This article entitled “Investment Fraud and the Role of Trust” by Dr. Susan Mangiero was originally published on April 19, 2017 in The Fraud Examiner, a publication of the Association of Certified Fraud Examiners that is distributed to some 65,000 fraud professionals.

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Investment fraud can happen to anyone, and unfortunately, there is no shortage of investment fraud possibilities. Affinity fraud, pyramid schemes, pump-and-dump security trading, high-return or risk-free investments, and pre-IPO scams are only a few of a long-list of schemes that could separate investors from their hard-earned money. 

Investors can find themselves the victims of fraud when they don’t do enough due diligence or put too much faith in the people selling or managing a fund. Investors around the world would be wise to grasp fundamentals of the financial services industry, especially since results from a 2016 survey conducted by the National Association of Retirement Plan Participants show that only one in 10 persons express confidence in financial institutions. Financial advisers are similarly viewed with doubt. This is problematic.

Due in part to these concerns, very few people are adequately saving for retirement and those with money frequently invest in riskier assets in hopes of high returns. Following the 2008 credit crisis, people are changing the kinds of assets allocated in their pension plans and foundation portfolios. Taking more risks isn’t necessarily bad as long as investors sufficiently understand what is being offered to them and have assurances that sufficient safeguards are in place. Moreover, savers urgently need reliable help. Fragile confidence in the intentions of financial service providers creates a friction that can discourage investors from getting the input they need.

But investment fraud isn’t just a problem for individuals. When it occurs, it taints the financial services industry and the professionals who operate with high integrity and put customers first. Low trust of an entire industry can invite additional regulation. The net effect can be unfair penalties that diligent investment stewards must pay for the trespasses of fraudsters.

Increasing Investor Confidence

Although there is no such thing as a risk-free investment, investors can take action to detect red flags and hopefully avoid problems. With the Madoff Ponzi scheme, there were some who seriously questioned whether the touted strategy was legitimate, let alone viable, and did not invest. Regarding Enron, some investors looked askance at the energy company’s reliance on a complex web of special purpose vehicles. One lesson learned from the Bayou hedge fund scandal is to verify whether auditors are independent and well respected.

In its guide for seniors, the U.S. Securities and Exchange Commission urges the use of publicly available databases to check the disciplinary history of brokers and advisors, warning that investors should “never judge a person’s integrity by how he or she sounds.” The guide also says to avoid those who use fear tactics and to thoroughly review documents. The Financial Industry Regulatory Authority cautions investors not to be pressured or to believe that a “once in a lifetime” opportunity will be lost without immediate action.

To help combat investment fraud, the North American Securities Administrators Association teamed up with the Canadian Securities Administrators to create an online quiz that anyone can take to enhance awareness of what to avoid.

Although there are organizations that formally grade companies on their trustworthiness, investors should not rely on a single metric alone. Instead they should study whether a financial service provider has a good reputation in the marketplace and what the company is doing to manage its economic and operational risks.

Financial service companies likewise have responsibilities to be trustworthy and ensure that adequate protections are put in place. Some of these critical action steps include:

  • Setting up controls to prevent rogue trading
  • Appropriately compensating salespersons to minimize conflicts
  • Providing existing and potential customers with clear and understandable investment documents
  • Regularly communicating what the organization does well to lower risks for its customers
  • Calling out questionable activities of its competitors and working with industry organizations to improve risk management and fraud prevention techniques.

Disclaimer: The information provided by this article should not be construed as financial or legal advice. The reader should consult with his or her own advisors.

As a forensic economist, I have worked on multiple matters relating to the quality of fiduciary practices provided by investment stewards. Sometimes, fraud is involved. Unfortunately, the statistics about fraud are not good. According to the 2014 Report to the Nations, published by the Association of Certified Fraud Examiners ("ACFE"), "the typical organization loses 5% of revenues each year to fraud" or about $3.7 trillion – roughly "22 days worth of trading on the New York Stock Exchange."

Last fall, I pursued and earned the designation of Certified Fraud Examiner. I had to meet an experiential requirement and successfully complete a series of rigorous exams. Click to read the press release and learn about the designation.

A few weeks ago, to my delight, I was asked for an interview by the ACFE. The result is a just-published Question and Answer profile entitled "Susan Mangiero: Take Pride in Curiosity." During the interview, I talked about trust and the value of maintaining a good reputation. Specifically, I described a situation that involved a trader who had backtracked on several deals. After news got out, few persons understandably wanted to deal with him.

