1. Misalignment of Interests: While RIAs are held to a fiduciary standard by the Investment Advisers Act of 1940, this does not entirely eliminate the risk of self-interest affecting an RIA’s advice. For instance, RIAs might favor only those investment products from firms that are paying significant commissions to the RIA for selling that product. This means there is a significant potential conflict of interest causing an RIA to recommend the same small set of investment products to every potential client.
2. Limited Product Offering: Many RIAs have a limited range of investment products due to affiliations with certain investment companies. This could mean you may not have access to the full spectrum of investment options that might be more suitable for your retirement needs.
3. Lack of Transparency: Even though RIAs are required to disclose all material facts to their clients, the complexity of the investment products such as annuities and life insurance products may result in you not fully understanding certain investments, the adviser’s commission for selling a specific product, or the risks involved in an investment strategy recommended by the RIA.
4. Qualifications and Experience: RIA’s expertise and experience can vary significantly. While some have extensive experience and hold multiple qualifications, others might be newer to the industry and less experienced. A less qualified RIA might not provide the best advice or understand the intricacies of complex investment strategies. Further, it is important to check your adviser at brokercheck.org and investigate their history. There are plenty of RIAs who are and RIA because they are unable to be a stockbroker (yes, there is a huge difference.)
5. Costs: RIAs usually charge a fee based on a percentage of assets under management, which might be higher than what you’d pay if you managed your investments independently or did not invest in annuities or life insurance products. Additionally, some RIAs may have hidden costs or might charge additional fees for specific services on top of the percentage fees they charge.
6. Poor Communication: In some cases, you might find that your RIA does not communicate effectively or regularly. This could leave you feeling uninformed about your investment decisions and progress toward your retirement goals.
7. Inadequate Personalization: Some RIAs might use a one-size-fits-all approach to investment strategies, which could result in your retirement assets not being fully able to meet your specific goals, risk tolerance, and timeline to, or in, retirement.
8. Limited Accessibility: Depending on the RIA, you may face issues regarding the accessibility of your adviser. If they manage a large number of clients, they might not be available when you need them, impacting your ability to make timely decisions. This applies to the investment products that RIAs may recommend to you because the investment products often have significant penalties for early ‘surrender’ and withdrawals, or even have no option to gain access to your money.
9. Risk Management: Not all RIAs are skilled in managing risk effectively. A failure to appropriately assess and mitigate risk could potentially result in substantial losses for your retirement portfolio.
10. Lack of Oversight: While RIAs are regulated by either the Securities and Exchange Commission (SEC) or state regulators, this does not guarantee that your investments are safe. If the oversight body does not effectively regulate the RIA’s practices, your retirement assets could be at risk. Another oversight issue is that many RIA’s have no insurance to provide coverage to you for the RIA’s potential negligent or fraudulent handling of your account.

Despite these potential problems, it’s important to remember that many RIAs provide excellent service and can significantly contribute to the growth and protection of your retirement assets. The key is doing your due diligence in selecting an adviser. Check their qualifications, regulatory records, and references. Understand their fees, services offered and their investment philosophy. Good communication is essential, so ensure you feel comfortable discussing your needs and goals with them. Finally, always remember that it’s your retirement – stay informed and involved in the management of your assets.

Retirement planning can be a complex process, but knowing the potential pitfalls of entrusting your retirement assets to an RIA can help you make an informed decision that aligns with your retirement goals and financial situation.

More information on the first three of these tactics – the “phantom riches” tactic, the “social consensus” tactic, and the “credibility” tactic – and how investors can avoid them can be found in Part One of this two-part series.

Here, we will consider the remaining two most common investment fraud tactics identified by FINRA and the SEC: the “reciprocity” tactic and the “scarcity” tactic.

The Reciprocity Tactic

Under the reciprocity tactic, supposed investment professionals will lead investors to believe that if the investor participates in the investment opportunity at hand, they will receive an outsized benefit relative to what they put in, while the investment professional purports to take some sort of a hit. [1]

In the real world this tactic can look like a fraudster offering an investor half off on a given investment opportunity, along with a break on usual commission, so long as the investor buys in immediately. [1]

Like many common investment fraud tactics, the reciprocity tactic is yet another example of an investment opportunity that appears too good to be true. The supposed investment professional or stockbroker puts pressure on the investor by offering what looks to be a great deal in exchange for the investor’s immediate buy-in, depriving the investor the critical chance to investigate and confirm the credibility of either the professional or the investment opportunity.

The best way to avoid falling prey to such a scheme is for investors to understand that authentic investment opportunities will not be sold using coercive tactics such as this one. Investors should never make an investment decision before taking the opportunity to fully vet the professional offering the opportunity and the opportunity itself.

The Scarcity Tactic

Similarly, the scarcity tactic also unduly coerces investors into taking immediate action with their dollars so as to “take advantage” of a seemingly can’t-miss investment opportunity. In reality, when this tactic is offered, investors should only expect to lose money, not gain.

When fraudsters employ this tactic, they convince prospective investors that if they do not buy into the investment opportunity immediately or very soon, the remaining units will be taken up by other, competing, investors. [1]

Investors should be on the lookout for communications implying that there are only a small, finite, number of units left to invest in, and that these units are going fast. [1] Any implication that the investment is scarce should alert investors to exercise heightened due diligence in determining whether the investment opportunity is legitimate.

Unfortunately, tactics employed by investment fraudsters continue to improve and shift over time. Luckily, investors can be their own first line of defense. With the help of online resources to validate the licensing status of investment professionals and investment opportunities, along with an understanding of the most common tactics and red flags to be aware of, investors can avoid falling prey to investment fraud.

Source:

[1] https://www.finra.org/investors/protect-your-money/avoid-fraud

Per the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC), three of the most common investment fraud tactics employed by scammers in the United States are known as the “phantom riches” tactic, the “source credibility” tactic, and the “social consensus” tactic. [1]

Each tactic essentially functions by allowing the fraudster to build a false narrative surrounding their supposed investment opportunity, thereby garnering interest and ultimately investment dollars from unsuspecting investor victims.

The Phantom Riches Tactic

The “phantom riches” tactic involves enticing investors with the prospect of gaining an unattainable increase in wealth. [1] An example of this tactic in practice would be a fraudster telling a prospective investor “most of our investors are making $8-9,000 a month off this deal.” [2]

This tactic works by offering investors an opportunity they feel is simply too good to pass up. When fraudsters use the phantom riches tactic, they are lying about the investment opportunity so as to trick investors not into thinking the opportunity is too good to be true, but instead that the opportunity is too good to turn down.

Often, the fraudster also makes the alleged opportunity appear exceedingly easy for investors to become involved with. Prospective investors are led to believe not only that if they participate, their investment will earn them outstanding returns, but also that the investment opportunity requires almost no effort on the investor’s part.

In reality, the fraudster has fabricated the investment opportunity, and their promise of high returns will instead materialize as considerable losses to the investor.

The Source Credibility Tactic

When employing the source credibility tactic, fraudsters also engage in deceit, this time about their true identity and professional credentials. By communicating to the world that the fraudster is a graduate of a well-respected academic institution or has relevant professional experience and/or professional certifications and licenses, the fraudster places themselves in a respected societal position, albeit a patently fake one. [2]

Operating from this supposedly elevated social and professional tier, fraudsters have a much easier time convincing investors to fork over their money, and eventually lose it for good. While this tactic can be challenging to navigate, given the false impressions the fraudster is setting forth, there are many resources available online which prospective investors can use to confirm the identity and licenses actually earned by the purported professional.

