The Growing Problem With Sales of Unregistered Securities

Recently I have been busy working to recover losses for a large number of investors who lost money in unregistered investments offered by Woodbridge and Future Income Payments or FIP. In many cases these investments were recommended by insurance agents who were not licensed to sell securities, and did not perform adequate due-diligence on these companies before they made the recommendation.

FIP offered pensioners upfront, lump-sum payments in return for a portion of their monthly pension payments over a specific term, often three to five years. FIP then used these pension payments to fund a monthly income stream back to the investors who put up the money for the lump-sum payments. In July of 2018 Scott Kohn, the 64-year-old felon who started the company, closed the doors and disappeared leaving investors with more than $100 million in losses.

Subsequently the SEC filed charges against thirteen individuals and ten companies who recommended and sold Woodbridge, including Utah-based Aaron Andrew and Live Abundant. Live Abundant and its agents were not licensed to sell securities, and yet they recommended both FIP and Woodbridge to hundreds of people here in Utah and throughout the western United States. Our lawsuits against Live Abundant and the individuals and entities who perpetrated this scheme are ongoing.

The common link between these two fraud schemes is that investments in FIP and Woodbridge were not registered with the SEC. These are sometimes referred to as private placements or unregistered offerings.  Generally, a company may not offer or sell securities in the United States unless the offering has been registered with the SEC or an exemption from registration is available. For more information about exempt offerings I recommend you look at this article on the SEC’s website.

Below is a repost of an article from Investment News that highlights some of the challenges for individual investors from these investments, and for the firms that offer them.


Sales of Unregistered Securities are a Growing Problem That’s Harming Investors — and the Industry

By Bruce Kelly

To an investor, Castleberry Financial Services Group’s promise of up to a 12.2% annual yield on the alternative investment fund it was selling might have seemed awfully tempting. So might the assurance that your principal would be insured and bonded by well-known insurance companies CNA Financial Corp. and Chubb Group.

In promotional materials, Castleberry claimed to have invested almost $800 million in local South Florida companies and to have a portfolio of real estate holdings that was generating $2.8 million in rental income annually.

But in late February, the Securities and Exchange Commission went into court to shut the company down, claiming it was all a fraud, including the involvement of CNA and Chubb.

Before the SEC acted, though, it said that Castleberry had managed to raise $3.6 million from investors, some of which was used to pay the personal expenses of its principals. Other funds were transferred to family members or other businesses the principals controlled, according to the SEC.

By all indications, the marketplace for all types of private, unregistered securities, including private placements sold to wealthy investors and institutions, is thriving. But what’s growing alongside this legitimate, if risky, market is a seedy side of the financial advice industry. Investment funds promising above-market returns that employ networks of brokers, former brokers, insurance agents or others lurking on the fringes of the industry to sell their investments are taking advantage of unsuspecting investors.

Add in the ability to offer private securities over the internet and solicit clients via social media, and unregistered, private securities being sold to less-than-wealthy investors, many of them senior citizens, are becoming increasingly dangerous. Fraudulent securities are damaging the reputation of the legitimate financial advice industry,​ and the industry itself might serve as the best solution to safeguarding the investing public.

“I’m seeing more of it:​ the spike in the sale of nontraditional investments,” said David Chase, a former SEC staff attorney who’s now in private practice and based in South Florida.

Sales soar

The proliferation of potentially fraudulent schemes comes at a time when the sale of legitimate private securities, which are exempt from having to be registered if they meet certain SEC guidelines, has taken off. While the annual amount of public stock offerings has remained relatively steady over the past decade, the sale of new private stock offerings has soared.

The most popular of these, known as Regulation D offerings, have more than doubled, from 18,295 in 2009 to 37,785 in 2017. Those deals, along with other types of private offerings, raised a total of $3 trillion in 2017.

Brokers and advisers can sell private, unregistered shares to only the wealthiest clients; investors need a net worth of $1 million or an annual individual income of $200,000 to buy in. But the public disclosure is negligible, making the securities opaque, some sources said, and that is hazardous.

The game plan of the fraudulent unregistered securities schemes currently roiling the investment advice market is simple. An investment manager claims to have an alternative investment to the stock market that beats the return on bonds or bank deposits. The investments are heavily marketed with investment seminars, dinners, and ads on radio and in local newspapers.

James Park, securities professor at UCLA, said the internet is giving the promoters one more outlet to sell their fraudulent investments.

“It’s now possible to get investors from everywhere,” he said. “In the old days, brokers would have to call up people to convince them to invest or put on a road show. Now it’s normalized with online platforms.”

In one of the largest recent cases,​ the SEC said the owners of Woodbridge Securities raised $1.2 billion over a five-year period by claiming they were selling loans to real estate developers.Source: North American Securities Administrators Association

Promising returns of 10%, the scheme reeled in 8,400 investors, many of them senior citizens, with the help of a network made up mostly of insurance agents and former stock brokers, according to the regulator. Woodbridge’s owners kept the scam going, the SEC said, by using money from new investors to pay off old investors — a classic Ponzi scheme.

Without admitting or denying the allegations, Woodbridge and its former CEO Robert Shapiro settled with the SEC for $1 billion in disgorgement and fines. Ryan O’Quinn, a lawyer for Mr. Shapiro, did not return a call seeking comment.

Beyond FINRA’s reach

One of the reasons these cons take time to detect is because the agents selling them mostly work outside the supervision of licensed broker-dealers, who are under the purview of the Financial Industry Regulatory Authority Inc. This gives the fraud ample time to flower before the SEC or a state regulator gets a complaint from an investor, investigates and shuts it down.

The largest Ponzi schemes in general are those that have tapped into a very successful and productive line of independent sales agents who typically have long-standing relationships with clients,” Mr. Chase said. “They sell the deal, and clients get defrauded.”

