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.”

The Woodbridge Group of Companies – Another Ponzi Targeting Utahns

The Woodbridge Group of Companies was run by a flashy promoter in Los Angeles named Robert Shapiro.  Woodbridge marketed promissory notes (which were in reality unregistered securities) to an estimated 7,000 retail investors throughout the United States, including Utah.  Investors were told their funds would provide a safe, secured return from short-term real-estate loans.

In reality, investor money was used to fund real-estate purchases made by shell companies run by Shapiro himself, including high-priced luxury homes in Los Angeles according to the SEC lawsuit filed in December of 2017.  The SEC alleged that investors received monthly interest checks that were actually funded by money from newer investors, which is a classic Ponzi scheme.

This story about the case appeared in the Wall Street Journal today, and is a follow-up to the WSJ’s fascinating article about the case from February:

 

Woodbridge Bankruptcy Spotlights CEO’s Luxury Spending

The money for his lavish lifestyle came from the pockets of thousands of people, from an 89-year-old widow in a memory care facility in Tennessee to ABC news anchor George Stephanopoulos, according to the Securities and Exchange Commission, which has accused Mr. Shapiro of running a Ponzi scheme.

“Like many others, I was a victim of Woodbridge and now must deal with the consequences of its bankruptcy,” Mr. Stephanopoulos told The Wall Street Journal. Woodbridge filed for chapter 11 bankruptcy protection on Dec. 4, a few days after Mr. Shapiro stepped down from the chief executive spot and, according to court papers, spent $16,000 of company money at Macy’s.

He expected to stay on as a $2 million-a-year consultant, but the arrangement didn’t last long: Woodbridge cut ties to him after the SEC sued him and the company for fraud on Dec. 20.

 Mr. Shapiro denies running Woodbridge as a Ponzi scheme and is fighting the SEC case in federal court in Florida. However, his former company has said it would admit to running a Ponzi scheme, and is providing details with new bankruptcy court filings that sketch a picture of a troubled company with tangled finances.

Woodbridge promised investors safe returns on short-term notes, which were to be secured by valuable real estate in some of the priciest markets in the country, from the Holmby Hills area of Los Angeles to Aspen, Colo.

An SEC fraud case filed in federal court in Florida alleges the real estate was bait to draw investors into Woodbridge’s $1.2 billion Ponzi scheme. Cash that came in from new investors was recycled to pay older investors, according to the civil fraud complaint and bankruptcy court testimony from an SEC expert.

The SEC lawsuit was the culmination of a year-long federal investigation into Woodbridge, which sold unregistered securities, often through unlicensed agents. Securities authorities in Arizona, California, Iowa, New Jersey, Oregon, South Carolina and Colorado were also looking into Woodbridge, court papers say.

Now in the hands of legal and real estate professionals, Woodbridge continues to operate under the watchful eyes of the SEC and a bankruptcy judge. The first order of business: start selling Woodbridge’s portfolio of more than 130 properties which are estimated to be worth more than $650 million and start paying off investors.

Estimates are that investors could get from 45% to 76% of what they are owed, if things go according to plan in Woodbridge’s bankruptcy proceeding. That recovery estimate doesn’t include what Woodbridge might be able to recover from lawsuits against its ex-chief executive and brokers that sold the notes, court papers say.

Mr. Shapiro invoked his Fifth Amendment right not to testify against himself during the SEC probe, and in the face of questions from creditors. His lawyer didn’t respond to a request to discuss Woodbridge’s spending.

In addition to paying Mr. Shapiro’s credit card bills, country club dues and other expenses, Woodbridge transferred $3.8 million to his wife, Jeri, in the year before the company’s bankruptcy filing, most of it through a media-buying company she owned, court records show. Others in the Shapiro circle—a nephew, an uncle, a brother-in-law, a stepson—profited as well, according to court records.

Investors such as Mr. Stephanopoulos could also come under scrutiny for possible clawback lawsuits. Mr. Stephanopoulos received $2.5 million in investor payments from Woodbridge in the 90-day period before the bankruptcy, court papers say. By that time, the SEC had gone public with its probe of Woodbridge. Court papers didn’t say how much Mr. Stephanopoulos invested.

 In many Ponzi schemes, the chief recovery for investor victims is suing other victims on the premise that the financial pain of the fraud should be shared equally.

“I will pursue any valid claims I have and will comply with all proper rulings of the bankruptcy court,” Mr. Stephanopoulos told the Journal.


Lessons to be Learned

Overall, I think there are a number of lessons to be learned from this very large (alleged) Ponzi scheme.

First, regardless of what you are told, Woodbridge Notes are securities under federal and state law.  All investments – including the purchase of promissory notes – must be made through a licensed stock broker or registered investment adviser.   Insurance salesmen are not able to solicit or recommend these investments unless they have the proper securities licenses.  If you want to find out if your “financial planner” or “retirement planner” has a securities license run their name through FINRA’s BrokerCheck database.

Second, there is a reason why it is very difficult to find investments that pay high monthly returns on a consistent basis; it’s just not sustainable.  Investments that pay monthly interest at above-market rates are, in my opinion, very likely to be a Ponzi scheme — or to turn into one eventually.  There just aren’t many businesses that can generate returns like that on a consistent basis.

Third, if your financial adviser recommends an investment like this make sure he or she has a big errors and omissions insurance policy, because that may be your only way to get your money back.

For more ideas on how to avoid losing money in a Ponzi Scheme, check out my Top Ten Ways to Avoid Losing Money in an Investment Scam.

I am working on a number of cases involving the Woodbridge Group of Companies, if you lost money and would like to discuss your legal options please contact me.

 

Copyright © 2018 by Mark W. Pugsley, All Rights reserved.