R. Allen Stanford’s conviction for running a $7 billion Ponzi scheme is yet another reminder that investors need to keep their guard up when presented with investment opportunities that sound too good to be true.

Stanford was accused of defrauding some 30,000 investors from 113 countries over the course of 20 years with bogus certificates of deposit sold by his bank inAntigua. According to prosecutors, investors thought their funds were being invested into safe and conservative assets when in actuality their money was used to fund risky businesses, as well as Stanford’s lavish lifestyle.

Financial frauds like Stanford’s are far from a rarity. Fraud complaints to the Federal Trade Commission (FTC) have quadrupled during the past decade and are up 35% in the past three years alone, according to The Rise of Financial Fraud, from the Center for Retirement Research atBoston College. It’s likely, however, that financial fraud is much more pervasive in that it often goes unreported to authorities.

The elderly are particularly vulnerable to financial fraud. Many individuals who become victims suffer from dementia or are desperate to find ways to recoup the financial losses they suffered during the 2008 market downturn.

The Boston College report includes a list of red flags regarding potential financial fraud schemes, including investments that sound too good to be true, financial products that supposedly guarantee high rates of return but little risk, and proposals that include the “free-lunch” seminar.

A Feb. 29 article by CBS Money Watch reminds investors that when presented with a financial opportunity or proposal to be aware of the rates of return that are available with different types of investments. As of March 2, the Board of Governors of the Federal Reserve System shows these rates of return as the following:

– 0.52% for six-month CDs;
– Under 1% for Treasuries with durations of five years or less;
– Returns of 1.97% for 10-year Treasuries and 2.74% for 20-year Treasuries;
– 3.82% and 5.08% returns for corporate bonds, depending on the bond’s duration and quality; and
– Returns of 3.72% for state and local municipal bonds.

The Securities and Exchange Commission (SEC) wants investors who were scammed by R. Allen Stanford in a $7 billion fraud scheme to be treated as brokerage customers by the Securities Investor Protection Corporation (SIPC). If that happens, investors would stand a chance of getting some of their money back.

The SIPC works as an insurance fund, and is backed by member brokerages. While it isn’t designed to cover investment losses, it is supposed to provide a measure of protection for investors in the event that their brokerage goes bankrupt or fails because of alleged fraud. The protection amounts up to $500,000 per customer.

In the Stanford case, the SIPC has been unwilling to pay up, even though the SEC told it to do just that more than two years ago. The SIPC, however, says the protection provided to investors does not apply to those who were bilked by Stanford because the bogus certificates of deposit they bought were sold through Stanford’s bank in Antigua, rather than being held by the brokerage.

That technicality was the subject of a March 7 congressional hearing, in which legal analysts and lawmakers offered their thoughts on the issue, along with recommendations for improving the SIPC.

 

It’s an idea that may be long overdue following the recent rash of Ponzi schemes and failed private placement deals: Revisiting the protections afforded to investors by the Securities Investor Protection Corporation (SIPC).

The SIPC, which is the public corporation charged with aiding victims when their brokerages fail or file bankruptcy, took center stage on March 7 at a Congressional hearing titled The Securities Investor Protection Corporation: Past, Present, and Future.

Steven Caruso, a partner with Maddox, Hargett and Caruso, P.C. testified at the hearing. His recommendations for improving the SIPC include increasing investor protection from $500,000 to $1.3 million and indexing that amount to the rate of inflation moving forward.

Currently, brokers pay an annual premium to fund the SIPC. Should SIPC coverage be expanded in the future, however, these same brokers may be tapped for additional funds.

Proponents of the idea say it enhances accountability, forcing brokers to improve their due diligence of the products and investments they market and sell to clients.

During the March 7 hearing, Caruso also suggested that investment advisers and brokers/dealers be required to purchase insurance given that they are entrusted with billions of dollars in investment funds.

“There is no free lunch in this world,” Caruso said in a March 7 Investment News article.

