The SEC and Prime Bank Instrument Fraud
By Michael A. Collora
Send Email to: mcollora@dwyercollora.com
This article first appeared in the Fall 1998 Boston Bar Association Criminal Law Newsletter, a publication of the Boston Bar Association.
Introduction
For lawyers practicing in the field of securities litigation, the world of prime bank instrument fraud may seem far off. However, the numerous injunctive actions filed by the SEC since 1994 (estimated at over 100), and frequent criminal references to the U.S. Attorney’s Office may mean you could easily be consulted by a promoter or victim of the scheme. Indeed, the International Chamber of Commerce has labeled this the crime of the century, entangling banks, law firms and other victims in its embrace.[1] This article outlines what has happened over the past decade in this area.
For those unfamiliar with these shady instruments, it might help to review how the scheme works. At its most basic, the myriad variations of selling prime bank instruments combine greed with plausibility (i.e., very high return, with no or very limited risk). In their sales pitch, promoters use various labels for what they are selling, such as prime bank instrument, international bank debenture, guaranteed letter of credit, blocked fund letters, and so on. These investments supposedly must be purchased in large amounts (your portion will be pooled with others to reach $10 million), secrecy is urged (the banks will deny the existence of these instruments), and guarantees abound. Enormous profits are promised. The money is allegedly earned off shore so no taxes need to be paid. A reputable bank or law firm is often used to add respectability. Similar to Ponzi schemes, the money is used by the promoters for their own purposes, including occasionally the payment of interest or repayment of some principal. No real investments are made, the instruments do not exist, and most investors lose everything.
A typical, although unsuccessful, scheme was depicted in the Commission’s Opinion, In the Matter of Kaiden.[2] There, Kaiden, a registered broker dealer was sued administratively for violations of 17(a) of the 1933 Securities Act. Prior to that, he had been enjoined by a federal court from any further violations of the Act.[3] According to the evidence, Kaiden had attempted to sell prime bank instruments to the John Hancock Mutual Life Insurance Co. As part of his sales pitch, typical for these types of promoters, he claimed these instruments were issued by “top banks,” discounted to yield 7.5% and traded weekly; additionally the instruments were guaranteed and profit was 2-5% per month. At the hearing, Kaiden could not support these assertions. The Commission found these purported instruments to be securities and based upon the record developed by the staff, non-existent. It debarred Kaiden.
Early Warnings
The Comptroller of the Currency as far back as July 7, 1986 issued an advisory warning to banks to be wary of opening up a banking relationship with anyone purporting to promote prime bank promissory notes.[4] Later, demonstrating the scheme had no geographical boundaries, in February of 1993, the Commercial Crime Bureau in England issued a warning about stand by Letters of Credit and similar instruments, noting a loss by the Salvation Army of over $8 million in one such scheme.[5]
Reacting to the increasing use of these sales pitches, the Federal Reserve Bank warned its members in October, 1993 that there had been an increase in these types of schemes; an Interagency Advisory dated October 21, 1993 was then issued by all the banking regulators to banks warning about prime bank schemes and asserting no such instrument existed. The SEC joined in with an advisory shortly thereafter, and opened a general file in 1994, HO 28-20, from which it began an overall investigation into these instruments.
