Robotic Regulators

1 Oct

Fifty trillion dollars worth of investment funds.  28,000 investment advisers.  Hundreds of thousandsof securities representatives.  And just one federal securities commission.  Is the Securities and Exchange Commission (SEC) adequately overseeing the securities industry?

According to the Wall Street Journal (WSJ), the House of Representatives recently introduced a bill that would basically take that job away from the SEC, and hand it over to the non-governmental Financial Industry Regulatory Authority (FINRA).[1]  FINRA is the “largest independent regulator for all securities firms doing business in the United States.”[2]  FINRA already oversees nearly 4,420 brokerage firms, 162,575 branch offices, and 629,280 registered securities representatives.[3]

Since both securities regulators already have so much overseeing to do, is there a better (and more efficient) way to regulate the securities market?  If there’s a will, there’s a way.  And the WSJ might have a way in mind.

On May 6, 2012, the WSJ released an article that discussed how investment advisers are often “being examined infrequently, inconsistently and incompletely.”[4]  Jason Zweig, a columnist for the Intelligent Investor, said the reason for the deficient examinations is due to the fact that regulators are heavily outnumbered and are still relying on outdated technology.[5]  In a world where business routinely runs on “big data,” Zweig says, “its time to put computers on the case.”[6]

Okay, let’s see the numbers.

So, last year, according to the WSJ, the SEC examined about 1,575 of the 12,600 advisers who were under its jurisdiction- that’s roughly 8%.

Additionally, there are about 5,000 advisers who have never even been audited by the SEC in the past.

Furthermore, “an adviser being examined in Los Angeles faces very different requirements than one being examined in Dallas,” says Brian Hamburger, a managing director of MarketCounsel, a firm that helps advisers comply with financial regulators.

Additionally, numerous investment advisers themselves, even commented that regulatory examiners have gone through an entire exam without verifying any sort of assets.[7]

Solution?  According to Zweig, a computer software should be developed so that advisers must upload monthly-standardized reports regarding their account values to a national data repository.  That way, once the reports have been updated, the software could then probe for inconsistencies between the reported account values and the firm’s independent records. [8]

Like Zweig, I think this solution is a good idea.  Developing such software would help keep regulators focused strictly on numbers and data, rather than on particularized factors that each regulator subjectively finds relevant.  However, I also believe that the software should only serve as a precursor for a more “humanized” analysis- that is, regulators should still look at each “red flag” on a case-by-case approach.

Yes, it’s most likely true that creating this new software might turn out to be pretty pricey.  But in the grand scheme of things, having this software can effectively serve to be a “check” on the securities industry.  Most importantly, it would serve as a step in helping us prevent scandalous investment scammers like Bernie Madoff or Raj Rajaratnam from fooling us again.

[1] Jason Zweig, Should Robots Replace Financial Regulators? The Wall Street Journal: Intelligent Investor(May 2012),

[3] Id.

[4] Should Robots, supra note at 1.

[5] Id.

[6] Id.

[7] Id.

[8] Id. 


The Dangers of Referrals From Friends and Relatives

25 Sep

The Securities and Exchange Commission (SEC) recently charged George Elia, a 67-year old South Florida investment manager, for using “affinity fraud” to target members of the gay community into an $11 million Ponzi scheme.[1]

What do I mean by affinity fraud?

Well, affinity fraud refers to investment scams that target members of identifiable groups, such as cultural or religious communities, the elderly, or various professional groups.[2]  In this case, Elia preyed upon the members of the gay community of Wilton Manors, Florida to fall for his fraudulent scheme.  According to the SEC, the reason why it’s difficult to detect an affinity scam in groups is because of the tight-knit structure that’s present in many groups.  So, when an investor gets financially-injured by being defrauded, the victims often fail to notify authorities and instead, try to work things out within their group.

That’s probably what happened to the twenty-five (25) investors who were scammed into trusting George Elia with a significant amount of their money.