“When we have a fiduciary who is out there as an investment professional, requiring insurance will go a long way to helping potential [fraud] victims.”

Investors whose portfolios have taken a hit recently might not be too keen to open their account statements. Bad move, according to the Financial Industry Regulatory Authority (FINRA). Instead, the self-regulator cautions investors to review their statements carefully and immediately contact the firm issuing their account statement about any unexplained fees, overcharges or unauthorized transactions.

“A single keystroke can make the difference between 100 and 1,000 shares,” says Gerri Walsh, FINRA’s Vice President for Investor Education.

On Feb. 23, FINRA issued a new Investor Alert titled It Pays to Understand Your Brokerage Account Statements and Trade Confirmations that details in plain language key elements of customer account statements, plus “red flags” that can help investors spot and avert problems.

The Securities and Exchange Commission (SEC) also is taking up the subject of unauthorized trading. On Feb. 27, it issued a risk alert outlining preventative measures to help brokerages improve their policing of authorized trades.

The collapse of Medical Capital Holdings has led to numerous lawsuits and arbitration complaints by investors against the brokerages that failed to perform their due diligence before selling them private-placement investments in the troubled company. Now, for what is believed to be a first, an individual has been criminally charged with securities fraud for his role in selling Med Cap notes.

Nine counts of securities fraud were filed Feb. 23 by the Weld County District Attorney’s Office against John Brady Guyette. According to the Weld County complaint, the former Colorado stockbroker sold $1.3 million of Medical Capital investments to investors between August and December 2008. During that time, Medical Capital was showing signs trouble and had already missed several payments to investors in certain note offerings.

As reported Feb. 27 by Investment News, the focus of the complaint against Guyette concerns allegations that he sold Medical Capital notes to investors after the company failed to make payments to investors.

One of those investors is Lucille Linde, 92, who lost her life savings in Medical Capital investments. She began investing in Medical Capital and with Guyette in 2005. Three years later, in August 2008, she invested $300,000 in Medical Capital VI, says the Investment News article.

“Linde reported that prior to writing the checks on Aug. 15, 2008, [she] had been told by a fellow MedCap investor, Borge Villemsun, that MedCap had been late in making principal and interest payments to [him],” the complaint reads. “Linde reported confronting [Mr. Guyette] with this information. Linde reported that [Mr. Guyette] assured [her] that Villemsun had been paid and that the MedCap VI investment was guaranteed safe.

“Linde was not aware that when [she] wrote the checks on Aug. 15, 2008, MedCap II had failed to make principal and/or interest payments due to MedCap II investors. [Mr. Guyette] failed to disclose this information to Linde.”

The Securities and Exchange Commission (SEC) filed fraud charges against Tustin-based Medical Capital Holdings in 2009, freezing its assets and appointing a receiver to oversee its financial books. A number of independent broker/dealers subsequently came under fire from regulators for failing to disclose key information about Medical Capital to investors.

Securities America was the independent broker/dealer subsidiary of Ameriprise. It was one of the broker/dealers of Medical Capital Investments, selling some $700 million of the private placements. In August 2011, the B-D was acquired by Ladenburg Thalmann Financial Services Inc. for a reported $150 million in cash.

Complaints involving tenants-in-common (TIC) real estate investments are on the rise, as more disgruntled investors come forth with a laundry list of allegations – including inadequate pre-sale due diligence – against the broker/dealers and brokerage firms that recommended their investments.

TIC investments, or 1031 exchanges, are a form of real estate ownership in which two or more parties own fractional interests in a property. In the early 2000s, TICs entered into a new wave of popularity after a 2002 tax-code change allowed investors to defer capital gains on real estate transactions involving an exchange of properties.

Toward the end of 2008, however, the real estate market became mired in a full-blown crash, and TIC investments felt the effects. One of the biggest distributors of TICs, DBSI, Inc., filed for bankruptcy. Prior to becoming insolvent, investors in all 50 states had put approximately $1 billion into DBSI’s TIC investments.