The SEC did a better job of shutting down what it said was a fraud in the case of Castleberry Financial Services Group after only a year in business. In February, the SEC was granted a temporary restraining order and temporary asset freeze against Castleberry and its principals.

​ Among other allegations, the SEC said the firm’s president, T. Jonathon Turner, formerly known as Jon Barri Brothers, had falsely claimed to have had extensive finance industry experience, an MBA degree and a law degree, while concealing that he had served 18 years in prison for multiple fraud, theft and forgery felonies.

Attorneys for Castleberry Financial and its executives did not return calls seeking comment.

State enforcement

In 2017, state regulators reported that enforcement actions against unregistered brokers and salespeople increased at a faster pace than actions taken against registered individuals. That means the risk from salespeople on the fringes of the financial advice industry is growing. And they are the type of people who often sell scams that are being marketed as unregistered securities.

“[The] enforcement survey reflects a large increase in enforcement actions against unregistered individuals and firms,” according to an October 2018 report from the North American Securities Administrators Association. Members of the group reported actions in 2017 against 675 unregistered individuals and firms — an increase of 24% over the prior year — and 647 registered individuals and firms — a 9% increase.

“The surge in cases against unregistered actors reversed a two-year trend in which registered individuals and firms in the securities industry, broker-dealers and investment advisers, had constituted the majority of respondents in state enforcement actions,” according to NASAA.

Perhaps the poster boy for selling phony unregistered securities is Barry Kornfeld, a leading seller of the Woodbridge Ponzi scheme.

The SEC barred Mr. Kornfeld from working as a broker in 2009. Regardless, he continued to sell private securities; he and his wife allegedly solicited investors at seminars and a “conservative retirement and income planning class” they taught at a Florida university, according to an SEC complaint.

From 2014 to 2017, he and his wife received $3.7 million in commissions after selling more than $60 million of the Woodbridge private securities, according to the commission. Mr. Kornfeld reached a settlement in January with the SEC, agreeing to be barred for a second time from the securities industry. Robert Harris, a lawyer for Mr. Kornfeld, did not return a call seeking comment.

Registered reps involved

Unregistered reps aren’t the only ones selling fraudulent securities. Registered reps working at broker-dealers also are involved.

“We’re starting to see more sophisticated means for registered reps within the broker-dealer space to get investors to invest in private securities,” Thomas Drogan, senior vice president at Finra, said in testimony last year about investor fraud before the SEC’s Investor Advisory Committee. “The challenge in that space has been reps encouraging their customers, for example, to send money from their brokerage account to their bank account. And once the money gets to the bank account, instructing the customer to then send the money to the individual reps’ outside business activity. This creates a problem. This creates a very big challenge for broker-dealers to conduct surveillance on.”

The practice, known as “selling away,” can be grounds for disciplinary action if the broker-dealer employing the broker has not approved the broker’s actions. Unregistered firms and individual topped the list of disciplinary actions by state securities regulators in 2017.

Advisers at independent broker-dealers are commonly paid 7% commissions when selling private placements, clearly on the high end of a broker’s pay scale.

“What’s driving this?” asked Adam Gana, a plaintiff’s attorney. “It’s commissions, commissions, commissions. Brokers think they can get away with selling whatever they want on the side.”

Even though these dubious private securities are creating havoc for investors and the financial advice industry, regulators may soon change the rules about how private securities transactions are supervised.

Simplify supervision?

Last year, Finra proposed rule changes that are intended to simplify how broker-dealers supervise a hybrid rep’s outside business activity and sale of private securities. The new rule focuses on the rep’s RIA firm and decreases some of the responsibility the broker-dealer has to watch over that separate line of business. It would cut costs for the firm and the broker. But some think these changes could prove dangerous.

William Galvin, secretary of the Commonwealth of Massachusetts and the most feared regulator in the securities industry, does not care for the Finra rule proposal.

“Finra claims that the proposed rule will strengthen investor protections, but it is not at all clear how investors will be protected by the removal of supervisory oversight,” Mr. Galvin wrote in a comment letter last April about the proposed rule. “The absence of proper oversight of outside business activities will increase the risk of fraud and abuse.”

Can financial advisers and the financial advice industry do anything to contain this problem?

Local investment advisers are often the best cops on the beat for detecting such frauds. Their knowledge often comes from clients who are being pitched such deals at “free” steak dinners that are provided to get them in the door for a presentation.

Advisers have the responsibility to report a suspicious private securities deal to their firm, said Mr. Chase, the former SEC attorney.

“If brokers get wind of these types of deals, they’ve got to go to the broker-dealer’s compliance department and report to the SEC or Finra,” he said. “They have the ability and obligation to report. There’s nothing wrong with putting these suspicious deals in front of regulators.”

FIVE QUESTIONS TO ASK BEFORE YOU INVEST

Whether you’re a first-time investor or have been investing for many years, there are some basic questions you should always ask before you commit your hard-earned money to an investment.

Question 1: Is The Seller Licensed?

Research shows that con-artists are experts at the art of persuasion, often using a variety of influence tactics tailored to the vulnerabilities of their victims. Smart investors check the background of anyone promoting an investment opportunity, even before learning about opportunity itself.

  • Researching brokers: Details on a broker’s background and qualifications are available for free on FINRA’s BrokerCheck website.
  • Researching investment advisers: The Investment Adviser Public Disclosure website provides information about investment adviser firms registered with the SEC and most state-registered investment adviser firms.
  • Researching SEC actions: The SEC Action Lookup – Individuals allows you to look up information about certain individuals who have been named as defendants in SEC federal court actions or respondents in SEC administrative proceedings.

If you are not sure who to contact or have any questions regarding checking the background of an investment professional, call the SEC’s toll-free investor assistance line at (800) 732-0330.

Question 2: Is The Investment Registered?