According to the complaint, Elia allegedly lied to investors by claiming that he had an “extensive track record of day-trading stocks and funds that yielded annual returns as high as 26%.”[3]  He also told investors that if he could trade on their behalf, it would “result in quarterly returns of up to 20%” for them.[4]

Elia met and pitched his scheme to prospective investors over expensive meals at fancy restaurants in Fort Lauderdale, Florida.[5]  Additionally, his clients came to him through word-of mouth referrals among friends and relatives.[6]

Elia allegedly misappropriated millions of dollars of investor funds by using the money to pay for his own personal expenses, such as his mortgage and car payments.[7]  He also used the funds to pay for an “associate” to introduce him to potential investors in order to sustain his Ponzi scheme.[8]  Elia transferred at least $2.5 million into his own two companies- Elia Realty, Inc. and 212 Entertainment Club, Inc.[9]

Eric I. Bustillo, the Regional Director of the SEC’s Miami Regional Office commented, “Elia’s blatant fraud and cruel deceptions have wrecked the lives of investors and their families.  This is a sad lesson that investors must always be skeptical of claims of high and steady investment returns, even when the manager is recommended by trusted friends or members of one’s own community.”

The SEC is seeking permanent injunctions, disgorgement of Elia’s ill-gotten gains plus pre-judgment interest, and civil penalties.

So, Investors, what’s the lesson to be learned here?

Always, always, always (and I can’t stress that enough) check out the investment, the broker and the investment manager for yourself.  Because even if it’s advice from your mother, father, sister, brother, cousin, significant other, best friend, etc. – if the investment sounds to good to be true, it probably is!

[1] Securities and Exchange Commission v. George Elia, International Consultants & Investment Group Ltd. Corp., and 212 Entertainment Club, Inc. Elia Realty, Inc.,

[2] Investor Alert: Affinity Fraud,

[3] SEC v. Elia, supra note at 1

[4] Id.

[5] Id.

[6] SEC Charges South Florida Man in Investment Fraud Scheme, Public Investors Arbitration Bar Association (Apr. 2012),

[7] SEC v. Elia, supra note at 1

[8] Id.

[9] Id. 

The State of SEC Enforcement Actions After Janus Capital

8 May

During the 30th Annual Federal Securities Institute, an interesting discussion evolved regarding the recent Supreme Court decision in Janus Capital Group, Inc. v. First Derivative Traders, 113 s. Ct. 2296 (2011).[1] Specifically, the panel addressed how this decision, which limited private securities claims, may change the landscape for sec enforcement actions in private securities matters.

In the case, the Supreme Court addressed whether Janus Capital Markets, the investment advisor and administrator for – but separate legal entity of – Janus Investment Fund, was liable under Rule 10b-5 of the Exchange Act for “making” false statements in prospectuses filed by Janus Investment Fund. The Court analogized the relationship to that between a speechwriter and speaker, holding that “even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. It is the speaker who takes credit—or blame—for what is ultimately said.” Thus, even though Janus Capital Markets was involved in preparing the prospectuses, it did not “make” the statements so no statements were directly attributable to Janus Capital Markets. Rather, Janus Investment Funds was the “maker” of the statements and had ultimate authority and control over content of the statements.

Central to the Court’s decision was the interpretation of the verb “to make.” Under Section 10(b) of the Exchange Act, a person or entity is prohibited from using or employing “any manipulative or deceptive device” in contravention of SEC rules[2]. In turn, SEC Rule 10b-5(b) makes it unlawful “to make” any untrue statement of material fact or omit a material fact.[3] Prior to the Janus decision, both private litigants and the SEC operated under the understanding that any person or entity who is responsible for a company’s misstatements may be held liable under Rule 10b-5. However, in the Janus decision, the Court relied on an extremely limited reading of the verb “to make,” holding that it differs from responsibility for or input into a statement and that it is a required prerequisite for primary liability under Rule 10b-5(b).[4]

In reaching this result, the Court relied upon several principals unique to private securities litigation and not applicable to SEC enforcement actions. First, a broader reading of “make” would undermine the Court’s decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., which found that rule 10b-5 did not afford private litigants a right of action for aiding and abetting. The rationale – which is not applicable to enforcement cases  since the SEC can bring causes of action of aiding and abetting violations under Rule 10b-5 – is that a broader meaning of “make” would permit individuals and entities who provided “substantial assistance” to a statement to be liable as primary violators, even where they could not be liable as aiders and abettors.[5] Second, the Court reasoned that a different interpretation of “make” would undermine its decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. because there could be no “reliance” by investors on a statement made by Janus Capital Markets. Finally, the Court noted that despite its previous decision that Rule 10b-5 creates a private right of action, judicial concerns about creating such a right discouraged its expansion.

