Scherzer Blog

SEC charges green-product company with running a $26 million Ponzi scheme

The Securities and Exchange Commission (SEC) announced today that it obtained an emergency court order to halt a Ponzi scheme that promised investors high returns on water-filtering natural stone pavers but bilked them of approximately $26 million over a four-year period.

Filed in the U.S. District Court for the Southern District of New York, the SEC alleges in its complaint that between 2006 and 2010, convicted felon Eric Aronson and others defrauded about 140 individual investors in PermaPave Companies, a group of firms based on Long Island, NY, and controlled by Aronson. According to the complaint, the investors were told that PermaPave had a tremendous backlog of orders for pavers imported from Australia, which could be sold in the U.S. at a substantial mark-up, yielding monthly returns of 7.8% to 33%. But in reality, the complaint states, there was little demand for the product, and the cost of the pavers far exceeded the revenue from sales.

In their Ponzi scheme, Aronson and two other PermaPave executives, Vincent Buonauro Jr. and Robert Kondratick, used the new funds to make payments to earlier investors and then siphoned off much of the rest for themselves, buying luxury cars, gambling trips, and jewelry, according to the complaint. Aronson also allegedly used the investors’ money to make court-ordered restitution payments to victims of a previous scheme to which he pleaded guilty in 2000.

The complaint further states that when investors began demanding their money, Aronson accused them of committing a felony by lending the PermaPave Companies money at the interest rates he promised them, which he suddenly claimed were usurious. Aronson and his attorney, Fredric Aaron, then allegedly made false statements to persuade investors to convert their securities into ones that deferred payments for several years.

The SEC also charges that the defendants used some of the money raised through the Ponzi scheme to purchase a publicly traded company, Interlink-US-Network, Ltd. Several months later, the SEC said that Interlink issued a Form 8-K, signed by Kondratick, which falsely claimed that LED Capital Corp. had agreed to invest $6 million in Interlink. According to the complaint, LED Capital Corp. did not have $6 million and had no dealings with Interlink.

The U.S. Attorney’s Office for the Eastern District of New York, which conducted a parallel investigation, filed criminal charges against Aronson, Buonauro, and Kondratick.

|Green Technology|

More states are restricting credit reports for employment purposes

Connecticut has joined five other states (Hawaii, Illinois, Maryland, Oregon, and Washington) that, with some exceptions, prohibit the use of credit reports in employment decisions. Effective October 1, 2011, S.B. 361 will ban many employers from using credit information in determining whether to deny employment to an applicant, terminate an employee, decide compensation, or evaluate other terms and conditions of employment. Financial institutions, as well as employers who are required to obtain credit reports under federal or state law, are excluded from the Act’s provisions

There are certain exceptions to the S.B. 361 prohibitions. Employers may request or use credit reports when such information is related to a “bona fide purpose that is substantially job-related.” The bona fide purpose exception generally applies to positions involving money handling or other sensitive job duties. If an employer requests or uses credit information for a bona fide purpose, it must disclose its intent to do so in writing to the employee or applicant.

As in Connecticut’s S.B. 361, employers in the other states that have passed employment-related credit report restriction laws need to ensure that their hiring, retention, and promotion practices fall within the guidelines of their legislation.

|Employment Decisions, Legislation|

Risk-based approach to employment screening rates high on value chain

In today’s world just about every company knows that an effective employment screening program is invaluable for hiring qualified individuals, reducing turnover, deterring fraud and other criminal actions, and avoiding or mitigating litigation.

Recognizing that a “bad” hire is a threat to the bottom line, many companies, from investment bankers to law firms, are taking a risk-focused approach to background investigations and deciding what is appropriate or how much should be done to ensure organizational success. For example, obtaining a credit report or checking civil records for an entry-level applicant with low risk responsibilities may be of limited use, while reviewing such record histories for someone who will handle money or have access to sensitive information may be imperative in assessing his/her suitability for a position of trust.

Best practices in both the government and in the private sector indicate that a risk designation should be determined for every position, based on its description of duties and responsibilities. The risk grade should be commensurate with the employee’s assigned trust level, financial accountability, access to sensitive and confidential information and critical data systems, autonomy, discretionary authority, and potential opportunity for misconduct.

