12/7/2009 1

Classic Frauds Revisited

Jeffrey D. SpillDeputy Director for Enforcement

New Hampshire Department of State&

John CurrySpecial Agent In Charge

North Carolina Secretary of State

12/7/2009 2

Purpose Identify the building blocks of

classic fraud Examine six categories of schemes

that have been used on investors with great success over the years

Equip you to recognize and appropriately handle each type in the field

Building Blocks There has to be a security Check for an investment contract Does it satisfy the Howey test? Not all notes are securities, Reves

v. Ernst & Young

12/7/2009 3

12/7/2009 4

The Oldies but Goodies: Ponzi, Multi-level marketing and

Pyramids FOREX/Foreign Currency Exchange Real Estate Investments Pump & Dump Promissory/Prime Bank Notes Oil & Gas Wells, Pay Phones and

ATM’s

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Ponzi, Multi-level Marketing, and Pyramids

Ponzi – Usually involves horizontal investing and a pooling of money to the promoter

Multi-level marketing of a product of some type

Pyramids – Usually involves multi-level distribution and vertical investing

12/7/2009 6

Ponzi, Multi-level Marketing and Pyramids- How it Works

Investment Contract – SEC v. Koscot, SEC v. GlennTurner, Trivectra

Common Enterprise Horizontal Commonality, Salcer v. ML Strict Vertical Commonality, Brodt Liberal Vertical Commonality,

Villeneuve v. Business Concepts, Koscot

12/7/2009 7

Ponzi, Multi-level Marketing and Pyramids- How it Works

Solely Through the Effort of Others Promoter activities Investor activities

Koscot and Trivectra

12/7/2009 8

Multi-level Marketing, Ponzi and Pyramids

Violation of Anti-fraud Restrictions of Section 101 of the Uniform Act

Mathematical impossibility

12/7/2009 9

Forex / Foreign Currency Exchange Fraud

Latin for “Give Me Your Money”

12/7/2009 10

Forex "With a $10,000 deposit, you can make

$1,000 a month!“ Risk options:

“I can take the risk away.”

"You take only as much risk as you see fit." "Whether the stock market moves up or

down, in the currency market you will always make a profit."

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Forex Fraud Forex fraud is any fraud that

entices investors by a promise of high returns using Foreign Exchange investments

Forex con artists may or may not actually invest in Foreign Exchange

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Forex Sounds sophisticated Highly specialized Mystique attracts unsophisticated

investors Not widely understood

12/7/2009 13

Forex Fraud Foreign currency contracts may be

legitimately traded either on a recognized futures exchange or in the "interbank market," which generally involves trading between large institutions such as banks and corporations

12/7/2009 14

Forex Fraud Fraudulent currency trading firms often

tell customers that their trading is done in the "interbank market" on their behalf

Many currency traders ask customers to give them "margin," often sums in the range of $1,000 to $5,000, leveraging the investment

12/7/2009 15

Forex Fraud Margin trading can make investors

responsible for dollar losses that greatly exceed the margin amount they deposited

The victims of these frauds are actually being sold a position in a currency forwards market which is both completely unregulated and provides no guarantee that the promoter has secured the forward position in the traded currency

12/7/2009 16

Forex Fraud Up to 50% commission on each deal Deceptive, misleading and high-

pressured sales solicitations  Failure to supervise employees and

agents in the conduct of their commodity futures activities

Churning accounts

12/7/2009 17

Forex Fraud

Representatives unregistered Misrepresent the likelihood of loss Misrepresent the risk Huge losses by investors

12/7/2009 18

Real Estate Investments

(Swamp) Land in Florida !

12/7/2009 19

Real Estate Investments- How it Works Investments sold in real estate portfolios

or funds for property development Often properties are overseas or otherwise

difficult for investors to verify Real estate holdings are non-existent or

grossly overstated High returns promised. Initially may be

realized Ponzi-style as large numbers of investors are recruited

12/7/2009 20

Real Estate Investments- Investigation I

Examine claims made in sales material: What assets are actually held?What investments were actually

made?

Court house record checks: Who owns the property now?

