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Monthly Archives: December 2011

Investment Fraud: Don’t Be a Victim

Information equals power, which is why securities regulators are encouraging investors to be aware about popular investment fraud scams so they don’t become a victim. One of the most popular vehicles for investment fraud includes unregistered securities such as private placements.

Also known as Regulation D offerings, private placements do not have to be registered with the Securities and Exchange Commission (SEC). This means they often lack detailed financial information, as well as a prospectus.

In 2010 and 2011, an increase in investor complaints regarding private placements caused the Financial Industry Regulatory Authority (FINRA) to launch a nationwide investigation of broker/dealers marketing and selling the products. As a result of the investigation, a number of fraud and sales practice abuses were uncovered. Two major cases involved Medical Capital Holdings and Provident Royalties.

Both entities were charged with fraud by the SEC in 2009. Since then, several broker/dealers that sold private placements in Medical Capital and Provident Royalties have faced enforcement actions, as well as fines by regulators. Meanwhile, investors are continuing to file lawsuits and arbitration claims over the failed deals.

As reported Dec. 14 by the Wall Street Journal, baby boomers are most vulnerable victims of investment scams involving private placements. Of the enforcements in 2010 for investors age 50 or older, cases involving unregistered securities outnumbered those related to ordinary stocks and bonds by a ratio of five to one, according to the North American Securities Administrators Association.

One of the victims of those crimes is Keith Grimes, 56. Grimes put $500,000 – his entire life savings – into an investment fund that promised returns of 14% to 24%. Described as having a manager with a successful track record of trading stocks and other financial products, the investment turned out to be a Ponzi scheme, in which money from new investors is used to pay returns to other investors.

The so-called manager of the fund in question was James D. Risher. On Dec. 6, Risher was sentenced to more than 19 years in federal prison. Meanwhile, Grimes, who lost almost all of his financial savings in the doomed deal, is now living in a borrowed mobile home and running an industrial-fiberglass business, according to the Wall Street Journal article.

According to the SEC, Risher raised $22 million from more than 100 investors, while placing only $2.5 million in brokerage accounts and losing about $890,000 through his trading. More than $8 million went to “management and performance fees,” with Risher spending $4.5 million on jewelry, gifts, property and personal expenses.

SEC Shines Spotlight on Crooked Hedge Funds

“Too-good-to-be-true” hedge funds are now undergoing intense scrutiny courtesy of the Securities and Exchange Commission (SEC) and a new computer system designed to analyze funds whose over-the-top performance could potentially indicate fraud.

The SEC began developing its computerized hedge fund analyzer in 2009; today it analyzes monthly returns for thousands of hedge funds. Officials at the SEC are keeping mum on exactly how the system works, but several civil-fraud lawsuits have been filed as a result of the effort.

One hedge fund that was sued by the SEC reported annual returns of more than 25% by allegedly overvaluing its assets, according to a Dec. 27 article by the Wall Street Journal. Another civil-fraud lawsuit involves ThinkStrategy Capital Management LLP and its Capital Fund-A hedge fund.

In 2008, Capital Fund-A reported a 4.6% return for the sixth year in a row. In comparison, the average hedge fund fell roughly 19% in 2008, with losses in eight of the year’s 12 months, according to data from Hedge Fund Research.

In a reality, Capital Fund-A hedge fund actually had a 90% loss in 2008, according to the lawsuit filed by the SEC against the hedge fund’s manager, Chetan Kapur.

As reported in the WSJ article, the SEC alleges that Kapur continued to report positive returns for the Capital Fund-A hedge fund even after it was liquidated and ceased trading in order to attract investors to his other funds. The SEC also claims that Kapur repeatedly inflated his firm’s assets under management in investor reports and invented a nonexistent management team.

Without admitting or denying wrongdoing, Kapur agreed to a lifetime ban from the investment industry. A federal court will later decide on penalties in the case.

Several Variable Annuities Carriers Exit Biz

Several well-known life insurance carriers are making a surprise exit from the variable annuities business, while others are drastically scaling back their exposure or evaluating their participation in 2012.

The combination of a volatile stock market and a prolonged low-interest-rate environment has made it both difficult and expensive for life insurers to hedge variable annuities with living benefits, according to a Dec. 18 article by Investment News. As a result, many insurers are opting to limit their exposure to those hedging costs by exiting, or scaling back, their VA business, the article says.

