July 2010

Common securities fraud schemes on the Internet

Pump and Dump: These types of schemes are quick manipulations of the stock price. The schemers buy thinly traded stocks and then transmit optimistic messages about the stocks, which cause investors to buy, thus driving up the price. The ownership interest that the schemers have in the particular stock is not disclosed. The schemers then sell the stock for significant gains. Their messages are transmitted through official looking e-mails, bulletin board posts or Web sites.

Dump and Diss: This is the pump and dump scheme in reverse. The schemers short-sell a stock and then transmit negative messages to investors causing the investors to sell, which in turn drives down the price. No disclosure is made of the negative position that the schemers have in the stock. They then buy the lower valued stock to fill their earlier sell orders and make a profit on the difference.

Insider Trading: The recipients of non-public information use the insider information to trade ahead of the information’s release, and subsequently realize profits.
Unregistered Offerings: Purported issuers of securities offer and/or sell securities through the Web without being registered or exempt from federal and state securities laws.
Pre-IPO Offerings: Purported issuers offer and/or sell shares of their company to investors based on the premise that the company soon will be going public. Some of these companies do not exist or are marginally successful.

Private Placement Offerings: Purported issuers offer and/or sell shares of their company with the usual promise of high returns, with the help of slick promotional materials. The companies turn out to be nonexistent.

Prime Bank Offerings: Purported sellers offer and/or sell interests in some type of prime bank instrument. The investors are advised to put their money into the prime banks of Europe in a program that generally is available only to the very wealthy, but because there is a “shortage” for the particular program, it is being offered for a smaller minimum investment. Prime bank instruments do not exist.

|Educational Series, Fraud|

Navigating through civil case jurisdictions in state and federal court systems

Courts within the federal judicial system:

Federal district courts are courts of original jurisdiction. District courts, as all federal courts, are also courts of limited subject-matter jurisdiction, meaning that they have the authority to hear cases of a particular type or relating to a specific subject matter, primarily based on federal questions and diversity of parties. The statute for federal question jurisdiction, 28 U.S.C. § 1331, provides that the district courts have subject-matter jurisdiction in all civil actions arising under the Constitution, laws, and treaties of the United States. This jurisdiction is not exclusive; state courts also can hear claims based on federal law. The statute for diversity jurisdiction, 28 U.S.C. § 1332, provides the district courts jurisdiction in actions that meet two requirements: 1) complete diversity – no defendant is a citizen of the same state as any plaintiff, and 2) amount in controversy exceeds $75,000. Federal courts also have removal jurisdiction, which is the authority to try cases removed by defendants from state courts.

Circuit courts are courts of appellate jurisdiction as they are authorized only to review decisions on appeal from district courts, certain specialized federal courts or federal administrative agencies. There are thirteen federal circuit courts; twelve for each one of the geographic circuits and one designated as the Federal Circuit which hears appeals from various specialized federal courts. Appeals from many of the administrative agencies are held in the Court of Appeals for the District of Columbia Circuit.

United States Supreme Court has original jurisdiction over cases affecting ambassadors and actions in which states are parties. Its appellate jurisdiction over all other types of cases is mostly discretionary.

Courts within the state judicial system

Courts of limited subject-matter jurisdiction are authorized to hear specific types of cases, such as small claims, traffic, landlord-tenant, or probate.

Courts of original and general jurisdiction hear all cases not exclusively apportioned to courts of limited jurisdiction, such as state claims and federal questions that also could be brought in federal district courts. State courts of general jurisdiction are often at the county level, and vary in their designations, e.g., Superior Court in California, Circuit Court in Virginia, Court of Common Pleas in Ohio and Supreme Court in New York. In some states, courts of general jurisdiction also hold appellate jurisdiction over cases originally tried in courts of limited jurisdiction.

Intermediate appellate courts exist only in more populous states. In some jurisdictions, the decision of the intermediate appellate court is final for most fact-bound and “routine” cases, such as domestic relations, and subject to discretionary appeal for constitutional questions.

Courts of appellate jurisdiction are variously called the Supreme Court, the Court of Appeals, or, in Massachusetts, the Supreme Judicial Court, and have the authority to change decisions and rulings of lower courts. Depending on the case type and original decision, an appellate review may consist of an entirely new hearing (a trial de novo), a hearing whereby the appellate court gives deference to factual findings of the lower court, or a review of specific legal rulings of the lower court (an appeal on the record.) An appeal from the intermediate appellate court to this higher court is mostly by permission, with the exception of a small number of cases selected by legislatures, such as administrative law actions.