Any offer or sale of securities must be registered with the SEC or exempt from registration. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.

Smart investors always check whether an investment is registered with the SEC by using the SEC’s EDGAR database or contacting the SEC’s toll-free investor assistance line at (800) 732-0330.

Question 3: How Do The Risks Compare With The Potential Rewards?

The potential for greater returns comes with greater risk. Understanding this crucial trade-off between risk and reward can help you separate legitimate opportunities from unlawful schemes.

Investments with greater risk may offer higher potential returns, but they may expose you to greater investment losses. Keep in mind every investment carries some degree of risk and no legitimate investment offers the best of both worlds.

Many investment frauds are pitched as high return opportunities with little or no risk. Ignore these so-called opportunities or, better yet, report them to the SEC.

Question 4: Do You Understand The Investment?

Many successful investors follow this rule of thumb: Never invest in something you don’t understand. Be sure to always read an investment’s prospectus or disclosure statement carefully. If you can’t understand the investment and how it will help you make money, ask a trusted financial professional for help. If you are still confused, you should think twice about investing.

Question 5: Where Can You Turn For Help?

Whether checking out an investment professional, researching an investment, or learning about new products or scams, unbiased information can be a great advantage when it comes to investing wisely. Make a habit of using the information and tools on securities regulators’ websites. If you have a question or concern about an investment, please contact the SECFINRA, or your state securities regulator for help.

Editor’s note: This is a repost of an article from the SEC’s
investor education website. I have a more extensive checklist of my top ten ways to avoid getting caught in a financial scam that is still highly relevant today. If you have questions about an investment or knowledge of ongoing fraud please contact me.

Top Ten Ways To Avoid Losing Money In A Financial Scam*

130911175808-financial-scam-620xaEvery week Utah residents lose money by investing with friends, family or neighbors – people they knew and trusted. Investment fraud is a big problem here in Utah, largely because our close-knit communities are a prime target for “affinity fraud.”  Our state has a long history of financial scams and Ponzi schemes, many of which have been perpetrated by members of the LDS church on members of their ward or stake.  It’s heartbreaking.

I have seen people who borrowed money against their homes or liquidated retirement accounts in order to fund risky investments based on pitch by someone they trusted.  Unfortunately by the time they call me, the money is long gone – and so is the person who took the money. Because I specialize in helping people recover losses in investment fraud cases I often get asked for advice on how to avoid needing me.  So, at the risk of all my work drying up, here is my TOP TEN ways to avoid investing in a financial scam:

10. Slow down.  According to the Insider Monkey blog, many people invest after only hearing the pitch; watch out for promoters who try to commit you on the spot.  Don’t do it!  Take your time, do your research, ask lots of questions, search the internet, review their financials, visit the company, kick the tires before you buy.  Be very wary of aggressive sales pitches and deadlines.  Ask the hard questions before you hand over your money, not after.

9.  Do your homework.  Run a simple Google search on the company and its managers, or the individual.  If it involves a company, ask for a private placement memorandum and company financials.  Hire an attorney to evaluate the investment and help you perform due diligence.  Attorneys have access to court databases to look for lawsuits and bankruptcies.  Contact federal and state securities regulators see if actions have previously been taken against the company or individuals involved.

8. Hire an attorney.  Attorneys can be expensive, but it is much cheaper to hire an attorney to document the transaction properly on the front end than to sue the bad guys when it all blows up.  A good lawyer can help you perform due diligence on the company and individuals, and can determine whether the investment is properly structured as a private offering and complies with state and federal statutes.  Your lawyer can review the offering materials and help you understand what the risks are.  Hiring a good attorney up front is an investment in your investment.

7.  Get it in writing.  I am amazed how often people will give hundreds of thousands of dollars to someone on nothing more than a handshake.  Don’t do it!  If things go bad later, proper documentation will be critical to me in my efforts to get your money back.  The terms of your deal should always be put in writing, and those terms should be reviewed by the competent attorney you hired.  (See number 8.) In any private investment opportunity you should receive a detailed lengthy disclosure document called a private placement memorandum (PPM).  Take the time to review it before you invest.  It contains detailed information about all aspects of the business including the business model, financial history, risk factors, biographical information on the managers, civil lawsuits, and the terms and conditions of the investment, among other things.  If the company soliciting your money has not prepared a PPM, that should be the end of your discussions with them.

6.  Beware of guarantees.  If anyone tells you that your investment is “guaranteed” that should cause some you concern.  All investments carry risk, and personal guarantees (especially oral ones) are rarely a means to get your money back. Even if you are approached to loan money and get a promissory note that is usually still considered to be an investment, and such loans can be very risky if not properly secured.  If you are told that the loan or investment is “secured” hire an attorney to document the security interest and verify the collateral.  (See Number 8.)

5.  Beware of secret trading strategies, offshore investments, commodity or currency (FOREX) trading, futures, options and minerals.  This could be an article all by itself.  Generally, avoid anyone who credits a highly complex or secretive investing technique or touts unusual success.  Legitimate professionals should be able to explain clearly what they are doing and how they make money.  And if the individual is really making as much money with their strategy as they say they are, they shouldn’t need yours.  These types of “alternative” investments nearly always involve extremely high risk, despite what you are told.

4.  Work through licensed stock brokers or investment advisors.  Even when investing in a private (unregistered) opportunity ask whether the promoter is licensed to sell you the investment, which regulator issued that license and whether the license has ever been revoked or suspended.  A legitimate securities salesperson must be properly licensed under most circumstances.  If you have any questions contact the Utah Division of Securities at (801) 530-6600.

3.  Don’t invest with friends and neighbors.  It may seem like doing business with someone you know and trust would be safer, but that is simply not true.  All investing involves risk, and just because you trust the individual soliciting the investment does not mean that the investment itself is good.  Trust but verify; and if things go badly do not hesitate to aggressively protect your interests.

