SECURITIES LAWS:SECURITIES LAWS:

Using Financial Investigation Using Financial Investigation ToolsTools

to Ferret Out Investment Fraud:to Ferret Out Investment Fraud:

International Association of Financial Crimes Investigators

Wayne KleinSeptember 9, 2010

Las Vegas

Spotting Fraud:Spotting Fraud:How does one distinguish a

legitimate investment from a fraud scheme?

Is it based on:◦The promised rate of return?◦The topic of the investment?◦Who is selling the investment?◦The documents provided to investors?

Examples.

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NASDAQ Rises 85.6% in NASDAQ Rises 85.6% in 1999:1999:

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Wall Street legend Wall Street legend Bernard Madoff Bernard Madoff arrested over '$50 arrested over '$50 billion Ponzi scheme'billion Ponzi scheme'

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Sample Solicitation:Sample Solicitation:

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The Power of The Power of Compounding:Compounding:

While earning 15% in one month is possible in commodities markets, doing so consistently is impossible – but profitable:◦After 2 years, the $10,000 becomes

$109,000.◦After 4 years, account is worth $1.2 million.◦After 6 years, $13.2 million.◦After 8 years, $145 million.◦After 10 years, $1.5 billion.◦After 12 years, $17.5 billion.

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Objectives of Securities Objectives of Securities Laws:Laws:The purpose of the securities laws

is to distinguish legitimate investment opportunities from fraud schemes.

“Trip wires” are laid out to catch violators, including those who violate the law ignorantly.

The law creates “safe harbors” for honest, legitimate investment programs.

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Separating Sheep from Separating Sheep from Wolves:Wolves:

While securities laws cover many types of transactions and can be complex, they contain three basic requirements:

Securities must be registered before sold;Sellers (stockbrokers) must be licensed;All relevant information must be disclosed.

◦Sellers must verify marketing information◦False statements are crimes◦Not disclosing negative information is a crime◦Caveat vendor, not caveat emptor.

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What Must be Disclosed?What Must be Disclosed?The prospectus must disclose:

◦Financial information about the company;◦How it will use the money raised;◦Background of company management;◦The success of prior ventures;◦Negative information such as criminal

records, bankruptcies, outstanding liens, judgments.

◦Risk factors associated with the investment.

Disclosure is where the fraud occurs:◦Fraud promoters must lie to sell the deal.

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What is a “Security”?What is a “Security”?Securities come in many forms:

◦Stocks, bonds, warrants◦Options◦Profit sharing agreements◦Evidence of indebtedness◦Notes, including many promissory notes◦Interest in oil and gas leases◦“Investment contract” securities

These can all be legitimate or can be used as the basis for fraud schemes.

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Investment Contract:Investment Contract:An investment contract exists

whenever a investor gives her money to another, expecting the other to turn a profit.◦Investor must be “passive”◦Most unusual investment scams are

proven using “investment contract” analysis. These are often called “exotic securities.”

Real estate example11

Examples of Securities Examples of Securities Schemes:Schemes:Ostrich farms“Cleopatra’s Secret”Gold mining

venturesOil drilling programsAdvance fee

schemesPrime bank schemesWine futures,

whiskey receiptsReal estate

Pay telephones“Blind pools”Foreign exchangeManaged

commodity accounts

“Black box” inventions

Medical discoveries

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Fraud techniques:Fraud techniques:Affinity fraud“Guaranteed,” no risk, high returnHigh pressure, cold callingAvoid taxes, or “IRA Approved”Bogus “credentials,” senior

designationsOnline pitchesFree lunch seminars“Off the books,” special, or private

deals“Headline” investments

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Fraud by Licensed Fraud by Licensed Brokers:Brokers:Fraud sometimes is perpetrated

by licensed firms:◦Boiler rooms◦Penny stocks, pump and dump

schemes◦Churning◦Unsuitable recommendations◦“Selling away”◦Manipulation◦Claims of insider information◦Refusal to sell manipulated stocks 14

Investigative Techniques:Investigative Techniques:Investigating securities fraud can be a lot

of fun. Techniques might include:◦Calling promoter, posing as potential investors◦Attending presentations◦Signing up for free offers, get phone pitches,

mail◦Surprise audits◦Recording sales pitches

This can be by the investigator or investors

◦Raiding boiler rooms◦Task force emphasis on certain types of

schemes15

Investigative Tools:Investigative Tools:An audit trail can almost always be

created from existing records.◦Even if the crook destroys records, bank and

investor documents can make the case.Regulatory databases contain

significant information about licensees.Regulators conduct on-site

examinations of firms to gather information.

Regulators can provide funding.Exceptional remedies may be available.

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Remedies Available:Remedies Available:Criminal:

◦Prison, finesAdministrative:

◦License revocation, cease & desist order, fines

Civil:◦Injunction, restraining order◦Appoint a receiver, conservator◦Disgorgement, rescission, fine◦Order removing officers, barring role in

future securities offerings or public company. 17

Special Advantages of Special Advantages of Securities Prosecutions:Securities Prosecutions:

Prosecutors have some unique advantages when trying securities cases:

Longer statutes of limitations:◦Generally five years – longer than other frauds.

Strict liability:◦Need not prove intent or injury.

Can show prior bad acts:◦Prosecutors can introduce evidence of prior

convictions, liens, bankruptcies, etc.Offers alone are illegal; don’t need actual

saleConvictions are won using only

documents. 18

Who Regulates and Who Regulates and Prosecutes?Prosecutes? State Securities Laws

◦ Each state has a securities law, regulatory agency

Reviews local offerings, licenses brokers, enforcement◦ State/local prosecutors bring criminal cases

Federal Securities Laws◦ SEC regulates exchanges, offerings;

enforcement◦ FINRA (formerly NASD) licenses brokers◦ FBI investigates, US Attorneys prosecute

Federal Commodities Laws◦ CFTC regulates exchanges, brings enforcement◦ National Futures Association licenses brokers◦ FBI investigates and US Attorneys prosecute

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Penalties Used to be Penalties Used to be Stronger!Stronger!In 1420, a man named Prelati said the devil told him where gold ingots were buried. He required believers to give him hearts of young children. Convicted of sorcery and sodomy, he was burned alive – his ashes scattered to the wind.

Pietro d’Apone was born in 1250. He claimed alchemy skills. But, he died in prison during his trial. The trial continued. He was found guilty, so they dug up his bones and publicly burned them.

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Investors Used to be Investors Used to be Smarter:Smarter:A man named Augerello was born in Italy in 1441. He claimed to be able to turn lead into gold.

When he asked Pope Leo X for a reward for his discovery, the pope:◦“with great ceremony and much

apparent kindness and cordiality, drew an empty purse from his pocket and presented it to the alchymist, saying that since he was able to make gold, the most appropriate present that could be made him, was a purse to put it in.”

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Wayne Klein

Klein & Associates, PLLC

_____

299 South Main, Suite 1300

Salt Lake City, UT 84111

(801) 534-4455

(801) 824-9616 (cell)

wklein@kleinutah.com

Klein & Associates is a forensic accounting and litigation consulting firm providing :◦ Receivership services, ◦ Forensic accounting,◦ Due diligence, internal

investigations,◦ Specialized subject-

matter expertise in securities, and commodities, and

◦ Expert witness services.

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