Combating Pyramid Schemes and Affinity Frauds

Andrew Ceresney, Director, Division of Enforcement

Chicago, IL

March 2, 2016

Good morning everyone. Thank you, Dr. Poser, for the warm welcome. It’s my privilege to be here taking part in today’s symposium on the very important topic of affinity fraud and how we can protect our communities from it. I’d like to thank UIC and Chancellor Amiridis for partnering with the SEC and hosting this public outreach initiative. I’d also like to thank our colleagues in law enforcement and the regulatory community, as well as the members of the community, who have taken the time to attend today.

Before we get started, I must give our standard disclaimer that the views I express today are my own and do not necessarily reflect the views of the SEC or its staff.[1]

Since many of you may not be particularly familiar with who we are and what we do, a little background on the SEC is probably in order. At the SEC, our tripartite mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The SEC is made up of different divisions, including the Enforcement Division, which furthers the SEC’s mission by investigating and bringing charges against violators of the federal securities laws. The idea of these actions is to both punish misconduct and to deter it, as well as to compensate harmed investors. The Office of Investor Education and Advocacy is responsible for educating investors on investments and fraudulent schemes, as well as liaising with the public.

Violations that target retail investors are a prime focus of the Enforcement Division’s investor protection efforts. We protect the interests of retail investors by bringing bad actors to justice and by returning money to victimized investors. While scams targeting retail investors may not grab the same level of public attention as violations by large companies and big banks, they are very important, and we are committed to focusing on violators who prey on retail investors.

In recent years, one area where we have seen a proliferation of attacks against retail investors is pyramid schemes. These schemes often target working class and immigrant communities, the most vulnerable retail investors. And combatting pyramid schemes is a priority at the SEC. Since 2012, we have brought 11 actions involving pyramid schemes that we allege did – or were set to – fraudulently raise over $4.2 billion from investors. In my remarks today I will discuss some of these actions, the trends we are seeing in this space, and how the work of our nationwide Pyramid Scheme Task Force is helping to raise awareness of these types of frauds.

Pyramid Schemes and Multi-Level Marketing

First, a little about pyramid schemes. Pyramid schemes typically involve what’s commonly referred to as a multi-level marketing program, or MLM. A legitimate MLM program involves selling a genuine product or service to people who are not in the program. Participants get compensated based on the products or services that they, or the distributors that they recruited, sell to others. However, some MLM programs are actually pyramid schemes, in which participants profit not from the product they are selling but almost exclusively through recruiting other people to participate in the program. In these schemes, there is usually no genuine product or service. Instead, participants in these schemes frequently claim to own, or be developing, some sort of ethereal technology service, such as Chinese media cloud computing services,[2] Voice over Internet services,[3] Internet marketing through websites,[4] or undefined e-commerce services.[5] These MLM schemes often target vulnerable and immigrant communities and can be global in scale.

Over the past few years, we have noticed what seems to be an increase in the number of complaints regarding such frauds. One common characteristic we have observed in our cases in this area is the increasing use of new technologies, most notably social media, to rapidly expand the reach of these fraudulent schemes. The use of social media, such as YouTube, Twitter, and Facebook, allows fraudsters to publicize and replicate their schemes very quickly, as well as reinvent them with new names. It also contributes to their international scope, making it economically viable for fraudsters to target investors in many countries at once. Today’s scam artist can leverage social media and other technologies to turn what, ten years ago, might have been a $5 million fraud involving a few hundred investors, into a $100 million scam ensnaring tens of thousands of investors worldwide. These frauds are easily duplicated, and at times, we find ourselves playing “whack-a-mole,” chasing the same set of fraudsters who, after feeling a bit of heat, simply close down one scheme and quickly set up a new one under a different name.

The SEC has responded aggressively to MLM-based pyramid schemes by filing emergency actions designed to shut down the frauds, freeze ill-gotten assets, bring the perpetrators to justice, and ultimately return money to harmed investors. For example, in 2014, the SEC announced charges and an asset freeze against the Massachusetts-based operators of a large pyramid scheme called TelexFree that raised $3 billion from investors around the world. TelexFree initially targeted Latino immigrants in the U.S. and then expanded its targets to multiple affinity groups in the U.S. We alleged that eight of TelexFree’s operators sold securities in the form of TelexFree “memberships” that promised annual returns of 200 percent or more for those who promoted TelexFree by recruiting new members and placing TelexFree advertisements on free Internet ad sites.[6] So far, we have succeeded in freezing tens of millions of dollars from this alleged scheme, and the criminal authorities have seized significant property holdings and high-end cars alleged to be proceeds of TelexFree.

