He bought $13,000 worth of stock in the companies, but made less than $100 of profit.

However, there was substantial short term damage to the targeted companies. The stock drop erases $1.6 million of shareholder value for at least a short time. There was enough of an impact that the NASDAQ halted trading in one of the companies.

It’s hard to believe that an unverified Twitter account that is poorly used could dupe the market into thinking that the claims were true. But I may be underestimating how much traders are using Twitter algorithms in their trading strategy. Craig’s accounts had very few followers and brief histories. Most people would discount the quiet tweeting from such an account. The algorithms did not.

For a few tweets and $100 of profit Craig faces a maximum prison sentence of 25 years, a fine of $250,000, penalties and restitution. Of course that is only if the US authorities can get their hands on him. His whereabouts are unknown.

If the case ever makes it to trial, it would be an interesting legal examination of the intersection of social media an securities fraud.

I don’t think I could be convicted of securities fraud for standing on a street corner and telling everyone that passes that Company X is a fraud and subject to upcoming charges. I didn’t think the same would be true if I did the same thing on Twitter. But maybe I’m wrong.

Sources:

Failing the Family

Some Securities and Exchange Commission cases catch my attention because of their headlines or their focus on a real estate investments. The case against Lee Dana Weiss caught my attention because it was from my home town.

newton mass

The story is one of alleged self-dealing and failure to disclose conflicts. In a complaint filed in U.S. District Court for the District of Massachusetts, the SEC alleges that Family Endowment Partners LP and its owner, Lee Dana Weiss, of Newton, Massachusetts, urged their clients to invest more than $40 million in illiquid securities issued by several related companies without disclosing that Weiss had an financial interest in the investments.

 

This was not the first round of trouble for Mr. Weiss and Family Endowment. In April, they lost an arbitration and had to repay $48 million to clients. The firm had recommended a series of private investments in a company that owned a Polish tobacco company and patents on a cigarette filter that it claimed would revolutionize the tobacco industry. Not only was it a sketchy investment, but apparently Mr. Weiss had an undisclosed performance interest in the success of the company.

Browsing through the Form ADV, you can see that it is filled with subsidiaries and the multiple hats that Mr. Weiss was wearing.  Given all of the existing disclosures, it seems that it should have been easier to include the additional disclosures that would have helped his case.

Given that Mr. Weiss had an ownership interest, and not just an incentive payment, the principal transactions rule would apply requiring explicit consent by the advisory client.

Sources:

False Credentials, Fraud and Fund-Raising

With graduation season upon us we are lauding those students who have excelled in academic achievement, or at least did just enough to earn their degrees. It is all too easy for a fraudster to concoct false degrees, titles and awards to lure in unwary investors. With two recent fraud cases, the Securities and Exchange Commission issued a new Investor Alert: Beware of False or Exaggerated Credentials.

14408184212_4938113d25_z

“Do not trust someone with your investment money just because he or she claims to have impressive credentials or experience, or manages to create a ‘buzz of success.’”

The SEC Enforcement Division announced two fraud cases against investment advisers who made false claims about their experience and industry accolades.

The SEC charged Todd M. Schoenberger of Lewes, Delaware, with misrepresenting that he had a college degree from the University of Maryland.  Also for defrauding investors. He was raising a fund and also raising money for his fund management company: LandColt Capital LP.  Schoenberger told prospective investors that LandColt would repay the notes through fees earned from managing the fund. Schoenberger never actually launched the fund, never had the commitments of capital to the fund that he claimed, and never paid investors in the management company the returns he promised. The SEC made a show of him because he had been a guest commentator on financial television shows.

I found the fake degree to be the least interesting part. The double-fraud is far more interesting. He was committing fraud in raising the fund and in raising capital for the management company at the same time.

An SEC investigation found that Michael G. Thomas of Oil City, Penn, claimed that he was named a “Top 25 Rising Business Star” by Fortune Magazine. He used that false badge in general solicitation for his private fund.  No such distinction actually exists at Fortune Magazine. As you might expect, Thomas also greatly exaggerated his own past investment performance and inflated the fund’s projected performance.  He claimed to have turned $600 in to $6 million, when he actually started with more than $600 and turned it into less.

I think the older Hicks case is a better example of false credentials. The SEC alleges that Hicks falsely represented in the offering memorandum for his Locust Offshore Management hedge fund that he had undergraduate and graduate degrees at Harvard University and that the fund’s quantitative strategies were based on mathematical models that Hicks developed while at Harvard earning those degrees. However, that is far form the truth. Hicks only attended Harvard for three semesters, was twice required to withdraw for failing to perform academically, and never graduated. Hicks only took one mathematics course during his time at Harvard, receiving a D- for a grade.