Subsequent investigations into DBSI’s financials revealed that the company had begun to experience major liquidity issues beginning as early as 2004. By 2006, DBSI’s cash shortages had worsened considerably, prompting it to allegedly create fraudulent investment and tax structures as part of a $500 million fund to buy new properties and attract new investors.

DBSI would later fail to pay investors their dividends out of legitimate rents from the new properties; instead, it allegedly issued payments from profits made by marking up various properties and then selling them at inflated prices to unsuspecting investors. Many of these investors were introduced to DBSI by their broker/dealer.

Today, DBSI investors are filing arbitration claims against various broker/dealers for misrepresenting DBSI and failing to perform their required due diligence before recommending the investment to them.

Brokerage firms are obligated to perform certain duties for their clients. This includes researching a company whose investments they are marketing and selling and thoroughly investigating that company’s fiscal stability. Brokers also are required to inform their clients about an investment’s specific risks and other features, as well as ensure that the product they recommend is indeed suitable for the client’s investing objectives and risk tolerance.

In the case of DBSI, that didn’t happen. Stu Newman had begun to suspect that all was not right with his DBSI investment back in 2007. According to a 2009 article by the Orange County Register, Newman initially became suspicious about DBSI because of its unusually brief and poorly composed quarterly reports. When he and another DBSI investor later shared notes, neither could determine exactly how DBSI paid its investors.

“I was convinced that the only way they kept this going is by selling (to new investors),” Newman said in the article.

Future lawsuits and investigations would come to the same conclusion.

“About the only difference between Douglas Swenson and Bernard Madoff is a decimal point,” Newman says.

DBSI Inc., once a heavy hitter in the world of tenant-in-common investments, continues to make headlines in the wake of its bankruptcy filing. In addition to an ongoing criminal probe, DBSI founder and CEO Doug Swenson may be looking at charges of tax evasion, money laundering, racketeering and securities fraud.

TICs in general experienced a number of financial woes following the downturn in the real estate market, but in the case of DBSI, the problem may have more to do with deception rather than economics.

At least that’s what many of the thousands of investors who put their money into DBSI believe. Now it appears some high-ranking officials, including Idaho’s Attorney General, the Internal Revenue Service and the FBI, may share their opinion.

The court-appointed examiner in DBSI’s bankruptcy case, James Zazzali, stated in a 264-page report that DBSI executives ran “an elaborate shell game,” one that included improper and fraudulent use of investor money to prop up the company, to spend on pet projects and to enrich themselves.

DBSI filed for Chapter 11 bankruptcy protection in November 2008. At the time, it held more than $2 billion in property nationwide and managed other assets worth more than $2.65 billion.

Many of DBSI’s 10,000-plus investors lost their life savings when DBSI filed for bankruptcy, while others took huge, life-changing financial hits. Bill Marvel invested $3.5 million into DBSI buildings. After the firm’s bankruptcy, Marvel lost three buildings to foreclosure, and expects to lose a fourth. Out of his initial $3.5 million investment, Marvel expects to hold onto only about $500,000, according to a Feb. 9 Idaho Statesman article.

Then there’s DBSI investors like Barb Korducki, who is still trying to pick up the pieces from her doomed investment foray in DBSI properties.

“I was told that DBSI had made profits for all of their investors, year over year, for over 20 years. Like most owners, I sold a rental (owned before marriage) and put all the proceeds into a building.  Three years after the bankruptcy, we are still plagued with attorney bills.  Though we have never missed a payment, our loan has been turned over to a special servicer, who continues to make unreasonable demands.  He has added thousands of dollars in attorney fees and hotel stays.  It is like a never ending nightmare,” she says.

Once a booming industry, tenant-in-commons (TICs) have become mangled in controversy – not to mention litigation as more investors come forth with allegations of misrepresentation and fraud.