2.  Keep church out of investing.  If someone pitching you an investment casually mentions that they used to be the bishop or in some other church position, watch out!  Church callings and temple worthiness are not relevant to investment decisions, so beware of those who bring these issues up in an investment pitch.

1.  If it sounds too good to be true it probably is.  If you are thinking about putting money into an alternative, unregistered, or unregulated investment that promises abnormally high returns, watch out.  The fact that others may have been getting their promised returns does not mean you will.  All Ponzi Schemes eventually implode, and you may be left holding the bag.

Note:  I wrote this article for The Enterprise  and it was published in their July 2014 issue.  Because their content is only available to subscribers I am posting it here.

Copyright 2014 by Mark W. Pugsley.  All rights reserved.


*This article is intended to address private investments, not those made through a licensed stock broker or registered investment advisor.

The Falls Event Centers; A Financial Scam Targeting Medical Professionals

Editor’s Note: This is an excerpt from a guest post that I wrote for The White Coat Investor, a fantastic website that provides financial tips and education to medical professionals.  

I have represented a number of doctors and dentists over the years in disputes with their stockbrokers and in Ponzi schemes and investment fraud cases.

My medical professional clients are typically intelligent and savvy with respect to managing their money, but because they are often too busy to dig into the details they can often be taken advantage of by unscrupulous investment advisors, and in some cases, they fall victim to fraud.
Below are a couple of war stories.  Of course, most investment professionals are good and well-qualified – but not all of them.  A keen intellect cannot substitute for taking the time to read the documents carefully.  The devil may really be in the details

The Falls Event Centers

Utah-based entrepreneur Steve Down had been pitching investments in The Falls Event Centers since 2011.  He raised approximately $120 million from more than 300 investors – the majority of whom are dentists throughout the United States.

On May 11, 2018 Down and his event centers were sued by the Securities and Exchange Commission for defrauding investors.

So why did so many dentists fall for this scheme?  How did he do it?
Steve Down is a gregarious 61-year-old promoter who billed himself as an “an innovative entrepreneur and successful business owner, is passionate about creating companies and providing jobs.”

One of Mr. Down’s companies was called CE Select, a continuing education provider for dentists.  According to the detailed complaint filed by the SEC, dentists attending CE Select seminars were pitched an investment in The Falls during their lunch break.

I honestly cannot figure out how he managed to make a pitch for a wedding reception center investment seem like a normal part of a dental continuing education seminar.  But I digress.

The investment was basically a hard-money loan to fund the purchase and construction of more event centers and was supposed to pay returns of 10 to 14% per year to investors.

Down’s investment pitch remained essentially the same for years. The SEC alleged that Down made the following representations to his captive audience of unsuspecting dentists:

  • The Falls had 8 profitable locations and was growing at a rapid pace,
  • The Falls would have 200 event centers by 2022
  • After The Falls had 12 centers, it would be able to obtain institutional loans to replace the hard money loans,
  • Many of the event centers were profitable even before they opened, because they were accepting event bookings before they opened, and continued to be profitable after they opened,
  • Each event center would earn gross revenues of $1 million per year and cover expenses of approximately $650,000, leaving a profit of approximately $350,000, or 35% of revenue, per year.
  • The 200 projected centers would bring in net income of $70 million per year.
  • The Falls would be worth $2.8 billion by the time it had 200 centers in 2022.

The problem, according to the SEC, is that many of these representations were false, and Down allegedly knew it.

The Falls’ own accounting records showed that the event centers had never been profitable.  Down also allegedly knew that his business model was unsustainable because of crippling debts owed to investors and mortgage holders.  But he nevertheless kept on pitching this “profitable” investment to dentists and other investors until the SEC finally shut him down.

Down did not admit or deny the allegations in the SEC’s complaint, but he and The Falls did consent to the entry of a final judgment permanently enjoining them from future violations of securities laws and Down paid a civil penalty of $150,000.  A final judgment was entered against Down and The Falls on May 11, 2018, by United States District Court Judge Jill Parrish.
Despite all this, according to an article in the local paper, Down planned to continue building his wedding center empire, and “The Falls will continue to conduct business as usual.”

But that won’t happen – The Falls filed for bankruptcy soon thereafter.

What do you think? Have you been a victim of investment fraud? Why do you think doctors often fall prey to fraudulent investments? Comment below!

Another Scam Comes to Light: Future Income Payments or FIP

Editor’s Note: I have been contacted by a number of individuals who invested in Future Income Payments or FIP through Utah-based Live Abundant, which is referenced in the article below.  This article appeared in the Wall Street Journal today and has a pretty good summary of the FIP situation.  Spoiler alert: it’s not good.

Private Pension Product, Sold by Felon, Wipes Investors Out

Investors accuse Future Income Payments of taking them for more than $100 million

By Jean Eaglesham of the Wall Street Journal – July 23, 2018 5:30 a.m. ET

Mr. Kohn’s company, Future Income Payments, appears shut, according to court filings. His investors are likely to be wiped out, according to lawyers representing them, who plan to sue scores of firms that sold Future Income products as soon as this week. At least 25 states have taken enforcement actions or are investigating the company, it said in April.

The blow-up shines a light on the boom in opaque private markets, to which investors have flocked in the hope of doing better than they can in traditional stock and bond markets.

Private-market products, including the ones offered by Future Income, are frequently sold by financial advisers. Sales targets are often retirees looking to beat the anemic returns on bonds and other savings products.

Future Income essentially sold investors other people’s pensions. Mr. Kohn’s firm would find workers entitled to pension payments and temporarily buy the rights to those payments—effectively lending the beneficiaries money against their future pension income in what is called a “pension advance.” Then, Future Income would sell the rights to investors for a lump sum. An investor might put up $100,000 in exchange for an income of 7% for five years, for example.