The discussion panel underscored the point that that company executives and representatives must now understand that they can be held liable for any documents that they sign or approve because since the Janus decision, courts are consistently finding that individuals who sign or approve documents such as financial statements or press releases “make” the statement. Specifically, the panel referenced scenarios where CFOs who signed and certified forms 10-K and 10-Q were “makers” of the statements therein.[6] The same is true for CEOs who approved press releases prior to their dissemination “made” statements under Janus, but corporate attorneys and directors who wrote the releases per the defendant’s request would not be liable as “makers” of the statements.[7]

The panel also addressed the current uncertainty regarding the extent to which Janus will apply to SEC enforcement cases. Thus far, the courts and the SEC ALJ have required Janus’s “make” requirement to be met in enforcement cases under rule 10b-5, However, the panel noted that SEC staff admitted at a recent meeting that Janus has already affected the way the SEC is charging defendants. For instance, the SEC is amending charges to replace or supplement primary violations with aiding-and-abetting or control person charges.[8] The SEC is also charging aiding-and-abetting and control person liability in lieu of primary violations, and where possible, it is alleging scheme liability under sections (a) and (c) of Rule 10b-5.[9]

In contrast to the effects on the “make” requirement, the panel noted it is less clear how Janus will affect scheme liability under Rule 10b-5 (a) and(c) and claims under section 17(a) of the Securities Act. So far, Janus has not changed the requirements for scheme liability. Prior to Janus, courts routinely found that scheme liability must be premised on more than merely false statements or omissions, and post-Janus actions appear to be consistent with this requirement. [10]

Courts are split, however, over whether Janus applies to Section 17(a) claims. The majority of courts find that Janus’ “make” requirement does not apply to Section 17(a) claims as the provision does not include the word “make”.[11] Nonetheless, SEC ALJ and S.D.N.Y. have found that the Janus rule applies to Statements under Section 17(a).[12]

Janus likely makes it harder for the SEC to prove primary liability, particularly in the case of parent, affiliate companies, or individuals who contributed but did not author documents. [13] However, unlike in the private context, the SEC can still pursue these individuals as secondary actors through aiding-and-abetting or control person theories, and because Dodd-Frank relaxed the standard in aiding-and-abetting cases, ultimately the SEC now needs only to show that the secondary actor “recklessly provided substantial assistance.” Nevertheless, Janus leaves many open issues, such as whether a parent corporation can have “ultimate authority” over a subsidiary’s statements.

[2] See 15 U.S.C. § 78j(b).

[3] Id.

[4] Janus at 12.

[5] See Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A.,  511 U.S. 164 (1994).

[6] See, e.g., SEC v. Das, 2011 U.S. Dist. Lexis 106982, *18 (D. NE. Sept. 20, 2011).

[7] See, e.g., SEC v. Carter, 2011 U.S. Dist. Lexis 136599 (N.D. Ill. Nov. 28, 2011).

[8] See, e.g. SEC v. Big Apple Consulting United States, Inc., 2011 U.S. Dist. Lexis 95390 (M.D. Fla. Aug. 25, 2011) and SEC v. Daifotis, 2011 U.S. Dist. Lexis 116631 (N.D. Cal. Oct. 7, 2011).

[9] See SEC v. Sells, CV-11-4941-HLR (N.D. Cal. Oct. 6, 2011) (alleging these defendants violated Rule 10b-5(a) and (c) by “orchestrating a scheme to defraud the investors of Hansen Medical by using undisclosed trickery to make it appear that the company had successfully sold its most expensive product when it had not actually completed the sales.”)