To be effective and non-discriminatory, employment screening policies need to specify a uniform set of background investigation elements for all position/assignment levels, including new hires, temporary workers, interns, transferred and promoted employees, contractors and volunteers.

SI has a full suite of employment background investigation products. Please visit our website at https://scherzer.co/ to learn more or order an investigation.

|Educational Series, Employment Decisions, Risk Management|

New FINRA rule for reporting requirements

FINRA’s Rule 4530, modeled after NASD Rule 3070 and NYSE Rule 351, went into effect on July 1, 2011. The rule requires all member firms to:

report to FINRA certain specified events and quarterly statistical and summary information regarding written customer complaints, and
file with FINRA documents of certain criminal actions, civil complaints and arbitration claims.

A member firm has 30 calendar days to report to FINRA violations of any securities, insurance, commodities, financial or investment laws, rules, regulations or standards of conduct committed by the firm or its associated persons. The 30-day period begins when the firm has concluded, or reasonably should have concluded, that a violation has occurred. Below is a summary of the provision.

Firms are not required to report every instance of non-compliant conduct, but they must report conduct that has widespread or potential widespread impact to the firm, its customers or the markets, or conduct that arises from a material failure of the firm’s systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts.
Violative conduct by an associated person must be reported only when it has widespread or potential widespread impact to the firm, its customers or the markets; conduct that has a significant monetary result on a member firm(s), customer(s) or market(s); or multiple instances of any violative conduct.
The “reasonably should have concluded” standard is applied on a good faith basis (by the firm) if a reasonable person would have concluded that a violation has occurred; if a reasonable person would not have concluded that a violation occurred, then the matter is not reportable. Firms must establish who, within the firm, is responsible for making such determinations. Stating that a violation was of a nature that did not merit consideration by the responsible person is not a defense to a failure to report such conduct.
The reporting obligation and internal review processes set forth under other rules – eg., FINRA Rule 3130 – are mutually exclusive.
While internal review processes may point to a firm’s determination that a specific violation has occurred, they do not by themselves lead to the conclusion that the matter is reportable – e.g., FINRA would not view a discussion in an internal audit report regarding the need for enhanced controls in a particular area, standing alone, as determinative of a reportable violation. An internal audit finding would serve only as one factor, among others, that a firm should consider in determining whether a reportable violation occurred.
Certain disciplinary actions taken by a firm against an associated person must be reported under a separate provision, rather than under the internal conclusion provision.

In addition to the above “internal conclusions” obligations, the new rules for “other reportable events” as per NASD Rule 3070 and NYSE Rule 351, have been modified somewhat in Rule 4530. For example, more customer disputes may have to be reported, as the new rule will now include attorney’s fees and interest penalties in customer settlements or awards with damages against a broker of $15,000 or more and against a firm of $25,000 or more, thus lowering the calculations threshold for reporting requirements.

|Legislation|

Rudiments of a Ponzi scheme

The scheme is named after Charles Ponzi, who duped thousands of New England residents into investing in postage stamp speculation in the 1920s. But Ponzi is not the original mastermind behind the scheme; various reports show that there were several similar scams before he was born. (Charles Dickens’ 1857 novel “Little Dorrit,” for example, described such a scheme whereby the fraudulent dealings of Mr. Merdle led to the collapse of his bank.) Ponzi’s operation, however, took in so much money that it was the first to become widely known in the United States. Ponzi promised investors that he could provide a 50% return in just 90 days, at a time when the annual interest rate for bank accounts was 5%. Based on the arbitrage of international reply coupons for postage stamps, Ponzi quickly diverted investors’ money to support payments to earlier investors and to himself.

As originally designed, a Ponzi scheme remains a fraudulent operation that pays returns to separate investors, not from an actual profit earned but from the investors’ own money or money paid by subsequent investors. The scheme typically entices new investors by offering returns that other investments cannot guarantee, in the form of short-term yields that are either extraordinarily high or unusually consistent.
The main reason why the scheme initially works is that the early investors, those who actually got paid the large returns (from the investments of new entrants) reinvest their money in the scheme. Meanwhile, the fraudsters gain the investors’ confidence, maintaining the deception of high profits. Claims of a “proprietary” investment strategy, which must be kept secret to ensure a competitive edge, frequently is touted to hide the fraudulent operation.

The fraudsters also try to minimize withdrawals by offering new plans to investors, often freezing their money for a long time in exchange for higher returns. If a few investors do wish to withdraw their money in accordance with the strict terms, the requests are usually promptly processed, giving the illusion to other investors that the fund is solvent.

But once the required continuous stream of investors slows down, the scheme begins to collapse as the fraudsters start to have problems paying the promised returns (the higher the returns, the greater the risk of collapsing). Such liquidity crises often trigger panics, as more people start asking for their money, similar to a bank run. (A bank run, also known as a “run on the bank” occurs when a large number of customers withdraw deposits because they believe the bank is, or might become, insolvent.)

External market forces, such as the global economy decline in 2008, also cause many investors to withdraw part or all of their funds, not necessarily because of fraud suspicions, but simply due to underlying market conditions. (In Madoff’s case, the fund could no longer appear legitimate after investors attempted to withdraw $7 billion in late 2008.)

And of course, there is rarely a happy ending to this story as fraudsters attempt to vanish, taking the remaining investment money with them.

|Educational Series, Fraud|

Controversy abounds in employment decisions based on social media searches

In May 2011, the Federal Trade Commission (FTC) ruled that companies providing social media information to employers – and employers who use the reports – must follow the same Fair Credit Reporting Act (FCRA) regulations that apply to more traditional sources. The FTC also stated that postings on any social media site can be saved by on-line background screening companies for up to seven years.

According to the FTC’s letter dated May 9, 2011 to a company that sells information from social networking sites for employment purposes, such a company is considered a Consumer Reporting Agency (CRA) and thus must take reasonable steps to ensure the accuracy of the information obtained from online social networks (as well as other sources) and positively identify it with the subject. It also must comply with other FCRA provisions, such as providing a copy of the report to the subject and maintaining an established protocol if the subject disputes the reported information. As with “traditional” background investigations, employers who use a report prepared by a CRA must certify to the CRA that the report will not be used in violations of federal or state equal employment opportunity laws or regulations. Additionally, both the CRA and the employer have a legal obligation to keep and dispose of the reports securely and properly. (For more information, see the FTC blog, “The Fair Credit Reporting Act & Social Media: What Businesses Should Know.”)

Social media legal experts and various literature point to a multitude of issues and risks faced by both the CRA and the employer who uses social media checks, which include, but are not limited to:

Problems under FCRA section 607(b) in exercising “reasonable procedures to assure maximum possible accuracy” of the information.
Since the information on social media sites is self-reported and can be changed at any time, it is often difficult if not impossible to ascertain that the information is accurate, authentic and belongs to the subject. Online identity theft is not uncommon, as are postings under another person’s name for the purpose of “cyber–slamming” (which refers to online defamation, slander, bullying, harassment, etc.)

Information may be discriminatory to job candidates or employees, or in violation of anti-retaliation laws.
Social sites and postings may reveal protected concerted activity under the National Labor Relations Act (NLRA,) and protected class information under Title VII of the Civil Rights Act and other federal laws, such as race, age, creed, nationality, ancestry, medical condition, disability, marital status, gender, sexual preference, labor union affiliations, certain social interests, or political associations. And while the information may have no impact on the employment decision, the fact that the information was accessed may support claims for discrimination, retaliation or harassment.

Accessing the information may be in violation of the federal Stored Communications Act (SCA).
To the extent that an employer requests or requires an employee’s login or password information, searches of social networking sites may implicate the SCA (18 U.S.C. § 2701) and comparable state laws which prohibit access to stored electronic communications without valid authorization. A California court recently ruled that the SCA also may protect an employee’s private information on social networking sites from discovery in civil litigation.

Assessing the information may violate terms of use agreements and privacy rights.
While certain social media sites have stricter privacy controls than others, most if not all limit the use of their content. The terms of use agreements typically state that the information is for “personal use only” and not for “commercial” purposes. Although the definition of “commercial” in connection with employment purposes is interpretive, most legal experts indicate that employment screening fits that scope.