The Social Consensus Tactic

Finally, the social consensus tactic involves stirring up investor interest in a scam by falsely stating that “everyone” or certain members of a group have already joined, and that those who have joined are making a great amount of money. [2] In reality, it is unlikely that many members of a group have joined the scheme – yet the mention of the community interest results in a greater sense of trust in the fraudster.

These tactics are just the first three of five main tactics that the SEC and FINRA warn investors to be aware of. Next week, this blog will cover the remaining two most common tactics used by investment fraudsters.

Remember that the first step in protecting assets is knowing the risks, like fraud, which they entail.

Sources: [1] https://www.finra.org/investors/protect-your-money/avoid-fraud [2] https://www.sec.gov/investor/seniors/outsmarting.pdf

Yet there is one investment risk – the risk of fraud – which at first glance seems uniquely difficult to mitigate. Fortunately, there are indeed several steps investors can take to protect their hard earned investment dollars from fraud.

In the United States, the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”) each offer investor resources for reducing the risk of investment fraud.

FINRA advises investors to follow three specific steps to avoid fraudulent schemes: staying informed about ongoing scams, thoroughly vetting the background of any investment opportunity or professional an investor chooses to engage with and keeping current with common tactics employed by fraudsters. [1]

Stay Informed With Investor Alerts

Importantly, both the SEC and FINRA issue periodic “investor alerts” which explain recent fraudulent investment schemes toward which investors should exercise caution. Investor alerts from the SEC can be found here, and investor alerts from FINRA can be found here. Vet the Investment Opportunity

investors should also thoroughly vet the background and credentials of any investment opportunity or professional they choose to engage with [1]

When it comes to vetting the background of investment professionals, FINRA first recommends directly asking whether the individual is licensed to sell the investment. [2] FINRA and the SEC also both offer online resources to help confirm whether the professional is indeed registered as required under law. [2]

These resources include repositories listing the financial professionals who are registered with federal and/or state agencies, as well as resources which indicate whether the individual has engaged in known fraudulent acts in the past. [2] Investors can also use these resources to determine whether the investment they are considering is registered with the SEC. A one-stop shop for each of these free resources can be found here. Keep Up to Date on Common Fraudulent Tactics

Finally, a third helpful strategy for keeping hard earned investment dollars safes is staying aware of common investment fraud schemes along with “red flags” that often signal fraudulent activity.

Investors should always keep in mind that if an investment opportunity seems “too good to be true,” then it likely is.

In particular, common red flags to be on the lookout for include mentions of guaranteed or overly consistent returns, particularly complex investment strategies, and “pushy” salespeople. [3] Often, fraudsters will employ high-pressure sales tactics to present supposed investment opportunities as exciting ways to make large sums of money with comparably little effort required from the investor. [3]

Investors should also keep in mind that many investments are inherently risky. If a supposed investment professional advertises a new investment opportunity with no risk at all, or if any other red flags arise, it is likely time to dig deeper into the specifics of the investment opportunity.

Exercising careful attention to both the supposed processional and the investment they are offering is often the best strategy to protect investments avoid falling victim to a fraudulent investment scheme.

Sources: [1] https://www.finra.org/investors/protect-your-money [2] https://www.finra.org/investors/protect-your-money/ask-and-check [3] https://www.finra.org/investors/protect-your-money/avoid-fraud/red-flags-fraud

The SEC’s complaint charged Justin Costello with violations of the anti-fraud provisions of several federal securities laws as a result of his role in this massive fraudulent scheme. [2]

While the SEC’s complaint alleges a broad web of fraudulent investment schemes, Costello mainly operated through deceit about his background, his qualifications, and the value of the companies he owned and operated. [2] Throughout the span of his fraudulent schemes, Costello was never registered with the SEC as a broker-dealer nor investment adviser. [2]

Costello’s success in bringing in clients largely rested on his fabricated credentials. Costello falsely stated to both the public in a press release and to the SEC in a Form 8-K filing that he graduated from the University of Minnesota and the Harvard Business School. In reality, Costello graduated from neither of these schools, but instead from Winona State University. [2]

Costello also alleged to prospective and existing clients that he was “the youngest hedge fund billionaire ever,” that he was a veteran of the United States Special Forces, and that he was licensed in money and investment management. [2] Each of these assertions was false yet helped to build Costello’s reputation and lure in unsuspecting clients. [2]

Once Costello secured advisory clients, he operated his fraudulent scheme by exercising complete and independent control over their brokerage account investments to invest only in securities of companies he owned.

In one case, Costello instructed a client never to log into their brokerage account while he managed it. While Costello managed all of the trades in the account, he advised the client that should the client’s brokerage firm ever reach out, the client should lie and state that the client had made the trades, not Costello [2]

Eventually, the client’s initial brokerage firm terminated its business with the client. Costello then convinced the client to allow him to manage another $1.27 million in a new brokerage account with a different brokerage firm, maintaining the same level of unfettered control. [2]

Costello’s independent control over the client’s brokerage accounts played directly into his fraudulent scheme. While he told the client that he would invest in a diversified portfolio of securities, Costello instead invested and traded only in microcap companies owned by him or in which he personally invested, presenting serious insider trading implications.

Costello began managing these brokerage accounts in 2019, and by 2022, the millions of dollars he was originally trusted to manage had dwindled downward by approximately 97% as a result of his fraudulent insider trading scheme. [1]

This is but one of several simultaneous fraudulent schemes Costello ran between 2019 and 2020. The SEC is seeking injunctions, disgorgement, civil penalties, and a prohibition against Costello ever serving as a broker dealer in the future. [2]

Protecting yourself from a fraudulent stockbroker may seem daunting, but the SEC’s Office of Investor Education and Advocacy publishes free resources on Investor.gov to help conduct reviews of a broker-dealer’s background before engaging in business.

Furthermore, if you think your stockbroker may have misrepresented their qualifications, license, or has engaged in fraudulent investment practices, the attorneys at Savage Villoch law can assist you – reach out for your consultation today.

Sources:

[1] https://www.sec.gov/news/press-release/2022-178

[2] https://www.sec.gov/litigation/complaints/2022/comp-pr2022-178.pdf

Per the SEC’s September 29, 2022 complaint, Bradley Goodbred, a registered investment adviser based in Illinois, misappropriated a total of $1,295,000 from a 97-year-old client between 2012 and 2021. [1] While the defendant, Goodbred, returned a portion of this money, his client still lost more than half a million dollars as a result of his fraudulent actions. [2]

According to the SEC’s complaint, Goodbred became the client’s investment adviser sometime before 2006, when the client and her husband were searching for a trusted, long-term financial adviser to help guide financial decisions in the event that the client’s husband passed away. [1]

After the client’s husband’s death in 2006, Goodbred became a “friend and confidant” to the client, who had no next-of-kin and who lived by herself. [1] By 2013, Goodbred had been appointed as the investment adviser for the client’s trust account and as power of attorney for purposes of the client’s health and property. [1]

As an adviser, and with a substantial amount of power over the client’s health and finances, Goodbred owed fiduciary duties to the client including the duty to act in her best interest and the duty to act towards her in good faith. [1]

The SEC alleges that Goodbred violated these duties when he misappropriated large sums of the client’s financial resources. Goodbred committed these fraudulent acts by soliciting the client to transfer more than $1 million from 2012 to 2021 to a business he owned. [1] Goodbred then purported to invest the client’s funds in real estate investment trusts (“REITs”) on the client’s behalf. [1]

In reality, Goodbred did not invest any of the client’s money in REITs on her behalf. [1] He instead used the money to cover personal and business expenses which bore no relation to the purported investments. [1] These expenses included income taxes, automobile loans, and credit card debt incurred by Goodbred and his wife. [1]

Today, the client suffers from dementia and is cared for by a court-appointed guardian. [1] Goodbred’s fraudulent scheme was only uncovered when the financial institution he worked for received a complaint suggesting that Goodbred was “exercising inappropriate discretion over the Client’s trust account,” for which an investigation was launched. [1]

The investigation resulted in Goodbred’s firing from the financial institution, and ultimately these charges by the SEC. [1]

Through its complaint, the SEC alleges 5 counts of federal securities fraud and seeks injunctions against Goodbred and appropriate civil penalties, ultimately to be determined via a jury trial. [1]

This case indicates the dangers posed by financial advisers who obtain undue power over their client’s financial resources and ultimately use it for their own betterment. Here, the client and her husband believed they had hired a trustworthy financial adviser to guide them as they both advanced in age. Instead, they became victims of more than $1 million in theft.