Sources:

Sure Fire Way To Spot a Fraud: Look for the SEC Seal

sec fraud

The Securities and Exchange Commission does not “approve” or “endorse” any particular securities, issuers, products, loans, services, professional credentials, firms or individuals. The SEC does not allow private entities to use its government seal. Yes, the staff of the SEC regularly meets with public companies, regulated entities, and others. Some of these investments and entities are required to be registered with the SEC.

But, the SEC never endorses an investment. Registration of a security does not imply its a good investment. Registration as an investment adviser does not mean you give good advice.

Investment advisers are required to include this statement on their Form ADV:

The information in this Brochure has not been approved or verified by the United States Securities and Exchange Commission or by any state securities authority. Registration as an investment adviser does not imply any level of skill or training.

Any claim – stated or implied – that the SEC has endorsed an investment is completely false. You are likely looking at part of a fraudulent scheme.

Sources:

Train Fares, Integrity, and Financial Services

Stonegate_Railway_Station

On Monday Britain’s financial regulator banned a senior financial services professional from the industry for life. His transgression was the failure to pay his train fare. BlackRock director Jonathan Paul Burrows was caught by inspectors at Cannon Street station last year.

Mr Burrows has admitted that, on a number of occasions, he deliberately and knowingly failed to purchase a valid ticket to cover his entire journey whilst traveling on he Southeastern train service between Stonegate Railway Station, East Sussex, and Cannon Street Station, London.

Based on Mr Burrows’ admission, the Authority considers that Mr Burrows is not fit and proper to conduct any function in relation to any regulated activity carried on by any authorised or exempt persons … because he lacks honesty and integrity.

That means his has failed to meet the FCA’s Fit and Proper Test for Approved Persons.

The fare he failed to pay was £21.50. That’s an expensive train ticket. Mr. Burrows avoided paying the fare by boarding the London-bound train at Stonegate, a rural station with no turnstiles. Without the turnstiles, there is no control to make sure passengers have a ticket.

But it was not just the one time. He was alleged to have failed to pay for his ticket on almost 2,000 occasions. He settled with the transit authority for £42,550.

Sources:

Stonegate Railway Station photograph is by Simon Carey
cc by sa

When Fundraising Becomes More Lucrative Than Running the Business

2235691874_5d51bc58ca_z

Erick Mathe had a vision of creating a media empire. Well, maybe not an empire, more of a small keep. His plan was to broadcast over Low Power Television Service. Those are locally-oriented television broadcasts in small communities. Mr. Mathe had a line up of streaming music and infomercials. He just needed capital to get the business going.

It won’t surprise you that Mathe has been charged with fraud. There is an SEC complaint in Florida and a criminal indictment in Pennsylvania. Mathe has not responded to the charges so I have to rely on the government’s view of the facts. It looks like Mathe saw that raising the capital and taking a commission was more lucrative than running the television business.

Vision Broadcast Network had four stations lined up for delivery of its content and said that it had licenses for 70 more. It’s “Ask the Specialist” subsidiary was lined up to provide medical educational resources. That subsidiary was particularly useful because it put Mathe in contact with wealthy doctors who were potential investors.

What caught my eye was a registration filing that Vision Broadcast Network made in 2009 with the Securities and Exchange Commission. It looks like it had the good intention at that time to be a legitimate business.

In the filing, there is a Code of Ethics as an exhibit.

“Act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or allowing one’s independent judgment to be subordinated. “

Mathe met Ashif Jiwa who persuaded him that he could help raise additional investment funds because he operated a hedge fund and acted as a financial adviser to the Prince of Dubai. Mathe paid Jiwa a commission on capital raised. At some point Mathe decided that he should also pay himself a commission for capital raised.

Perhaps that was the turning point. Mathe became more focused on raising capital than operating his business. According to the SEC complaint Mathe was misleading investors about revenue, capital commitments, and the success of the business.

He was ignoring his own code of ethics.

Sources:

Not Securities Fraud By Reason of Insanity

insanity

Some investment fraud schemes sound crazy, but leave just a enough truthful-sounding bits to catch people. But Thomas Lawler’s scheme sounds completely bonkers. He established the Freedom Foundation to offer investors the chance to erase their debts and collect lucrative profits through the purchase of “administrative remedies”.

Never heard of profit-making “administrative remedies”? Lawler can sell you the secret.

Lawler investigated the banking system and discovered the startling “truth.” At birth, we each have an account established in our name. When you borrow from the bank, you are actually borrowing your own money that resides in your account. For a mere $1000, Lawler will prepare notices to the creditors, using the Uniform Commercial Code, international admiralty law, and papal decree to cancel the debt.

At least that is according to the SEC’s complaint. I checked out the Freedom Club USA website to find more information. The website is a big collection of crazy.

