More On Legal & Compliancefrom The Advisor's Professional Library
- Meeting and Exceeding Clients and Regulators’ Expectations Although it can be difficult, there are ways for RIAs to meet or exceed client expectations, increase customer satisfaction, and help firms retain current clients and attract new ones.
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
Among recent enforcement actions taken by the Securities and Exchange Commission (SEC) were charges against a man who was high school dropout and a phony “investment advisor” who spent his clients’ funds on drugs and gambling; charges against a group of former high school buddies who were engaging in insider trading; and charges against the operators of a Ponzi scheme purporting to be a secret European trust.
Phony ‘Advisor’ Who Was High School Dropout Charged With Fraud
Stephen Colangelo, Jr. was charged by the SEC with defrauding investors whom he convinced to invest in his startup businesses. Instead he spent their money on illegal drugs and gambling. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Colangelo.
The SEC alleges that Colangelo repeatedly misled investors while raising $3 million in investments for four startup companies he created. He also persuaded three other investors to let him act as their investment advisor and they gave him more than $1 million to invest in the markets on their behalf.
Colangelo boasted a phony professional and educational background and hid his past criminal activities from potential investors, and he falsely claimed to have historically achieved extremely high returns buying and selling securities.
According to the SEC’s complaint filed in the U.S. District Court for the Southern District of New York, Colangelo’s fraudulent scheme began in 2009 when he induced investors to invest more than $750,000 in the Brickell Fund LLC, a pooled investment vehicle that he created, advised and controlled.
In March 2009 when the Brickell Fund did not have any investors and Colangelo was not buying and selling securities on behalf of the fund, he sent numerous e-mails to potential investors boasting phony information. For instance, one e-mail claimed, “BEST TRADING DAY OF MY LIFE!!!!!!!. . . . Up over 400% and documented. Mind boggling to say the least.” In reality, Colangelo did not make any trades that day.
Meanwhile, Colangelo siphoned off at least $1 million in investor funds to pay such unauthorized personal expenses as his federal income taxes, illegal narcotics, gambling, cigars, and travel for him and his family.
The SEC alleges that after spending or losing all of the money invested in the Brickell Fund, Colangelo continued to fraudulently raise funds from investors for three other startup businesses he created: Hedge Community LLC, Start a Hedge Fund LLC, and Under the Radar SEO LLC. Some individuals provided Colangelo with funds directly to invest on their behalf. Colangelo continued to use investor funds for a variety of purposes that weren’t disclosed to investors, namely personal expenses and unrelated business expenses.
According to the SEC’s complaint, Colangelo created a profile on the LinkedIn website used for professional networking and misrepresented that he had studied finance at Nyack College from 1986 to 1989. Colangelo provided a link to his profile to potential and existing investors in one of his startup companies. His representations to investors were false because he never attended Nyack College and has not even graduated from high school.
The SEC’s complaint charges Colangelo with violations of the anti-fraud provisions of the federal securities laws, and seeks permanent injunctions, financial penalties, and disgorgement of ill-gotten gains plus prejudgment interest.
Former High School Buddies Charged With Insider Trading
On Monday the SEC charged three health care company employees and four others in a New Jersey-based insider trading ring, who had been friends in high school, generating $1.7 million in illegal profits and kickbacks by trading in advance of 11 public announcements involving mergers, a drug approval application, and quarterly earnings of pharmaceutical companies and medical technology firms.
The SEC alleged that Celgene Corp.’s director of financial reporting John Lazorchak, Sanofi S.A.’s director of accounting and reporting Mark Cupo, and Stryker Corp.’s marketing employee Mark Foldy each illegally tipped confidential information about their companies for the purpose of insider trading. Typically the nonpublic information involved upcoming mergers or acquisitions, but Lazorchak also tipped confidential details about Celgene’s quarterly earnings and the status of a Celgene application to expand the use of its drug Revlimid.
The SEC alleges that Cupo’s friend Michael Castelli, along with Lawrence Grum, who attended high school with Castelli, were the primary traders in the scheme. The other two traders charged are Lazorchak’s high school friends Michael Pendolino and James Deprado, who now live in New Hampshire and Virginia, respectively. The others live in New Jersey. In a parallel criminal action, the U.S. Attorney’s Office for the District of New Jersey announced criminal charges against Lazorchak, Cupo, Foldy, Castelli, Grum and Pendolino.
According to the SEC’s complaint filed in U.S. District Court for the District of New Jersey, the scheme began in late 2007 when Lazorchak and Cupo, who were friends and colleagues at Sanofi, discussed Lazorchak’s new position at Celgene where he’d have access to nonpublic information about mergers and acquisitions. Lazorchak told Cupo that he was initially working on Celgene’s possible acquisition of another pharmaceutical company, Pharmion.
