Proposed Legislation Will Allow CFTC and SEC to Regulate Derivatives Market

A few years ago, I wrote an article entitled Controlling a Financial Jurassic Park which analyzed the unregulated Forex market, derivative trades, and fraud. The article discussed the cause of Forex derivatives fraud, its rampant increase in the last 10 years, and recommended proposed legislation to regulate and prevent fraud in the Forex derivatives market. One recommendation was for Congress to provide the Commodity Futures Trading Commission(CFTC) and the Securities & Exchange Commission (SEC) expanded authority under the Commodities Exchange Act and the Securities Exchange Act to aggressively regulate and prosecute derivative traders that defraud the public.

Imagine my elation when the Obama administration formally proposed legislation to regulate derivatives. The administration proposed that most derivatives should be traded on regulated exchanges similar to the way stocks and bonds are currently traded. The legislation also proposed tightening the banking regulations that inter-connect with the proposed derivative trading regulations. Additionally, the SEC, the CFTC and the banking regulatory agencies would share responsibility for oversight of the derivatives market. Shared regulation is a crucial element for preventing fraud in the market. As various federal agencies work through complex and sophisticated derivative transactions their shared analysis will allow for a better understanding of the transactions, and will create a better synergy to prevent fraud in the future.

AFFINITY FRAUD: INVESTOR BEWARE!!!

Affinity Fraud: A Major Problem that the General Public Knows Little About

With the large downtick in the economy, there has been a noticeable uptick in fraudulent activity. INVESTOR BEWARE!!! Recently, Securities and Exchange Commission (“SEC”) Commissioner Luis Aguilar delivered a speech in Atlanta on May 28, 2009, at the Third Annual Fraud and Forensic Accounting Education Conference where he talked about fraud at home and abroad. Commissioner Aguilar spent time in his speech talking about affinity fraud and Bernie Madoff’s Ponzi Scheme. When you utter the words “affinity fraud” to most members of the general public you undoubtedly draw a blank and a puzzled expression. What is affinity fraud? Well, affinity fraud is the name given to a fraudulent scheme that targets members of a specific demographic. Victims of affinity fraud are often targeted because of their race, ethnicity, age, class, gender, national origin, religion, immigrant status, social, cultural, or professional affiliations. Affinity fraud organizers portray themselves as members of the targeted group or as individuals who can relate to members of the group in order to garner the group member’s trust and money.

Peeling back the layers, Ponzi and Pyramid schemes often exhibit elements of affinity fraud in that a particular demographic is targeted and victimized. A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to the investor. The Ponzi scheme generates returns for old investors by acquiring new investors. Eventually, Ponzi schemes collapse when new investors can no longer be acquired. A Pyramid scheme is an illegal investment scam based on a hierarchical setup. “New recruits make up the base of the pyramid and provide funding, or so-called returns, given to the earlier investors/recruits above them.”

The dialogue in an affinity fraud scheme is often basic. “You can trust me because I’m African-American just like you,” the scam artist will often say. The affinity label or demographic identification can go on and on and on. “I’m a Baptist like you.” “I’m a member of your fraternity.” “You know you can trust me because I’m elderly like yourself.” I think you get the picture. The scam artist will conclude by saying “because we share the same experience and background invest your money with me, I’ll get you a fabulous return.”

Affinity fraud has become such a large problem that recently the SEC publicized the problem in a publication designed to educate the public. Affinity fraud is on the radar screen of state regulators, securities and corporate commissions, and attorneys general. Indeed, affinity fraud schemes have been uncovered in Canada, Australia, and New Zealand and throughout the world.