Information may be subjective and irrelevant to the employment decision.
Blogs, photos and similar postings often do not provide an objective depiction of the subject or predict job performance. The California Labor Code, for example, specifically provides that an employer is prevented from making employment-related decisions based on an employee’s legal off-duty conduct. Employers may use such information only if the off-duty conduct is illegal, if it presents a conflict of interest to the business or if it adversely affects the employee’s ability to do his/her job. And the evidence of such activities must be clear.

The popularity of employment-related background checks that include social media searches is growing rapidly. But the unreliable and unverifiable information from these sources is a potential landmine of legal liabilities.

|Employment Decisions|

Subcommittee approves legislation to protect consumers against data theft

On July 20, 2011, the Energy and Commerce Subcommittee on Commerce, Manufacturing, and Trade approved legislation to protect consumers from cyber attacks and identity theft. The Secure and Fortify Electronic Data Act (H.R. 2577), or SAFE Data Act now moves to the full Energy and Commerce Committee for consideration.

The Act would require all businesses that maintain personal information to implement security programs, which, among other mandates, would include a protocol to notify affected individuals of an information security breach. Preempting over 45 existing state information security and breach notification laws, the Act would task the Federal Trade Commission with developing the security rules.

According to its author, Chairman Bono Mack, the Act will enhance protection of personal information by establishing uniform national standards for data security and data breach notification. The preemption provision also would provide certainty for businesses in addressing information security breaches that now are subject to the multitude of state requirements.

Some legislators and advocates have criticized the proposed law as too narrow, as it would require breach notifications only when an individual’s name, telephone number or credit card number is compromised along with a Social Security number, driver’s license number or other government-issued ID. With some state laws requiring notification when, for example, a credit card number, financial account number, Social Security number, or biometric data alone (without the individuals name) is compromised, the practical notification threshold under current state breach notification laws may be significantly lower than that proposed by the Safe Data Act.

|Educational Series, Legislation|

Challenges of international background investigations

Many transactions today, whether they involve an employment hiring decision or a new business relationship, are cross-border or have an international component. The need for effective risk management both in the U.S. and abroad has vastly expanded in recent years with the passing of legislation and increased enforcement actions. Behind just about every business decision, there is a widening range of stakeholders — from regulators to shareholders to board members — who expect that the due diligence process will minimize unlawful activities.

International background investigations, which are essential for a comprehensive approach to due diligence, present special challenges since each country has its own laws, customs, and procedures. Language barriers, name variations and transliterations, limited information and technology, broad definitions of crimes, and proliferation of fraudulent educational and accreditation institutions, are just some of the factors that add to the complexity of these investigations.

As a general rule, in most European countries, criminal records are not available to the public. In Asia, public accessibility to most court filings is limited. In South America, public records vary greatly from country to country. South Africa provides some disclosure of police records and warrants to the public, along with civil filings. Canada’s public records availability differs by province, and only a few permit criminal records release. India and Australia have the most searchable records, similar to the U.S.

For employment purposes, the Fair Credit Reporting Act (FCRA) imposes certain obligations for international background screening performed by a U.S. Consumer Reporting Agency (CRA), including mandating reasonable procedures to ensure the accuracy of the information it reports. If a public record such as a criminal conviction is found, the CRA must ascertain that the information is correct, up-to-date, and reported in a way that does not violate data or privacy protection rules.

In 2000, an agreement between the U.S. Department of Commerce and the European Commission established privacy and data protection guidelines, the “Safe Harbor Principles,” to enable U.S. companies to satisfy a requirement under European Union law for adequate protection of personal information transferred from the European Economic Area (the 25 member states of the European Union plus Iceland, Liechtenstein and Norway.) In addition to these principles, the Gramm-Leach-Bliley Act (GLBA) requires financial institutions and businesses that receive personal information to establish safeguards for the handling and disclosure of that information. And the Fair and Accurate Credit Transactions Act (FACTA), a federal legislation, also contains provisions to help reduce identity theft and obligates the proper disposal of personal consumer information.