TICs are complex investments to begin with, and their private-placement memorandums do little to make them less confusing. Too often, the information on a TIC is so mired in hard-to-understand jargon that investors unknowingly set themselves up for potential problems down the road.

A tenant in common, or 1031 exchange, enables investors to own a fraction of a single real estate property. In return, tenant in common investors receive a monthly income, plus the ability to defer capital gains on real estate transactions involving the exchange of properties. The TIC industry experienced a significant boost in popularity during the years of 2002 to 2007. Investors bought $13 billion worth of TICs between 2004 and 2008, according to OMNI Real Estate Services of Salt Lake City.

Then, in late 2008, things began to unravel for the TIC world with the burst of the real estate bubble. TIC investors quickly saw the value of their properties plummet, and two leading TIC players – DBSI and Sunwest Management – sought bankruptcy protection after several of their deals went south. Investors in those deals were left with plenty of questions and, for some, the loss of their life savings. Many investors have gone on to file complaints with the Financial Industry Regulatory Authority (FINRA).

As reported Feb. 19 by Investment News, investors have, in fact, filed arbitration claims with FINRA for $12.6 million in cases involving direct broker/dealer sales of TIC deals from DBSI. Since June 2010, arbitration panels have awarded investors $4.8 million in those cases.

LPL Financial LLC also has had to face the music regarding TIC deals gone bad. On Feb. 10, a FINRA arbitration panel awarded an elderly California couple $1.4 million in a case involving two LPL real estate deals.

Investor complaints over TICs focus on a number of issues, including allegations that they were misinformed from the start by their broker/dealer about their TIC investment. Many TIC investors had no previous investment experience before getting into a TIC. Moreover, several contend they repeatedly told their financial advisor that their appetite for risk was in the “conservative” range and that their investment objective was to “generate income.”

Those characteristics do not describe a TIC. Unfortunately a few unscrupulous brokers used their clients’ lack of investing sophistication for their own personal gain.

An elderly couple has been awarded $1.4 million by an arbitration panel of the Financial Industry Regulatory Authority (FINRA) in a claim involving sales of two tenant-in-common exchanges (TICs). The TICs were sold by former LPL broker David Glenn. The investors, Heinrich and Araceli Hardt, have gone on to file a separate lawsuit against the sponsor of the two TICs, Direct Invest LLC.

The award contained several allegations by the Hardts, including federal securities fraud and elder abuse.

A TIC is an investment in real estate whereby two or more parties own a fractional interest in a particular property. In 2002, TICs discovered new-found popularity after a change in an Internal Revenue Service ruling gave investors the ability to defer capital gains on real estate transactions involving an exchange of properties.

Turmoil in the economy has caused financial issues for several TICs and their sponsors in recent years. One leading TIC sponsor, DBSI Inc., filed bankruptcy protection in 2008. Since then, a number of broker/dealers involved in DBSI deals have found themselves at the center of arbitration complaints filed by investors.

In the Hardts’ case, the broker behind the TICs left LPL in 2010; he is now affiliated with United Planners’ Financial Services of America, according to a Feb. 14 article by Investment News.

“When these deals were structured, they used tricks,” stated the attorney representing the Hardts in the Investment News article. “A euphemism known as a “yield enhancement” for the TICs relied on “borrowed money” and “returning investors’ money back to them.”

The two TICs in question apparently produced distributions for only a couple of years. By the end of 2009, the Hardts say they stopped receiving payments on both of their TIC investments.

According to the lawsuit, documents for the private-placement offerings by the sponsor, Direct Invest, “contain multiple false and misleading statements regarding the strength and experience of the manager and property manager, the stability of the cash flows, the potential for appreciation, the superiority of the location, the nature and strength of current projected conditions for the greater Boston office market, the strength of the leases and their corresponding projections, the building fundamentals, the use of proceeds, and the purchase price in relation to the replacement cost.”