But Future Income’s apparent collapse has left investors stranded. The company is no longer collecting the pension money that funds its own payments to investors, according to court documents. Mr. Kohn couldn’t be reached for comment. It isn’t clear if he has a lawyer.

JC and Mary Barb at home in Hemet, Calif. Mr. Barb says that money they invested ‘was to be a big help to us in our retirement and now it’s not there, it’s gone.’
JC and Mary Barb of Hemet, Calif., say their financial adviser Kevin Kraemer persuaded them to invest some $78,000 with Future Income last year. “He came to us and said, ‘Hey we can make some more money on your money,’ [and] sold us this new deal,” said Mrs. Barb, a 66-year-old retired postal worker. Her husband, a 63-year-old retired teacher, said the money “was to be a big help to us in our retirement and now it’s not there, it’s gone.” Mr. Kraemer declined to comment.

Unlike publicly traded investments, there are few rules on how pension advances can be sold or by whom. “They illustrate the problems with the financial services industry selling opaque, high-commission private investments,” says Joe Peiffer, a New Orleans-based plaintiffs’ lawyer representing some purchasers of Future Income’s products. “We have clients who were advised to cash in their pensions and refinance their homes to buy these things.”

In a letter sent to investors in April, Mr. Kohn said his company was suffering from “intense regulatory pressure and legal expense,” and investors had been told there were “no guarantees [they] would receive all payments.” Future Income didn’t respond to emails, and its phones appear to be down. Christopher Jones, a lawyer representing the company over a civil investigation by the Consumer Financial Protection Bureau, didn’t respond to requests for comment. The CFPB declined to comment.

Future Income called itself “America’s largest pension cash-flow originator,” boasting of a “global footprint of over 200 employees.” Its mailing address is a mailbox at a United Parcel Service Inc. store in a strip mall outside Las Vegas. The same address has been used by Mr. Kohn for dozens of other companies, most of them now defunct, state records show.

Mr. Kohn formed Future Income in 2011, company records show. In 2016, he set up a separate company, FIP LLC, controlled via a Philippines-based corporation of which he is the sole owner, according to a complaint filed last year by Minnesota regulators. He pleaded guilty to trafficking in counterfeit goods in 2006 and served 15 months in federal prison.

State regulators took action against Future Income as early as 2014 over the terms on which it was buying pension benefits, saying the firm was lending illegally. Some states said the company was breaching state laws limiting the interest that can be charged on loans. A disabled Gulf War veteran who borrowed $2,700 was required to send $450 a month from his benefits for five years—a total of $27,000, or an annual percentage rate of 200%, according to one example cited in the Minnesota lawsuit. Mr. Kohn in his April letter said the company was in the process of agreeing, or had agreed to, settlements with the states that limited the amounts it could collect.

“Future Income Payments’ illegal loans were outrageously expensive,” said Lisa Madigan, the Illinois attorney general, who filed a suit against the firm on the same grounds this year.

The string of regulatory actions didn’t stop advisory firms and others selling the commission-rich products, many as part of a retirement-savings strategy. A Future Income marketing presentation urged retirees to “give your savings the opportunity to grow,” with “competitive fixed rates,” according to a copy reviewed by The Wall Street Journal.

The sellers included Live Abundant, a firm based in Salt Lake City that promises on its website to “empower you to live a more abundant life by replacing your old, outdated retirement philosophy.” It has sold products from both Future Income Payments and Woodbridge Group of Cos. LLC, another private-market investment that collapsed, according to lawyers representing investors who said they intend to sue Live Abundant.

Loren Washburn, an attorney for Live Abundant, said the firm plans to review what it “could have done better” in vetting the deals. “This outcome where we’re having to explore options to collect [the money due to investors] is obviously not optimal.”

The sellers also included independent advisers registered with the Securities and Exchange Commission, such as Gus Marwieh of Austin, Texas. Mr. Marwieh “used his strong religious beliefs to engender trust from investors,” said Mr. Peiffer, who is representing some of them. Mr. Marwieh confirmed he sold Future Income products but declined to comment further.

An SEC spokesman declined to comment.

Investors are now scrambling to try to recover money. Mr. Peiffer said he is “highly confident that the losses suffered by investors are well over $100 million.”

Faw Casson & Co., an escrow company in Dover, Del., that held funds on behalf of investors, sued Future Income Payments in May. Faw Casson, whose lawyer declined to comment, said in a court filing it has received calls from several investors including a “retired secret service agent [who] said that if we do not return his phone call, he is coming to the office and trust me that is not what we want.”

Link to original article in the WSJ

The Problem With Private Placements

One of the biggest problems I am seeing these days is private placements (also called alternatives or non-registered investments) that are sold to accredited investors through a private placement memorandum or PPM.  Because these investments are not registered with the SEC the information that you can get about them is far more limited, and can even be fraudulent.

According to this article in the Wall Street Journal yesterday, sales of private placements are surging, as part of a broader rise in private capital markets.  Private placements can be great opportunities, but they nearly always carry significant risk and in some cases they can be Ponzi schemes.  Caveat emptor.

Aside from the risk, one of the biggest concerns regulators have is how the products are sold.  FINRA has warned in the past about “fraud and sales practice abuses” by firms and brokers in the market.  In some cases this may be due to the fact that these smaller, less known firms tend to hire troubled brokers for their track record in aggressively selling high-commission deals, sometimes using questionable tactics.  Most of these firms are small to midsize brokerages, with fewer than 500 brokers, and are spread throughout the country.

