2021 Midwest Road │Suite 200 │Oak Brook, Illinois 60523
INVESTMENT FRAUD RISK EXAMINATIONS
Ponzi Schemes
Although there are numerous actual or fabricated derivations of investment products that fraudsters can utilize to perpetrate their crimes, the Ponzi scheme is the vehicle of choice by which most operate. The Ponzi scheme, the most prevalent type of investment fraud, is where investors are led to believe that a company’s success originates from profitable business operations, e.g., trading, real estate, and product sales. However, they remain unaware that other investors are the actual source of those profits. The Ponzi scheme generates returns for older investors by acquiring new investors and then uses these new funds to pay back earlier investors.
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Investing in alternative assets such as hedge funds and Regulation D private placement offerings requires much more than understanding an investment strategy. It is critical to assess business model soundness and evaluate the scope and effectiveness of firm oversight and controls. Equally important is examining the financial instruments and corresponding asset classes being examined.
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Although Ponzi schemes can reside anywhere, they tend to incubate and thrive within the alternative asset environment. Hedge funds and Regulation D private placements are complex vehicles that may invest in a diverse array of alternative assets including private equity, futures, options forex, real estate, commodities, precious metals, structured derivative products, consumer or commercial products, and even collectibles. Applying subject matter expertise to these complex financial instruments with unique payoff diagrams is a prerequisite to any investigation.
We employ several methods to identify and measure investment fraud risk that includes:
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securing legal documents, financial statements, and regulatory filings
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performing extensive background checks
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testing the quantitative validity of performance returns
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verifying the existence of client assets
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mapping the investment firm ownership structure
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evaluating sales and marketing material and client offering documents
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assessing trading procedures, internal control policies, and asset valuation and fund accounting methods
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surveying outsource service provider relationships and possible conflicts of interest
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documenting ongoing operational risk concerns and potential for fraud.
The deliverable, an Investment Fraud Risk Report presented in a one-on-one consultation, communicates a professional opinion founded on targeted information. Our report illustrates a 360-degree perspective of the investment, investment firm, principals and key employees, and outsource partners. This information promotes greater transparency and enables better decision-making giving you an advantage: the ability to act quickly and possibly reduce the chances of falling victim to investment fraud and avoiding significant losses to your finances, reputation, and legacy.
Products used in securities and investment fraud include stocks, bonds, mutual funds, pre-IPO issues, penny stocks / micro caps, promissory notes, prime bank notes, high yield bonds, futures, options, forex, precious metals, fixed and variable annuities, real estate, REITs, collectibles, structured products, Reg D private placements, managed futures accounts/funds and hedge funds.
Securities Fraud
Investment fraud Ponzi schemes can be perpetrated either by unlicensed individuals or those licensed in the financial industry. We investigate securities and commodities fraud committed by FINRA and NFA-licensed individuals holding a Series 3, 6, 7, 31, and 82 licenses and Series 65 Registered Investment Advisors (RIAs) for instances of misconduct and civil or criminal fraud. Securities and commodities fraud transpires when a licensed party (broker, financial advisor, Registered Investment Advisor) misrepresents or makes false statements during any stage of the investment process. Most instances of fraud occur during the sales process when brokers may withhold material information, divert a conversation or outright lie – using any means to downplay risk, boost profit potential, and avoid investment suitability and liquidity questions.
Other securities fraud violations involve the conduct of fiduciaries. Trustees, for example, have a fundamental obligation to provide investment advice that always acts in their clients' best interests. A breach of this duty can make the trustee liable for losses resulting from the mismanaged securities. The Cornell Law Dictionary defines fiduciary duty as “performing the highest standard of care." It means always acting in your clients’ best interest first. Fiduciaries sometimes breach their duty by recommending financial products based on commissions or as part of a soft-dollar arrangement, which may not be the best option for the client.
Examples of common regulatory violations include but are not limited to:
Breach of Fiduciary Duty
A fiduciary has been placed in a position of trust and confidence and has a duty to act in his or her clients’ best interests. Registered Investment Advisors (RIAs), trustees, attorneys, and CPAs who maintain discretionary authority over investment accounts are fiduciaries. Breaches of fiduciary duty include unsuitable investments, excessive trading, and misrepresenting investment risk.
Churning or Excessive Trading
Churning occurs when an investment advisor or broker engages in excessive trading of securities in a client’s account for the primary purpose of generating commissions.
Failure to Supervise
Brokerage firms have a duty to maintain and enforce internal policies to adequately supervise investment advisors and brokers licensed through that firm. Therefore, if an investment advisor or broker engages in misconduct, causing a client to incur financial losses, the supervising firm may also be subject to liability for allowing said misconduct to occur.
Investment Misrepresentation and Omission
Financial advisers and brokers have a duty to disclose all of the risks associated with the investments they recommend to their clients. They may misrepresent or omit material facts such as risk, fees, expenses, and liquidity to sell a particular investment.
Negligence
Investment advisor or broker negligence is any conduct that falls below the set standard of care that a reasonable, prudent person would have utilized in the same situation. If a reasonable, prudent financial advisor would have foreseen the potential for the consequences arising out of such an act and not taken reasonable steps to prevent such consequences from occurring, the act can be deemed a negligent one.
Over Concentration
When an investment advisor or broker recommends investing all or a large percentage of assets in one product or industry sector, the potential exists for excessive losses, more so than that of a more diversified portfolio.
Selling Away
Selling away is when an investment advisor or broker sells or solicits the sale of securities or financial products not held or offered by the brokerage firm with which he or she is registered or affiliated.
Unsuitable Investments
An investment advisor or broker has an obligation to know and understand his or her clients and to recommend suitable investment strategies. Investment recommendations must be consistent with the client’s expectation of returns, tolerance, and appetite for risk, and overall investment experience history. An investment may be deemed unsuitable, for example, if a client cannot incur the potential loss associated with an investment's inherent risk, or if the client was not properly educated about the risks associated with the recommended investment.
Unauthorized Trading
Unauthorized trading occurs when an investment advisor, broker, or third-party who does not have discretionary trading authority over an account place trades without obtaining the client’s prior approval.
Variable Annuity or Mutual Fund Switching
When an investment advisor or broker recommends selling out of one mutual fund or variable annuity and buying into another. This switching may be done to generate higher brokerage commissions and not necessarily be in the best interest of the client.