 [10] See SEC v. Kelly, 2011 U.S. Dist. Lexis 108805 (S.D.N.Y. Sept. 22, 2011) (dismissing securities fraud claims against AOL executives for failure to “make” a statement as required by Janus and declining to permit SEC to plead scheme liability as defendants’ conduct was not inherently deceptive, but “became deceptive only through AOL’s misstatements in its public filings,” and permitting the sec to plead scheme liability based on false statements would render Janus meaningless). See also SEC v. Mercury interactive LLC, 2011 U.S. Dist. LEXIS 134580 (N.d. ca. Nov. 22, 2011) (in declining to reconsider motion to dismiss in light of Janus, court stated it was unnecessary to decide whether defendant was “maker” of statements since facts were sufficient to plead scheme liability); SEC v. Boock, 2011 U.S. Dist. LEXIS 129673, at *5-6 (S.D.N.Y. Nov. 9, 2011) (upholding scheme liability claim following Janus where allegations were not based on misstatements but on participation in fraudulent scheme); SEC v. Landberg, 2011 U.S. Dist. LEXIS 127827, *11-12 (S.D.N.Y. Oct. 26, 2011) (dismissal not required because complaint alleges conduct beyond making of statement)

 [11] See, e.g., SEC v. Mercury Interactive LLC, 2011 U.S. Dist. LEXIS 134580 (N.D. Ca. Nov. 22, 2011); Daifotis, 2011 U.S. Dist. LEXIS 83872, at *14.

 [12] In re Flannery, SEC Admin. Proc. 3-14081 (Oct. 28, 2011) (finding that Janus test is the appropriate standard to apply in evaluating defendants’ conduct under 10(b) and 17(a), and concluding that defendants did not have ultimate authority or responsibility for documents in which alleged misstatements were made). SEC v. Kelly, 2011 U.S. Dist. LEXIS 108805, at *13-15 (applying Janus to Section 17(a) claims as the elements are essentially identical to a rule 10b-5 claim and the only purpose in enacting rule 10b-5 was to extend Section 17(a) liability to “purchasers” of securities).

 [13] See, e.g., SEC v. Daifotis, 2011 U.S. Dist. LEXIS 83872 (N.D. Ca. Aug. 1, 2011) (finding defendant did not “make” statements in advertisement that included his picture but was not otherwise attributed to him).

Madoff loses a prisonmate….Nadel dies at the age of 79

27 Apr

According to the Federal Bureau of Prisons, Athur Nadel has died at the age of 79 on Monday.  Nadel which received a 14 year sentence in 2010, was in the same correctional facility as Bernard “Berny” Madoff.  Nadel was detained at the Butner Federal Correctional Complex in North Carolina for operating an elaborate Ponzi scheme from 1999 to 2009 that cost investors close to $162 million.

Like Madoff, Nadel was a Florida fund manager who “was in his seniors years and secretly had been presiding over a long-running, monumental fraud.”  Although Madoff cost investors billions of dollars, Nadel’s scam still cost nationwide investors hundreds of millions.  Nadel’s scam consisted of 6 hedge funds that eventually collapsed when the investors demanded their money.  Along with his partners Neil and Christopher Moody (the Moodys were not criminally charged, but plead guilty to civil fraud and forfeited $42 million in payouts from the funds), Nadel told nearly 400 investors that the hedge funds were worth $330 million, when in fact the value was close to $500,000.  Nadel also represented that the funds had returns between 20.5 to 46%.

After disappearing from Sarasota, FL, Nadel turned himself in to the FBI in 2009.  He pleaded guilty to 15 federal counts and was sentenced in October 2010.  According to the U.S. Attorney of the Southern District of New York, this “mini-Madoff” used his investors’ money to finance his lavish lifestyle and “cheated victims our of their retirement and savings,” leading some to poverty.

In 2011, in a statement to the Herald-Tribune, Nadel was quoted saying:  “I did not plan a Ponzi scheme,” he said. “At the age of 70 and in poor health, I would hardly have any expectation that I would become the head of a multi-million dollar operation, and even less that it would take a crime to achieve it.”

Nadel’s former attorney, Mark Gombiner, was quoted saying that “Arthur […] took responsibility for his actions and he faced his punishment with dignity.”  Unfortunately, many of the investors that lost money after investing with Nadel and his partners, do not feel the same way that Gombiner does, nor do they feel that Nadel ever really expressed any remorse towards them.