According to the WSJ, more than 1,200 brokerage firms sold around $710 billion of private placements last year, and sales for the first five months of this year will be even higher.  To make matters worse, securities firms with an unusually high number of “bad brokers” are selling tens of billions of dollars a year of private stakes in companies. The WSJ reviewed records of who was pushing these investments and identified over a hundred firms where 10% to 60% of the in-house brokers had three or more investor complaints, regulatory actions, criminal charges or other red flags on their records.  This is not normal (always run your broker or advisor’s name through Brokercheck).

The bottom line is that investors are far more likely to be exposed to losses or fraud in private investments. If your broker or advisor recommends a private placement or “alternative” investment make sure he/she has a good track record and has done extensive due diligence.

If you get a cold call from a firm you’ve never heard of trying to convince you to invest in one of these, just say NO.

Copyright 2018 by Mark Pugsley.  All rights reserved,

Does Disclosure of a Ponzi Scheme in the PPM make it legal? No.

Dee_Randall-1Dee Randall ran one of Utah’s largest Ponzi schemes, raising more than $72 million from approximately 700 investors nationwide.

On June 18, 2014 Utah Attorney General Sean D. Reyes’ office filed a criminal information and affidavit of probable cause against Randall for multiple counts of securities fraud and other related charges.  Randall, a resident of Kaysville, Utah, was charged with 21 second degree counts of felony securities fraud, one third-degree felony securities fraud count, and one second degree count of pattern of unlawful activity.

At the initial hearing on his criminal case victims testified that Randall, who was the owner of Horizon Mortgage & Investment, sold what he called “Horizon Notes” which were supposed to pay annual returns of 9 to 17 percent.  Investors were told that their funds would be used to finance car loans and real estate, but in reality Randall used investor funds for other things, such as payments to his other entities and payments to earlier investors – a classic Ponzi scheme. If you are in the market for a new home then you need, NorthPoint Mortgage.

What is unique about this case is Randall argued in court that although it may have been a Ponzi it was nevertheless legal because he disclosed it to his investors in the Private Placement Memoranda (or PPM).  Specifically, he disclosed that he was going to use new investor money to make payments to earlier investors, apparently hoping such a disclosure would get around securities laws.  So if you tell someone you’re going to defraud them is it still fraud?

Keith Woodwell, head of the Utah Division of Securities, says there’s no such thing as a “legal fraud” since Utah law also says it is illegal to operate a business in way that defrauds investors. “Using money from new investors to pay older investors, with no way to generate profits to pay people back, is a fraud regardless of whether you disclose it or not.”  This novel argument was also rejected by the bankruptcy judge.

My question is this: did anyone ever actually read the Horizon PPM?  PPM’s are required for a non-registered offerings of securities and are definitely worth reading before you invest.  In this case potential investors who read the PPM would have discovered that their money was going to be used to pay off other investors and (hopefully) would have declined to participate in this investment opportunity.  But the unfortunate reality is that  hardly anyone ever reads PPM, they are long and usually difficult to understand.

After months of legal maneuvering, this week Randall finally pleaded guilty to four counts of securities fraud and one count of pattern of unlawful activity, each punishable by up to 15 years in prison. Sentencing is set for Feb. 6, 2017.

If you are a victim of the Dee Randall/Horizon Financial scam feel free to share your story in the comments below.   The bankruptcy trustee is Gill Miller of Rocky Mountain Advisory, and his website can be found here.

Utah Division of Securities Releases Top Investor Threats for 2013

SALT LAKE CITY, Utah – Keith Woodwell, Director of the Utah Division of Securities, announced today that the Division has released a new list of Top Investor Threats facing consumers with its partner, the North American Securities Administrators Association (NASAA). The 2013 list examines offers, practices, and investment scenarios that are being aggressively marketed to those trying to build and protect their nest eggs for retirement. The Utah Division of Securities investigators are concerned that with the passage of the JOBS Act lifting advertising restrictions on securities and other investments, consumers face even greater challenges when deciding where to invest their earnings.

“With new advertising flooding the marketplace and currency vehicles such as Bitcoin making headlines, investors are facing new and confusing messages,” cautioned Director Woodwell, “Rest assured, our messages at the state level remain stable: Choose your investments carefully, don’t jump into something you don’t fully understand, and work with a licensed professional when it comes to protecting your money.”

The 2013 list was compiled by the members of North American Securities Administrators Association.

Private Offerings: Fraudulent private placement offerings continue to rank as the most common product or scheme leading to investigations and enforcement actions by state securities regulators. These offerings commonly are referred to as Reg D/Rule 506 offerings, named for the exemption in federal securities laws that allows private placements to be sold to investors without registration). By definition these are limited investment offerings that are highly illiquid, generally lack transparency and have little regulatory oversight. While Reg D/Rule 506 offerings are used by many legitimate companies to raise capital, they carry high risk and may not be suitable for many individual investors. With the passage of the JOBS Act and recent adoption of rules implementing certain aspects of the Act, restrictions on how Reg D/Rule 506 offerings can be marketed to the general public have been relaxed, including the lifting of an 80‐year ban on general solicitations (advertising). Investors soon will begin to see advertisements for private placement offerings on a variety of platforms including social media, billboards, or t‐shirts on window washers as one startup has proposed, even though only a very small percentage of the population will be eligible to invest. And, as is often the case, scam artists are likely to use this legally permissible avenue to their advantage leading, no doubt, to another year of Rule 506 offerings holding the top spot as the most frequent source of state securities enforcement actions.

Real Estate Investment Schemes: The popularity of investments involving distressed real estate continues throughout the boom and bust cycle in the U.S. housing market. Even as housing prices continue to recover in many U.S. markets, investors should be aware that schemes related to new real estate development projects or buying, renovating, flipping or pooling distressed properties are popular with con artists. In the latest NASAA enforcement survey, real estate investments were the second‐most common product leading to securities fraud investigations by state securities regulators. While legitimate real estate investments can be an important part of a diversified investment portfolio, there are substantial risks with many types of real estate investments. In particular, state regulators have seen problems with non‐traded real estate investment trusts (REITS), properties that are bank‐owned, pending short‐sale, or in foreclosure, and flimsy promises
of investment funds being secured by an interest in real property when the property in question is already highly leveraged and has no
remaining equity. As with all investments, careful vetting and due diligence is a must with real estate investments.

