May 4, 2017
By Chelsey Franks
As has been recently released to the public by the FBI and the SEC, a California-based, self-described merchant banker was sentenced to prison for his part in a penny-stock fraud scheme that resulted in investor losses totaling a staggering $39 million. In reviewing the Complaint and other information made available in this case, several “red flag” takeaways become immediately apparent.
For one, the SEC Complaint states that the perpetrator “sold unregistered securities and solicited investors to purchase  stock [in his various enterprises] without being registered with the Commission as a broker or dealer.” A seasoned investigative due diligence firm could have confirmed the individual’s registration (or lack thereof) within minutes.
Next, according to the FBI, the fraudster was on a company-creation spree: “From about 2008 to 2013, he created nearly a half-dozen small public shell companies -- entities that do no actual business and have no assets. He then offered public shares in the company’s penny stocks, which are financial instruments generally worth less than $5 a share.” The FBI goes on to explain that “using fictitious names, [he] would issue shares in his shell companies to himself and a number of co-conspirators. Then he paid kickbacks to those same co-conspirators -- most of them financial brokers -- in exchange for using their clients’ funds to purchase additional shares of his company stocks.” An investigative review of these entities could have confirmed their incorporation states/dates and good standing status, along with identifying the existence of corporate websites and other evidence of legitimacy.
Among other “red flags” that would have come up in a thorough investigative review, the fraudster had been embroiled in numerous lawsuits since the 1990s and had multiple tax liens taken out against him in recent years by the IRS and other state agencies. To make matters even more complicated, this fraudster has utilized no less than four name variations, including assuming his wife’s surname.
Only a seasoned investigative due diligence firm would be able to connect all of these dots and provide the thoroughness of research necessary to give a potential investor the “big picture” in a scenario like this. Are you armed with this kind of knowledge prior to investing?