Having a good reputation in business, especially financial services, is still important. In recent years, I have been asked to quantify the economic relationship between reputation and the ability for a firm to generate revenue based on the trust factor. Feeling comfortable with an advisor, consultant, banker or asset manager is paramount for an institutional investor who is obliged to carefully select and monitor a third party service provider.

Coincidentally, the CFA Institute just released its study entitled "From Trust to Loyalty: A Global Survey of What Investors Want." In its "Key Insights" section, the point is made that performance and ethical conduct are both important, with investment managers needing to demonstrate that they have gone beyond "adherence to mandatory codes of conduct." This makes sense. Governance is seldom a "check off the box" exercise. (As an aside, I am proud to say that I am a CFA® charterholder."

With the investment community abuzz about the U.S. Department of Labor’s proposed Conflict of Interest Rule and its international regulatory equivalents, transparency, ethics and performance issues will no doubt remain high priorities for investors.

Dr. Susan Mangiero, financial expert and author, has earned the Certified Fraud Examiner (CFE) credential from the Association of Certified Fraud Examiners (ACFE), having successfully met the ACFE’s character, experience and education requirements for the CFE credential, and having demonstrated knowledge in four areas critical to the fight against fraud: Fraudulent Financial Transactions, Fraud Prevention and Deterrence, Legal Elements of Fraud and Fraud Investigation. Dr. Susan Mangiero joins the ranks of business and government professionals worldwide who have also earned the CFE certification.

According to its recent comprehensive study, the ACFE estimates that the average organization loses roughly five percent of revenues each year to fraud. This translates into an estimated worldwide loss of $3.7 trillion every twelve months. CFEs on six continents have investigated more than 1 million suspected cases of civil and criminal fraud.

Dr. Mangiero is currently a Managing Director of Fiduciary Leadership, LLC and lead contributor to Pension Risk Matters and Good Risk Governance Pays. Dr. Mangiero has served as a testifying expert and behind-the-scenes forensic economist on multiple investment and financial valuation and risk assessment matters. She is a CFA® charterholder and holds the Financial Risk Manager (FRM®) designation. In addition, Dr. Mangiero has earned the Accredited Investment Fiduciary Analyst™ professional designation from Fiduciary360. She has received formal training in investment fiduciary responsibility and is certified to conduct investment fiduciary assessments.

About the ACFE

The ACFE is the world’s largest anti-fraud organization and premier provider of anti-fraud training and education. Together with more than 75,000 members, the ACFE is reducing business fraud world-wide and inspiring public confidence in the integrity and objectivity within the profession. Identified as “the premier financial sleuthing organization” by The Wall Street Journal, the ACFE has captured national and international media attention. For more information about the ACFE visit ACFE.com.

About Fiduciary Leadership, LLC

Fiduciary Leadership, LLC is an investment risk governance and forensic economic analysis consulting company. Clients include asset managers, transactional attorneys, litigation attorneys, regulators and institutional investors.

For those who don’t know, I am the lead contributor to an investment compliance blog known as Good Risk Governance Pays. I created this second blog as a way to showcase investment issues that had a wider reach than just the pension fund community. While I strive to publish different education-focused analyses on each blog, sometimes there are topics that I believe would be of interest to both sets of readers. A recent article that I co-wrote is one example. Entitled "Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel" (The Corporate Counselor, September 2014), Mr. H. David Kotz and Dr. Susan Mangiero explain the basics of the Foreign Corrupt Practice Act. Examples and links to reference materials are included, along with a discussion as to why this topic should be of critical importance to pension funds and other types of institutional investors. Click to download a text version of "Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel."

Dr. Susan Mangiero, CFA, certified Financial Risk Manager and Accredited Investment Fiduciary AnalystTM is pleased to address service provider due diligence and investment manager risk mitigation as part of the upcoming 2012 Governance, Risk and Control conference. Sponsored by the Institute of Internal Auditors, this event is part of a multiple day examination of ways to improve internal controls. Join us in Palm Beach from 8:30 am to 9:45 am on August 22, 2012 for a discussion of “Vendor Contracts and Risk Assessment: Lessons Learned from Fraud Convictions.”

