Securities Law Blog

The founders and co-owners of the Miami-based real estate development company Royal West Properties, Inc. have been charged with fraud for conducting a $135 million Ponzi scheme. The Securities and Exchange Commission (SEC) alleges that Gaston E. Cantens and his wife allegedly sold promissory notes to investors after acquiring various properties and later financing their sale.

According to the civil complaint filed by the SEC, the Cantens targeted members of the Cuban-American community. Well-known within the close-knit community, the couple gained the trust of mostly elderly investors whom they met at charitable and religious gatherings, and at events hosted at their Miami home. Mr. Cantens also allegedly used his connections as an alumnus and board member at the Belén Prep School to recruit investors. Outside of their immediate community, investors were attracted by televised commercials broadcast on Spanish-language channels nationwide.

Despite the Cantens not being registered with the SEC under the federal securities laws to make securities offerings to investors, reportedly no questions were asked of the couple that a community regarded as old friends.

In a statement given by Director of the SEC’s Miami Regional Office, Eric I. Bustillo commented on the couples’ recruiting tactics, saying that “They portrayed themselves as a pious couple closely involved with educational and religious organizations, while in reality they were living lavishly off money from defrauded investors.”

Along with allegedly using investor money to repay earlier investors, the SEC also contends that the Cantens misappropriated more than $20 million to fund personal business ventures, pay themselves high salaries, and allocated an estimated $1 million to their children and grandchildren citing “consulting fees”.

The Cantens allegedly made promises to investors of high annual returns of 9 to 16 percent. Investors were told the money would come from mortgages on land in southwest Florida sold by Royal West. The SEC claims that the Cantens made “numerous material misrepresentations and omissions about the safety and security of investors’ principal and returns, the success of Royal West’s business, the source of purported investment returns, and the use of investor funds.” The South Florida couple is charged with violating the securities registration and antifraud provisions of the federal securities laws. The SEC is seeking permanent injunctions, sworn accountings, disgorgement of ill-gotten gains and financial penalties against the Cantens.

The company that was started in 1982 allegedly began showing operating losses by 2002 when property owners began defaulting on their mortgages, but continued to promote their business as financially sound in order to attract new investors. The couple allegedly began using new investor funds to make principal and interest payments to earlier investors. When Royal West went bankrupt last year and ceased making interest payments, rumors began about the mismanagement of the real estate development company.

Following the charges issued March 3, 2010, the couple released a statement denying the SEC’s claims. Instead they cited the collapse of the real estate market as the cause of their company’s financial problems.

A 2007 lawsuit filed against the Financial Industry Regulation Authority (FINRA) was dismissed on March 1, 2010. The suit stemmed from a complaint that National Association of Securities Dealers (NASD) members were misled during the 2007 merger of the NASD and the regulatory arm of NYSE. The plaintiffs, Standard Investment Chartered Inc. and Benchmark Financial Services Inc., each filed class-action lawsuits in 2007 and 2008 respectively.

Judge Jed S. Rakoff, of the U.S. District Court for the Southern District of New York, held that the NASD, now known as FINRA, has immunity from “private damage suits challenging official conduct performed within the scope of their regulatory functions.”

The lawyers for the plaintiffs argued that their claim was unrelated to the organization’s regulatory function. Instead it was based on allegedly misleading statements made by the NASD and its executives regarding their finances.

The disputed issue was the adequacy of the $35,000 payout received by NASD member firms at the completion of the merger. The intent of the payout was to compensate members in exchange for giving up significant voting rights under the new FINRA corporate structure. Both plaintiffs said the NASD allegedly misled its members by telling brokerages that due to Internal Revenue Service (IRS) rules governing non-profits, the $35,000 payout was the maximum it could dish out to each member firm.

According to Jonathan Cuneo, lawyer for Benchmark Financial and Standard Investment, a March 2007 IRS letter to FINRA gave a very different range of permissible payouts. Allegedly the letter showed that the NASD could have paid brokerages between $70,000 to $111,000 each. However, the letter was sealed in 2007 by another U.S. District Judge, the late Shirley Whol Kram, with the dollar amounts of the possible payments redacted. Judge Kram’s reasoning was that disclosure of the IRS payment range would harm the NASD’s competitive advantage.

Another brick in the Madoff scam crumbles under further investigation by the Securities and Exchange Commission (SEC). On February 25, 2010, the former Director of Operations at Bernard L. Madoff Investment Securities, LLC (BMIS), Daniel Bonventre, was charged for his involvement in the multi-billion dollar fraud.

At BMIS, Bonventre oversaw the firm’s accounting and securities clearing functions for about the last thirty years. The SEC’s complaint, filed in the U.S. District Court for the Southern District of New York, made several allegations about Bonventre’s role in the scam.

According to the SEC complaint, Bonventre allegedly falsified financial reports to investors to avoid disclosing the firm’s massive liabilities. BMIS financial reports were allegedly doctored by Bonventre to inappropriately state how investor funds were being used and maintained.