Bernie Madoff and Affinity Fraud

In recent months, unless you have been living under a rock, or lived on a deserted island as a result of a plane crash, we have all heard the name Bernard “Bernie” Madoff at least mentioned and discussed. One thing is certain: Bernie Madoff will live in infamy!!! Usually, in legal circles we lament the leniency of white collar crime sentences. In June, Bernie Madoff was sentenced to 150 years in prison. This month, Madoff was moved to a federal prison in North Carolina, to serve his sentence for his part in a $50 billion Ponzi scheme. This represented an extremely harsh and unprecedented sentence for a white collar crime. United States District Court Judge Denny Chin had no remorse for the 71 year-old Madoff, and balked at the 12 year sentence suggested by Madoff’s lawyers based on his age. Perhaps this time for a white collar criminal, the time fit the crime.

Madoff’s “client” or “victim” list ran over 160 pages in length and included over 13,500 names. The Madoff scandal amounts to “…a $50 billion Ponzi scheme that preyed heavily on fellow Jews and ultimately drained the fortunes of numerous Jewish charities and institutions.” One important factor lost in the Madoff scandal is how he used his religious affiliation and background to target other Jews who trusted him. In some ways, Madoff exploited his religion to extend his fraudulent scheme.

Examples of Recent Affinity Fraud Schemes Investigated by the SEC

A selected group of recent affinity fraud schemes uncovered by the SEC include the following:

Ponzi scheme solicited elderly members of Jehovah’s Witnesses congregations
The SEC complaint alleges that the defendants operated a Ponzi scheme and used investor funds to pay lavish personal expenses. The defendants raised over $16 million from more than 190 investors nationwide. Many of the victims were elderly members of Jehovah’s Witnesses congregations and were promised returns of up to 75 percent.

Ponzi scheme targeted African-Americans and Christians
Defendants perpetrated an affinity fraud, raising at least $16.5 million from mostly African-Americans and Christians by falsely representing they would receive returns through investments in, among other things, real estate, small businesses, and "markets of the world."

"Church Funding Project" costs faithful investors over $3 Million
This nationwide scheme primarily targeted African-American churches and raised at least $3 million from over 1000 investing churches located throughout the United States. Believing they would receive large sums of money from the investments, many of the church victims committed to building projects, acquired new debt, spent building funds, and contracted with builders.

125 members of various Christian churches lose $7.4 million
The fraudsters allegedly sold members non-existent "prime bank" trading programs by using a sales pitch heavily laden with Biblical references and by enlisting members of the church communities to unwittingly spread the word about the bogus investment.

Practical Advice on How to Avoid Affinity Fraud

Often, regulators and governmental authorities move in too late to protect the general public from affinity fraud. The Madoff scandal is a prime example of the late and ineffectual policing of affinity fraud schemes on the part of governmental actors. Ironically, the SEC thought it was important to educate the public about affinity fraud; but ignored or failed to investigate concrete allegations against Madoff that had been brought to the SEC’s attention months and years before the Madoff scandal became public knowledge. The government can’t always help you avoid affinity fraud. YOU MUST PROTECT YOURSELF FROM AFFINITY FRAUD. Here are some tips and suggestions to follow:

· Make sure that the seller/promoter and investment are registered and licensed in your state. Call your state securities regulator.

· Seek the advice of a neutral professional, not affiliated with the investment or group, who you trust to evaluate the risks and merits of the investment. This could be an attorney, accountant, or financial planner you trust.

· Investigate all statements and representations, even those coming from friends or loved ones; after all they may have been duped themselves. Do your own due diligence.

· Be extremely cautious of investments that are “no-risk” offer or “spectacular” and “guaranteed” profits and returns. VIRUTALLY ALL INVESTMENTS INVOLVE RISK. If it is too good to be true, it probably is too good to be true.

· Get it in writing! If an investment is not described in writing this should raise a major red flag. If someone tells you to keep an investment confidential, be cautious. Obtain a prospectus or other written information on the investment.

· Scam artists are tech-savvy. Watch out for unsolicited emails from people you don’t know that introduce you to an investment opportunity.

· Take your time to investigate. Don’t feel pressured to rush into an investment before you have had time to think about it. “Once in a lifetime” opportunities may ruin your financial life and well-being.