To decide a case, a court must have a combination of subject-matter jurisdiction (defined previously) and either personal jurisdiction (defined as having the power to render a judgment against a particular defendant) or territorial jurisdiction (defined as having the power to render a judgment involving events that occurred within a well-defined territory) along with adequate notice (a requirement that the parties be aware of the legal process affecting their rights, obligations and duties.)

|Educational Series|

Federal Trade Commission’s Red Flags rule enforcement for accountants and other professionals is postponed

The American Medical Association (AMA), the American Bar Association (ABA) and the American Institute of Public Accountants (AICPA) all have brought legal actions against the FTC on the Red Flags rule. In the most recent suit filed on May 21, 2010 by the AMA, the American Osteopathic Association, and the Medical Society of the District of Columbia, the groups argued that the FTC will require them to start verifying their patients’ identities before they agree to treat them. In August 2009, in a suit brought by the ABA, the district court barred the FTC from applying its Red Flags rule to lawyers. The FTC appealed the ruling in February 2010. A decision in the appeal is pending.

The AICPA’s suit, filed on behalf of its members on November 10, 1009, charged in part that the FTC exceeded its statutory authority by extending the rule to regulate accountants and public accounting firms. The AICPA said that “it did not believe there is any reasonably foreseeable risk of identity theft when CPA clients are billed for services rendered.” That suit is now linked to the outcome of the appeal of the ABA ruling. AICPA members have been granted a 90-day grace period – a 90-day delay of enforcement of the rule – from the date on which the U.S. Court of Appeals for the District of Columbia Circuit renders an opinion in the ABA’s case against the FTC.

On May 28, 2010, the FTC announced that it again delayed the implementation until December 31, 2010 of a proposed Final Rule relating to Identity Theft Red Flags under the Fair and Accurate Credit Transactions Act of 2003. The proposed “Red Flags” rule is designed to help prevent identity theft among credit providers and financial institutions.

|Educational Series, Judgment|

Resources for information about fraud

Fraud is defined as any act, expression, omission, or concealment calculated to deceive another to his or her disadvantage. Fraud can be committed through many methods, including mail, wire, telephone, written instruments, and the Internet. State and federal statutes criminalize fraud, but not all cases rise to the level of criminality. Prosecutors have the discretion in determining which cases to pursue. Victims may also seek redress in civil court. Fraud must be proved by showing that the defendant’s actions involved five separate elements: (1) false statement of a material fact, (2) knowledge by the defendant that the statement is untrue, (3) intent by the defendant to deceive the alleged victim, (4) justifiable reliance by the alleged victim on the statement, and (5) injury to the alleged victim as a result.

Below are several Web sites that provide information about various types of fraud, including tips for protecting yourself and filing formal complaints.

|Educational Series, Fraud|

FINRA will make more information about brokers and former brokers available to the public

On July 13, 2010, the Financial Industry Regulatory Authority (FINRA) announced that it will be implementing changes to its free online BrokerCheck service. With recent approval by the Securities & Exchange Commission, the amount of information available to the public about current and former securities brokers will expand significantly in the coming months, including the number of customer complaints reported publicly. The public disclosure period for the full record of a broker who leaves the industry will be extended from two years to 10 years, and certain information, such as criminal convictions and selected civil injunctive actions and arbitration awards, will be on record permanently. The changes will also formalize a process for current and former brokers to dispute or update the information disclosed through BrokerCheck.

“This additional information will benefit investors who are considering whether to conduct or continue to conduct business with a particular securities firm or broker,” said FINRA chairman and CEO Rick Ketchum. “Just as important, it will provide valuable information about persons who have left the securities industry, often not of their own accord, and who have established themselves in other segments of the financial services industry and can still cause great harm to the investing public.”

|Educational Series|

What is the difference between an expunged criminal record and a sealed record?

The words “expunged” and “sealed” often are used interchangeably. A ”sealed” record means that the record is hidden from the general public. An “expunged” record means that the record has been destroyed. In most states, arrests and convictions for serious, violent felonies usually cannot be expunged or sealed.

Each state has its own rules and laws for expungement, and some states label expungement as “expunction,” “removal,” or “destruction” (of criminal records.) But the record may not completely disappear and may be available to law enforcement and the federal government. In most states, for adults, arrest and conviction records are not automatically expunged or sealed after a period of years. For juveniles, court and arrest records are sealed automatically once the juvenile is arrested and a trial or “adjudication” begins.

The rules and laws for the sealing of criminal records also vary from jurisdiction to jurisdiction. In most instances, a court order to unseal a record is required. Some states order the records to be destroyed after they have been sealed. Further, once a record is sealed, in certain states, the contents/crime are legally considered never to have occurred and are not acknowledged by the state.

In most states, but with some exceptions, after a record is sealed or expunged, the subject may truthfully state that he/she has never been arrested, charged, or accused of a crime. However, as noted above, the federal government does not have to honor an expungement and an expungement of a conviction does not relieve a person from having to disclose it on an application for public office or on certain professional license applications.

|Educational Series|

Decoding criminal records in the UK

In the UK, a criminal record is technically any conviction in a court of criminal offence. However, many motor vehicle offences are not deemed as crimes for criminal record purposes, since such offences carry fixed penalties and are not considered criminal convictions. Offences that are prosecuted by local authorities are sometimes classified as criminal offences, although they are unlikely to be in the Police National Computer (the “PNC”). Even if an individual has accepted a “police caution” as an alternative to prosecution, this would count as a criminal conviction.