The SEC alleges that Bonventre was aware that billions of investor funds were not being used to purchase securities on behalf of investors, and worked alongside Madoff and others to disguise the information. When BMIS came under review, Bonventre and others allegedly produced reams of false reports and data filled with “serial misrepresentations.”

George S. Canellos, Director of the SEC’s Regional New York Office said, “A fraud of this magnitude requires a coordinated effort. Bonventre played an essential part by creating bogus financial records to give BMIS the appearance of legitimacy, when in fact the firm lost money and could not have survived without the fraud.”

To hide that BMIS was consistently operating at a significant loss, the firm allegedly used over $750 million in investor funds to artificially improve reported revenue and income.

Finally the SEC alleges that the former Director of Operations made an estimated $1.9 million in illicit personal profits through fake backdated trades in his own investor accounts at BMIS. One such trade was backdated by twelve years.

If convicted on all charges, Bonventre, 63, faces up to 77 years in prison. The SEC is also seeking to impose financial penalties and disgorgement of all ill-gotten gains.
The charges against Bonventre mark the SEC’s seventh enforcement action concerning the Madoff scam since its collapse in December 2008. Previous actions where parties have pleaded guilty to criminal charges include Madoff and BMIS, DiPascali, and auditors David G. Friehling and David G. Friehling & Horowitz CPAs, P.C. Certain feeder funds have also been charged with committing securities fraud, and two computer programmers at Madoff’s firm were charged for their role in concealing the scheme.

The Financial Industry Regulatory Authority (FINRA) recently released a regulatory notice to remind firms of their responsibilities when dealing with deferred variable annuities. FINRA outlines several steps that ought to be taken in order to ensure customer suitability when buying deferred variable annuities and compliance measures that can be set up by the firm.

The recommendation requirements state that:

*No recommendation of the purchase or exchange of a deferred variable annuity shall be made unless a member or person associated with a member has reasonable basis to believe that the customer has been informed of various features of deferred variable annuities, and that the customer would benefit from certain features of deferred variable annuities.

*Prior to recommending the purchase, the associated person must research the customer’s background and needs. Such fields should include but are not limited to age, income, financial situation, investment experience/objectives, assets and risk tolerance.

*After receiving necessary information, the application should be submitted to the firm’s office of supervisory jurisdiction (OSJ).

*A registered principal shall review and determine whether he/she approves the recommended purchase or exchange of the deferred variable annuities prior to submitting to the insurance company.

*Each suitability determination should be documented and signed by the person recommending, approving or rejecting the transaction.

FINRA also reminds firms that it is their responsibility to establish and maintain specific supervisory procedures reasonably designed to achieve compliance. Surveillance procedures should be implemented to prevent inappropriate exchanges and corrective measures should be in place to deal with inappropriate conduct.

Training policies or programs should be developed and documented to ensure that persons who effect and those who review transactions dealing with deferred variable annuities comply with the requirements of this Rule and understand material features of deferred variable annuities.

Since the boom of investment fraud uncovered during the financial crisis, lawmakers and state securities regulators are attempting to assume oversight of many investment advisers currently under the supervision of the Securities and Exchange Commission (SEC).

According to the testimony given by Texas Securities Commissioner and the North American Securities Administrators Association (NASAA) President Denise Voigt Crawford, “As the regulators closest to the investors, state securities regulators provide an indispensable layer of protection for Main Street investors.”

Crawford was one of many industry leaders to testify before the U.S. Financial Crisis Inquiry Commission (FCIC) during its first round of hearings in January 2010. The FCIC is a 10-member bipartisan panel established to examine the cause of the financial crisis with the intention of producing a report offering recommendations to prevent a reoccurrence.

The financial regulation proposals in Congress could bring about 4,000 advisers who manage between $25 million and $100 million in assets under the supervision of state regulators, according to NASAA. Currently the SEC says it inspects from 9% to 12% of the 11,000 advisory firms it oversees. Allowing each state to oversee anywhere up to around 600 additional advisers, as would be the case in California, would lead to more frequent examinations. State regulators are in the process of generating a mutual agreement to cooperate with one another in policing additional advisers if the proposal passes.

“Our presence did not contribute to the crisis; rather, the fact that our regulatory and enforcement roles have been eroded was a significant factor in the severity of the financial meltdown,” testified Crawford.

Since the passage of the National Securities Markets Improvement Act of 1996 (NSMIA), the responsibility of enforcement shifted from state to federal government. Now the states are fighting to get it back.

The NASAA President offered a series of recommendations to improve the ability of state regulators to pursue financial fraud. A few of these recommendations include: restoring state regulatory oversight of all Regulation D Rule 506 offerings; increasing state regulation of investment advisers; reexamining and removing the hurdles facing securities plaintiffs in private actions; and providing additional resources to uncover and prosecute securities fraud cases.