The panel will be moderated by Mr. Frank Lazzara, Managing Director with FTI Consulting. Co-panelists include Dr. Susan Mangiero, Managing Director with FTI Consulting, Ms. Annie Dugas, CA, DIFA, CFE, Director – Investigative & Forensic Services with Raymond Chabot Grant Thornton Consulting Inc. and Paul E. Zikmund, MBA, MAcc, MBEC, CFE, CFD and Director – Global Integrity and Forensic Audit with Bunge, Ltd.

The program will include the following:

  • Discussion of best practices for selecting and monitoring service providers within an enterprise risk management framework;
  • How to vet related party transaction disclosures to prevent problems;
  • How to identify and mitigate conflicts of interest such as when a customer has an equity stake in a vendor;
  • When to use independent experts to conduct investigative due diligence on the vendor and key persons;
  • Understanding bribery and anti-money laundering issues when dealing with non-US vendors;
  • Discussion of lessons learned from prominent fraud convictions that involved service providers and what internal auditors should do as a result.

Economic growth may be anemic but fraud continues to find a life of its own. According to the Financial Fraud Research Center, at least 30 million people are impacted by fraud each year with an annual cost of $100 billion for retail fraud alone.  In a 2011 speech, the head of the U.S. Securities and Exchange Commission discussed how key offices and divisions are working together in all areas of its anti-fraud efforts and how the SEC is collaborating more frequently with state regulators, criminal prosecutors or local nonprofits in an effort to weave these initiatives into an increasingly fine-meshed net that is focused on fighting fraud. While the U.S. Department of Labor is not exclusively focused on fraud, enforcement teams have been busy with a closure of nearly 3,500 civil cases and 302 criminal cases, monetary results of $1.39 billion and 129 indictments.

Surprisingly, there is little information available to institutional and individual investors alike as to how to mitigate the risk of losing money to fraudsters. The goal of this webcast is to empower investors to better protect themselves with knowledge of situations to avoid whenever possible. Attendees will hear experts talk about:

  • Common causes of investment fraud;
  • Enforcement and litigation trends relating to investment misdeeds;
  • Lessons learned from financial scandals of the last decade;
  • Role of the investment fiduciary in vetting service providers;
  • Red flags to detect poor internal controls that could lead to fraud; and
  • Regulatory action to stem financial fraud and preserve the integrity of the capital markets.

Speakers for this 75-minute event include:

  • Dr. Susan Mangiero, CFA, FRM – Managing Director, FTI Consulting
  • Jonathan Morris, Esq. – Day Pitney LLP / former General Counsel of Barclays Wealth
  • Brian Ong – Senior Managing Director, FTI Consulting
  • Karen Tyler, North Dakota Securities Commissioner and former president of the North American Securities

To attend this webcast scheduled for Wednesday, June 13, at 1 pm Eastern and sponsored by FTI Consulting, please visit the investment fraud webinar page at http://www.securitiesdocket.com/2012/05/18/june-13-webcast-what-every-fiduciary-needs-to-know-about-how-to-mitigate-investment-fraud-risk/.

In recent discussions with asset managers, pension trustees and consultants, investment fraud continues to attract attention. It is no surprise that people want to know more about what constitutes bad practice versus crossing the line, especially in the aftermath of a devastating few years of economic losses. New disclosure regulations are another catalyst for learning more about how to avoid trouble. Email your request if you want more information about what can be done to detect fraud and/or would like to receive research and thought leadership on the topic of investment fraud.

Impending changes to fiduciary standards and allegations of fiduciary breach likewise continue to create a stir.

In "The EBSA Cracks Down on Retirement Plan Advisors," AdvisorOne’s Melanie Waddell (March 26, 2012) describes a material increase in enforcement actions brought by the U.S. Department of Labor ("DOL"), Employee Benefits Security Administration ("EBSA"). Besides effecting nearly 3,500 civil cases in 2011, EBSA closed 302 criminal cases with "129 individuals being indicted," "75 cases being closed with guilty pleas or convictions" and an excess of $1.3 billion in monetary damages collected. Quoting Andy Larson with the Retirement Learning Center, the article mentions fiduciary negligence as a key concern of regulation and a driving force behind a proposed expansion of ERISA fiduciary duties to numerous professionals who work with retirement plans in an advisory capacity.

ERISA Attorney David Pickle points out that fraud and embezzlement of 401(k) plan money have been investigated for years by the DOL and U.S. Department of Justice ("DOJ") but recent investigations are being done now as part of the formal Contributory Plans Criminal Project ("CPCP"). He observes that "the DOL is conducting an increasing number of investigations of financial service providers, including registered advisers, banks and trust companies (both as trustees or custodians but also as asset managers), and consultants. For other insights about ERISA pain points, read "An Excerpt From: K&L Global Government Solutions (R) 2012: Annual Outlook."

