Keep on High Alert: Fraudulent Stock Promotions May Be Coming Your Way

By: Alexandra Hughes, Spring 2016 Clinic GRA

The SEC’s Office of Investor Education and Advocacy recently released an updated Investor Alert on Fraudulent Stock Promotions “to warn investors about fraudsters who promote a stock to drive up the stock price and then sell their own shares at the inflated price, making money at investors’ expense.” These stock promoters are generally paid promoters or company insiders. If stock promoters don’t disclose the compensation they receive from promoting a stock, the SEC will bring charges. However, disclosure of compensation does not necessarily mean that the promotion is legitimate.

Fraudulent stock promotion was recently discussed in a SEC press release. In March 2016, the SEC settled charges against Tobin Smith, a former market analyst and TV news commentator, and NBT Group Inc., for fraudulent promotion of a penny stock to investors. Smith and NBT were barred from involvement in future penny stock offerings and disgorged compensation from the penny stock promotion in the amount of $165,900 plus $16,893 in interest. Smith was also required to pay a $75,000 penalty to settle the charges.

The SEC warns investors that promotion of stock by fraudsters can occur on “seemingly independent and unbiased sources” like:

  • Online Advertisements
  • Internet Chat Rooms
  • Direct Mail

The SEC advises that the most susceptible stock prices to manipulate, and thus the easiest targets for fraudsters interested in stock promotion, are those of microcap stocks and penny stocks. For microcap stocks, the dangers of fraud are further increased because publicly available information about these stocks is scarce and false information about them can be easily spread. Warning signs of microcap fraud may include:

  • SEC trading suspension of the security or of other securities also promoted by the promoter
  • Increases in the stock price or trading volume
  • Press releases or promotion activity about events (that actually never occur)
  • No real business operations
  • Issuance of shares without a corresponding increase in company assets
  • Changes in company name or business type

Ski Resort Gets More Than Just Snow, It Gets Completely Frozen

By: Alexandra Hughes, Spring 2016 Clinic GRA

In an April 14, 2016 press released titled SEC Case Freezes Assets of Ski Resort Steeped in Fraudulent EB-5 Offerings, the SEC announced “fraud charges and an asset freeze against a Vermont-based ski resort and related businesses allegedly misusing millions of dollars raised through investments solicited under the EB-5 Immigrant Investor Program.” The charges alleged that Ariel Quiros, William Stenger, and their companies fraudulently raised in excess of $350 million from investors saying the money would be used to build a ski resort and biomedical research facility in Vermont. Instead, it appears that some of the money from these investors was used to pay off losses from earlier projects, reflecting a “Ponzi-like” scheme (an explanation of Ponzi schemes can be found at the SEC’s website). Quiros also allegedly fraudulently used investor funds to: purchase a condo, pay his income taxes, pay other taxes, and acquire another ski resort. Essentially, as Andrew Ceresney, Director of the SEC’s Division of Enforcement stated, “the defendants diverted millions of EB-5 investor dollars to their own pockets, leaving little money for construction of the research facility investors were told would be built and thereby putting the investors’ funds and their immigration petitions in jeopardy.” To read the entire SEC complaint, click here.

The EB-5 Immigrant Investor Program, administered by the U.S. Citizenship and Immigration Services (USCIS), allows entrepreneurs to be eligible to apply for a green card if they (1) “make the necessary investment in a commercial enterprise in the United States” and (2) “create or preserve 10 permanent full-time jobs for qualified U.S. workers.” To learn more about the EB-5 Immigrant Investor Program, click here.