Cupo discussed Lazorchak’s position with Castelli, a friend with whom he attends winemaking club meetings. Castelli brought in Grum, who he considered a sophisticated trader with knowledge of the securities industry. Castelli and Grum devised the scheme in which Lazorchak tipped Cupo with nonpublic Celgene-related information. Cupo, as the middleman, tipped Castelli and Grum so they could illegally trade. Castelli and Grum paid Cupo for his tips, and gave Cupo money to pass along to Lazorchak for the initial tips. Lazorchak never knew the identities of Castelli or Grum, but was aware that Cupo was passing confidential Celgene information to other traders.
The SEC alleges that Lazorchak’s high school friend Foldy entered the scheme in 2007, when Lazorchak tipped him with confidential details about the impending merger between Celgene and Pharmion, and Foldy illegally traded on the information prior to the public announcement of the deal. Lazorchak and Foldy devised and used code phrases while conversing to identify instances when Lazorchak was passing inside information or Foldy was seeking more details.
After the illegal trading occurred and Foldy obtained illicit profits of $14,500, Lazorchak repeatedly demanded that Foldy compensate him for the inside information. Foldy ultimately paid Lazorchak at least $500 and later returned the favor with illegal tips of confidential information about a tender offer involving his employer, Stryker Corp. Lazorchak acted as a middleman and did not trade, instead tipping Pendolino so he could trade on the nonpublic information. Pendolino in turn tipped Deprado, who also traded. Lazorchak additionally tipped Cupo, who did not trade but acted as a middleman and tipped Castelli and Grum, who both traded.
The SEC alleges that Cupo began tipping inside information about his employer in late 2009, when he learned that Sanofi was planning to announce a tender offer to acquire another pharmaceutical company, Chattem Inc. Cupo learned of the imminent tender offer a few days prior to the public announcement; he tipped Castelli and Grum with the confidential details, and they both traded on the nonpublic information.
The trading was carefully orchestrated so there was usually someone acting solely as a nontrading middleman who received the nonpublic information from the insider and tipped others. They hoped to avoid detection with no direct connection between the insiders and the traders, and the insiders were later compensated for the inside information with cash payments made in installments to avoid any scrutiny of large cash withdrawals.
Among the ways Castelli and Grum tried to hide their illegal conduct was by compiling binders of research to serve as a false basis for their trading. They actively traded in Celgene securities to create a pattern of long-standing positions in the stock. Grum reassured Cupo that discovery of the scheme and consequent legal action was unlikely due to limited government resources to police insider trading activity. Grum said, “At the end of the day, the SEC’s got to pick their battle because they have a limited number of people and a huge number of investors to go after.”
The SEC is seeking permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, financial penalties, and officer and director bars for Lazorchak, Cupo, and Foldy. The investigation is continuing.
Bank Schemers Charged, Emergency Freeze Order Sought
The SEC charged the operators of a long-running prime bank scheme with defrauding investors who were promised sky-high returns on loans to a secret European trust. It also is seeking an emergency court order to freeze the operators’ assets for the benefit of investors.
The SEC alleges that Billy McClintock, who lives in Florida, and Dianne Alexander, a former Georgia resident who now lives in California and is also known as Linda Dianne Alexander, raised $15 million from at least 220 investors in more than 20 states, primarily Georgia. McClintock portrayed himself as the “U.S.director” of a secret European trust that had the power to create money and claimed to have appointed Alexander as a “U.S.regional director” for the trust.
According to the SEC’s complaint filed in U.S. District Court for the Northern District of Georgia, McClintock and Alexander began conducting the scheme by at least 2004 and misrepresented or omitted facts about investment risks, expected returns, and how investor funds would be used.
McClintock and Alexander led investors to believe that they could receive 38% annual interest on loans to the trust, provided they abide by the trust’s strict rules requiring secrecy. However, investor money was instead used to merely pay other investors, the hallmark of a Ponzi scheme.
The complaint charges McClintock and Alexander with violating the securities registration, broker-dealer registration, and antifraud provisions of theU.S.securities laws and a related SEC antifraud rule.
The SEC’s complaint also names as relief defendants two entities that McClintock controls—MSC Holdings USA LLC, and MSC Holdings Inc.—and another entity controlled by Alexander—MSC GA Holdings LLC. The SEC believes the three firms may have received ill-gotten assets from the fraud that should be returned to investors.
The investigation is continuing.