D. Elizabeth Wills Wills Law Firm LLC. Miles M. Gersh Miles M. Gersh, LLC

Transcription

1 RECOGNIZING AND AVOIDING INVESTMENT FRAUD: Protecting Your Nest Egg From Fraudsters D. Elizabeth Wills Wills Law Firm LLC Miles M. Gersh Miles M. Gersh, LLC

2 RECOGNIZING AND AVOIDING INVESTMENT FRAUD WHAT IS INVESTMENT FRAUD? 2

3 WHAT IS INVESTMENT FRAUD? Investment Fraud is Securities Fraud Federal and state securities laws are based on principle of full disclosure. All material facts must be disclosed. A fact is material if a reasonable person would consider it important to know in making a decision to invest. It is illegal to misrepresent or omit to disclose material facts. General Rule: Offerings must be registered with the SEC and states unless an exemption is available. Salespersons must also be licensed and registered with FINRA and each state in which they intend to contact investors. 3

4 WHAT IS INVESTMENT FRAUD? What is a Security? Traditional securities: stocks, bonds Notes, other than notes issued in purely commercial or consumer transactions (mortgages, bank loans, consumer financing) Fractional undivided interests in oil, gas or other mineral rights Investment contracts: An investment of money In a common enterprise With an expectation of profits To be derived from the entrepreneurial or managerial efforts of others 4

5 WHAT IS INVESTMENT FRAUD? How are Fraudulent Schemes Promoted? Telephone, or other social media Internet websites Broker or advisor Sales pitch includes misrepresentations and omissions to state material facts 5

6 RECOGNIZING AND AVOIDING INVESTMENT FRAUD WHO IS MOST VULNERABLE? 6

7 Who is Most Vulnerable? Investment fraud can happen to anyone, even experienced investors have been defrauded by their trusted advisors You will only be defrauded by someone you trust! (After all, you wouldn t give your money to someone you didn t trust!) Some are more vulnerable than others: Americans aged 65 and older are particularly vulnerable (Research Report issued by FINRA Investor Education Foundation in Sept entitled Financial Fraud and Fraud Susceptibility in the United States ) According to the FINRA Research Report, over 40% of those surveyed cannot identify some classic red flags of fraud. When it comes to financial fraud, America is a nation at risk. (Gerri Walsh, President, FINRA Investor Education Foundation) 7

8 Who is Most Vulnerable? 8 Retired and almost-retired investors are looking to get a better return on their money than current low interest rates to make their savings last longer Investors who are wary of the stock market are more receptive to scammer s pitches. Fraudulent investments are often promoted as alternatives to stock market ( Wealth Without Wall Street ) Investors who have lost money in the market and are afraid and/or looking to recover their losses Widows or divorcees whose husbands handled all of the investments and financial matters during the marriage Investors wanting a home run not where they think they should be at that point in their life

9 RECOGNIZING AND AVOIDING INVESTMENT FRAUD RED FLAGS OF FRAUDULENT INVESTMENTS 9

10 Red Flags of Fraudulent Investments Investors At Risk Because They Cannot Identify Red Flags 2012 SEC Study found that retail investors lack basic financial literacy, have a weak grasp of elementary financial concepts, such as diversification or the difference between stocks and bonds, and lack critical knowledge of ways to avoid investment fraud. Women, African-Americans, Hispanics, the very elderly and those with little education have an even greater lack of investment knowledge The FINRA Investor Education Foundation Research Report found that many Americans are vulnerable to fraudulent solicitations because they cannot identify the classic red flags of fraud. 10

11 Red Flags of Fraudulent Investments Red Flags 11 The investment is unsolicited Pressure to invest immediately or the investment will not be available; Never get this type of opportunity again High rate of return promised high (14% and above) annual returns not likely; too good to be true Investment is touted as being safe, secure, risk-free, guaranteed, or liquid and focus on the potential return and not the risk per FINRA Research Report, 43% found fully guaranteed investments were appealing despite the fact that virtually no investment is riskless and guarantees are a common pitch of fraudsters Investor is encouraged to borrow against home equity to invest; put your equity to work for you