Here is a snippet:

The Vatican created a world trust using the birth certificate to capture the value of each individual’s future productive energy. Each state, province and country in the fiat monetary system, contributes their people’s value to this world trust identified by the SS, SIN or EIN numbers (for example) maintained in the Vatican registry. Corporations worldwide (individuals became corporate fictions through their birth certificate) are connected to the Vatican through law (Vatican to Crown to BAR to laws to judge to people) and through money (Vatican birth accounts value to IMF to Treasury (Federal Reserve) to banks to people (loans) to judges (administration) and sheriffs (confiscation)

The website includes ramblings about a lost 13th amendment to the Constitution, the illegality of the 1040, the Cosmic Time Plan, and an audio recording from the Prime Creator.

In sorting through the crazy, it’s hard to tell if it’s a securities fraud issue. It’s certainly a fraud. Anyone giving money to this kind of full-blown crazy is throwing their cash away. It sounds like Lawler may be selling a service and not an investment. There is too much crazy on the website for me to discern what Lawler is actually selling.

You can look to the Howey four-part definition of an investment contract. There is certainly an investment of money and the reliance on others. There is a reasonable expectation of profits. Cancelling debt is income, so the SEC can probably get over that hurdle.

But I’m not sure there is a “common enterprise.” Lawler’s scheme seems more like fraudulent credit reduction scheme than a securities investment.

Sources:

Image of Insanity by Albert Einstein by Marla Elvin
CC BY SA

The SEC is Late to a Real Estate Fraud

Company Theft

The Securities and Exchange Commission charged M. “Shi” Shailendra with making false representations to investors, misappropriating money, and acting as an unregistered broker. Shailendra was selling interests in his Interstate North 5 Acres fund known as Shi Six. He was purportedly using the money to acquire distressed real estate. Instead, he was pocketing most of the capital.

Shailendra had plans to create a massive real estate empire built with capital from the Indian community. His plans got derailed by the 2008 financial crisis and his own misdeeds.

According to news reports, the unraveling of his misdeeds has been happening for several years. Shi Investments One sued the Shailendra Group back in early 2011 for the diversion of investor funds to personal accounts and other self-dealing.

It’s good that the SEC caught him, but it seems that his investors had already grabbed him. Among the SEC’s penalties, Shailendra was ordered to disgorge over $2 million in ill-gotten gains and penalties. But the SEC waived that amount based on his inability to pay.

The fund is handed over to investors to try and regain whatever capital may remain. From the accusation in the complaint it sounds like most of the investors’ capital went to Shailendra for personal use or to fund affiliate transactions.

At a minimum, Shailendra is permanently barred from association with any broker-dealer, investment adviser or other firm under the jurisdiction of the SEC. However, lots of real estate investment operates outside that jurisdiction.

Sources:

How Do You Exit a Ponzi Scheme?

Charles Ponzi

It looks like Bernie Madoff was $45 billion short of funds in his “investment strategy.” How was he ever going to get out of this?

The original Ponzi schemer, Charles Ponzi, seems to think he could get out of his situation, at least according to Mitchell Zukoff, author of Ponzi’s Scheme: The True Story of a Financial Legend.

It sounds like Madoff and Ponzi fell into the same trap. At some point early on they did not realize their promised investment goals. Instead of being honest with their investors, they posted a fake return. The hope was that they could make up for the miss later on.

The central characteristic of a Ponzi scheme is that current returns to investors are paid from new investments instead of a return on the invested capital.

The duration of a Ponzi scheme is dependent on a few factors.

The first factor is the promised return rate. The higher the promised return the shorter the duration. One of the reasons Madoff continued for so long is that his promised return was typically low. He was generally in the 15% range. Since Ponzi was promising returns of 50% in three months, he had a short fuse on the length of his scheme.

The second factor is the redemption rate. The promised return is only meaningful when you have to pay out cash. The better the schemer is at getting investors to keep rolling over returns, the longer the duration. Madoff was undone by the 2008 financial crisis, crushed by a wave of redemptions as people were desperate for cash.

The third factor is the investment rate. The better Ponzi schemers can keep the cash flowing in. As long as the investment rate of cash flowing is in excess of the redemption rate, the scheme will not collapse unless discovered. Once the redemption rate exceeds the investment rate, the schemer will not have the cash to make payouts and the scheme will likely be discovered.

The fourth factor is discovery. This is a wild card. Once an accusation of fraud is made, there will likely be an sharp increase in the redemption rate and a reduction in the investment rate. Ponzi has high profile and attracted attention. Madoff was very secretive. If you can’t stand up to scrutiny, the less scrutiny the better.

The fifth factor is actual returns. I would theorize that many Ponzi schemes start as a legitimate investment proposals. So there may be some actual investment returns that could offset the need for a higher investment rate. Ponzi never made a legitimate investment so this factor was zero for his scheme. Madoff was apparently investing legitimately at some point, but ended up at zero for many years leading up to the collapse. Stanford was generating returns in his banking empire. Just not enough.

The obvious exit is to increase the actual returns to meet the promised return rate before the redemption rate exceeds the investment rate. You can look at Sam Israel who seemed to think he was always just a few trades way from making back all of the promised money.

Sources: