Almost 12 years have passed since Bernie Madoff was sentenced to 150 years in prison with restitution of $170 billion for perpetrating an elaborate Ponzi scheme that harmed thousands of clients. Widely regarded as the largest fraudulent investment scandal in U.S. history, the Madoff case widely publicized the need for advisors and investors to perform their own due diligence by reviewing documents and asking relevant questions before investing.
Ongoing legal action against New York-based investment advisor GPB Capital Holdings, LLC, serves as a reminder of the need for advisers to adhere to their fiduciary duty to clients and the importance for investors – in this case, many of them seniors – to understand the inherent risk in any investment opportunity.
The Case Against GPB Capital
The North American Securities Administrators Association (NASAA) announced on February 4, 2021, that seven state securities had filed regulatory actions against GPB Capital. The same day, the U.S. Securities and Exchange Commission (SEC) charged Jeffry Schneider, David Gentile, and Jeffrey Lash of GPB Capital and affiliated entities with violating federal securities laws by running a $1.7 billion Ponzi-like private placement scheme that allegedly swindled more than 17,000 retail investors nationwide, approximately 4,000 of them seniors. See the SEC Press Release here. The defendants have entered pleas of not guilty.
The alleged scheme was centered on the sale of unregistered, high-commission limited partnership interests in a series of alternative-asset investment funds that focused on auto dealerships. The funds were sold to broker-dealers who, in turn, supposedly targeted accredited investors whose net worth or income qualified them to participate in private placement securities transactions that are exempt from SEC and state registration.
The funds lured brokerage firms with the promise of 8% sales commissions, with additional expenses and fees going to the wholesale broker-dealer and entities directly owned by the defendants. In many cases, the total fees paid upfront at the time of an investment into a GPB fund were as much as 11%. An SEC filing alleges more than 60 firms acted as “downstream broker-dealers” for GBP products, generating $187 million in fees and commissions from accredited investors and unsophisticated investors who stand to lose everything. In turn, harmed investors have filed hundreds of arbitration claims with the Financial Investment Regulatory Authority (FINRA).
Regulators allege that defendants created backdated performance and falsified financial statements to generate fictitious income in order to cover their shortfalls and promote their luxury lifestyle. Filings state that GPB and its principals used their money to finance private jets, hire a $90,000-a-year flight attendant, direct millions of dollars into private bank accounts and payments to family members, and buy a $355,000 Ferrari FF.
GPB’s Chief Compliance Officer and Whistleblowers
In 2019, federal regulators charged Michael S. Cohn with obstruction of justice, unauthorized computer access, and disclosure of confidential information less than a year after he left his position as an SEC examiner to take a $400,000 role as GPB’s chief compliance officer. The charges allege Cohn joined GPB after leaving the SEC with proprietary information he retrieved from databases he wasn’t allowed to access, including compromising information about an SEC investigation into GPB.
Separately, the SEC has charged GPB Capital with violating whistleblower protection laws for including language in termination and separation agreements from going forward to the SEC and for retaliating against a known whistleblower. Another whistleblower, a former NASD Regulation/FINRA examiner with more than 20 years of experience, had her employment terminated by a brokerage firm when she refused to be silent after her due diligence into GPB Capital raised several major concerns.
Green Lights and Red Flags
There are many ways financial advisers, broker-dealers, accredited investors, and unsophisticated investors can “kick the tires” before making any investment. As an example, potential investors can use FINRA’s publicly available www.broker.org site to run background checks. Retail investors who did their homework on Schneider would have uncovered a securities broker with a long regulatory and disciplinary record and a history of association with questionable or demonstrably fraudulent activity.
Another step in the due diligence process is to follow valuable advice from legendary investor Warren Buffett and never invest in something you don’t understand. If you can’t understand an offering document, don’t invest. And never invest in something that seems too good to be true, because it usually is.
It’s important to weigh the potential benefit of an investment opportunity against its tax consequences, investment risk, and fees and expenses. An 8-11% upfront commission for a private placement not registered by the SEC should sound alarm bells. A question to ask is, “Where did you hear about this investment?” It’s one way to determine whether potential conflicts of interest exist.
Your Due Diligence
All retail investors, regardless of their sophistication level, should do at least some homework of their own before making any investment. And all firms have a responsibility to maintain policies and procedures on their ongoing supervision of investment managers, their employees, and their clients.
Our team of specialists at Core Compliance and & Legal Services, Inc., can assess your firm’s due diligence processes and provide recommendations and build a strong and efficient compliance program customized to your specific needs. Contact us at 619.278.0020 or corecls.com to schedule a consultation.