12 Red Flags of Fraudulent Investments Red Flags Business plan is hard to understand or doesn t meet the smell test The sales person is not registered to sell securities with FINRA or in the state in which the investor resides Little or no documentation, including financial statements, is provided Salesperson tells you to just sign the subscription documents and s/he will complete the rest of the form for you The offering is not registered with the SEC or with the securities department of the state in which the investor resides Salesperson s representations are different from what is in the written materials (ALWAYS READ THE WRITTEN MATERIALS!) 12

13 RECOGNIZING AND AVOIDING INVESTMENT FRAUD EXAMPLES OF FRAUDULENT INVESTMENTS 13

14 Examples of Fraudulent Investments Ponzi Schemes Named after Charles Ponzi, who duped investors with a postage stamp speculation scheme in the 1920s In a Ponzi scheme, prior investors are paid from funds contributed by new investors Because there are little or no legitimate earnings from the business, the scheme requires a consistent flow of money from new investors to continue Ponzi schemes collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out 14

15 Examples of Fraudulent Investments Ponzi Schemes 15 Bernie Madoff, currently serving 150-year sentence, swindled thousands of investors in multi-billion dollar Ponzi scheme. Phony account statements showed moderate, but consistent positive returns, even during turbulent markets Local Ponzi schemer Sean Mueller created fictitious account statements showing handsome returns; used prestigious country club memberships to recruit investors, such as John Elway Will Hoover targeted a small group of his most loyal and trusting clients to promote the opportunity to invest in a high paying account at Fleet Bank, also created false monthly account statements

16 Examples of Fraudulent Investments Inappropriate Advice from Investment Advisors or Brokers Madoff, Mueller, Merriman and Will Hoover were all investment advisors who swindled their clients. Investment advisors are licensed to give investment advice and owe a fiduciary duty to their clients. Brokers and broker-dealers must obtain the customer s authorization for each transaction in the account. They do not owe fiduciary duties to their clients unless they have discretion (trading authorization) over the account. Always review your trade confirmations and monthly brokerage account statements for accuracy and to make sure all transactions were authorized. Unauthorized transactions is a major claim in arbitrations. 16

17 Examples of Fraudulent Investments Affinity Fraud An investment promoted by a person who uses a common affiliation to support his/her credibility and the quality of the investment, such as a church, social or professional organization, country club, special interest group. etc. Promoters profit by abusing relationships of trust - Trust but verify Senior fraud is a form of affinity fraud Madoff preyed on the Jewish community Merriman preyed on the Mormon (LDS) community Often turn out to be Ponzi schemes 17

18 Examples of Fraudulent Investments Affinity Fraud Alan Bird (Colorado Springs) sentenced to 24 years for a $24 million hedge-fund investment scam with 450 victims, including churches and church members. A pastor who helped recruit investors was also convicted. While Bird was being prosecuted in first scam, he bilked new investors out of almost $700,000 in a second scam promising high rates of returns on currency trading. He used part of the $700,000 to pay his defense attorney in the first case and used the rest for himself. 18

19 Examples of Fraudulent Investments Oil and Gas Drilling Programs Oil and Gas investments are risky. Exploratory drilling is most risky. Usually offered in the form of a limited partnership where limited partners have limited liability. Must read limited partnership agreement carefully. Limited partnership agreement is a legal document so seek professional advice if you don t understand it. Oil and gas and real estate deals are usually private placements, not registered with the SEC or states. They are often sold by unlicensed sales agents who cold call investors. NASAA has published an Investor Alert warning of the dangers of different types of energy investments. 19

20 Examples of Fraudulent Investments Promissory Notes A favored investment vehicle for Ponzi schemes, promissory notes were named by 20 state regulators as one of the most common products in fraudulent schemes. The ability to repay the note depends upon the financial condition of the issuer of the note. Touted as safe alternatives to bank CDs, they are often marketed to safety-conscious retirees who have little investment experience, and are usually a scam. An investor should do their due diligence before lending any money or purchasing any promissory notes! 20

21 Examples of Fraudulent Investments Real Estate Deals Many different schemes involving real estate e.g., high risk construction loans, hard money loans (loans secured by value of real estate and have a high interest rate), mortgage loans, fix-and-flip Touted as being secure and liquid because the loans are purportedly secured by real estate, therefore downplay risk Offer very high rates of return (10-16%) Often use an independent self-directed custodian to bolster credibility and deceive investors into believing that a third party has analyzed and validated the investment. In fact, these custodians only hold the assets in a self-directed IRA and do not evaluate the quality or legitimacy of any investment and/or its promoters. 21