According to the ERISA enforcement manual, civil violations include:

  • Failure to operate a plan prudently and for the exclusive benefit of participants
  • Use of plan assets to benefit the plan administrator, sponsor and other related parties
  • Failure to properly value plan assets at the current fair market value
  • Failure to adhere to the terms of a plan (assuming that those terms are compatible with ERISA)
  • Failure to properly select and monitor service providers
  • Unlawfully taking action against a plan participant who seeks to exercise his or her rights.

Criminal violations include:

  • Embezzlement of monies
  • Accepting kickbacks
  • Making false statements.

The "oops – I didn’t know" strategy is unlikely to serve those who work with or for pension plans. The spotlight continues to focus on ways to improve the management of $17+ trillion U.S. retirement system and rightly so. There is so much at stake for millions of people.

George Washington said that "In executing the duties of my present important station, I can promise nothing but purity of intentions, and, in carrying these into effect, fidelity and diligence.

ERISA and public pension trustees are likewise tasked to be faithful and diligent, among other things. For those who choose a different path, the outcome can be dire indeed. Jail time and stiff penalties as well as legal costs are a few of the potential costs associated with a fraud conviction, not to mention shame and the loss of income.

 

Join me on May 1, 2012 for a timely and interesting program about alternative investment fund due diligence and other considerations for ERISA plan sponsors, their counsel and consultants. Click here for more information.

This CLE webinar will provide ERISA and asset management counsel with a review of effective due diligence practices by institutional investors. Best practices will be offered to mitigate government scrutiny and suits by plan participants.

Description

With the DOL’s and SEC’s new disclosure rules and heightened concerns about compliance and valuation, corporate pension plans that invest in alternatives must focus on properly vetting asset managers more than ever before or risk being sued for poor governance and excessive risk-taking.

The urgencies are real. The use of private funds by asset managers is crucial for 401(k) and defined benefit plan decision makers. Understanding the obligations of private funds is essential to any retirement funds with limited partnership interests.

In addition, suits and enforcement actions against asset managers make it incumbent on counsel to hedge fund and private equity fund managers to fully grasp and advise on full compliance with the duties of ERISA fiduciaries to plan participants.

Listen as our ERISA-experienced panel provides a guide to the legal and investment landmines that can destroy portfolio values and expose institutional investors and fund managers to liability risks. The panel will outline best practices for implementing effective due diligence procedures.

Outline

  • ERISA fiduciary duties for institutional investors
    1. Hedge funds and private equity funds compared to traditional investments
  • Regulatory developments
    1. Disclosure
    2. Compliance
    3. Valuation
  • Developments in private litigation involving pension plan fiduciaries and alternative fund managers
  • Best practices for developing due diligence plans

 

Benefits

The panel will review these and other key questions:

Following the speaker presentations, you’ll have an opportunity to get answers to your specific questions during the interactive Q&A.

  • Regulatory developments
    1. Disclosure
    2. Compliance
    3. Valuation
  • Developments in private litigation involving pension plan fiduciaries and alternative fund managers
  • Best practices for developing due diligence plans
  • What are the regulatory concerns for ERISA pension plans that allocate assets to hedge funds and private equity funds?
  • What are the potential consequences for service providers that fail to comply with new fee, valuation and service provider due diligence regulations?
  • What can counsel to pension plans and asset managers learn from recent private fund suits relating to collateral, risk-taking, pricing, insider trading and much more?
  • How should ERISA plans and asset managers prepare to comply with expanded fiduciary standards?

 

Following the speaker presentations, you’ll have an opportunity to get answers to your specific questions during the interactive Q&A.

Faculty

Susan Mangiero, Managing Director
FTI Consulting, New York

She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors as well as offered expert testimony and behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence, risk and valuation matters.

Alexandra Poe, Partner
Reed Smith, New York

She has over 25 years of experience in investment management practice counseling managers of hedge funds, private equity funds, institutional accounts, mutual funds and broker-dealer advised programs. She counsels hedge and private equity fund advisers in all stages of their business and due diligence matters.

 

 

According to "Washington Mutual settles class-action suit for $208.5 million," Associated Press, July 1, 2011, pension plans that include the Ontario Teachers’ Pension Plan Board (as lead) will benefit as shareholders of the failed bank (if and once the Bankruptcy Court approves the terms).

