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Protecting Against Fraud, Mis-Appropriation And SIFMA’s Compliance & Legal Society 2020 Annual Seminar Protecting Against Fraud, Misappropriation and Other Schemes March 18, 2020 I. Introduction A. Numerous provisions of the federal securities laws require broker-dealers and investment advisers to prevent fraud by their representatives and by customers using their facilities. II. Latest Developments on Fraud Types and Trends A. SEC Priorities 1. As the SEC’s Division of Enforcement’s 2019 Annual Report reflects, last year, the SEC continued its focus on, among other things, (1) Ponzi schemes and other fraudulent conduct involving Main Street investors, and (2) cyber- related misconduct. See 2019 Annual Report – Division of Enforcement, available at https://www.sec.gov/files/enforcement-annual-report-2019.pdf (hereinafter “Annual Report”). B. Focus on Retail/Main Street Investors 1. According to the Annual Report, in fiscal year (“FY”) 2019, the Division sought to “focus its efforts on protecting retail investors,” who are “often particularly vulnerable to the conduct of bad actors in the securities markets.” Id. at 10. In light of its “retail” focus, the SEC highlighted cases it brought last year involving offering frauds, pump-and-dump schemes, and misconduct by investment advisers and broker dealers directed at individual clients in which average investors appeared to be victimized. 2. The Division’s Retail Strategy Task Force (“RSTF”), which was formed in FY 2018, further reflects the SEC’s “intertwining of retail investor protection and technological sophistication. See id. at 11. 3. In FY 2019, RSTF—“undert[ook] a number of lead-generating initiatives and swift enforcement actions built on the use of data analytics.” Id. In addition to leading the Chairman’s Teacher’s Initiative and the Military Service Members’ Initiative, “which focus enforcement and investor education resources on, respectively, teachers, and veterans and active duty military personnel,” id., it also has “strip[ped] wrongdoers of their ill-gotten gains and return[ed] funds to victims as quickly as possible.” Id. This focus has “resulted in the return of nearly $1.2 billion,” including a $1 billion in combined penalties and disgorgement from a series of actions against Woodbridge Group of Companies (“Woodbridge”) handed down in January 2019. Id.; see also Press Release 2019-3, Court Orders $1 Billion Judgment Against Operators of Woodbridge Ponzi Scheme Targeting Retail Investors (Jan. 28, 2019), available at https://www.sec.gov/news/press-release/2019-3 (hereinafter “Press Release 2019-3”). C. Focus on Cyber-Related Misconduct 1. Regarding the Enforcement Division’s continued focus on cyber-related misconduct, the Annual Report highlighted the fact that in FY 2019, the SEC brought cases involving ICOs and digital assets, securing systems against cyber threats in public companies and regulated entities, and leveraging technology to investigate unlawful trading. Id. at 12–13. For example, in SEC v. Ieremenko, filed in January 2019, the Commission brought charges against nine defendants “for their alleged roles in a scheme to hack into the SEC’s EDGAR system and extract nonpublic information for use in illegal trading.” Id. at 13; see also Press Release 2019-1, SEC Brings Charges in EDGAR Hacking Case (Jan. 15, 2019), available at https://www.sec.gov/news/press-release/2019-1. The “painstaking” case showcased “ a number of [the Commission’s] complex analytic tools and capabilities” to counteract the “technological sophistication of the perpetrators.” Annual Report at 13. III. Detecting And Preventing the Latest Schemes A. Ponzi Schemes 1. In 2013, the SEC adopted amendments to fortify governance of broker- dealer “custody practices.” See 17 C.F.R. § 240.17a-5 (2017); 17 C.F.R. § 240.17a-11 (2017); 17 C.F.R. § 249.639 (2017). Then SEC Commissioner Luis Aguilar explained in a letter, dated July 31, 2013, that the amendments were promulgated in response to the Bernie Madoff Ponzi scheme, and highlighted certain aspects of the amendments to Rule 17a-5(d). See Public Statement from Luis A. Aguilar, Commissioner, SEC, Strengthening Oversight of Broker-Dealers by Instituting a Framework to Prevent Another Madoff (July 31, 2013), https://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370539742041. a. In addition to the financial statements and supporting schedules required under the existing rule, broker-dealers would also be required to file a compliance report (or an exemption report) and a related report prepared by an independent public accountant based on the accountant’s review of the broker-dealer’s compliance or exemption report. See Broker-Dealer Reports, SEC Exchange Act Release No. 34 -70073 (July 30, 2013), 78 Fed. Reg. 51910 (Aug. 21, 2013), available at https://www.sec.gov/rules/final/2013/34- 70073.pdf. Such a compliance report would be required to contain a description of each identified material weakness in the Internal Control Over Compliance, as defined in the Rule, over the most recent fiscal year, and a description of any instance of non- compliance with Rule 15c3-1 or paragraph (e) of Rule 15c3-3 as of the end of the most recent fiscal year. Id. at 29-30. b. The goal of both the new compliance report and the related independent public accountant review of such report was to (1) focus independent public accounts on the custody practices of broker- dealers and (2) to identify control weaknesses. 