Unfortunately, the EB-5 Immigrant Investor Program is no stranger to investment fraud claims. In October 2013, the SEC issued Investor Alert: Investment Scams Exploit Immigrant Investor Program, which cautioned investors to “research thoroughly any offering that purports to be affiliated with EB-5” as the program was and continues to be used to carry out investment scams. The Investor Alert advised investors to take the following steps before investing: Continue reading

FINRA Investor Alert: What You Need to Know About Creating a Power of Attorney for Your Investments

By: Alexandra Hughes, Spring 2016 Clinic GRA

On March 23, 2016, FINRA issued a FINRA Investor Alert: Power of Attorney and Your Investments—10 Tips. Managing financial affairs and investment accounts is often a battle of competing interests (present v. future needs) for investors. Although it may be easier for an investor to manage his financial affairs taking a “one day at a time” approach, such thinking is too short sighted. It is equally important for investors to plan for their future needs, especially when unfortunate life events, such as sickness and other health issues, are inevitable, and may leave an investor unable to manage his investment accounts and financial affairs.

POA: What is it?

Power of Attorney (POA) is one way an investor can plan for the future. FINRA’s investor alert defines POA as “a legal document you sign to grant someone you trust with authority to make decisions on your behalf. Based on the authority you grant, this attorney-in-fact, or agent, has the legal right to make the decisions you would make if you were able.”

10 Tips for POA: What Every Investor Should Know

 The following are 10 tips FINRA thinks every investor should know about POA:
Continue reading

Beware Financial Fraud: It’s Closer Than You Think

By: Alexandra Hughes, Spring 2016 Clinic GRA

Generally, the IAC focuses on claims of misconduct on the part of investment advisers and broker-dealers. Such claims involve the unsuitability of a recommended investment, or misrepresentations or omissions to the investor. However, what happens when the underlying financial information, which is distributed to investors in a prospectus or quarterly reports, ends up being inaccurate? Such financial inaccuracies would not only deeply affect an investor’s understanding of the business he has invested in, but would be almost impossible for the regular or even prudent investor to detect. The SEC recently issued a press release discussing what happens when investors are so deceived.

On April 19, 2016, the SEC released a press release entitled SEC Announces Financial Fraud Cases, discussing “a pair of financial fraud cases against companies and then-executives accused of various accounting failures that left investors without accurate depictions of company finances.” The “pair” of companies are: Logitech, a company manufacturing accessories for computers and tablets, and Ener1, a lithium-ion battery manufacturer. The SEC also released orders detailing cease and desist proceedings and penalties against Logitech and Ener1. SEC’s Division of Enforcement Director, Andrew Ceresney, said “In these two cases, we allege deficiencies in Ener1’s failure to properly impair assets on its balance sheet and Logitech’s failure to write down the value of its inventory to avoid the financial consequences of disappointing sales.”

For such accounting failures, Logitech agreed to pay a $7.5 million penalty. The SEC found that in fiscal year 2011, Logitech inflated its financial results, which subsequently caused investors to have an inaccurate and impaired view of the company’s finances. Logitech’s then-controller, Michael Doktorczyk, and then-director of accounting, Sherralyn Bolles, also agreed to pay penalties of $50,000 and $25,0000, respectively, for their part in the accounting related violations. However, Logitech is not out of the woods yet. On April 18, 2016, the SEC filed a complaint against Logitech’s then-CFO, Erik K. Bardman, and then-Acting Controller, Jennifer F. Wolf, seeking injunctive relief and damages for multiple securities act violations.

As for Ener1, the SEC found the company had “materially overstated revenues and assets for year-end 2010 and overstated assets in the first quarter of 2011.” Former executives of the company: Charles L. Gassenheimer, CEO and chairman of the board, Jeffrey A. Seidel, CFO, and Robert R. Kamischke, chief accounting officer, paid penalties of $100,000, $50,000, and $30,000, respectively for the violations. Further, the SEC found Ener1’s auditor, Robert D. Hesselgesser, violated “professional auditing standards when he failed to perform sufficient procedures to support his audit conclusions that Ener1 management had appropriately accounted for its assets and revenues.” As a result, Hesselgesser has been suspended as an accountant.

For more information, see the SEC press release here.

There Is No Such Thing as a Free Lunch, or in This Case, Dinner

By: Alexandra Hughes, Spring 2016 Clinic GRA

On April 4, 2016, the SEC published a press release, SEC Charges Four in Fraudulent Free Dinner Scheme, “announc[ing] it has charged four individuals in a fraud whose victims included seniors who were solicited at ‘free dinner’ investment seminars in Florida.” The “cast of characters” in this free dinner scheme were: Joseph Andrew Paul, John D. Ellis, Jr., James S. Quay, and Donald H. Ellison.

Essentially, the SEC alleges that Paul and Ellis created fraudulent marketing materials, which included materials that were literally copy and pasted from an unrelated firm’s website. According to the SEC’s allegations, false materials in hand, Quay and Ellison sent out a mass-mailing offer enticing seniors to come to a free dinner to learn about the investments. The SEC alleges in its complaint that most of the money raised from these hoodwinked senior investors was never actually invested. Instead, the money allegedly went into the palms of Paul, Ellis, Quay, and Ellison. To make matters worse, Quay was the subject of a previous 2012 enforcement action and was using an alias “Stephen Jameson.” Neither “Stephen Jameson” nor Ellison were registered during the period the scheme took place.

This certainly isn’t the first and probably isn’t the last time fraudsters will attempt to use a “free lunch” or “free dinner” scheme to convince seniors to invest in products that don’t exist. Senior investors should refer to Investor Alert for Seniors and Seniors—Beware of Investment Seminars for more information. The SEC also advises investors to check the registration status and disciplinary history of financial professionals, before making an investment, via its website.

 FINRA has also discussed the dangers of these “free lunch” investment seminars in Investor Alert: “Free Lunch” Investment Seminars—Avoiding the Heartburn of a Hard Sell. In this Investor Alert, FINRA advises investors, especially senior investors, to be on the look out for these seminars which generally put on a convincing show but not necessarily a good investment. Persuasion techniques that fraudsters may try to use at such seminars include:

  • Phantom Riches: A tactic that entices the investor with the “riches” that can be produced by the investment.
  • Source Credibility: A tactic that uses a reputable firm or an individual’s special credential to persuade the investor to invest.
  • Social Consensus: A tactic that makes the investor believe the investment is a good idea because “other savvy investors have already invested.”
  • Reciprocity: A tactic that uses a prize or meal to guilt the investor into reciprocating with an investment.
  • Scarcity: A tactic that “creat[es] a false sense of urgency by claiming limited supply.”

What Your Investment’s Performance Claim Might Not Be Telling You

By: Alexandra Hughes, Spring 2016 Clinic GRA

On April 15, 2016, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin discussing Performance Claims. The SEC stated that investors “will likely come across sales and marketing materials that describe an investment’s performance” but that performance claims may be presented in a way that doesn’t disclose everything an investor would or should want to know. The SEC advises that before making an investment decision, the investor should understand how information underlying a performance claim “is calculated and presented—and whether or not the claim is reliable and applies to [the investor’s] particular circumstances.”

The Investor Bulletin breaks down understanding performance claims made about an investment into two categories: (1) understanding how the information underlying the performance claim is calculated and presented and (2) evaluating the reliability of that performance claim. Understanding these issues is vital to the prudent investor. The SEC recommends that before an investor relies on a performance claim, they understand these two categories. A summary of the Investor Bulletin is below. Continue reading

Part 10: FINRA Dispute Resolution Task Force: Enhancing Securities Dispute Resolution One Recommendation At A Time. Forum Access, Unpaid Awards, Frivolous Motions to Vacate, Requiring Arbitrators to Apply the Law, and the Proposed FINRA-DR Merger.

alexhughesBy: Alexandra Hughes, Spring 2016 Graduate Research Assistant

  1. Forum Access

Although the task force did not make any recommendations regarding forum access in FINRA arbitration proceedings, the task force did discuss the following issues:

  • Definition of “Customer”

A customer, according to FINRA Rule 12100(i), “shall not include a broker or a dealer.” Although this definition has been subject to criticism, the task force found reformulating the definition not necessary because the issue is being addressed by the courts.