On a related note, Judge Mary F. Walrath of the U.S. Bankruptcy Court for the District of Delaware tells certain Washington Mutual ("WaMu") employees that they are "entitled only to general unsecured claims because they do not have a right to the funds that is superior to the rights of the other general unsecured creditors." She added that "Because the plans were unfunded, and the funds were identified as property of WaMu," it was not possible to "impose a constructive trust because the money allegedly owed to the participants can no longer be clearly traced to funds or property in their possession." See "WaMu wins bankruptcy fight over employee retirement funds," Thomson Reuters News & Insight, June 20, 2011.

The two articles caught this blogger’s attention as a timely example that financial distress can impact multiple constituencies in completely different ways.

According to TechCrunch ("Canopy Financial Turns Into Sad, Comical Game of Hot Potato" by Michael Arrington), nearly $90 million in venture capital money may have done little to thwart alleged fraud at Canopy Financial. If true that this company has been reporting incorrect numbers, why has it taken so long to uncover?

Here is what I’ve been able to uncover from a quick search of the web (with no guarantees that these website links will remain live much longer, if they even exist now):

  • Canopy Financial was listed #12 on Inc. Magazine’s 2009 list of fast-growing companies with reported growth of nearly 8,000%, 84 employees and 2008 revenue of $19.8 million. Click to read more.
  • Important website links for Canopy Financial except for a single Contact Us page (About Canopy, Learning Center, Solutions, Press Releases, Clients) are broken.
  • Red Herring reported that Canopy Financial raised $15 million in a "funding round led by Granite Global Ventures," allowing this health insurance-related service company to "develop and market some of its new products and services." Read "Canopy Financial Banks $15M" by Cassimir Medford (January 10, 2008).
  • Healthcare Finance News reported on an acquisition by Canopy Financial about a year ago. See "Canopy Financial buys CareGain" (October 20, 2008).
  • PE Hub writes that Canopy Financial’s CEO claims "no prior knowledge whatsoever of any fraud…" Click to read "Statement from Canopy Financial’s Ex-CEO" by Dan Primack (November 24, 2009).
  • The link to Perkins Coie is likewise broken though Google shows text that reads "Represented Canopy Financial in its Series A and Series B Preferred stock financings."
  • Crunchbase.com lists financing for Canopy Financial in the amounts of $15 million Series A funding (January 2008), $8 million Series B funding (August 2008), $4 million in debt funding (2009) and $62.5 million in Series C funding (October 2009). Click to read more.
  • Health Care IT News reports a partnership between Canopy Financial and Wolters Kluwer Financial Services to "make Canopy’s healthcare banking platform available to all banks and credit unions." See "Financial providers integrate HSAs for banks" by Molly Merrill (February 14, 2008).
  • Canopy Financial reports the release of its "Mobile Consumer Directed Healthcare (CDH) Software Application." Read the May 13, 2009 press release.
  • Canopy Financial sought to recruit a product analyst as recently as November 9, 2009.
  • Canopy Financial’s November 3, 2009 press release describes a partnership witih A.D.A.M., a "leading provider of healthcare information technology." Click to read more.
  • Canopy Financial sends out a March 2009 press release that lauds its successful completion of the "Statement on Auditing Standards No. 70 (SAS 70) Type II audit, which assesses the operational effectiveness of internal controls within service organizations." Read "Canopy Financial Achieves SAS 70 Type II Certification."

The list continues. If true, yet another fraud perpetuated on investors would be shocking. Questions abound, some of which are listed below.

  • Who was conducting the due diligence for each funding round?
  • What due diligence was done on Canopy as relates to several acquisitions and partnerships?
  • What was the role of the auditor?
  • What questions were asked of the management team by the Canopy Financial board of directors? 
  • Did institutional investor limited partners utilize finder firms or contract with the venture capital general partners directly?
  • Did any of the investors review the SAS 70 audit report and find it wanting?

Until more facts are uncovered, everyone deserves their day in court and we can’t make hasty judgments.

On a general note, the hope is that lessons are learned along the way about who is tasked to do what, on what basis and with what rigor. While I truly believe that there are many, many good players who do their work thoroughly and with high integrity, one is compelled to reflect on why the stigma and shame of dishonesty is discarded by those who rightfully deserve a place in the Financial Hall of Ignominy.