The “Peer-to-Peer” Lending Market

25 Apr

Peer-to-peer lending, or person to person lending, allows investors to skip the bank and borrow from other people.(1) In a time when credit is hard to come by, peer-to-peer lending has become more popular. Credit card companies have been raising rates and dropping consumer rewards.(2)

Plus, lenders can look beyond credit scores and loan money to people for a variety of reasons. “If I see a person who doesn’t have a high credit rating, and who served in the military and is just getting started and maybe made some mistakes in the past—maybe they have three credit cards maxed out and they’re trying to consolidate them—I’m more apt to invest in someone like that and give them a chance to get back on their feet,” says Hoffman, a major in the U.S. Marines. (3) Hoffman also believes that peer-to-peer lending also benefits from a general lack of trust towards banks by the public. Id.

As Hoffman demonstrates, the average person can be more forgiving of a bad credit score than a bank. The lender is taking on more risk, “but if [the lender] can tolerate the uncertainty of lending money to strangers, some with spotty credit histories, [the lender] can generate returns much better than can be gotten from most government or corporate bonds” according to Joe Light of the Wall Street Journal. (4)

Peer to peer lending can be used to pay off high-interest credit-card debt, but it can be used for any number of reasons, “such as to build a swimming pool.” Id. “The main driver, the investors say: higher returns.” Id. Safe five-year U.S. Treasurys yield just 0.9%, while higher risk U.S. high-yield, or “junk,” corporate bonds, with a duration of four years, have yields of 7.33%. Conversely, three-year loans rated B1 by a company called Lending Club, “whose borrowers typically have a FICO credit score above 720, pay a 10% average annual interest rate, according to the company.” Id.

Of course, with higher yields comes more risk. The loans are unsecured, meaning there isn’t collateral for lenders to keep if the borrowers don’t pay. Id.

Since peer-to-peer companies like Prosper and Lending Club are only a few years old, some planners say they are wary of the companies’ default projections. (5) Peer-to-peer lending is a relatively new industry; peer-to-peer lending services launched in the mid-2000s. Investors should give these loans time to mature. Whether these loans continue to be successful has yet to be seen. Id. Another downside to peer-to-peer lending is lack of liquidity. It is difficult to get money back before the loans mature, notes Trevor Welch, partner with Praesideo Management LLC.(6)

Also, unlike high-yield bonds, which sometimes recover some money in the event of a default, Prosper and Lending Club loans offer investors almost no chance of recovery. (7) Fortunately there is some Security Exchange Commission oversight (“SEC”). The SEC believes these peer-to-peer companies are selling investment vehicles and therefore subject to SEC rules. (8)

The average investor should not try and go after huge returns right away. Investors should try and mitigate risk by fully researching the credit rates assigned by the peer-to-peer companies and only get the highest-quality loans. The average investor should also diversify funds across several loans. Since investors can bid with as little as $50, it not too difficult to diversify the investor’s money.(9)


5.    Id. supra note 2.
6.    Id. supra note 4.
7.    Id.
8.    Id. supra note 2.

“Bad Boys of Trading” Compared to Psychopaths?

24 Apr

What do Kweku Adoboli, UBS trader; Jerome Kerviel, Société Générale trader; and Nick Leeson, Barings Bank trader have in common?  Easy: they are all labeled as “Rogue Traders.”  Each of these rogue traders cost their respective employers billions of dollars due to illegal trading schemes.

According to a study conducted at the University of St. Gallen, a reason why these types of traders are willing to risk billions using criminal trading schemes may be because the behavior of a stockbroker “is more reckless and manipulative than that of psychopaths.”[1]  Researchers at the Swiss institute compared the behavior of psychopaths with that of 28 professional traders who took part in simulations and intelligence tests.[2]  Shocking to the researchers “was the fact that the bankers weren’t aiming for higher winnings than their comparison group, [i]nstead they were more interested in achieving a competitive advantage.”[3]  The traders main goals were to get higher returns than their competition or fellow traders.   The researchers also found that the bankers had an appetite for destruction, but they could not explain this aspect of the behavior.

According to, the profile of a rogue trader or a “bad boy of trading” is as follows:

  • the trader does not care for money, but is rather concerned with winning in the market[4];
  • the trader will start by breaking a law or take a shortcut from the required accounting steps which will result in a successful trade[5];
  • then more poor decisions are made which lead to unsuccessful trades and losses[6];
  • the trader becomes concerned with making up the losses and no longer cares about the company, clients, pay, etc[7].

