Bernie Madoff made the other investing hucksters seem penny ante. It's still surprising how many fraudsters prey on investors. More surprising is the seemingly endless supply of willing victims.
The schemes are primitive. It's amazing anyone would fall for them. Yet, a review of some of the litigation releases issued by the SEC this past week (!) tells a very different story.
In SEC v. Jonathan R. Curshen, et. al (Litigation Release No. 21862), the defendants are charged with pumping up -- then dumping -- the shares of a sham company without significant assets or operations. The stock was quoted on the pink sheets (which, in itself, is a red flag). By using a false media campaign, and with the alleged assistance of an attorney who issued a fraudulent opinion letter, the defendants made profits of over $7 million.
While this conduct, if proven, is indefensible, the gullibility of the investors who fell for it is equally staggering.
Lessons learned:
- Don't buy penny stocks.
- The expected return of any individual stock is the same as the index to which it belongs, but with significantly increased risk.
The Amish are a pillar of honesty and integrity. It was particularly disturbing to learn they are not immune from "affinity fraud" perpetuated by one of their own.
In SEC v. Monroe L. Beachy (Litigation Release No. 21856), Mr. Beachy, a 77-year-old Amish man, is alleged to have raised more than $33 million from 2600 fellow Amish investors through the sale of "investment contracts." Mr. Beachy promised to purchase risk-free U.S. government securities, yielding higher than bank rates. How he could have achieved these excess returns is beyond me. He is alleged to have used the money to make speculative investments in high yield (junk) bonds, mutual funds and stocks. When he incurred the inevitable losses, he filed for bankruptcy.
Lessons learned:
- People who look, act, talk and pray like you, can abuse your trust;
- Higher returns means higher risk. There is no free lunch in the capital markets.
- "Risk free" (which is a misnomer) means U.S. government treasury bills and FDIC insured bank accounts.
In SEC v. Michael W. Perry and A. Scott Keys (Litigation Release No. 21853), the SEC charged three former senior officers at IndyMac Bancorp with securities fraud for misleading investors about its deteriorating financial condition. They are alleged to have issued rosy predictions in connection with a $100 million stock offering, without disclosing the deteriorating financial condition of IndyMac.
Lesson learned:
Protect yourself against this kind of risk by purchasing a globally diversified portfolio of index funds. Any one company can issue misleading reports. When you own thousands of stocks, this risk is effectively mitigated.
Finally, in SEC v. Neal R. Greenberg (Litigation Release No. 21852), a final judgment was entered against Mr. Greenberg, the former chief executive officer of a registered investment adviser. Mr. Greenberg (who did not admit liability) was alleged to have misrepresented the "safety, suitability and diversification" of a group of hedge funds, which were sold in many cases to conservative investors in or near retirement.
Lessons learned:
- Hedge funds are rarely suitable investments;
- Conservative investors need to be intensely focused on their asset allocation to insure they are not taking excessive risk.
There's an overriding message in SEC litigation releases:
I have never seen one involving an index fund or a registered investment adviser who recommends portfolios of index funds, passively managed funds or exchange traded funds.
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