All investment advisers should be thoroughly vetted, and clients should do all they can to monitor the activity of their advisers, or otherwise appoint a neutral third party without direct power over the finances to assist in monitoring.

If you think you have been taken advantage of by your financial or investment adviser, the trusted attorneys at Savage Villoch law are ready to help. Reach out for your consultation today!

Sources:

[1] https://www.sec.gov/litigation/complaints/2022/comp25536.pdf

[2] https://www.sec.gov/litigation/litreleases/2022/lr25536.htm?utm_medium=email&utm_source=govdelivery

On September 20, 2022, the SEC fined financial services giant Morgan Stanley Smith Barney (“MSSB”) $35 million for failing to adequately protect its customer’s records and personal identifying information (“PII”). [1] The fine was entered via a settlement between the SEC and MSSB, through which MSSB has agreed to pay a civil penalty for the SEC’s charges without admitting to nor denying the violations. [2]

MSSB is a subsidiary of Morgan Stanley and focuses on wealth management services for clients ranging from individuals to large corporations. [3] More specifically, MSSB is the broker-dealer designation for the group more commonly known as Morgan Stanley Wealth Management. [3] During the second quarter of 2022, Morgan Stanley Wealth Management recorded $5.7 billion in net revenues. [4]

Through its order, the SEC alleged that MSSB engaged in two separate violations of federal securities laws. First, the order alleged that MSSB willfully violated the Safeguards Rule, a federal regulation which requires broker-dealers to adopt written policies and procedures regarding safeguards for the protection of customer data. [1]

Second, the order alleged MSSB’s willful violation of the Disposal Rule, a federal regulation requiring broker-dealers which possess consumer data to “take reasonable measures to protect against unauthorized access to, or use of, the information in connection with its disposal.” [1]

MSSB’s alleged violations occurred in connection with its effort in 2016 to decommission two data centers (the “2016 Data Center Decommissioning”). [1] To accomplish the decommissioning process, MSSB contracted with one approved vendor, referred to as “Moving Company,” to “pick-up, transport and decommission” devices from the MSSB data centers. [1] While Moving Company was one of MSSB’s approved vendors, MSSB never approved any sub-vendors for the decommissioning process. [1]

Despite this fact, Moving Company worked jointly over the course of the decommissioning process with two separate, unapproved sub-vendors – “IT Corp A” and “IT Corp B.” [1] Initially, Moving Company collected devices from the data centers and delivered them to IT Corp A. IT Corp A would either complete the required data-wiping processes and resell the devices, or destroy the devices altogether. [1] Inventories were kept, and MSSB received information about the wiped and destroyed devices from Moving Company. [1]

Not long after the decommissioning began, however, Moving Company ceased working with IT Corp A in favor of IT Corp B. Per the SEC’s findings, Moving Company sold the MSSB devices to IT Corp B under the guise that the devices had already been wiped of any MSSB data. In reality, the devices had not been wiped, yet IT Corp B gained possession of the devices and began selling them to downstream customers. [1]

MSSB became aware of this data breach when an IT consultant from Oklahoma emailed MSSB to inform them that it had purchased hard drives via an online auction, and that the hard drives contained accessible MSSB customer data. [1]

In all, the SEC’s order seeks to hold MSSB accountable for its failure to properly safeguard the sensitive data its customers entrust it with. Per the SEC’s findings, MSSB failed to adequately vet the data wiping and destruction processes of its approved vendor, Moving Company, and further failed to maintain its own internal policies and procedures to ensure customer data is disposed of properly. [1]

This situation serves as a cautionary tale. While MSSB contends that it has received no reports of customer data being misused as a result of this breach, the company still clearly has room for improvement in maintaining the security of its customer data. No matter the size of the broker, investors should be wary of the safety of their personal data.

Have concerns about a breach of your personal data? Reach out to one of the trusted attorneys at Savage-Villoch Law for a consultation.

Sources:

[1] https://www.sec.gov/litigation/admin/2022/34-95832.pdf

[2] https://www.sec.gov/news/press-release/2022-168

[3] https://www.morganstanley.com/content/dam/msdotcom/en/about-us-ir/shareholder/2q2022.pdf

The jury convicted Schena of three counts of securities fraud, two counts of payment of kickbacks, one count of conspiracy to pay kickbacks, two counts of health care fraud, and one count of conspiracy to commit health care fraud and conspiracy to commit wire fraud. [1] While he won’t be sentenced until early 2023, Schena faces a maximum of 20 years for each count of securities fraud alone. [1]

While this case draws quite a few parallels to the early-2022 trial and eventual conviction of Elizabeth Holmes, the founder of Theranos, it has thus far drawn far less media attention. [2] Still, Schena’s conviction provides another important glimpse into the dangers investors may face when dealing with alleged cutting edge or “revolutionary” technologies.

Schena was the president of Arrayit Corporation, a publicly traded company based in California’s Silicon Valley. [1] On the securities fraud counts, the evidence at trial convinced jurors of Schena’s elaborate scheme to defraud investors through false and misleading statements about the company’s operations and technology, along with failures to release Arrayit’s financial disclosures as required by the Securities and Exchange Commission (“SEC”). [1]

Arrayit purported to offer blood testing via a “revolutionary technology” that could use one drop of blood to test for a wide array of diseases. [1] Schena even dubbed himself the “father of microarray technology,” as part of his efforts to “lull” concerned investors into a sense of comfort even as they doubted the company’s legitimacy. [1]

Schena and his publicist further leveraged false press releases and tweets, purporting to evidence partnerships with governmental entities and large companies, as part of the scheme to build false investor confidence in Arrayit. [1] As some investors began expressing doubt in Arrayit’s technological capabilities, Schena continued to falsely represent that the company’s valuation sat above $4 billion. [1]

Separate and apart from Schena’s investment fraud scheme, the jury also concluded that Schena perpetrated a scheme involving illegal kickbacks and health care fraud. [1] These schemes involved allergy testing, which Arrayit would run on every single one of its patients irrespective of medical need. [1]

While Arrayit’s allergy tests were not even diagnostic tests to begin with, the company touted their accuracy in diagnosing allergies, and paid kickbacks to marketers in order to obtain additional blood samples to test. [1] Arrayit then billed Medicare and commercial insurers for these allergy tests at a rate higher than any other lab in the United States. [1]

Finally, in 2020 when the Covid-19 pandemic hit, Arrayit pivoted toward marketing its own Covid-19 test. [1] Despite the Food and Drug Administration’s refusal to conclude that Arrayit’s Covid-19 blood test was accurate enough to receive an Emergency Use Authorization, Schena continued to claim that Arrayit’s test surpassed PCR tests in accuracy. [1]

In all, Schena defrauded investors of more than $77 million through his various fraudulent schemes related to Arrayit. [1] This case is yet another illustration of the pitfalls investors can face when making investments in start-ups or other companies touting new and innovative technologies. Please reach out to a trusted attorney at Savage-Villoch if you have questions.

Source: [1] https://www.justice.gov/opa/pr/medical-technology-company-president-convicted-77-million-covid-19-and-allergy-testing-scheme [2] https://lawandcrime.com/covid-19-pandemic/federal-jury-convicts-tech-executive-in-first-of-its-kind-covid-19-testing-related-securities-fraud-he-even-lied-about-being-a-nobel-prize-candidate/

The Investor Alert, released by the SEC’s Office of Investor Education and Advocacy, highlights the unique dangers investors face when evaluating investment prospects and making investment decisions via social media platforms or over the internet. In particular, the alert warns investors that investment information portrayed on social media may be “inaccurate, incomplete, or misleading.” [1]

Furthermore, the alert cautions that the broad-reaching and low-cost nature of social media can create “false impression of consensus or legitimacy” of investment prospects, creating the illusion that far more people are making the investment than truly are. [1]

More specifically, the Investment Alert sheds light on several common schemes used by fraudsters to target and take advantage of unsuspecting investors online. These schemes include impersonation schemes, “crypto” investment scams, and romance scams. [1]

Impersonation schemes are often, and easily, perpetrated over social media because social media platforms allow fraudsters to create false or misleading profiles. [1] For example, a fraudster might create a social media account impersonating a legitimate broker or investment adviser. [1] The fraudster can then use their false identity to convince investors to make investment decisions which enrich the fraudster at the investor’s expense.

As a result, social media users should be wary of investment opportunities communicated solely over social media platforms. Investors are urged to look out for typos within a supposed broker or adviser’s profile page or messages, as well as by considering whether or not the social media platform has “verified” the user as person they claim to be. [1]

Crypto investment scams are also on the rise, given the continued popularity of cryptocurrencies and their relative novelty. These scams often sound “too good to be true” and may take the form of a Ponzi or pyramid scheme involving crypto or the blockchain, promising low or no risk with high investment returns. [1] If an investor chooses to invest in cryptocurrency, the credentials of the investment opportunity can be investigated by using the search tool provided by the investor.gov website. [1]

Finally, online romance scams have also become increasingly prevalent in recent years. This type of scheme typically starts with a fake dating app or social media profile, which reaches out to a victim to begin the trust-building process. Once a relationship of trust has been created, the fraudster behind the fake profile will begin to inform the victim about supposedly lucrative cryptocurrency or other investment opportunities. [1]

Because trust has been built over time, victims may be more likely to believe the fraudster and funnel their hard earned money into one of these fraudulent investment scams.

Along with providing background information on each of the fraudulent schemes discussed here, the SEC’s Investment Alert provide additional information on market manipulation schemes and community-based investment fraud schemes. [1]

The overarching takeaway from this Investor Alert is clear: fraudsters are increasingly using social media and other online platforms to take advantage of unsuspecting investors, and their schemes are only becoming more creative.

Investors should remember that online platforms allow fraudsters to easily fabricate and disperse misleading investment information to the masses. Often, the best way to protect an investment is through careful research into any investment opportunity. Per the Investor Alert, a heavy dose of skepticism when an opportunity sounds “too good to be true” goes a long way.

If you have a question or concern about an existing investment or investment opportunity, reach out to the attorneys at Savage-Villoch law.

Sources: [1] https://www.sec.gov/oiea/investor-alerts-and-bulletins/social-media-and-investment-fraud-investor-alert

The eleven defendants include Forsage’s four founders as well as several “promoters” of the Forsage scheme. [2] The SEC’s complaint notes that to date, more than $300 million worth of transactions have occurred via Forsage smart contracts, despite the fact that the retail investors powering this scheme have received no good or service of value in return for their “investments.” [2]

Forsage is a classic pyramid scheme in that those at the top – namely the founders and promoters charged by the SEC – stood to gain the most wealth, especially as others joined the scheme after them. In fact, a recent scholarly report on the scheme found that more than 88% of Forsage users incurred net losses on their investments with the platform, with those at the top generating massive gains. [3]

While Forsage was promoted as an “income-generating opportunity” with impressive returns, the SEC alleges that the founders and promoters were well aware that their monetary gains were far higher than, and would be unattainable to, the retail investors they recruited. [2]

The Forsage scheme functioned exactly like a pyramid and Ponzi scheme, as wealth was almost exclusively generated through recruitment of additional “investors.” When an investor joined Forsage, the first step was to create a crypto-asset wallet, which was assigned a sequential Forsage ID. [2] The higher the Forsage ID, the later the investor had joined the scheme, and in turn, the lower returns an investor could actually expect to generate. [2]

Once an investor created their crypto-asset wallet, they could begin purchasing “slots” within Forsage’s smart contracts. [2] The purchase of a slot did not allocate any good or service of value to the investor. Instead, each slot purchased broadened the investor’s compensation earned from both new Forsage recruits and from existing members of the Forsage community. [2]

Upon purchasing a slot, the algorithm-based Forsage smart contracts would automatically direct crypto funds to the investor’s crypto-asset wallet whenever the investor recruited additional investors to join the scheme. [2] The smart contracts also automatically directed shares of funds from the broader Forsage community as a form of profit-sharing. [2]

A Forsage investor could not join the scheme without sending currency, in the form of Ether, over the platform. [3] In line with the structure of the Forsage smart contract code, currency sent by a new investor was automatically sent first to existing investors with lower Forsage IDs, thereby allowing those who had joined earliest to obtain the highest returns. [3]

The SEC’s complaint categorizes the slots within Forsage’s smart contracts as investment contracts which constituted securities. [2] These securities were not registered with the SEC. [2] As a result, the SEC alleges several violations of federal securities law, concluding that the founders and promoters were engaged in the unauthorized offer or sale of securities. [2]

This type of scheme is especially dangerous to unwitting investors because of the relative novelty of the cryptocurrency sector, along with the inability of law enforcement authorities to intervene and halt a scheme which is hosted over the decentralized blockchain. [4]

Additionally, hosting a scheme like this one over the blockchain affords the organizers the luxury of anonymity, something that would not be possible for organizers of a traditional pyramid or Ponzi scheme. [4]

Investors are urged to carefully evaluate their investment prospects to avoid falling prey to a cryptocurrency pyramid or Ponzi scheme like Forsage. While tales of high returns can be tempting, these schemes are specifically designed to trick investors into believing they will see returns that they won’t, while instead buffering the wallets of those who “invested” before them.

If you have questions or concerns about a potential cryptocurrency pyramid or Ponzi scheme, please reach out to the trusted attorneys at Savage Villoch law.

Sources: [1] https://www.sec.gov/news/press-release/2022-134 [2] https://www.sec.gov/litigation/complaints/2022/comp-pr2022-134.pdf [3] https://arxiv.org/pdf/2105.04380.pdf [4] https://www.coindesk.com/layer2/2022/08/08/how-to-stop-forsage-meta-force-and-other-smart-contract-pyramid-schemes/

The ruling by Judge Cecilia Altonaga of the U.S. District Court for the Southern District of Florida denied Robinhood’s motion to dismiss shareholder allegations of market manipulation. The allegations stem from Robinhood’s actions in the wake of the meme stock frenzy of early 2021. [1] In the lawsuit, Robinhood shareholders allege that Robinhood engaged in tactics aimed at artificially lowering the prices of nine stocks at the center of the frenzy. These stocks included GameStop, Bed Bath & Beyond, and AMC. [1]

The meme stock frenzy took place in January 2021 when social media users stirred extraordinary investment interest in several unexpected stocks. The outpour of interest in these stocks was not founded on each stock’s actual performance, but rather on the prospect of triggering a short squeeze on the stocks.

Retail investors organized via social media to begin buying these stocks in droves, thus sending their prices skyward. As stock prices skyrocketed, the meme stock investors reasoned that hedge funds who had shorted the stocks stood to lose vast sums of money.

The meme stock investors were, in many cases, correct. One hedge fund, Melvin Capital Management, lost more than $1 billion per day during the height of the January 2021 frenzy as a result of its bets against stocks like Gamestop. [2]

While the meme stock frenzy posed clear challenges for hedge funds like Melvin, it also posed a thorny problem for Robinhood – that of maintaining required cash reserves as meme stock prices rose.

Robinhood’s online securities trading platform was one of the major vehicles through which retail investors purchased these so-called meme stocks. Further, as a securities broker, Robinhood is required by the National Securities Clearing Corporation to maintain a certain amount of cash available to clearinghouses. [1] During the height of the frenzy, Robinhood’s clearinghouse cash requirement rose to over $3 billion, an obligation which Robinhood struggled to meet. [1]

Thus, in an effort to meet its clearinghouse cash requirement, Robinhood temporarily froze its user’s ability to buy certain stocks, while placing limits on the number of shares users could purchase of other stocks. [1] Robinhood users allege that these actions and others, including cancellation of purchase orders and liquidation of some customers’ shares, amounted to market manipulation by Robinhood, as well as a violation of federal securities laws. [1]

While Robinhood continues to “vigorously defend” itself from these allegations, maintaining that their actions were “appropriate and necessary to protect and support [their] customers,” Judge Altonaga noted in her August 11 ruling that the case presents “interesting legal questions” which are only complicated by the infancy of the app-based securities trading industry. [3]

As a result, the eventual decision on the merits of this case will likely be foundational to the future of online securities trading regulation in the United States. As the case develops, important updates here can be found here on the Savage Villoch Securities Fraud Lawyers Blog.

Sources:

[1] https://www.reuters.com/markets/us/robinhood-must-face-us-market-manipulation-claims-over-meme-stock-rally-judge-2022-08-11/

[2] https://www.wsj.com/articles/melvin-plotkin-gamestop-losses-memestock-11643381321

[3] https://www.forbes.com/sites/dereksaul/2022/08/11/class-action-suit-moves-forward-against-robinhood-over-halting-meme-stock-trading/?sh=5ed1ded564b3

Before sharing his view of the SEC’s role in crypto markets, Chairman Gensler first compared the technology to that of the dotcom bubble in 2000 and subprime lenders leading up to the 2008 financial crisis. His message: the flurry of attention on crypto and related innovations does little to vouch for its long-term viability or success. Instead, as was borne out in 2000 and again in 2008, cryptocurrency could indeed be a technology destined for failure.

The SEC’s role then, in Gensler’s view, is to protect investors from the potential financial blowback of such a failure. While Gensler lauded the spirit of entrepreneurship common in the United States, he also argued that the SEC should approach crypto regulation in a “technology neutral” way. In so doing, the SEC could carry out their mission to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets, while still allowing crypto markets to flourish.

Gensler chose to focus on three discrete areas in which the SEC might appropriately step in with a regulatory scheme: crypto trading and lending platforms, stablecoins, and crypto tokens.

First, on the topic of crypto trading and lending platforms, Gensler noted the importance of these platforms being registered, thus allowing regulation in a similar manner to regulation of traditional securities exchanges. Gensler argued that in light of the functional similarities between “traditional regulated exchanges” and crypto platforms, investors on crypto platforms deserve similar regulatory protections. Such investor protections, Gensler noted, in turn promote investor confidence, which allows markets to work.

According to Gensler, stablecoins, which can be likened to bank deposits or money market funds, pose their own differing set of potential policy considerations. Stablecoins are rarely used in commerce, are not a legal tender, and are not issued by any central government.

As a result, stablecoins may impact monetary policy and financial stability within larger markets, may facilitate illicit activity, and may put U.S. investors at risk of losses created by unique conflicts of interest. Such conflicts arise because many of the platforms on which stablecoins are traded also physically own the stablecoins they trade.

Finally, Gensler approached the topic of the SEC’s regulation of all other crypto tokens. Most notably, Gensler stated that most crypto tokens are “securities” or “investment contracts” under U.S. law, thus necessitating registration by the SEC pursuant to existing federal securities laws.

The U.S. Supreme Court has held that an investment contract, or security, exists “when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Gensler noted that many crypto tokens are being sold by entrepreneurs who are looking to raise money from the public. This use-case places crypto tokens squarely within the definition of security or investment contract, and thus, submits crypto tokens to federal oversight. Regulation of crypto markets in this way safeguards not only crypto investors, but also the broader stability of the economy.

While Gensler emphasized that the views in his speech were his own and not representative of the SEC, his perspective will likely impact the SEC as it moves forward with enforcement policy. In the interim, Savage Villoch attorneys are available to consult on your cryptocurrency investment questions or concerns!

Sources: [1] https://www.investopedia.com/tech/question-why-should-anyone-invest-crypto/#:~:text=Another%20common%20reason%20to%20invest,dilute%20their%20value%20through%20inflation.

[2] https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422

“Boiler room” operations are fraudulent schemes in which high-pressure, coercive sales tactics are used to induce clients into purchasing stocks or other investments. [3] Often, these operations consist of groups of salespeople working from offices in foreign countries who cold-call clients in an attempt to defraud them. [3] The salespeople involved in boiler room schemes are rarely licensed brokers, and the stocks they purport to sell may not exist at all. [3]

In the instant case, the DOJ alleges that the defendants conspired to commit securities fraud when they engaged in a boiler room scheme involving fake investment firms and shell companies used to mislead investors. [1] The alleged scheme operated from approximately June 2019 until August 2021, and defrauded English-speaking investors across the globe of more than $8 million. [4]

The defendants falsely held themselves out to prospective investors as employees of well-regarded investment firms, going so far as to fabricate websites and email accounts that appeared to be associated with these actual firms. [4]

Furthermore, the DOJ alleges that the defendants engaged in classic boiler room scheme telemarketing tactics to convince clients to wire large sums of money from their bank accounts to the defendants, under the false impression that they were purchasing securities. [4] Yet the defendants never invested the money, nor did they return the money to the victims. [4]

After stealing more than $8.4 million through this scheme, the DOJ alleges that the defendants went on to launder over $4.6 million of the stolen money, once again sending it overseas. [4] The proceeds were then split amongst the scheme’s conspirators. [4]

The SEC’s parallel civil action sheds additional light on the details of this boiler room scheme. According to the SEC”s February 9, 2022, complaint, the scheme primarily targeted retirement-age and elderly victims, whom the defendants convinced to purchase fake securities traded on U.S. exchanges. [ 2]

The complaint notes that Defendant Robert Leonard Booth operated boiler rooms with offices in both Thailand and Panama from 2019 until 2020. [2] Booth was not registered with the SEC in any capacity and worked in connection with other defendants who owned the various shell companies which victims were instructed to wire their payments. [2]

The group of fraudsters charged in this case stole the hard-earned savings of more than 140 unsuspecting victims. [2] As noted in the SEC”s complaint, this schemes particularly targeted elderly victims, highlighting the insidious nature of boiler room schemes within this particular vulnerable population. Of course, the hard-selling tactics employed by boiler room investment fraudsters could well mislead any prospective investor.

You can protect yourself from boiler room fraud by staying alert for a few key red flags commonly employed by these fraudsters. Some such red flags include offers for outrageously lucrative yet low-risk investment opportunities, a reluctance to divulge detailed information about the investment firm the salesperson works for, and references to secret or insider information. [5]

Additionally, investors are cautioned not to make immediate investment decisions over the phone or by email. Instead, it is important to carefully consider any potential investment opportunities by pausing and conducting research on the credibility of the firm and investment opportunity. [5] A simple way to check a stock salesperson who calls is to put their name into www.brokercheck.com and see what pops up.

