Forced to sit at home under government-ordered decree, and having finished binge-watching Season 3 of Ozark and Season 4 of Money Heist on Netflix, what’s left to do except prey upon scared investors – particularly seniors – who have been watching the markets not so much fly as plummet? With (perhaps) that very thought in mind, on Thursday last week, the SEC’s Investor Advisory Committee hosted a conference call – nice social distancing! – with other regulators to discuss what sales practice issues have already arisen, and what issues might soon be expected, once the dust from the coronavirus settles. Frankly, if you didn’t already have enough to be scared about, if you work in the securities industry, this list might just put you over the edge.
Microcap fraud. Scammers love to take advantage of people’s fears. The fear of dying prematurely, unaccompanied by loved ones, especially when combined with the simultaneous fear of losing all of one’s money, can be pretty motivating. To that end, the SEC has warned investors that there are lots of companies out on the internet touting their supposed COVID-19 cures, treatments and even vaccines, designed to induce people to invest in them now. NOW!! As most amateur epidemiologists, like myself, well know, there is yet no known cure or treatment or vaccine for this virus. Given that hard fact, these companies have a decent chance of being scams, pump-and-dump schemes designed to enrich the few insiders who already own shares. FINRA, too, has issued its own warning on this subject. And inasmuch as the CARES Act allows retirees to withdraw up to $100,000 from their retirement accounts without incurring a penalty, it is easy to see why suddenly cash-heavy seniors may be particularly targeted.
Non-scam private placements. A private offering does not need to be a scam, of course, to present sales practice issues. There are real companies promoting private offerings related to COVID-19, e.g,, vaccines, personal protective equipment – that, as NASAA has pointed out, use the same techniques as a pump-and-dump scheme. Because these private offerings are not subject to review by federal or state securities regulators, however, they present their own unique risks. They can have high up-front sales costs, they may have limited liquidity opportunities, they may be difficult to price, and, most obvious, the prospects for actual success may be quite limited. There is nothing inherently wrong with a private placement, contrary to what regulators seem to suggest; but they do require a healthy amount of due diligence.
Use of margin. Margin can be a very useful tool; especially in a rising market. But, in a market like we’ve seen over the last few weeks, one that drops very quickly and very dramatically, owning securities purchased on margin can be devastating. The market losses are magnified, and can cause forced sell-outs, resulting in massive realized losses. Not surprisingly, therefore, the regulators have warned that complaints about margin may be around the corner. Sadly, I have to agree.
Operational issues. Another problem created by extremely fast moving markets is simply the crush of investors trying to place orders, or just contact their brokers. According to FINRA, it has already received complaints from customers who experienced problems trying to trade, because phones were not answered and/or because of internet connectivity. Undoubtedly, some of these investors will eventually complain that they incurred losses that could have been avoided or mitigated had their orders – or should we say supposed orders – been entered in a timely fashion. And this cuts both ways. In some cases, the complaint will be that a sell order could not be placed, period. In others, it will be that the sell order was timely placed, but the order was not timely filled, and by the time it was filled, the market had dropped even further. And in others, there will be complaints from sellers who supposedly tried to cancel their sell orders but could not, incurring losses as a result.
Precious metals fraud. It is no secret that when the securities market tanks, some investors move their cash to gold and silver, tried and true investments that are touted as being recession/depression/inflation/deflation proof. Fraudsters are well aware of this phenomenon, and take advantage of it. I am not saying gold is a bad investment, or a good one; what I am saying is that because there will be a demand for this stuff, invariably, and sadly, some of the available investments will not be legitimate.
Good, old-fashioned suitability claims. Beyond these fancy-schmancy issues that are unique to the particularly peculiar times in which we all now live, there are the bread-and-butter claims that investors have been raising since time immemorial: suitability. Or, more accurately: unsuitability. With the benefit of hindsight, investors who lose money in this market chaos can be counted on to argue that they are the victims of unsuitable recommendations made long ago, and rather than blaming the market, or the virus, or the government, for their predicaments, they will straight-facedly blame their brokers. They will argue that, somehow, their brokers should have known what would happen, and, therefore, never should have recommended that they buy – and you can fill in the blank with whatever stock you want, e.g., American Airlines, Carnival Cruise Lines, etc. These claims ought to be pretty defensible, but it not always easy, and never cheap, to defend even bogus claims.
It is hard enough dealing with this terrible virus, and the disruption it has created in all of our lives. It makes it worse to understand, however, that fraudsters are out there trying to take advantage of people who are already anxious and afraid. And, on behalf of brokers, it is also distressing to know that claimants’ counsel are sitting in their quarantines, licking their collective chops, thinking of the arbitrations they will invariably be filing.
 You want proof of the regulators’ interest in this subject? On Friday last week, the SEC filed two orders temporarily halting trading for No Borders Inc., a dental supply company, and Sandy Steele Unlimited Inc. Regarding No Borders, the SEC was concerned about a representation the company made that it had an agreement to bring its “COVID-19 specimen collection kits” to the U.S. As for Sandy Steele, apparently, “unknown sources” have sent emails to prospective investors claiming that the company has the capability to manufacture protective masks “that are in high demand due to the COVID-19 crisis.”