The Criminal Records Bureau standard and enhanced disclosures contain information about convictions, cautions, reprimands, and warnings retained in the PNC and the equivalent systems in Scotland and Northern Ireland. For the purposes of CRB disclosures, a caution, reprimand, or warning that has been entered into the PNC will constitute a criminal record.

Criminal convictions also are labeled as “spent” and “unspent.” A “spent” conviction is removed from public records, meaning that the defendant has served time and passed through a rehabilitation period. Until then, the conviction is “unspent.” Some convictions, such as crimes with a prison sentence of more than 2.5 years, remain “unspent” indefinitely, regardless of the elapsed time. For convicted minors under 18 years of age, the “unspent” period is cut in half.

During the “unspent” time, the conviction must be disclosed when applying for jobs and on other applications. And for certain jobs such as law enforcement, some roles in the financial services sector, prison services, health services, private security, and for work with children, the elderly, and disabled, “spent” convictions also must be disclosed.

|Criminal Activity, Educational Series, International|

Regional religiosity and financial scandals

A July 2, 2010 article in the Nashville Business Journal and other publications reported that a study by accounting faculty members Sean McQuire, Thomas Omer and Nathan Sharp at the Mays Business School of Texas A&M University revealed that the more religious the state, the less chance there is of financial malfeasance. The researchers concluded that for every 10% increase in the population’s religiosity, the odds that a firm headquartered there will be sued over accounting issues decreases by 49%. According to a Gallop poll of residents who said that religion was important to them, Mississippi, at 86% was number one, followed by Alabama at 84%. New York was last, at 44%.

The study also found that small and medium-sized firms tend to use religion as a self-regulating mechanism in the absence of more formal external monitoring. Sharp cautioned that the study is more a measure of an overall accounting approach among multiple firms of various sizes in the Bible Belt and cannot predict massive frauds such as those at Birmingham-based HealthSouth Corp., Clinton, Miss.-based WorldCom and Houston-based Enron. “We would view them as anomalies,” Sharp said. “We focused on smaller, systemic aggressive accounting occurring as almost a part of doing business. On average, when you hold everything constant, accounting practices are less aggressive in areas with high religiosity.” Sharp added that the study did not account for people using religion itself as a means to defraud.

|Criminal Activity, Educational Series, Fraud, Research|

Challenging the constitutionality of the Public Company Accounting Oversight Board (PCAOB)

The U.S. Supreme Court, on June 28, 2010, issued its decision in the constitutional lawsuit that challenged the PCAOB, affirming in part and reversing in part the judgment of the Court of Appeals in favor of the PCAOB. The case, Free Enterprise Fund vs. Public Company Accounting Oversight Board, was brought on behalf of a Nevada accounting firm, Beckstead & Watts, which challenged the constitutionality of the law after objecting to the PCAOB’s inspection findings. The Free Enterprise Fund, a group opposed to government regulation, has lost the case twice before, in district and appeals courts.

The PCAOB Web site (http://pcaobus.org/Pages/default.aspx) posted the following: “The Supreme Court held that the Sarbanes-Oxley Act’s provisions making PCAOB Board members removable by the Securities and Exchange Commission (SEC) only for good cause were inconsistent with the Constitution’s separation of powers. Because the Court severed these provisions from the Act, however, no legislation is necessary to bring the Board’s structure within constitutional requirements. The consequence of the Court’s decision is that PCAOB Board members will be removable by the SEC at will, rather than only for good cause. All other aspects of the SEC’s oversight, the structure of the PCAOB and its programs are otherwise unaffected by the Court’s decision. Accordingly, all PCAOB programs will continue to operate as usual, including registration, inspection, enforcement, and standard-setting activities.”

|Educational Series, Judgment|

More on fake Web sites

Bogus company Web sites mimicking government entities and promising easy money SECare sprouting in record numbers. In March, the SEC issued warnings to investors about a fraudulent Web site set up by a company named International SecurityInvestor Protection Corporation (ISIPC) which claimed that $1.3 billion in Madoff money has been found in Malaysia and urged Madoff victims to submit personal information to verify that they are on the restitution list. The site copied most of the content and design of the Securities Investor Protection Corporation Web site, and provided links to several legitimate government entities such as the United Nations, the International Monetary Fund, the World Bank and the IBA, falsely touting their sponsorship. (The SIPC is a non-profit organization created by Congress in 1970 toprotect customers in the event of a brokerage failure, acting as a trustee or working with independent court-appointed trustees to recover funds).

Two months after the ISIPC made its debut, the SEC posted an alert that a Web site for an entity calling itself the “US Securities and Equities Administration” was attempting to dupe investors by claiming that funds were being held by the U.S. government on their behalf, and asking for upfront fees to collect the funds.

One of the easiest ways to spot government-related online scams is to look at the Web site and e-mail addresses. No U.S. government agency has a Web site or e-mail address that ends in anything other than “.gov”, “.mil”, or “fed.us”.

|Educational Series|

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