More On Legal & Compliancefrom The Advisor's Professional Library
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
Among recent enforcement actions taken by the SEC were charges against five former real estate executives for a $300 million Ponzi scheme that purported to develop five-star resorts; against a day trader who targeted ethnic groups in a high-volume trading scheme; and against a former broker-dealer executive who defrauded investors buying mortgage-backed securities (MBS).
Former Real Estate Execs Charged in $300 Million Ponzi Scheme
Investors who thought they were funding the development of five-star resorts in Florida and Las Vegas were actually being fleeced in a Ponzi scheme by five former real estate executives, according to the SEC.
According to the charges, Fred Davis Clark Jr., president and CEO; David Schwarz, chief accounting officer; Cristal Coleman, manager and sales agent; Barry Graham, sales director; and Ricky Lynn Stokes, sales director, used new investor deposits from the scheme to pay leaseback returns to earlier investors. They also helped themselves to exorbitant salaries and commissions totaling more than $30 million, and used some investor funds to buy airplanes and boats.
Beginning in 2004, Cay Clubs Resorts and Marinas, says the complaint, raised more than $300 million from nearly 1,400 investors nationwide through a network of hundreds of sales agents, marketing seminars and podcasts that touted the profitability of purchasing units at Cay Clubs resort locations.
Clark, Coleman, Graham and Stokes solicited investors and promised them guaranteed income from a guaranteed 15% return, instant equity in undervalued properties, historic appreciation, and at least $30,000 in upgrades to the units they purchased at Cay Clubs resort locations in Florida and Las Vegas. In addition, the four promised a future income stream through a rental program that Cay Clubs managed.
Also, Stokes wrote directly to potential investors, calling the leaseback payments and profits “guaranteed” and proclaiming that Cay Clubs was a “very stable financially healthy company worth BILLIONS.”
Not true. Profitability and instant equity claims were false; the purported triple-digit returns came from undisclosed insider transactions with Cay Clubs by Coleman, Graham and Stokes, not from actual returns. Those secret actions made it look as if Cay Clubs units’ values had quickly skyrocketed, but the transactions were just part of an insider flipping scheme.
The investor money went astray, into the pockets of the execs, via multiple bank accounts controlled by Clark, Coleman and Schwarz. Not just boats and planes, but precious metals and even a liquor distillery that produced, appropriately enough, Pirate’s Choice Rum were the targets of their spending. Even as it continued to advertise itself as a profitable venture, Cay Clubs began to abandon ship. Many investors’ properties went into foreclosure.
After Cay Clubs gave up the ghost in 2008, Clark and Coleman, now husband and wife, decamped to the Cayman Islands, where they continued to spend remaining assets and funnel at least $2 million to offshore accounts.
The SEC is seeking financial penalties from Clark, Coleman and Stokes, and the disgorgement of ill-gotten gains plus prejudgment interest by all five executives. The complaint also seeks injunctive relief to enjoin them from future violations of the federal securities laws as well as an accounting and an order to repatriate investor assets.
Lebanese, Druze Communities Targeted in High-Volume Trading Scheme
A Sugar Land, Texas-based day trader was charged by the SEC for targeting, in particular, investors in the Houston-area Lebanese and Druze communities in a high-frequency trading program.
Firas Hamdan was charged with defrauding investors in the trading program; he also provided those investors with falsified brokerage records that drastically overstated assets while at the same time hiding Hamdan’s huge trading losses. The SEC also seeks an emergency court order to put an end to the scheme and to freeze Hamdan’s assets and those of his firm, FAH Capital Partners.
Hamdan, according to the SEC’s complaint, is well-known in the Lebanese and Druze communities in the Houston area and is a former treasurer of the Houston branch of the American Druze Society. He took advantage of that fact by talking to friends and family in both communities about his trading program, which supposedly conducted high-frequency trading via a proprietary trading algorithm. He also asked these people to spread the word, and unfortunately they did.
Hamdan allegedly told investors that his program brought in positive returns in 59 out of 60 months between 2007 and 2012, and produced phony documentation to “prove” it. One faked statement provided to investors for Q1 of 2010 showed an opening balance of over $2.3 million, quarterly trading gains of $2.7 million and a closing balance over $5.1 million, The real statement for that period had an opening balance of $27,970.76, quarterly trading losses of $7,452.80, and a closing balance of $148,210.02.
Hamdan allegedly told numerous other lies to investors, such as claiming that a cash reserve account secured their investments, that there was a $5 million key man policy in effect, and that a Dallas-area hedge fund manager had invested $1 million with him and promised to do more. None of these things were true.
The SEC’s complaint seeks various forms of relief, including a temporary restraining order, preliminary and permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest and financial penalties.
Former Exec Charged with Defrauding Investors on MBS
Jesse Litvak, a former executive at broker-dealer Jeffries & Co., was charged by the SEC with defrauding investors on sales of MBS after the financial crisis to bring in more money for the firm.
The SEC’s complaint alleges that Litvak, formerly managing director of the MBS desk at Jeffries in the Stamford, Conn. office, was responsible for, among other things, arranging trades for customers. From 2009 to 2011, when he bought MBS from one customer and then sold them to another, he often lied about the price paid for the MBS to the purchasing customer so that he could charge more and keep the difference for the firm’s coffers. Other times, he simply created a fictional seller so that he could give the buyer a higher price on MBS from the firm’s inventory.
Among Litvak’s customers were some funds created by the U.S. government under a program designed to help strengthen the markets for MBS during the financial crisis. If those customers had known the MBS they bought could have been had for a lower price, they probably would have sought out that lower price. And since MBS have low liquidity and are tough to price, honesty in the information provided by the broker is particularly important.
Litvak’s actions not only brought in more than $2.7 million for the firm that it would not otherwise have had, but it also boosted both his standing and his bonuses, since the latter was based on how profitable his efforts were.
The SEC’s investigation is continuing, and the U.S. Attorney’s Office for the District of Connecticut has also announced criminal charges against Litvak.