If you think you have been impacted by a boiler room scheme or another fraudulent investment scheme, a trusted attorney at Savage Villoch law is ready to assist you in navigating your situation.

Sources: [1] https://www.justice.gov/usao-sdny/pr/five-defendants-charged-84-million-boiler-room-fraud-and-money-laundering-scheme [2] https://www.sec.gov/litigation/complaints/2022/comp25326.pdf [3] https://www.investopedia.com/ask/answers/what-is-a-boiler-room-operation/ [4] https://www.justice.gov/usao-sdny/press-release/file/1470416/download [5] https://www.forbes.com/sites/bartastor/2017/09/09/cracking-down-on-boiler-room-fraud-self-defense-tactics-to-fight-off-the-crooks/?sh=160a10e527ec

Members of Congress are inherently privy to more information about in-process legislation, forthcoming policy shifts, and potential economic impacts than the average market participant. [1] Such “insider” knowledge is a direct result of the duties entailed in a lawmaker’s job, and some argue this insider position presents an unmistakable conflict of interest. [1]

Congress previously sought to address this conflict of interest with its passage of the Stop Trading On Congressional Knowledge (“STOCK”) in April 2012. [2] At its most distilled, the STOCK Act explicitly made congressional insider trading illegal, and put in place disclosure requirements for each individual stock trade made by a member of Congress. [2] Prior to the passage of this law, insider trading – that is, trading by members of Congress based on material, nonpublic information – had been perfectly legal. [2]

Unfortunately, the STOCK Act has not seemed to adequately deter insider trading by members of Congress as planned. [1] Namely, noncompliance by Congress members with STOCK Act trading disclosure requirements is rampant. In 2021 alone, 54 members of Congress violated the STOCK Act by failing to meet the stipulated requirements for disclosing financial information about individual stocks they traded. [3]

This noncompliance may well be driven by the insignificant penalty imposed on offenders – typically a simple $200 fine. However, it is also worth noting that no prosecutor has ever brought charges stemming from the STOCK Act. This likely stems from the difficulty involved in adequately proving that a member of Congress’ trade was in truthy made as a result of particular insider information they possessed. [1]

So, how can the issue of congressional insider trading be remedied? One bipartisan coalition of congress members is actively proposing bills to limit the potential for unlawful insider trading within Congress. [1] One such bill aims to require members of Congress to place their individual stocks in a trust fully operated by another person, while a second bill aims higher by proposing an outright ban on members of Congress trading individual stocks. [1]

While bipartisan support does exist for these potential steps forward, there are also plenty of dissenters on both side of the aisle. Democratic leader Nancy Pelosi has voiced her distaste for new legislation proposing additional limits on stock trades by Congress members, arguing that members of Congress “should be able to participate in” the free market economy of the United State’s just as other citizens may. [1]

To the contrary, critics of the current state of congressional stock trading note that members of Congress are in a vastly more informed, and thus advantageous, position when compared with the average U.S. citizen. Others argue that Congress members are elected to their positions, and run for election by their own free will. Should they wish to freely make trades on the market, they are free to solicit employment within the private sector instead. [1]

Research shows that Congress member’s insider knowledge has resulted in “higher than average returns on their stock investments.” With this information becoming public knowledge, lawmakers are likely considering the importance of public perception and trust amongst their electorate. [1]

While the future of new legislation in this space remains unclear, main street investors can be encouraged that the conversation surrounding this ethically-questionable congressional stock trading is gaining attention once again.

Sources:

[1] https://nyti.ms/3KV33oQ

[2] https://www.investopedia.com/terms/s/stop-trading-on-congressional-knowledge-act.asp

[3] https://www.businessinsider.com/congress-stock-act-violations-senate-house-tradin

Under existing federal law, private firms with less than 2,000 shareholders are not required to register with the SEC nor provide routine disclosures, unlike their public counterparts. [1]

While exemption from such regulatory requirements may provide private startup companies with the freedom to develop their business unimpeded by government, thus encouraging valuable innovation, the rapid growth of the private capital market has experts questioning whether some degree of SEC oversight may be warranted.

In fact, during her remarks at the “SEC Speaks in 2021” event held in October 2021, SEC Commissioner Allison Herren Lee signaled that the regulatory body is in the beginning stages of evaluating whether they may indeed have an obligation to consider “address[ing] the reduced transparency in U.S. equity markets” brought on by private market growth. [2]

So, what exactly does recent growth in the private market look like? To start, over two thirds of the capital currently being raised is being raised privately, in essence dwarfing that which is raised publicly. [3] What’s more, the number of “unicorns,” or private companies with valuations of more than $1 billion dollars, has skyrocketed from just 40 in 2013 to over 900 today. [1],[4]

But why does this explosive growth matter to the SEC, or even to the average investor?

According to Commissioner Allison Herren Lee, the shift of capital from public to private markets is akin to a large swath of the market, and thus the economy, “going dark.” [2] As private companies continue to raise billions of dollars from investors without any true pressure to go public, the rest of the world, and even the company’s investors themselves, remain largely in the dark about the company’s true operations and financial position. [2]

This lack of transparency poses risks not only to wealthy individual investors and employees who hold equity in the private firms for which they work. There are also risks to those whose retirement assets are invested indirectly in private markets through institutional investors. [2]

Furthermore, the sheer size of the private market and its continued growth poses other systemic issues, including the possibility of obscuring climate change or other Environmental, Social, and Governance (ESG) risks that these companies face or perpetuate. [2]

The Theranos saga is illustrative of some of the myriad risks posed by unicorn companies in the absence of regulatory requirements from the SEC. Theranos was a company which purported to have produced a “portable blood analyzer” which would “revolutionize the blood testing industry,” though in actuality the product did not function as was represented. [5]

Ultimately, Theranos and its management were charged by the SEC for making false statements about their business and technology in violation of the anti-fraud provisions of federal securities laws. [5] Theranos had raised more than $700 million from private investors and venture capitalists, and while its value topped $10 billion in 2015, it was completely liquidated, and worthless, by 2018. [6]

The lesson here is evident – as capital continues to shift from public to private markets, investors are at greater risk of falling prey to a fraudulent scheme like that of Theranos, and the broader economy may well feel the aftershocks. When private startups raise large sums of money in the absence of mandated SEC disclosures, their value may well be inflated, and investors may not find out until their money is already lost.

While the SEC is still in the early stages of considering new reporting requirements for large private firms, this is a key area for investors to keep their eyes on in the coming months.

Sources: [1] https://www.wsj.com/articles/sec-pushes-for-more-transparency-from-private-companies-11641752489 [2] https://www.sec.gov/news/speech/lee-sec-speaks-2021-10-12#_ftnref20 [3] https://www.forbes.com/sites/anatalonbeck/2021/10/15/going-dark-the-explosive-growth-of-private-markets-and-other-thoughts-on-sec-commissioner-lees-remarks/?sh=63ed2b9d21c0 [4] https://www.cbinsights.com/research-unicorn-companies [5] https://www.sec.gov/news/press-release/2018-41 [6] https://www.investopedia.com/articles/investing/020116/theranos-fallen-unicorn.asp#:~:text=the%20same%20day.-,Theranos%20Inc.%2C%20a%20consumer%20healthcare%20technology%20startup%2C%20was%20once,venture%20capitalists%20and%20private%20investors.

In total, the number of new enforcement actions filed by the SEC in FY 2021 increased by 7% over the previous year, with 434 new enforcement actions. While the total number of enforcement actions – including new actions along with other “follow-on” or open proceedings – decreased slightly year over year in FY 2021, the SEC remained committed to its role as “cop on the beat for America’s securities laws,” as described by Chair Gary Gensler. [1] The SEC maintained a sharp focus on protecting the integrity of the country’s capital markets through enforcement actions against bad actors even in the face of the persisting COVID-19 pandemic persisted.

In announcing its progress on enforcement actions during FY 2021, the SEC concentrated on several key priority areas. Some of these priority areas, per a recent SEC Press Release, included “holding individuals accountable,” “ensuring gatekeepers live up to their obligations,” “rooting out misconduct in crypto,” “policing financial fraud and issuer disclosure,” “cracking down on insider trading and market manipulation,” and “swiftly acting to protect investors.” [1]

While focusing on “holding individuals accountable,” the SEC noted that during FY 2021, it successfully lodged charges against top-level executives of corporate powerhouses. including CEOs at both Wells Fargo and Nikola, an alternative-fuel trucking company. [1]

In “ensuring gatekeepers live up to their obligations,” the SEC focused its attention on auditors and attorneys from various backgrounds who had behaved improperly, unprofessionally, or failed in their duties when auditing other companies. [1]

The SEC was able to further its “rooting out misconduct in crypto,” objective by carefully studying misconduct within the emerging cryptocurrency market, and subsequently charging both entities and individuals who fraudulently offered digital asset securities, such as bitcoin, thereby defrauding investors. [1] These actions garnered particular concern, given the largely unregulated state of the cryptocurrency space.

Beyond cryptocurrency concerns, the SEC also proved its focus on “policing financial fraud and issuer disclosure,” by continuing to diligently trace potentially fraudulent activities within the market. In doing so, the SEC uncovered possible violations of securities laws, and also investigated disclosures made by public companies which improperly failed to note potential COVID-19 pandemic impacts on their businesses. [1]

During FY 2021 the SEC also had its eyes on “cracking down on insider trading and market manipulation” by pursuing charges for insider trading relating to a biopharmaceutical company acquired by COVID-19 vaccine manufacturer Pfizer, Inc., as well as an insider trading ring connected to confidential data regarding Netflix’s subscriber growth over time. [1]

In pursing its myriad enforcement actions, the SEC also focused on “swiftly acting to protect investors” throughout FY 2021. Many cases involved the SEC filing emergency actions or restraining orders against defendants in Ponzi schemes, as well as suspending trading of more than 20 “meme stocks,” as concerns about market volatility reached a head in early 2021. [1]

In all, the SEC’s FY 2021 enforcement actions resulted in obtaining “judgments and orders for nearly $2.4 billion in disgorgement and more than $1.4 billion in penalties.” [1] Furthermore, FY 2021 was the highest year ever for whistleblower awards, as the whistleblower program awarded $564 million to just over 100 whistleblowers, and surpassed $1 billion in lifetime awards paid out. [1]

As the world rebuilds and adapts to life in the midst of a global pandemic, the SEC looks poised to continue its work in closely monitoring and enforcing federal securities laws through enforcement actions, with the ultimate aim of protecting not only capital markets, but also investors of all backgrounds.

Sources: [1] https://www.sec.gov/news/press-release/2021-238

At the heart of the decision to pivot in this manner has been a focus on steadily rising inflation, which some policymakers fear the pandemic’s longevity will only amplify. [1] This fear stems from the fact that in large part, populations are learning to coexist with the virus.

As time passes and each new wave appears, is studied, and spreads toward dominance, people become generally better equipped to deal with the pandemic’s impacts – economic and otherwise. Whether because of rising vaccination rates or better overall caution and awareness, many now agree that the largest current threat to the economy is inflation rather than COVID-19. [1]

This is, of course, not to say that COVID-19 doesn’t continue to significantly impact the global economy, as it has since it was first discovered about two years ago. When news of the most recent Omicron strain was released near Thanksgiving, stocks and energy prices took a significant dive, with the Dow Jones Industrial Average falling 2.5% for its steepest one-day percentage downturn in over a year. [2] In the several weeks following Omicron’s emergence, however, the stock market has largely rebounded.

Given the many remaining questions surrounding Omicron, including existing vaccines’ ability to effectively protect against the strain, as well as the severity of infection, further economic impacts may certainly come to fruition. As details continue to fill in, however, it is a fitting time to carefully consider some of the myriad market impacts already ushered in by the COVID-19 pandemic.

One of these market impacts has been the meteoric rise in retail investing, fueled by app-based securities trading platforms like Robinhood and Stash, aimed for use by the average main street investor. These platforms empower retail investors to participate in the stock market by facilitating trades on fractions of shares, all from the convenience of a smart phone. The use of these apps also facilitated the “meme stock” frenzy, wherein retail investors gathered over social media and stoked intense interest in stocks like GameStop and AMC – sending their share prices flying.

While these app-based platforms have empowered more investors than ever to enter the market, they’ve also posed potential financial pitfalls along the way. One such pitfall involves margin investing, wherein investors may supercharge their potential gains in the market by investing not only their own money, but also money they’ve borrowed. While the rewards of margin investing may be great, the risks are potentially even greater. [3]

Specifically, investor’s trading with margin are subjected to a minimum balance in their accounts. If their balance falls below this minimum – as can very well happen during a sudden market downturn or sell-off like the one effectuated by the news of Omicron in late November – the investor may be subjected to a margin call. When a margin call is issued, the investor is required to deposit additional money into their account in order to meet their required minimum balance.

Furthermore, many equate excessive levels of margin investing with “euphoric” behavior in the market – which can often be a sign of a serious impending market downturn. [3] As of now, the market does not appear to have reached dangerous levels of such market euphoria. [3] But as inflation continues to rise and COVID-19 continues to impact our lives in new ways, investors should exercise caution, as always, when making decisions about margin investing.

Sources:

[1] https://www.wsj.com/articles/central-banks-worry-omicron-could-sustain-inflation-11639909805

[2] https://www.wsj.com/articles/global-stock-markets-dow-update-11-26-2021-11637901748?mod=article_inline

[3] https://www.wsj.com/articles/black-friday-rout-shows-dangers-of-margin-borrowing-11638100800

According to the alert provided by the SEC’s Office of Investor Education and Advocacy (“OIEA”), the SEC has received reports of several individuals receiving communications from people posing as SEC personnel. Whether these communications come in the form of emails, phone calls, or letters, the SEC warns investors that they are “in no way connected to the SEC.” [1]

The fraudulent phone and voicemail messages are particularly misleading because they come from phone numbers that appear to be connected to the SEC. [1] The communications have targeted victims by raising investment-related concerns, such as “suspicious activity” in both checking and cryptocurrency accounts.[1]

In raising these false concerns, the fraudulent callers solicit personal information as well as payments for alleged SEC enforcement actions. In some cases, the fraudsters may even impersonate a particular SEC employee in an effort to gain trust from their victims. As such, the OIEA urges investors to independently verify the identity of anyone claiming to be an SEC or other government employee. [1]

The alert also offers several ways to verify whether a communication is actually coming from an SEC employee. First, you can check with the SEC’s personnel locator in order to get in direct contact with the staff member who purportedly reached out from the SEC. The phone number is (202) 551-6000, which can be used to speak directly with SEC staff members to confirm whether they contacted you. [1]

In addition, concerned investors can also call (800) SEC-0330 or email help@SEC.gov to verify whether a communication truly came from the SEC. It is critically important to verify using one of these methods before providing personal information or any form of payment in response to an unsolicited communication claiming to come from the SEC. [1]

In responding to this impersonation scheme, the SEC also unequivocally noted that its employees do not make unsolicited contact with members of the public and do not solicit payments or seek personal information outside the bounds of formal enforcement actions. Furthermore, the SEC asks that anyone who receives a communication falsely appearing to be from the SEC submit a complaint to the SEC’s Office of Inspector General. [1]

Beyond this particular fraudulent scheme, the SEC has released several similar investor alerts in recent years. In general, impersonations of SEC and other government staff target victims who may trust the communication due to the seemingly serious nature of the communications and the illusion that the communications have come from trustworthy government actors.