On October 1, 2015, the first day of the new fiscal year, the SEC announced fraud charges and asset freezes against Steve Chen, the operator of a worldwide pyramid scheme, and 13 California-based entities, alleging that they raised approximately $32 million from investors through false promises of profit from a venture purportedly backed by the company’s massive amber holdings.[7]

Recently, in December 2015, in a case investigated by our Chicago regional office, the SEC charged a company called TeamVinh.com and its Chairman and CEO, Vinh Le, with fraudulently raising more than $3 million from over 5,600 investors throughout the United States and in various foreign countries. In that case, we alleged that Le, who previously had been convicted of forgery and barred from offering or selling securities by state authorities in Minnesota and Wisconsin, and TeamVinh lured unsuspecting investors into buying memberships in a program that Le and TeamVinh claimed to be a referral network that investors could use to earn an income from MLM companies without the investors having to do any work. In fact, these memberships lacked any legitimacy; as alleged in the SEC’s complaint, investors never received the promised payments, and Le misappropriated the overwhelming majority of investor money to fund his own lavish lifestyle, including spending more than $2 million of investor funds at a Las Vegas casino.[8]

Our actions in this space also demonstrate the different tactics we are prepared to use when charging the promoters and architects of pyramid schemes. In addition to including fraud charges, we routinely charge certain defendants with other violations, such as violations of the registration provisions of the Securities Act of 1933. Our ability to charge registration violations – which are generally easier to prove than fraud – enables us to bring violators to justice and obtain relief for harmed investors in a more efficient and timely manner.[9] We also can charge individuals who may have obtained ill-gotten gains, but whom we cannot show were involved directly in the misconduct, as relief defendants, thereby maximizing our recoveries to victimized investors.

Affinity Fraud

As I mentioned, affinity fraud that targets members of identifiable groups, such as ethnic, immigrant, military or religious communities, is another theme we see in connection with these schemes, as well as other types of schemes. Affinity frauds typically involve investments that turn out to be fake, or contain lies about important details of the investment. The investment opportunities often promise sky-high profits with little or no risk, which are classic warning signs of fraud. The fraudsters are commonly members, or pretend to be members, of the group they are trying to defraud. In addition, the wrongdoers often try to enlist respected leaders from the affinity group, who may not be aware of the fraud, to convince others to join the investment.

Many affinity frauds are pyramid or Ponzi schemes, where promoters of the scheme approach investors with what appears to be a legitimate investment opportunity. When new investors give their money to promoters, some of the new money is paid to earlier investors so that it looks like the so-called investment is a successful one. However, Ponzi and pyramid schemes have baked within them a fatal flaw – in order for the scheme to continue, new participants must continually be found to pay off existing investors. Therefore, all pyramid and Ponzi schemes are ultimately doomed to collapse, invariably leaving defrauded investors in their wake.

The SEC has brought significant actions involving affinity-based schemes victimizing a wide spectrum of groups, including the military, Asian-American and Latino communities. For example, in August 2013, the SEC’s Chicago Regional Office brought an emergency action to halt an approximately $1.8 million investment scheme by former Marine Clayton Cohn and his hedge fund management firm Market Action Advisors. We alleged that Cohn masqueraded as a successful trader to defraud fellow veterans, current military, and other investors, and that he lied to investors about his success as a trader, the performance of the hedge fund, his use of investor proceeds, and his personal stake in the hedge fund. Cohn allegedly only invested less than half of the money raised from investors and instead used more than $400,000 for such personal expenses as a Hollywood mansion, a luxury automobile, and extravagant tabs at high-end nightclubs. He allegedly used his lavish lifestyle to carefully contrive the image of a successful trader and investor, when in reality he lost nearly all of the money invested through the hedge fund. In order to cover up his fraud and continue raising money from investors, Cohn allegedly generated phony hedge fund account statements showing annual returns exceeding 200 percent.[10]