22 Examples of Fraudulent Investments Liquefying Home Equity Recommendation to refinance and use the equity in the home to put into the market or another investment The investment being promoted will pay a sufficient return to cover the new mortgage payment Little if any risk because payments are covered make your home equity work for you Investors are still falling for this pitch! Even worse if take out an interest only mortgage If the investment fails, investors must still pay the new mortgage payment often the only monthly income is social security, which is needed to pay living expenses 22

23 Examples of Fraudulent Investments Liquefying Home Equity Recommended Reading: Betting the Ranch: Risking Your Home to Buy Securities, FINRA Investor Alert, 3/13/ P005961; Notice to Members 04-89, Liquified Home Equity, 12/ pdf See also the Remarks to the SIA Compliance & Legal Conference, by Mary Schapiro, Vice Chairman, NASD President, Regulatory Policy and Oversight, 3/22/04 ( 99% of the time, a recommendation that an investor mortgage his or her home in order to speculate in the securities market IS UNSUITABLE and subject to potential enforcement action We brought three enforcement cases last week against individual brokers for making unsuitable recommendations that included convincing clients to mortgage their houses. 23

24 RECOGNIZING AND AVOIDING INVESTMENT FRAUD NEW THREATS 24

25 Jumpstart Our Business Startups Act Adopted in April 2012 Stated purpose is to increase job creation and economic growth by improving access to public markets for emerging growth companies Very, very early stage companies Two provisions make it easier for scammers to gain access to investors retirement assets Elimination of ban on general solicitation and advertising in private placements effective 9/23/13 Crowdfunding SEC proposed rules on Oct. 23, 2013 rules not yet adopted 25

26 Jumpstart Our Business Startups Act Relaxation of rules which have protected investors for years = more opportunity for fraud and misrepresentation These two provisions were at the top of NASAA s 2012 annual list of financial products and practices that threaten to trap unwary investors because they could unwittingly open a floodgate of fraud. Particularly under Crowdfunding provisions, stock promoters will have access over the Internet to small, unsophisticated investors, who were previously off limits for such investments. Internet + $ = opportunity for fraud 26

27 Elimination of Ban on General Solicitation and Advertising Prior to September 23, 2013, general solicitation and advertising could not be used in the sale of unregistered offerings a/k/a private placements A pre-existing relationship used to be required in order to contact investor Ban on general solicitation and advertising protected smaller investors from solicitations Under new rules, salesmen will be able to offer investments through cold calls (perhaps on the way out, replaced by other means of contact), the internet, direct mail or media advertisements, free lunch/diner seminars 27

28 Elimination of Ban on General Solicitation and Advertising Private placement offerings conducted using general solicitation or advertising may only be made to accredited investors: A person who (individually or with spouse) has a net worth of $1 million, exclusive of their primary residence, or A person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years, and expected income of $200,000 (individual) or $300,000 (joint) in the current year Accredited investors are also considered to have such knowledge and experience in financial matters that they are capable of fending for themselves 28

29 Elimination of Ban on General Solicitation and Advertising Because of their financial status, accredited investors are deemed not to require the protections of the Federal securities laws Many retirees may qualify as accredited investors because of their net worth, but certainly do not have the financial knowledge and experience to protect themselves from scam artists and are at risk Investors in private placements that employ general solicitation and advertising must be accredited investors or the issuer must reasonably believe they are accredited investors Self-certification will not suffice 29

30 Elimination of Ban on General Solicitation and Advertising Investors will have to disclose their tax returns, bank, brokerage and similar documents: Income test: tax returns + representation re: current year income Net worth test: bank/brokerage statements + representation re: liabilities Will be new industry set up to verify net worth and income requirements 30

31 Crowdfunding Crowdfunding is an online money-raising strategy Began as a way for the public to donate small amounts of money to help artists, musicians, filmmakers etc. to finance their projects Often use social networking websites Recently promoted as a way of assisting small businesses and startups to help get their business ventures off the ground - anything from a food truck to a laser line on the football field to a porta-potty Crowdfunding rules proposed, but not yet adopted; if adopted, companies can raise limited amounts from an unlimited number of unsophisticated investors each year without registration 31