  • Forum Selection Clauses
    • Federal appeals courts are currently split on whether a forum selection clause providing for litigation in federal courts can trump a customer’s right to chose arbitration pursuant to FINRA Rule 12200. Although providing no formal recommendation, the task force agreed that a forum section clause could not waive a retail customer’s right to arbitrate. However, the task force did not agree as to whether a sophisticated investor could negotiate around FINRA Rule 12200 or whether waiver of the right violated 29(a) of the Exchange Act.
  • Inclusion of Investment Advisers/ Firms in FINRA’s Forum
    • The task force considered whether FINRA’s authority should extend to investment advisers in additional to the already regulated member firms and associated persons. The task force did not make a recommendation because this issue is a highly charged political question and because the task force does not have experience regarding investment advisers. For an explanation of investment advisers and registered representatives, visit FINRA’s website.
  1. Unpaid Awards

Although an arbitrator may award an investor damages for a claim, that doesn’t necessarily guarantee the investor will receive payment. In order to help make sure claimants get their awards paid, FINRA imposes suspension or threatens suspension on active firms and associated persons. However, penalties don’t always seem to be enough. This is especially true when the firm or associated person is no longer in business. Currently, FINRA does the following to help investors: alerts the investor prior to filing the claim that the firm or associated person is not in business, prohibits the firm or associated person from enforcing written agreements mandating arbitration in a FINRA forum, and providing streamlined default proceedings.

Despite these measures, some investors still leave FINRA empty handed. In 2013, of 539 investor arbitration cases with awarded damages, 75 awards were not paid, leaving a total of $62.1 million damages missing in action for investors. Of those 75 awards, 51 awards were against firms or associated persons no longer registered in the securities industry. To help remedy these concerns, FINRA considered, in 2014, imposing an insurance requirement for the payment of awards. The task force discussed reconsideration of the insurance requirement, but reached no consensus.

  1. Frivolous Motions to Vacate

FINRA Rule 12904(j) provides: “all monetary awards shall be paid within 30 days of receipt unless a motion to vacate has been filed with a court of competent jurisdiction.” A motion to vacate allows the party responsible for paying the award to challenge the award in court. A court will grant a motion to vacate (or overturn) the award on limited grounds. For more information, visit FINRA’s website.

Although the task force heard concerns about securities firms filing excessive and baseless motions to vacate, the task force found no evidence of this misconduct. The task force only recommended that FINRA continue to monitor filed motions to vacate, especially those motions to vacate explained decisions.

  1. Requiring Arbitrators to Apply the Law

FINRA’s long standing position is that the FINRA forum is equitable and therefore arbitrators cannot be restricted by the written law in reaching arbitration decisions. However, the idea that arbitrators do not have to apply the law does not sit well with other organizations. The task force heard comments from the North American Securities Administrators Association (NASAA) that arbitrators should be required to base their arbitration awards on the strict application of applicable state and federal laws.

The task force could not reach consensus on whether arbitrators had to strictly apply the law and subsequently made no recommendation. The FINRA position still applies.

  1. Proposed FINRA-DR Merger

In October 2015, the Federal Register published a notice of filing of a proposed rule change to merge FINRA Dispute Resolution, Inc. into FINRA Regulation, Inc. In 1999, the FINRA dispute resolution program was moved into a separate entity in order to ensure its independence and credibility. The task force heard concerns that if the dispute resolution program once again became part of FINRA Regulation, Inc., its independence, as well as investor perception of the neutrality of FINRA’s forum, would be jeopardized. The task force did not make a recommendation on the proposed merger due to time concerns and an inability to fully analyze the issue and its implications. On December 22, 2015, the proposed merger was approved. FINRA believes that the merger will reduce administrative costs but will not impact the services and benefits the dispute resolution provides.

Again, this blog series is a summary of the FINRA Dispute Resolution Task Force report. It highlights the task force’s recommendations as well as those areas that received no recommendations, but are still of great importance to ensuring the transparency, impartiality, and efficiency of FINRA’s forum. The full report is available online.