Another example is the SEC’s 2014 charges and asset freezes against the operators of a worldwide pyramid scheme targeting Asian and Latino communities in the U.S. and abroad. We alleged that three entities collectively operating under the business names WCM and WCM777 and controlled by “Phil” Ming Xu posed as MLM companies in the business of selling third-party cloud computing services. We alleged that the defendants raised more than $65 million from tens of thousands of investors who were promised a return on the cloud services venture of 100 percent or more in 100 days. However, rather than building out cloud services or incubating high-tech companies, we allege that Xu and the WCM entities used investor funds to make Ponzi payments of purported investment returns to some investors and purchase golf courses and other U.S.-based properties.[11]

Finally, about a year ago, we charged three company officers and 12 promoters behind an international pyramid scheme targeting Latino communities in the U.S. In that case, we alleged that the three Portuguese companies – operating under the name Wings Network – claimed to run an MLM that offered digital and mobile solutions to customers, including apps and cloud storage. In fact, Wings Network’s revenues actually came solely from selling memberships to investors, not from the sale of any products. The company relied upon the recruitment of new members for funding, and commissions were paid to earlier investors with money received from later investors. The scheme allegedly raised at least $23.5 million from thousands of investors, including many in Brazilian and Dominican immigrant communities in Massachusetts.[12]

In addition, in a case that originates from our Chicago Regional Office, we charged Neal Goyal, an investment manager, with fraudulently raising over $11 million from members of the Indian-American community.[13] In this action, which will be a focus of one of today’s panels, we alleged that Goyal told investors that the private funds he managed would invest in securities following a “long-short” trading strategy. However, Goyal actually did little trading and simply operated a Ponzi scheme that used new investor funds to pay redemptions to existing investors and fund his own lavish lifestyle. Goyal concealed the poor results of the few investments he did make by sending investors phony account statements that grossly overstated the performance of the funds. We obtained an order freezing his assets and the Commission subsequently barred him from the securities industry.[14]

The SEC’s Pyramid Scheme Task Force

After seeing an increase in complaints regarding pyramid schemes and affinity fraud, the SEC formed a nationwide Pyramid Scheme Task Force in June 2014 to provide a disciplined approach to halting the momentum of illegal pyramid scheme activities in the United States. The goal of the Task Force is to target these schemes by aggressively enforcing existing securities laws and increasing public awareness of this activity.

The Division is deploying resources to disrupt these schemes through a coordinated effort of timely, aggressive enforcement actions along with community outreach and investor education. More than fifty SEC staff members are part of the nationwide Task Force, which is enhancing its enforcement reach by collaborating with other agencies and law enforcement authorities. We are also using new analytic techniques to identify patterns and common threads, thereby permitting earlier detection of potential fraudulent schemes.

Collaboration with other regulators, including criminal authorities, is an important goal of the Task Force. To advance this goal, the Task Force has hosted an interagency summit attended by over 200 representatives from other federal and state agencies and has presented at local trainings and agency-specific conferences. And, of course, we have partnered with other regulators and criminal authorities to bring high-impact actions in this space. For example, one month after we filed our enforcement action against the operators of the TelexFree pyramid scheme, two of TelexFree’s principals were charged by the criminal authorities.[15] On the same day we announced our charges against Mr. Goyal, he was charged criminally based on the same facts and circumstances that gave rise to the Commission’s charges against him. Mr. Goyal subsequently pled guilty, was sentenced to six years of imprisonment, and ordered to pay more than $9.2 million in restitution.[16]

Public outreach also is a significant goal of the Task Force. We message our actions in this space through translating our public announcements and charging documents into the native languages of the targeted investors. We have a page on our website aimed at investor education about these nefarious frauds.[17] The Task Force, in conjunction with the SEC’s Office of Investor Education and Advocacy, has prepared investor bulletins warning of the dangers of pyramid schemes and affinity fraud.[18] We also strive to educate communities about the red flags of pyramid schemes and increase public awareness of pyramid schemes through collaborative outreach efforts such as today’s event.

We have an exciting program this morning, beginning with a panel focused on raising public awareness of affinity fraud, the red flags of Ponzi and pyramid schemes, and the tactics used to induce targeted group members to invest in such scams. Our second panel will discuss resources that are available to protect communities from affinity fraud. Both panels will also highlight enforcement efforts to combat these types of fraud. I am sure these panels will be thoughtful and effective in conveying the hallmarks of these schemes and how we can collectively work to end them.

Conclusion

Thank you for your time and participation in today’s symposium. The SEC is the cop on the beat in the securities markets and we want you to know that we are aggressively combatting the serious misconduct that pyramid schemes and affinity frauds represent.