In 2018, the SEC discovered instances of social media accounts impersonating the SEC and urged investors to independently verify that any social media account they engaged with and which purported to be connected to the SEC was in fact SEC-affiliated.[2] The SEC also reminded investors that per their policies, no SEC official would discuss nor endorse specific investments over social media. [2]

In our increasingly connected world, investors are encouraged to remain vigilant and skeptical of unsolicited communications asking for personal or financial information. And as always, please reach out to your trusted advisor or attorney at Savage Villoch Law with any questions or concerns.

Sources: [1] https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/beware-0 [2] https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/investor-11

In fact, the SEC has recently begun sanctioning the very victims of cyberattacks – investment firms that have fallen prey to such attacks – citing their deficient cybersecurity procedures as partly to blame for the unauthorized third-party access to investor’s private information. [1]

On August 30, 2021, the SEC released three orders sanctioning eight firms for their failures in protecting their customers’ personally identifiable information due to inadequate cybersecurity policies and procedures. These orders each proceeded as violations of Rule 30(a) of Regulation S-P, colloquially known as the “Safeguards Rule.” [2]

The Safeguards Rule requires that any broker-dealer or investment adviser registered with the SEC adopts “written policies and procedures reasonably designed to:

(1) insure the security and confidentiality of customer records and information;

(2) protect against any anticipated threats or hazards to the security or integrity of customer records and information; and

(3) protect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to any customer.” [3]

In response to the orders, each firm settled with the SEC without admitting to nor denying the charges, paying a sum total of $750,000 in penalties. [2]

The first order was lodged against Cetera Advisor Networks LLC, Cetera Investment Services LLC, Cetera Financial Specialists LLC, Cetera Advisors LLC, and Cetera Investment Advisers, LLC (collectively “Cetera Entities”) for failing to adequately leverage the myriad tools they had available to mitigate cybersecurity risks, resulting in a violation of the Safeguards Rule. [3]

From November 2017 to June 2020, unauthorized third parties gained access to the emails of over 60 Cetera Entities personnel, exposing more than 4,000 Cetera Entities customers’ personally identifiable information. The SEC alleged that while Cetera had the ability to implement multi-factor authentication (“MFA”) on email accounts, none of the compromised emails had enabled that security feature. [3]

As a result, the SEC concluded that Cetera Entities violated the Safeguards Rule because their “policies and procedures to protect customer information and to prevent and respond to cybersecurity incidents were not reasonably designed” to adequately protect their customers’ PII. [3]

The second order alleged that Cambridge Investment Research, Inc., and Cambridge Investment Research Advisors, Inc., willfully violated the Safeguards Act in a similar manner by failing to activate MFA on the cloud-based email accounts of their registered representatives. [4] As a result of this failure, more than 121 Cambridge representatives’ cloud-based email accounts were breached by third parties, exposing the personally identifiable information of more than 2,000 Cambridge customers. [4]

Finally, the SEC’s third order alleging a violation of the Safeguards Rule was entered against KMS Financial Services, Inc., again for failing to properly safeguard the cloud-based email accounts of the company’s registered financial advisers. [5] The result of this failure was exposure of sensitive personally identifiable information of nearly 5,000 KMS customers. In addition, the SEC found that even after KMS became aware of the unauthorized third-party breach in November 2018, it failed to adopt firm-wide increased security measures relating to email accounts for more than 20 months. [5]

The release of these three orders clearly signals the SEC’s desire to protect investor data held by broker-dealer firms across the United States, essentially forcing the adoption of increased security measures across the industry. Interestingly, each of the three orders explicitly notes that the email breaches in question “do not appear” to have resulted in any realized financial damages to the customers via their compromised accounts.

Given this information, these SEC actions appear almost cautionary in nature, attempting to serve as a warning to all broker-dealer firms as they design their cybersecurity policies. While these policies may impose costs on investment firms, the interests of investors are well-served by this stance on protecting personal information.

Sources: [1] https://www.reuters.com/legal/legalindustry/cyber-attack-victims-face-one-two-punch-sec-ramps-up-enforcement-actions-2021-10-12/ [2] https://www.sec.gov/news/press-release/2021-169 [3] https://www.sec.gov/litigation/admin/2021/34-92800.pdf [4] https://www.sec.gov/litigation/admin/2021/34-92806.pdf [5] https://www.sec.gov/litigation/admin/2021/34-92807.pdf

According to the SEC’s complaint, Sky Group ran its fraudulent scheme from at least January 2016 through March 2020. During this time, Sky Group raised approximately $66 million through the sale of promissory notes while representing itself as a payday lender soliciting investors to fund its business. [2]

In particular, Sky Group targeted Venezuelan-American investors in South Florida, who in turn often spread information about the investment opportunity by word-of-mouth. Betancourt specifically pitched Sky Group investments as “a great opportunity for members of the Venezuelan immigrant community to generate investment income,” touting its supposed $70 million loan portfolio as evidence of the investment’s safety.

Sky Group investors each signed a Sky Group “Loan Agreement and Promissory Note” which formed the basis of the agreement in which the investors would receive monthly interest payments and the return of their principal after one year. [2] Annual interest rates were advertised from 24 to 120 percent, and such rates often served as one of the main factors in securing investors. [2]

In all, Sky Group recruited between 505 and 685 retail investors under this guise, most of whom purchased promissory notes with principal values ranging from $10,000 to $150,000, with an outlier having invested $1.1 million. [2] Sky Group and Betancourt employed outside sales agents to contact and pitch the investment to potential investors; none of whom were registered as brokers nor associated with registered broker-dealers. [2] Betancourt also frequently met investors in person, over the phone, and via email to secure their buy-in personally. [2]

While Sky Group investors were assured that their investments would be used solely for consumer payday loans and any costs associated with them, the reality was quite different. Of the $66 million it raised from investors, Sky Group used less than 20% for consumer payday loans. [2] It also only received $20.5 million in customer loan repayments, a far cry from the $70 million loan portfolio it advertised to investors as a reserve for repayment if needed. [2]

As for the remaining 80% of investor dollars, Sky Group improperly used about $12 million on its operating expenses, almost $10 million to pay its sales agent commissions, $19.2 million to simply repay prior investor’s principals and interest, and at least $6.5 million on personal and family expenses. [2]

In its complaint, the SEC alleges that Sky Group and Betancourt’s fraudulent actions and omissions violated several provisions of the Securities Act of 1933 and the Exchange Act of 1934.

This case is of unique importance because Sky Group and Betancourt relied heavily on the insidious tactic of affinity fraud. At a base level, affinity fraud targets a specific, often tight-knit group of people who share something in common – here, a common nationality. Fraudsters then attempt to gain trust within the group and use that trust to financially exploit the group through their fraudulent investment scheme. [3]

The SEC has published an investor alert on the topic of affinity fraud, which urges investors to take the following steps to avoid falling prey to an affinity fraud scheme:

• Carefully research the background of any person who makes an investment offer, even if they seem trustworthy.
• Do not make investment decisions based solely on a recommendation from a member of a group you belong to.
• Be on the lookout for investments with unusually high or “guaranteed” returns – investments are rarely risk-free, and when an investment seems too good to be true, it often is. [3]

While this case is ongoing, our attorneys are available to guide you through any inquiries you might have related to affinity fraud or to this complaint.

Sources: [1] https://www.sec.gov/litigation/litreleases/2021/lr25234.htm [2] https://www.sec.gov/litigation/complaints/2021/comp25234.pdf [3] https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/investor-60