Beginning in 1994, the SEC has commenced a major effort to both educate the public and stop the promoters of these instruments. It has added “prime bank” to its web page, commenced numerous administrative and federal district court proceedings and it and other agencies have produced witnesses to testify in congressional hearings. For example, Richard Walker, then Director of Enforcement for the SEC, spoke before the U.S. Senate Permanent Subcommittee on Investigations on March 23, 1999 regarding internet fraud, and referenced prime bank offerings as using the internet. He testified “no such securities exist and the names of well known domestic and foreign banks are improperly used to add credibility to the offerings.”[6] Deputy Special Agent in charge of the Secret Service, Dana Brown addressed the Senate Banking Committee’s Subcommittee on Financial Services on September 16, 1997 and also advised that prime bank fraud was a focus of their investigative efforts. Herbert Biern, an Associate Director of the Federal Reserve addressed the Senate Committee on Banking on July 17, 1996 and detailed the efforts of the central bank to stop prime bank instrument fraud. In May 1999, the SEC announced the third of its internet fraud sweeps, filing several law suits involving prime bank notes and use of the internet as the sales tool.[7] All involved a similar type of exaggerated sales pitch; several were stopped before any investors lost money.[8]
SEC Violations
At the outset, the sales of these instruments could normally violate § 5 of the 1933 Securities Act[9] because the instruments are alleged securities and, of course, are never registered with the Commission. Other applicable statutes used by the SEC in seeking an injunction and other equitable remedies are § 17 of the 1933 Act[10] and § 10b[11] and Rule 10b-5 of the 1934 Act.[12]
The SEC and its staff have consistently held that these instruments do not exist. This is demonstrated by expert witnesses such as James Byrne, a law professor, who testified for the Commission in Reese, or numerous documentary evidence as provided to the hearing officer in Kaiden. [13] Some defendants have argued that if the allegations in an SEC complaint are true, i.e., that this security is non-existent, then it follows that the federal courts do not have jurisdiction over non-securities. This argument was rejected by the Seventh Circuit in SEC v. Lauer.[14] The court held that although prime bank instruments do not exist, it is the representations to the investors that determine whether an instrument is a security.[15] In Lauer, the promoters had falsely claimed that all of the monies would be pooled – the existence of this investment contract was enough for jurisdiction said the Court. Lauer was cited approvingly by the Third Circuit in SEC v. The Infinity Group, et al.,[16] upholding an injunction against the sale of “property transfer contracts,” which it concluded was a form of investment contract and thus a security.
Ordinarily in these cases, the SEC will file suit in federal court seeking an immediate injunction, asset freeze and appointment of a receiver. Administrative proceedings may also be commenced and criminal references can be made. A complaint typical of the agency’s actions was filed in Massachusetts in 1998 alleging losses of $20 million from 80 investors in 16 states.[17] The SEC obtained a freezing of assets for two of the individuals. Several salesmen were also sued and relief defendants holding assets were joined.[18] The apparent offering at issue was a private pool of international bank debentures, with promised returns of ½ to 4% a week, guaranteed by GNMA bonds. Koontz claimed he was an international bank trader affiliated with Barclays Bank and he also claimed he could sell debentures through a secret secondary market existing between the top twelve international banks. All of those representations were apparently false, as Koontz later pled to a federal criminal Information in Florida and was sentenced to over 15 years and restitution of $23,118,907.[19] Four others were also convicted and received jail terms. In addition, numerous related parties have settled such as salesmen and had civil judgments entered against them.[20]
Another prime bank instrument case drawing considerable publicity is SEC v. Rivlin,[21] where the SEC in 1999 sued a prominent Washington, D.C. attorney named Lewis Rivlin and others for injunctive relief and disgorgement under 17(c) of the 1933 Securities Act[22] for defrauding an Ecuadorian charity of $6 million by selling them prime bank instruments. As usual, the investment was purportedly risk free, profits of 20-100% were to be paid every ten days and Rivlin “guaranteed” the results to some investors. Apparently all of the money was lost. Rivlin was preliminarily enjoined by the Court from further selling these vehicles[23] and others have settled.[24] The case is still open.
Defending these cases is difficult. The SEC has had no difficulty convincing the courts these instruments are fraudulent. The investors are outraged. The money is missing. There is generally a hearing on a preliminary injunction which most defendants lose. Often the best you can do for your client is settle and hope for a favorable disposition. Peripheral parties and relief defendants always have an easier time of it, but these are expensive suits to defend. Review of dockets indicate the SEC eventually moves for summary judgment.[25]
Criminal
Criminal references and prosecutions occur in the more egregious situations. In one case in Massachusetts, three Americans, including one Harold Glantz had defrauded several German investors of over $24 million, claiming to purchase prime bank guarantees on a monthly basis[26] and were also sued civilly by the SEC.[27] In that case, the defendants dissipated the money on themselves, on real estate and other losing ventures. The defendants went to jail for up to four years and restitution orders issued, but the investors got back only cents on the dollar from those defendants.