32 Crowdfunding A company may raise up to $1 million during any 12-month period. If your annual income or net worth is less than $100,000, you can invest the greater of $2,000 or five percent (5%) of your annual income or net worth. If your annual income is equal to or greater than $100,000, you can invest 10% of your annual income or net worth, but not more than an aggregate of $100,000. Offerings must be conducted through the Internet (or similar electronic medium) and only through an intermediary (but only one intermediary) to be consistent with the underlying principles of crowdfunding: widely accessible by the public so as to benefit from the collective wisdom of the crowd. 32

33 Crowdfunding The issuer must provide specified information to the SEC, investors and to the public: information regarding the company, its management, business plan, financials, use of proceeds from the offering, the target amount of the offering and any deadlines, the offering price or how it will be determined Start-ups are very risky! A Harvard Business School study found 30%- 40% of start-ups lose all of their investors' money, while 90%-95% of them fail to meet declared projected goals Your only return may be a (commemorative) t-shirt! 33

34 Investigative Resources Do due diligence BEFORE you invest! Check the background of the salesperson calling you to see if s/he is licensed to sell the investment: BrokerCheck is a free service offered by FINRA at or call (888) You will need the name of the person to use BrokerCheck. Call the Colorado Division of Securities to see if the person is registered in Colorado. You can reach the Colorado Division of Securities at (303) or online at SD/CBON/DORA/

35 Investigative Resources Check to see if the investment is registered in your state: Contact the Colorado Division of Securities (or your state s securities department). Give the regulator the name(s) of the people involved in the business and ask if they have any history of regulatory problems. 35

36 Remedies If you believe your client may have been defrauded or sold an investment by a salesperson who was not licensed in Colorado, your client may be able to file a claim to recover the amount of the investment, interest, attorneys fees and costs under the Colorado Securities Act. Claims under the federal securities laws are also available. If the investment was in a brokerage account, an arbitration provision in the new account agreement requires the dispute be arbitrated under FINRA s arbitration rules. If the investment was not in a brokerage account, your client may have the option of filing a complaint in court. 36

37 Remedies The regulators typically will not help your client to recover their lost investment. Advise your client to consult with experienced investment fraud counsel. FINRA arbitration - required under most brokers new customer account agreements. To be eligible, claims must be filed within 6 years of the transaction giving rise to the claim. If there is no arbitration agreement in place, a complaint may be filed in court. Under the Colorado Securities Act, scienter is not required to be proved, only a false statement or omission. 37 Aiding and abetting liability - actionable under the Colorado Securities Act, but not under the federal securities laws, and is a primary vehicle for obtaining accountability of those who assist securities wrongdoing, e.g., bankers, accountants, lawyers etc

38 Remedies Control person liability is also actionable under both the Colorado Securities Act and the federal securities laws. In addition, common law causes of action, including fraud, breach of fiduciary duty, breach of contract and negligent misrepresentation. Depending on the facts, damage enhancements may be available under the Colorado Organized Crime Control Act and the Consumer Protection Act. Punitive damages and attorneys fees, while often requested, are rarely awarded. Statutes of limitations are short: 3 years from when you knew or should have known and a 5 year statute of repose. 38

39 List of Don ts What to Tell Your Client 1. If you don t understand the investment, or how it makes money, or you can t explain it to someone else, don t invest! 2. If it is touted as having a high rate of return or returning substantially more than the current interest rate, see #1! 3. Don t fall for the pitch that you have to make an immediate investment! Ask for written materials, read them and think about it. Ask your CPA or attorney for a second opinion. Do your due diligence. 4. NEVER mortgage your home to invest unless you can comfortably make the mortgage payments from another source of income. 39

40 List of Do s What to Tell Your Client 1. Ask if the venture has audited financial statements. Ask for audited financial statements and check out the accounting firm online. 2. Consult with counsel, your CPA or other independent trusted advisor. 3. Read the written materials provided! 4. Do your homework! You would be surprised (or dismayed) what you can find on the internet! 5. If you do suspect you have invested in a scam, get help! Contact a securities attorney who is experienced in investment fraud arbitration/litigation. 40

41 41 THANK YOU!