2. According to the SEC’s Annual Report, for FY 2019, securities offering cases—which include cases involving Ponzi schemes—comprised 21% of the year’s enforcement actions, second only to investment advisory and investment company issues, which accounted for 36% of standalone cases. Annual Report at 15. 3. In FY 2019, the SEC was focused on bringing cases involving Ponzi Schemes targeting seniors and their retirement savings. a. As noted above, in January 2019, a federal court in Florida levied a $1 billion judgement against Woodbridge and its former owner, Robert Shapiro, for operating a Ponzi scheme that targeted retail investors. See Press Release 2019-3. The $1 billion included $892 million in disgorgement against Woodbridge and its related companies, and $100 million, $18.5 million, and $2.1 million in civil penalties, disgorgement of ill-gotten gains, and prejudgment interest, respectively, against Shapiro. The order was the culmination of the Commission’s December 2017 emergency action charging Woodbridge and the related defendants with “operating a $1.2 billion Ponzi scheme that defrauded 8,400 retailed investors nationwide, many of them seniors who had invested retirement funds.” Id. Additionally, in August 2018, charges were filed against unregistered brokers who unlawfully sold securities of Woodbridge to retail investors. SEC Press Release 2018-157, SEC Charges Unregistered Brokers Who Sold Woodbridge Securities to Main Street Investors (Aug. 20, 2018), available at https://www.sec.gov/news/press- release/2018-157. The five individuals and their companies the SEC named as Defendants in its latest Complaints were among Woodbridge’s top revenue producers, “selling more than $243 million of its unregistered securities to more than 1,600 retail investors.” Id. The SEC alleged that the Defendants “touted Woodbridge as a ‘safe and secure’ investment,” and solicited investors “at seminars and a ‘conservative retirement and income planning class’ they taught at a Florida university.” Id. According to the SEC, when Woodbridge filed for bankruptcy, “investors stopped receiving monthly interest payments and have not received a return of their investment principal.” Id. For its alleged misconduct, Woodbridge agreed to settle the liability portion of the SEC’s charges without admitting or denying the allegations and reached a resolution with the SEC and creditors in a bankruptcy action regarding the ongoing control and management of Woodbridge. Id. As of August, the SEC’s monetary claims against Woodbridge were pending, and the SEC’s investigation was still ongoing. Id. b. In November 2019, the SEC announced charges against a new York investment adviser for operating a multimillion-dollar investment club that was in fact a fraudulent Ponzi scheme. See SEC Press Release 2019-234, SEC Charges Adviser for Running Ponzi Scheme Targeting Haitian Community (Nov. 6, 2019), available at https://www.sec.gov/news/press-release/2019-234. The scheme allegedly targeted members of the Haitian community, as well as defendant Ruless Pierre’s family and friends. Id. The complaint further alleged that Pierre ran an investment club called Amongst Friends Investment Group and that from at least March 2017, he raised over $2 million from 100 or more investors. Id. Pierre was able to induce potential investors by “promising unrealistically high rates of return of at least 20 percent every 60 days,” when in fact he “incurred heavy losses trading securities and concealed them by using new investor funds to pay older investors.” Id. Moreover, the complaint posited that Pierre “fraudulently raised at least $375,000 from more than 15 investors related to a scheme involving the sale of partnership interests in a fast food franchise, with agreements that falsely guaranteed monthly returns of 10 percent plus quarterly profit sharing.” Id. Pierre was charged with violating the antifraud provisions of federal security laws, with a parallel criminal action by the U.S. Attorney’s Office for the Southern District of New York. Id. c. Also in November 2019, the SEC announced that it filed an emergency action and obtained a temporary
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