SECURITIES LAWS: Using Financial Investigation Tools to Ferret Out Investment Fraud:

1. SECURITIES LAWS:Using Financial Investigation Toolsto Ferret Out Investment Fraud: International Association of Financial Crimes Investigators Wayne Klein September 9, 2010 Las Vegas

2. Spotting Fraud: • How does one distinguish a legitimate investment from a fraud scheme? • Is it based on: • The promised rate of return? • The topic of the investment? • Who is selling the investment? • The documents provided to investors? • Examples.

3. NASDAQ Rises 85.6% in 1999:

4. Wall Street legend Bernard Madoff arrested over '$50 billion Ponzi scheme'

5. Sample Solicitation:

6. The Power of Compounding: • While earning 15% in one month is possible in commodities markets, doing so consistently is impossible – but profitable: • After 2 years, the $10,000 becomes $109,000. • After 4 years, account is worth $1.2 million. • After 6 years, $13.2 million. • After 8 years, $145 million. • After 10 years, $1.5 billion. • After 12 years, $17.5 billion.

7. Objectives of Securities Laws: • The purpose of the securities laws is to distinguish legitimate investment opportunities from fraud schemes. • “Trip wires” are laid out to catch violators, including those who violate the law ignorantly. • The law creates “safe harbors” for honest, legitimate investment programs.

8. Separating Sheep from Wolves: While securities laws cover many types of transactions and can be complex, they contain three basic requirements: • Securities must be registered before sold; • Sellers (stockbrokers) must be licensed; • All relevant information must be disclosed. • Sellers must verify marketing information • False statements are crimes • Not disclosing negative information is a crime • Caveat vendor, not caveat emptor.

9. What Must be Disclosed? • The prospectus must disclose: • Financial information about the company; • How it will use the money raised; • Background of company management; • The success of prior ventures; • Negative information such as criminal records, bankruptcies, outstanding liens, judgments. • Risk factors associated with the investment. • Disclosure is where the fraud occurs: • Fraud promoters must lie to sell the deal.

10. What is a “Security”? • Securities come in many forms: • Stocks, bonds, warrants • Options • Profit sharing agreements • Evidence of indebtedness • Notes, including many promissory notes • Interest in oil and gas leases • “Investment contract” securities • These can all be legitimate or can be used as the basis for fraud schemes.

11. Investment Contract: • An investment contract exists whenever a investor gives her money to another, expecting the other to turn a profit. • Investor must be “passive” • Most unusual investment scams are proven using “investment contract” analysis. • These are often called “exotic securities.” • Real estate example

12. Examples of Securities Schemes: • Ostrich farms • “Cleopatra’s Secret” • Gold mining ventures • Oil drilling programs • Advance fee schemes • Prime bank schemes • Wine futures, whiskey receipts • Real estate • Pay telephones • “Blind pools” • Foreign exchange • Managed commodity accounts • “Black box” inventions • Medical discoveries

13. Fraud techniques: • Affinity fraud • “Guaranteed,” no risk, high return • High pressure, cold calling • Avoid taxes, or “IRA Approved” • Bogus “credentials,” senior designations • Online pitches • Free lunch seminars • “Off the books,” special, or private deals • “Headline” investments

14. Fraud by Licensed Brokers: • Fraud sometimes is perpetrated by licensed firms: • Boiler rooms • Penny stocks, pump and dump schemes • Churning • Unsuitable recommendations • “Selling away” • Manipulation • Claims of insider information • Refusal to sell manipulated stocks

15. Investigative Techniques: • Investigating securities fraud can be a lot of fun. Techniques might include: • Calling promoter, posing as potential investors • Attending presentations • Signing up for free offers, get phone pitches, mail • Surprise audits • Recording sales pitches • This can be by the investigator or investors • Raiding boiler rooms • Task force emphasis on certain types of schemes

16. Investigative Tools: • An audit trail can almost always be created from existing records. • Even if the crook destroys records, bank and investor documents can make the case. • Regulatory databases contain significant information about licensees. • Regulators conduct on-site examinations of firms to gather information. • Regulators can provide funding. • Exceptional remedies may be available.

17. Remedies Available: • Criminal: • Prison, fines • Administrative: • License revocation, cease & desist order, fines • Civil: • Injunction, restraining order • Appoint a receiver, conservator • Disgorgement, rescission, fine • Order removing officers, barring role in future securities offerings or public company.

18. Special Advantages of Securities Prosecutions: Prosecutors have some unique advantages when trying securities cases: • Longer statutes of limitations: • Generally five years – longer than other frauds. • Strict liability: • Need not prove intent or injury. • Can show prior bad acts: • Prosecutors can introduce evidence of prior convictions, liens, bankruptcies, etc. • Offers alone are illegal; don’t need actual sale • Convictions are won using only documents.

19. Who Regulates and Prosecutes? • State Securities Laws • Each state has a securities law, regulatory agency • Reviews local offerings, licenses brokers, enforcement • State/local prosecutors bring criminal cases • Federal Securities Laws • SEC regulates exchanges, offerings; enforcement • FINRA (formerly NASD) licenses brokers • FBI investigates, US Attorneys prosecute • Federal Commodities Laws • CFTC regulates exchanges, brings enforcement • National Futures Association licenses brokers • FBI investigates and US Attorneys prosecute

20. Penalties Used to be Stronger! • In 1420, a man named Prelati said the devil told him where gold ingots were buried. He required believers to give him hearts of young children. Convicted of sorcery and sodomy, he was burned alive – his ashes scattered to the wind. • Pietro d’Apone was born in 1250. He claimed alchemy skills. But, he died in prison during his trial. The trial continued. He was found guilty, so they dug up his bones and publicly burned them.

21. Investors Used to be Smarter: • A man named Augerello was born in Italy in 1441. He claimed to be able to turn lead into gold. • When he asked Pope Leo X for a reward for his discovery, the pope: • “with great ceremony and much apparent kindness and cordiality, drew an empty purse from his pocket and presented it to the alchymist, saying that since he was able to make gold, the most appropriate present that could be made him, was a purse to put it in.”

22. Wayne Klein Klein & Associates, PLLC _____ 299 South Main, Suite 1300 Salt Lake City, UT 84111 (801) 534-4455 (801) 824-9616 (cell) wklein@kleinutah.com • Klein & Associates is a forensic accounting and litigation consulting firm providing : • Receivership services, • Forensic accounting, • Due diligence, internal investigations, • Specialized subject-matter expertise in securities, and commodities, and • Expert witness services.