The cost of an international background investigation typically is higher than domestic searches, and varies with each country, the type of information that needs to be obtained and the purpose of the investigation. When performed by a reputable firm with qualified foreign contacts, an international background investigation can reduce negligent hiring liability, and prevent a catastrophic investment or reputational damage.

|Educational Series, Legislation|

Dodd-Frank Act amendment for credit scores took effect July 21, 2011

The Federal Reserve Board and the Federal Trade Commission (FTC) issued final rules to implement the credit score disclosure requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. If a credit score is used in setting material terms of credit or in taking adverse action, the statute requires creditors to disclose credit scores and related information to consumers in notices under the Fair Credit Reporting Act (FCRA).

The final rules amend Regulation V (Fair Credit Reporting) to revise the content requirements for risk-based pricing notices, and to add related model forms that reflect the new credit score disclosure requirements. These rules also amend certain model notices in Regulation B (Equal Credit Opportunity), which combine the adverse action notice requirements for Regulation B and the FCRA.

For employers, this means that if a consumer report that includes a credit score is used to determine eligibility for employment, the employer will be required to disclose to the subject the usage of the credit score in an adverse employment decision and to provide information about the credit score, including the score itself, up to four key adverse factors in the score, and the identity of the agency that provided the score.

For credit transactions, creditors, including banks, credit unions, credit card issuers, and utilities, that extend credit on terms that are less favorable than those offered to other consumers because of information contained in a credit report, or if other adverse action is taken, will have to provide to the subject a “risk-based pricing notice” which discloses the credit scores and related information. Such notice will include: 1) the numerical credit score used by the creditor in making the decision; 2) the range of possible scores under the model used by the creditor; 3) the key factors that adversely affected the credit score; 4) the date on which the credit score was created, and 5) the name of the entity that provided the score.

In certain cases, such as for applications for a mortgage, auto loan, or another type of credit, a lender will have to furnish to the subject a “credit score notice” that lists the credit score and how the score compares to other consumers’ scores regardless of the credit terms offered. If no credit score is available for a consumer, the lender’s notice will identify the particular credit bureau which reported this information. Additionally, if a consumer’s annual percentage rate (APR) on an existing credit account is increased based on a review of a credit report, the creditor will have to provide an “account review notice.”

The Board and the FTC have stated that it is imperative to have the regulations and revised model forms in place as close as possible to July 21, 2011. This will help ensure that consumers receive consistent disclosures of credit scores and related information, and facilitate uniform compliance when Section 1100F of the Dodd-Frank Act becomes effective.

|Dodd-Frank, Legislation|

Consumer Financial Protection Bureau seeks input on non-bank entities

On June 23, 2011, the Consumer Financial Protection Bureau (CFPB) released a Notice and Request for Comment seeking public input on a key element of its non-bank supervision program — the statutory requirement to define who is a “larger participant” in certain consumer financial markets.

Created by the Dodd-Frank Act, the CFPB has been empowered to regulate non-bank financial entities. But exactly what is a “non-bank?” Various literature generally defines “non-bank” as a company that offers consumer financial products or services, but does not have a bank, thrift, or credit union charter and does not take deposits. Products from non-banks have a significant share of the overall consumer financial marketplace. Under Dodd-Frank, many of these non-banks will be subject to a federal supervision program for the first time.

In its Notice and Request for Comment, the CFPB has identified the following markets for potential inclusion in an initial rule: debt collection, consumer reporting, consumer credit and related activities, money transmitting, check cashing and related activities, prepaid cards, and debt relief services. The larger participant rule will not impose substantive consumer protection requirements. Instead, the rule will enable CFPB to begin a supervision program for larger participants in certain markets.

The issues for discussion in the Notice include:

What criteria to use to measure a market participant;
Where to set the thresholds for inclusion;
Whether to adopt a single test to define larger participants in all markets (measure the same criteria and use the same thresholds) or to use tests designed for specific markets;
What data is available to use for these purposes;
What time period to use to measure the size of a market participant;
How long a participant is to remain subject to supervision after initially meeting the larger participant threshold, and if it subsequently falls below the threshold; and
What consumer financial markets to include in the initial rule.

|Dodd-Frank, Legislation|

Previous 454647 Next