High‐Yield Investment and Ponzi Schemes: Retail investors chasing yield often find themselves falling prey to high‐yield investment and Ponzi schemes promising unbelievably high rates of returns. That trend continues and does not appear to be going away any time soon. As with other alternative investments, high yield means higher risk and these types of alternative investments are favorites of scam artists. Whether a typical Ponzi scheme or a high‐yield investment program, many of the characteristics are the same – promise of incredibly high return coupled with low risk; a reasonably plausible explanation of why the investment is so good; a scam artist with credibility often based on claims of holding false credentials or being part of a particular group or organization. Initial investors are paid a return and help spread the word by promoting the investment to others.

Ultimately the scam will collapse leaving later investors with nothing to show for their trust in the scheme. One way to protect yourself is to ask questions and when you think you have asked all the questions you have, ask more questions. As Bernie Madoff, the king of Ponzi schemes, once said, he only turned people away when they asked too many questions.

Affinity Fraud: Marketing a fraudulent investment scheme to members of an identifiable group or organization continues to be a highly successful and lucrative practice for Ponzi scheme operators and other fraudsters. Fraudsters know that people tend to trust someone who is perceived to have a common interest, beliefs or background and use that trust to exploit members of specific groups. The most commonly exploited are the elderly or retired, religious and ethnic groups, and the deaf community. Members of the group often find it hard to believe that “one of their own” could be scamming them. Consequently, affinity fraud can go unreported or when a regulator becomes involved,
members of the group choose not to cooperate. Investors should keep in mind that investment decisions should be made based on a careful evaluation of the underlying merits of the offer rather than common affiliations with the promoter.

Scam Artists Using Self‐Directed IRAs to Mask Fraud: Scam artists are using self‐directed individual retirement accounts (IRAs) to increase the appeal of their fraudulent schemes. State securities regulators have investigated numerous cases where a self‐directed IRA was used in an attempt to lend credibility to a bogus venture. While self‐directed IRAs can be a safe way to invest retirement funds, investors should be mindful of potential fraudulent schemes when considering a self‐directed IRA. Custodians and trustees of self‐directed IRAs may have limited
duties to investors, and generally will not evaluate the quality, value or legitimacy of an investment or its promoters. Fraud promoters pushing a Ponzi scheme or other investment fraud can misrepresent the responsibilities of self‐directed IRA custodians in order to deceive investors
into believing that their investments are legitimate or protected against losses. While a scam artist may suggest that self‐ directed IRA custodians analyze and validate investments, those custodians only hold the assets in a self‐directed IRA and generally do not evaluate the quality,
value or legitimacy of any investment. In some cases, fraud promoters convince investors to move assets from an existing self‐directed or traditional IRA into a fake self‐directed IRA held by a supposed custodian created and owned by the scam artist. Fraudsters also exploit the tax‐deferred characteristics of self‐directed IRAs, and know that the financial penalty for early withdrawal may cause investors to be more passive or to keep funds in a fraudulent scheme longer than those who invest through other means.

Self‐directed IRAs also allow investors to hold alternative investments such as real estate, mortgages, tax liens, precious metals, and private placement securities. Financial and other information necessary to make a prudent investment decision may not be as readily available for
these alternative investments.

Risky Oil and Gas Drilling Programs: Investors exploring alternatives to traditional securities may be attracted to the lucrative returns often associated with investments in oil and gas drilling programs. Retail investors increasingly are turning to alternative investments including oil and gas drilling investments as opposed to traditional stocks, bonds and mutual funds. These investments appeal to those frustrated with stock market volatility or skeptical of Wall Street.  Unfortunately, energy investments generally prove to be a poor substitute for traditional
retirement planning. Investments in oil and gas drilling programs typically involve a high degree of risk and are suitable only for investors who can bear the loss of the entirety of their principal. Some promoters will conceal these risks, using high pressure sales tactics and deceptive
marketing practices to peddle worthless investments in oil wells to the investing public. There are active investigations into suspect oil and gas investment programs in more than two dozen states and in every region of the U.S. and Canada. Investors should conduct thorough due diligence and assess their own tolerance for considerable risk when considering the purchase of interests in oil and gas programs.

New Threats to Investors

Proxy Trading Accounts: Investors should be wary of individuals who claim to have trading expertise and offer to set up or manage a trading account on an investor’s behalf. Allowing an unlicensed individual to have access to the username and password for your brokerage account or worse, allowing an unlicensed individual to set up a brokerage account in your name, is a recipe for disaster. Allowing someone without the legally‐required safeguards of proper registration and bonding requirements to control your account often leads not only to substantial trading losses, but the loss of investment funds through improper withdrawals from the account including theft. Investors should check with their state securities regulator to confirm that anyone offering to manage your accounts is properly registered and has a clean background. Financial professionals who make the commitment to be properly registered also commit to act ethically and honestly. If they do
not uphold that obligation, they will answer to state or federal regulators. Unfortunately, the same cannot be said for the unlicensed individual looking to capitalize on an investor’s trusting nature.

Digital Currency: Virtual reality may exist only in science fiction, but consumers now are able to purchase goods and services with virtual money such as Bitcoin, PP Coin and other digital currencies. Unlike traditional coinage, these alternatives typically are not backed by tangible
assets, are not issued by a governmental authority and are subject to little or no regulation. The value of Bitcoins and other digital currencies is highly volatile and the concept behind the currency is difficult to understand even for sophisticated financial experts given the complicated
mathematical algorithms that determine when new blocks of coins will be released. This environment has provided fertile ground for scam artists to capitalize on the increasing popularity and acceptance of digital currencies. Investors should be aware that investments that incorporate abstract money systems present very real risks, including the possibility of virtual reality leaving an investor virtually broke.