As noted previously, the SEC had begun civil proceedings in Chicago federal court against a John Lauer and others on June 21, 1994, which eventually resulted in a preliminary injunction.[28] These proceedings were followed by an indictment of Lauer, his plea and appeal of his sentence where the Circuit Court held that an additional intended loss of $5 million could be added to the actual loss of $19 million for sentencing purposes.[29] Lauer was later criminally sued for violating his civil injunction by engaging in an additional fraudulent scheme. He received additional jail time, resulting in a sentence exceeding 40 months.[30]
The SEC filed a civil complaint in a federal court in Massachusetts on April 18, 1998, against Edward Paradise and Walter Snyder. Permanent injunctions were issued under 17(a) of the 1933 Securities Act.[31] Following that, there was a criminal indictment in Massachusetts for mail and wire fraud.[32] According to the Indictment, the defendants sought an upfront fee to obtain a valuable letter of credit; the fee was to be escrowed by defendant attorney Snyder until the instrument was purchased. No escrow existed, no letter of credit existed, and over $600,000 was diverted to personal use.
A German businessman named Bernd Weber and an American, Donald Rishell, were indicted this year in Philadelphia for allegedly combining an upfront fee scan with a prime bank scheme. The City of Philadelphia was the intended victim. Oddly, the peripatetic Weber was an earlier victim in the Glantz scheme and an apparent acquaintance of Rivlin.[33]
These criminal cases are also difficult to defend since there are usually several victims, abundant misrepresentations and lost money. Jail time is inevitable for the larger schemes and for the individuals who were the promoters.
Civil Proceedings
Promoters have made a substantial effort to add respectability to their offerings by lacing them with powers of attorneys and legal documents. In such instances, innocent third parties with deep pockets have become implicated under various theories in prime bank instrument schemes. For example, as an outgrowth of the Rivlin case, the First National Bank of Maryland was sued by a victim for participating in the transfer of $3 million to England, where it apparently disappeared.[34] The Bank lost a motion for summary judgment, when the court held it was disputed whether the electronics transfer order was conditional and whether the plaintiff was contributory negligent, even though the Bank argued plaintiff should have recognized the scam. That, said the Court, could be easily turned around so one could argue the Bank should also have recognized what was going on.
In a similar case, promoter Harold Glantz and others convinced the Bank of Boston to open up accounts for purchasers of prime bank instruments; the monies were wired into the Bank to be used for this purpose. The bank failed to note the limitations in the powers of attorney and wired out $20 million without following the conditions in the Power of Attorney. In two extensive opinions, a federal judge granted summary judgment for the investors under Article 4A of the Uniform Commercial Code resulting in a large judgment against the Bank.[35]
Summary
Prime Bank Instruments continue to plague the lower reaches of the securities market, as the public falls for these “high yield, guaranteed instruments.” For the securities and criminal attorney, there will continue to be business, as the promoters are still in business and SEC appears adamant it will halt these activities.
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[1] Report of ICC Commercial Crime Bureau, January 10, 1994.
[2] In the Matter of Kaiden, Securities Exchange Act Release No. 41629 (July 20, 1999).
[3] In the Matter of Kaiden, Initial Decision Release No. 124 (March 24, 1998).
[4] Comptroller of the Currency, BC 141, Supp. 4 (July 7, 1986).
[5] Fraud and Standby Letter of Credit, Commercial Crime Bureau, United Kingdom (Feb. 22, 1993); see also, Special Report of the International Chamber of Commerce on Prime Bank Instrument Frauds, International Chamber of Commerce at 3, ¶¶ 1.8-1.9; Nick Fielding & William Lewis, What the Lord Giveth..., ASS. NEWSPAPERS, Feb. 28, 1993, at 76.