In 2011, two big VA players – Genworth Financial and Sun Life Financial – announced that they would be leaving the variable annuities market. Others like Jackson National Life Insurance Co., MetLife Inc. and Prudential Financial are making plans to eliminate living benefits and limit investment options.

In addition, John Hancock Life Insurance Co. announced in November that it planned to withdraw an array of annuity products, including variable annuities, as well as limit distribution of existing products to only a small number of broker/dealers.

A variable annuity is a contract between you and an insurance company whereby the insurer agrees to make periodic payments to you beginning either immediately or at some future date. In return, you agree to purchase a variable annuity contract by making either a single purchase payment or a series of purchase payments.

In general, variable annuities are designed to be long-term investments to meet retirement and other long-range goals. They are not suitable for meeting short-term goals because substantial taxes and insurance company charges if money is withdrawn early. Variable annuities also involve certain investment risks.

Increasingly, variable annuities have become the focus of a growing number of legal disputes and investor complaints. Earlier this year, an arbitration panel of the Financial Industry Regulatory Authority (FINRA) awarded a Texas man and the estate of his deceased wife $1.7 million, after finding that an independent contractor, Paul Davis of Raymond James Financial Services, sold life insurance and variable annuity products that were inappropriate investments given the couple’s age and risk tolerance.

According to FINRA’s ruling, Davis sold the couple’s $3.8 million portfolio (which had been heavily invested in municipal bonds) in favor of life insurance and annuity products. He then invested in one annuity after another from 2002-2006, causing the Texas couple substantial financial penalties.

College Illinois Halts Prepaid Tuition Sales

College Illinois, the prepaid tuition program for Illinois residents, has suspended sales of new contracts amid reports that the $1 billion program is facing a 30% shortfall.

Earlier this year, an investigation by Crain’s Chicago Business revealed that the College Illinois Prepaid Tuition Program had the greatest deficit of any prepaid tuition program in the United States and that the fund was plowing money into unconventional – and risky – investments to close the gap. Moreover, many parents were shocked to learn that the program itself was not guaranteed by the state if it came up short on cash.

More than 30,000 Illinois families hold contracts in College Illinois. The plan allows parents to lock in tuition costs at public universities at today’s prices before their children actually go to college.

Kym Hubbard, chairman of the Illinois Student Assistance Commission, says the commission plans to make recommendations to the governor and lawmakers early next year on what can be done to fix College Illinois. Those recommendations are likely to include major changes to the 13-year-old program. Those changes could mean universities, parents or both would have to plug the gap between what the plan accumulates and actual tuitions, according to a Dec. 13 story by Investment News.

Madoff Three Years Later

Dec. 11th marked the three-year anniversary of the Bernard Madoff debacle. The mastermind behind the biggest Ponzi scheme – $65 billion – in U.S. history spent the day in North Carolina, in a medium-security prison, where he is serving a 150-year prison sentence. But for the investors who lost their money to Madoff, the day is constant reminder of financial futures permanently destroyed and their lives forever altered.

The list of investors who became a victim to Madoff runs the gamut – from Hollywood actors to ordinary citizens. Fortunes were wiped out overnight, as were middle-class nest eggs and college savings. Many investors are still trying to get their money back.

As reported Dec. 11 by the New York Times, Madoff trustee Irving Picard has approved 2,425 claims as of Dec. 2 totaling almost $7.3 billion. But two-thirds of the 16,519 claims originally filed have been denied, either because claimants took out more cash from Madoff’s firm, Bernard L. Madoff Investment Securities LLC, than they paid in over the years or did not have an account directly with the firm, according to the article.

Some Madoff investors are like Alexandra Penney, a New York City photographer. Penney is relatively lucky. So far, she’s been able to keep her New York studio, which she feared she might have to let go after losing her life savings to Madoff. To date, she has been paid “a small fraction of my claims,” she said in the New York Times story.

“But I don’t think about Madoff at all, at all,” she said. “However, I have to think about the impact of what happened every day — whenever I stop to consider ‘Do I take a bus or walk?’ It is ever-present and it will always be.”


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