New Threats to Small Businesses

Capital‐raising Pitfalls: Recent law changes and newly available capital from investors including “angels” – affluent individuals who provide capital for a business startup – have changed the business funding landscape. The new and enhanced opportunities to raise capital through
crowdfunding, public advertising for investors under JOBS Act regulations and angel funding “solutions” also carry risks for unwary entrepreneurs. Securities offerings either must be exempt from registration requirements or properly registered, even under the new laws. Exempt securities remain subject to federal or state anti‐fraud provisions meaning entrepreneurs must provide full and accurate disclosures as part of any offering. Remember a security can be a stock, note, agreement, financial instrument or anything else that provides an investor with an expectation of participating in the profits the entrepreneur generates. The inadvertent failure of an entrepreneur to follow securities laws can result in money judgments for investors that can rob the profits of a new or expanding business enterprise. It pays to research your selected method of capitalization before you solicit any investors.

Unregulated Third Party Service Providers: The implementation of the JOBS Act has created opportunities for unregulated third parties to provide ancillary services. Whether a crowdfunding portal or an accredited investor aggregator, it is important to do your due diligence and to
understand that use of an unregulated third party to provide such services does not change your obligations under federal and state securities laws. Not only should a small business or other entrepreneur make sure they are dealing with a legitimate service provider, they should also make sure that the service being offered is in full compliance with all federal and state requirements. Since the passage of the JOBS Act, new firms have joined existing firms that offer to sell lists of accredited investors for use in private placement offerings. However, new rules recently adopted by the SEC include more stringent requirements replacing the old fail safe of reliance on an investor‐ completed questionnaire claiming accredited investor status. If not done carefully and with federal requirements in mind, an entrepreneur will suffer the consequences, which could include the loss of any claimed exemption. Use of crowd funding portals, while subject to some regulation, also opens the door to scams. Startup businesses, especially small local businesses, should be very careful to verify the legitimacy of a portal before engaging their services.

Investors are not alone in their potential to be scammed. Using a fraudulent portal means both the
business and the investor stand to lose.

About NASAA

Organized in 1919, the North American Securities Administrators Association (NASAA) is the oldest
international organization devoted to investor protection. NASAA is a voluntary association whose membership consists of 67 state, provincial, and territorial securities administrators in the 50
states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico. In the United States, NASAA is the voice of state securities agencies responsible for efficient capital formation and grass‐roots investor protection. Their fundamental mission is protecting consumers who purchase securities or investment advice, and their jurisdiction extends to a wide variety of issuers and intermediaries who offer and sell securities to the public. NASAA members license firms and their agents, investigate violations of state and provincial law, file enforcement actions when appropriate, and educate the public about investment fraud. Through the association, NASAA members also participate in multi‐state enforcement actions and information sharing. NASAA also coordinates and implements training and education seminars annually for state/district/provincial and territorial securities agency staff.

About the Utah Division of Securities

The Division of Securities enhances Utah’s business climate by protecting Utah’s investors through
education, enforcement, and fair regulation of Utah’s investment industry while fostering
opportunities for capital formation. Investors should do business with licensed securities brokers
and advisers and report any suspicion of investment fraud to the Utah Division of Securities by
calling (801) 530.6600; toll free at 1.800.721.7233 or logging on to our website.

CLIENT ADVISORY: SEC Rule 506 Private Securities Offerings Can Now Be Publicly Advertised

Here is a summary of the new SEC’s new Rule 506 written by Mark Cotter, who is the chair of our firm’s Corporate Finance and Securities Law Section.

Summary.  In a fundamental shift in federal securities laws, new U.S. Securities and Exchange Commission (“SEC”) rules will permit companies seeking to raise capital in Rule 506 private placements to engage in “general advertising and solicitation” (e.g., internet solicitations, mass mailings, website banner ads, etc.) to attract investors.  Thus, 80 years of securities laws requiring that “non-public offerings” or “private placements” remain “private” (including conditions intended to limit the offering to potential investors with whom the company or its senior management have pre-existing relationships) have been overturned.

The new rules affect securities offerings under Rule 506 of SEC Regulation D and are effective as of September 23, 2013.  In effect, companies seeking to raise capital under the Rule 506 exemption from securities registration requirements can now make public solicitations in order to cast a wide net for investors, though companies seeking to utilize these more permissive “manner of offering” rules may only sell securities to “accredited investors” and must satisfy heightened compliance requirements (including new “bad boy” disqualification rules). Continue reading “CLIENT ADVISORY: SEC Rule 506 Private Securities Offerings Can Now Be Publicly Advertised”

Not All Ponzi Schemes Are Prosecuted by the SEC

This week a Utah man named Kenneth Tebbs was sentenced to six and a half years in federal prison for operating a $49 million Ponzi Scheme in Salt Lake City.  According to the article in the Salt Lake Tribune the investment scheme victimized more than 100 investors, many of them elderly people, family and friends.

This case is somewhat unique because civil charges were never filed by the Securities and Exchange Commission or the State of Utah.  Instead, Mr. Tibbs filed for bankruptcy – but only after soliciting more investments from, among other, an elderly widow.  According to her letter to Judge Sam, Tebbs had sat her a couch and held her hand while telling her an investment of practically all of her savings would be profitable and safe. Two weeks later, he filed for bankruptcy. Many of the victims “were victimized on the eve of bankruptcy, when the wheels of the filing of bankruptcy were in motion” according to the article. Continue reading “Not All Ponzi Schemes Are Prosecuted by the SEC”