Of course, not all traders act under this type of behavior.  But, this behavior does seem to be associated with most of the rogue traders that make their way into the news.  So how do we fight back against these rogue traders? Well, considering the United Kingdom has seen its fair share of “bad boys of trading,” it has become one of the world leaders in fighting back.  For example, the U.K. has created the Consumer Protection from Unfair Trading Regulations which contains more than 200 provisions and 31 types of unfair practices.[8]  Some of these unfair practices include:

  • “7. Falsely stating that a product will only be available for a very limited time, or that it will only be available on particular terms for a very limited time, in order to elicit an immediate decision and deprive consumers of sufficient opportunity or time to make an informed choice.”[9]
  • “14. Establishing, operating or promoting a pyramid promotional scheme where a consumer gives consideration for the opportunity to receive compensation that is derived primarily from the introduction of other consumers into the scheme rather than from the sale or consumption of products.”[10]
  • “26. Making persistent and unwanted solicitations by telephone, fax, e-mail or other remote media except in circumstances and to the extent justified to enforce a contractual obligation.”[11]

These regulations sound like actions that are oddly familiar and also occur in the United States.  Unfair practice #7 relates to the practice of pressuring individuals by saying they will miss out on a deal, pressure that often occurs in “free lunch seminars.”  Unfair practice #14 relates to what we call pyramid and Ponzi schemes, something that many investors have unfortunately invested in and that resulted in high losses.  Unfair practice #26 is similar to the practice of “cold calling” where persistent brokers call unsophisticated investors and apply pressure to sell investments.

The point is, as more fraudulent actions occur and as more of these rogue traders act recklessly, countries have adopted different but also quite similar regulations in order to fight all types of fraudulent trader/broker behavior.  Although this commonality has come about due to unfortunate actions, hopefully these types of regulations will act as an increasing deterrent for these types of traders.  Furthermore, it will be interesting to see if additional studies become available concerning rogue traders and whether these studies will give us further insight, as well as possible tools, to help detect and stop these individuals before they cost people and companies millions and billions of dollars.

NFL Star Falls Victim to Investment Fraud

23 Apr

Super Bowl Champion and Seven-time pro bowler Dwight Freeney is now among the many professional athletes who have fallen victims of financial fraud.  As Yahoo Finance reports, Freeney, star defensive end for the Indianapolis Colts, was scammed out of about $2.2 million by his financial adviser, Eva Weinberg.

In 2010, Weinberg, who worked as Freeney’s financial adviser for the past two years after leaving Bank of America Corp.’s Merril Lynch financial management division, reportedly wired about $2.2 million in nearly 140 separate transactions from Freeney’s bank account to a company owned by her lover, Michael Stern, without Freeney’s approval or knowledge.  According to an FBI affidavit, Stern told a confidential informant that the money was to be used to pay his bills and personal expenses.

This story comes on the heels of an initiative by FINRA and the NFL meant to curb the prevalence of investment fraud amongst NFL players.  The NFL and FINRA announced this joint venture earlier this year in order to assist incoming NFL players spot and avoid investment fraud and begin their professional careers by making informed financial decisions.  The initiative will include 60-minute presentations at scheduled events and the distribution of FINRA and NFL resources geared to teach players and their families how to choose the right financial professional and how to do a background check.

FINRA will present its Outsmarting Investment Fraud (OIF) curriculum at each of the events, a key feature of which is an explanation of the psychological persuasion tactics fraudsters use to get their victims to make emotional rather than logical investment decisions.  A version of this presentation can be ordered at  Unfortunately for Mr. Freeney, this initiative was not in place in time for him to have learned tips to avoid falling victim himself.

Some tactics scammers use include using consistent pressure, and playing up the urgency of buying a given investment product right away or making it seem as if that investment deal is scarce.  These type of tactics make an investor feel like they’ll lose out if they don’t buy now.  Scammers may also use guarantees to make you feel at ease when making an investment decision.  Looking out for these type of tactics may reduce your susceptibility to investment fraud.  In addition, an investor should always check a broker’s background before choosing him/her as an advisor.  This can be done by searching the broker’s name on FINRA BrokerCheck .  Taking these type of steps in advance can greatly reduce an investor’s chances of becoming a victim of fraud along with Freeney.