[6] Richard H. Walker, Remarks before the U.S. Senate Permanent Subcommittee on Investigations Committee on Governmental Affairs United States Senate (Mar. 23, 1999) (transcript available http://sec.gov/news/testimony/testarchive/1999/tsty0699.txt).
[7] See, SEC Steps Up Nationwide Crackdown Against Internet Fraud, Charging 26 Companies and Individuals for Bogus Securities Offerings, SEC NEWS ITEM, 99-49 (May 12, 1999), available in http://www.sec.gov/news/headlines/nets0599.htm.
[8] Id.
[9] 15 U.S.C. § 77e (1997).
[10] 15 U.S.C. § 77q (1997).
[11] 15 U.S.C. § 78j(b) (1997).
[12] 17 C.F.R. § 240.10b-5.
[13] In Re Kaiden, supra note 2, at 5; In the Matter of Reese , Initial Decision Release No. 142 (May 6, 1999).
[14] SEC v. Lauer, 52 F.3d 667 (7th Cir. 1995).
[15] Id. at 670.
[16] SEC v. The Infinity Group, et al., 212 F.3d 180 (3rd Cir. 2000).
[17] See SEC v. Koontz, No. 98 CV 11904-NG (D. Mass. Sept. 17, 1998); see SEC Litig. Release. No. 15892 (Sept. 21, 1998).
[18] On June 29, 2001, Judge Nancy Gertner of the United States District Court for the District of Massachusetts permanently enjoined Jeffery A. DeVille and Mykael Deville from future violations of antifraud and registration provisions of the federal securities laws. SEC Litig. Release No. 17055 (June 29, 2001). In addition, the Court ordered the Devilles to pay disgorgement and permanently barred Jefferey Deville from associating with a broker or dealer. Id.
[19] See U.S. v. Kootz, et al., No. 8:00-CR. 341-ALL (M.D. Fla., Sept. 20, 2000); SEC Litig. Release. No. 16727 (Sept. 27, 2000).
[20] See, e.g., SEC Litig. Release No. 16736 (Sept. 28, 2000).
[21] SEC v. Rivlin, No. 99-1455 (D.D.C. Oct. 23, 2000).
[22] 15 U.S.C. § 77q (1997).
[23] SEC Litig. Release No. 16779 (Oct. 25, 2000).
[24] SEC Litig. Release No. 16593, (June 15, 2000); SEC Litig. Release. No 16934 (March 16, 2001).
[25] E.g., Memorandum in Support of Plaintiff’s Motion for summary Judgment and for a Preclusion Order, SEC v. Blink, H.L., No. 5:99-CV-372-3 (M.D. Ga. June 6, 2001).
[26] See U.S. v. Glantz, 94-CR10200 JLT (D.Mass.)
[27] SEC v. Glantz, 1995 U.S. Dist. Lexis 1370 (S.D.N.Y. 1995).
[28] SEC Litig. Release. No. 14705 (Oct. 31, 1995); see supra note 14, at 671.
[29] U.S. v. Lauer, 148 F.3d 766 (7th Cir. 1998)
[30] SEC Litig. Release, No. 16408 (Jan. 14, 2001); SEC Litig. Release, No. 14705 (Oct. 31, 1995).
[31] SEC Litig. Release No. 16897 (Feb. 14, 2001); 15 U.S.C. § 77q (1997).
[32] See U.S. v. Paradis, Cr. 2001-40006 (NMG) (D.Mass. filed Feb. 7, 2001).
[33] U.S. v. Rishell and Weber, Docket No. 01CR00051 (E.D. Pa). Weber vouched for prime bank guarantees according to Lewis Rivlin. See Order (entering a Preliminary Injunction) dated Oct. 23, 2000 in SEC v. Rivlin, 99 CV01455 (RCL) p. 5, (D.D.C.)
[34] Piedmont Resolution, LLC v. Johnson, Rivlin & Foley, 999 F.Supp. 34 (D.D.C. 1998).
[35] Grabowski v. Bank of Boston, 997 F.Supp. 111, 130 (D.Mass. 1998).