12/7/2009 21

Real Estate Investments- Investigation II

What real efforts were made to develop the property as advertised?

Permits applied for, inspections done?

12/7/2009 22

Pump & Dump

“What goes up, must…”

12/7/2009 23

Pump & Dump- How it Works I Usually Involves Microcap Stocks

Requires Market Manipulation: Dissemination of false

information Use of the Internet Use of e-mail and telephone

12/7/2009 24

Pump & Dump- How it Works II Motivators for investment: “Medical Breakthroughs” Phony Consumer Demand On-line Businesses Phony RE Projects Phony Mergers and Acquisitions

12/7/2009 25

Pump & Dump- How it Works III Involves Multiple Players: Dealmakers Boiler Rooms Sales Promoters Traders

Find The Source

12/7/2009 26

Promissory Note Fraud

Promising & Delivering High Interest, Commissions and

Losses !

12/7/2009 27

How It Works I Often a fictitious business

promotion The con artist hires a marketing

firm to develop a flashy sales program

The con artist hold seminars to entice insurance agents to join a network of sellers

Interest rates are very attractive

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How It Works II Investments are marketed as safe

with guaranteed yields Initial investors begin receiving

high monthly interest payments More investors are recruited based

on early results Everyone is happy, briefly

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How It Works III At the end of the initial investment

period, investors happily rollover Agents are happily receiving big

commissions Eventually new investors dry up Money runs out and the company

offering the notes disappears

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Investigation I Is the seller registered to sell

securities? Follow the money trail – get bank

records Where do the proceeds of the notes

go? Who is paying the “interest”? Is there really a legitimate business?

12/7/2009 31

Investigation II Where are they located? Are they licensed?

12/7/2009 32

Oil & Gas, Pay Phones and ATM’s

No, not like at your convenience store…

12/7/2009 33

Oil & Gas Wells- How it works Company sells shares of specific wells

to be drilled If successful, the investor will get a

share of the sale of oil and natural gas from that well for the life of well

Affinity fraud- increasing U.S. oil production and decreasing foreign dependence is appealing to many investors

12/7/2009 34

Oil & Gas- Investigation I When it fails- Is it Fraud or just bad luck? Contact state regulatory agency:No permit sought= willful intentIf company is drilling or has other wells

already operating, was investors money misused in completing/operating these?

State agency employees often know facts and hear rumors (leads) from the field

12/7/2009 35

Oil & Gas- Investigation II Check advertising for outrageous

claims and promises, Internet and blogs also.

Examine bank records for inappropriate expenditures and outright theft.

12/7/2009 36

Pay Phones & ATM’s- How it Works I “Investment Contracts” are sold, often

for more hardware than is ever purchased

Lease payments & “buy backs” offered Guarantees make third party

management the only option Not a viable business

Poorly/superficially managed Not profitable

12/7/2009 37

Pay Phones & ATM’s- How it Works II False Promises made:

“Agreements in place to put ATM’s in all Las Vegas casinos”

18% return each month “Can’t lose”

In Ponzi fashion, early investors paid

with funds from subsequent investors

12/7/2009 38

Pay Phones and ATM’s- Investigation Obtain records of hardware sales

from manufacturers Obtain installation, activation and

phone company billing records Obtain bank and business records Interview employees Locate & inventory assets

12/7/2009 39

General Investigative Issues-I

Gather all paper and read it carefully

Check registrations Interview victims thoroughly Talk to the seller/promoter

12/7/2009 40

General Investigative Issues-II

Internet searches may disclose action taken in other jurisdictions

Use NWCCC data searches surgically

“Cast your nets broadly” when seeking information sources, witnesses and physical and financial evidence

12/7/2009 41

General Investigative Issues III

Follow the money – where did it come from and where did it really go?

Good relationships help detail oriented Investigators!

12/7/2009 42

Take Action

Cease and Desist Order/TRO Other Administrative or Civil

Actions Seizure of Assets/ Appointment of Receiver Criminal Prosecution

12/7/2009 43

Classic Frauds Revisited

Thank you for attending-

Classic Frauds Revisited !