A Compilation of Enforcement and Non-Enforcement Actions

27 January 2009 Publication
Authors: Peter D. Fetzer Terry D. Nelson

Legal News: Investment Management Update

Non-Enforcement Matters

Court Dismisses Suit by Hedge Funds With Prior Information
The U.S. Court of Appeals for the Seventh Circuit recently affirmed the dismissal of securities fraud claims by the two hedge funds, Stark Trading and Shepherd Investments International Ltd. (Funds), because they knew of the alleged securities fraud in a tender offer but still tendered their shares. The Funds maintained they tendered their shares while knowing of the alleged fraud because they feared that they would be squeezed out with no apparent remedies to pursue under Canadian law (the country where the issuer of the shares is domiciled).

This case involved the efforts of the majority owner (Brascon Corp.) to get out of its position in Noranda Inc. (Noranda). Both are Canadian companies. Noranda offered to purchase shares from its shareholders at a price of $25 a share, which included Brascon Corp. The offer succeeded and the Funds, also shareholders of Noranda, accepted the buy-out and tendered their stock, even though the Funds knew that Noranda was attempting to buy out the minority shareholders on the cheap.

The Funds then looked to the U.S. federal securities laws for a remedy. The court ruled that the Funds did not have a claim under U.S. securities laws because they knew of the alleged fraud and therefore were not deceived and could not show reliance. At most, the court concluded, the Funds were “victimized by a heartless majority shareholder,” and U.S. securities laws do not provide a remedy for being an oppressed minority shareholder.

Investor Claims Are Dismissed for Failure to Allege UBS Acted as an Investment Adviser
The U.S. District Court for the Southern District of New York dismissed investors’ claims under state and federal law that UBS Financial Services Inc. (UBS) violated the Investment Advisers Act of 1940 (Advisers Act) by inducing their clients to purchase certain auction rate securities (ARS). Because UBS was the primary participant for the ARS at issue, when UBS no longer participated in the market, the investors allege they were unable to liquidate their ARS holdings. The investors sought (1) a refund of their investment and (2) disgorgement of the money UBS accepted from the investors for their ABS purchases.

The court dismissed the federal claims under the Advisers Act because there was no investment adviser relationship. The court was unwilling to infer one in this context, where UBS ran a non-discretionary brokerage account. The court noted that the investors failed to allege that any investment adviser agreement existed; that UBS was paid special compensation for providing investment advice; or that, to the extent UBS provided investment advice, it was not incidental to the servicing of the investors’ brokerage accounts. The court also noted that the remedies the investor sought are not provided for under the Advisers Act.

The court dismissed the state claims, which the investors contended were not governed by New York’s blue-sky law, the Martin Act. Since the court determined the claims were governed by the Martin Act, the court held the claims were preempted by the Martin Act.

Enforcement Matters

A Focus on Ponzi Schemes
Recent news stories about investment advisers and others are rife with tales of “Ponzi schemes,” which use newly acquired investments to create the illusion of a profit for previous investors. Given the lack of new investors in these troubled economic times, many Ponzi schemes are unable to sustain the illusion with new investments. For that reason, the uncovering and enforcement actions taken against Ponzi schemes are on the rise. This month, we devote our Enforcement Matters section exclusively to stories about Ponzi schemes.

The broad and thorough media coverage of Ponzi schemes has largely neglected a major issue: Those found civilly liable for orchestrating a Ponzi scheme also may be found criminally guilty (either later or earlier) for the same acts. Although the U.S. Constitution bars double jeopardy (or being criminally prosecuted twice for the same crime), there is no bar to pursuing one criminal prosecution and one civil case. The burden of proof is different for civil and criminal cases, with a much higher burden of proof in a criminal case.

In a criminal case, the government must prove the wrongdoing beyond a reasonable doubt; in a civil case, the burden of proof is lower, often merely requiring a showing “clear and convincing” evidence of the wrongdoing. The most notorious and infamous recent examples of the difference in the burden of proof standards (although not in a Ponzi scheme situation) are the O.J. Simpson criminal and civil trials. Mr. Simpson was found not guilty of criminal charges for a double murder, but, on the same evidence, he was found civilly liable for the murders. With that background, consider these three enforcement matters regarding Ponzi schemes.

CFTC and SEC Enforce Civil Sanctions on $50 Million Ponzi Scheme Artist
The U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have each filed an action against Joseph S. Forte, a Philadelphia investment fund manager, who is accused of running a $50 million Ponzi scheme. The SEC accused Mr. Forte and his firm of falsifying returns to investors, falsifying the size of his fund, using investors’ funds to pay off other investors, and failing to register with the SEC. The CFTC accused Mr. Forte of fraud in soliciting funds, misusing pool funds, and failing to register with the CFTC.

According to the complaint filed by the SEC, Mr. Forte took $50 million in investments. Although he claimed that his portfolio contained in excess of $150 million, it actually contained only $147,000. The balance of the investments went to Mr. Forte in fees and to pay off earlier investors. The SEC investigation is ongoing, while regulators are attempting to find the missing investment funds.

SEC Enforces Civil Sanctions on Ponzi Scheme Artist
The SEC filed a complaint against Richard S. Piccoli and the company he owns, Gen-See Capital Corporation a/k/a Gen Unlimited (Gen-See). The SEC alleges that Mr. Piccoli orchestrated a Ponzi scheme that targeted clergy, Catholic parishioners, and senior citizens. He promised returns of between 7.1 percent and 8.3 percent. In fact, the SEC alleges, Gen-See offered securities to the public without the securities being registered with the SEC under the Securities Act of 1933, as required. Moreover, Mr. Piccoli did not invest the funds at all, but instead used the funds to pay off earlier investors. The SEC sought to freeze Gen-See’s assets and to disgorge gains Mr. Piccoli fraudulently received on interest in these investments.

U.S. Attorney Files Criminal Suit Against Previously Liable Ponzi Scheme Artist
Anthony A. James, a South Florida investment adviser, had been adjudged liable in September 2008 for running a Ponzi scheme in violation of the Securities Exchange Act of 1934 and the Advisers Act. Three months after the court found Mr. James civilly liable in this matter, a federal prosecutor filed an indictment against Mr. James on two counts of mail fraud in connection with misappropriation and running a Ponzi scheme. The complaint alleges that Mr. James received $5.2 million from 44 clients but that he never invested any of the funds in the stock market. Instead, according to the prosecutors (and the court that found Mr. James civilly liable), he used the funds for personal gain and to pay off earlier investors.

Even though Mr. James was previously found civilly liable for orchestrating a Ponzi scheme, he is currently facing prosecution for criminal violations related to the same matter. Given that Mr. James’ civil adjudication occurred in September 2008, prior to the recent boom in civil enforcement for Ponzi schemes, we expect a spike in criminal prosecutions of Ponzi schemes over the course of the next year.

Legal News: Investment Management Update is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:


Terry D. Nelson
Madison, Wisconsin

Joseph D. Shumow
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin