Enforcement News: Founder of Online Digital Sweepstakes Company Charged with Securities FraudPrint Article
- Posted on: Feb 15 2019
Securities fraud comes in all shapes and sizes. While the substance of a fraudulent investment scheme may change depending upon the circumstances and the fraudster involved, the types of securities fraud tend to fall into one of the following (non-exclusive) categories: financial statement/accounting fraud; pyramid schemes; Ponzi schemes; pump-and-dump schemes; affinity fraud; promissory note fraud; Internet fraud; “microcap” stock fraud; and fraud concerning information about a company, its operations and future prospects.
Fraudsters use techniques that are designed to persuade a target or victim into buying the security at issue. Some of these techniques include: (1) phantom riches representation – that is, the investment will yield “incredible gains,” is a “breakout stock pick” or has “huge upside and almost no risk”; (2) guaranteed returns – that is, high returns and low risk are “guaranteed” or “can’t miss”; (3) source credibility or “halo” effect – the fraudster tries to build credibility by claiming to be with a reputable firm or to have a special credential or experience; (4) “I believe in the company, so should you” assurance – the fraudster tries to assure the target that the investment is a sound one because he/she also invested in the company; (5) “everyone is buying it” representation – the fraudster stresses that other people are buying the security and, therefore, so should the target or victim; and (6) the reciprocity representation – the fraudster offers to do a small favor for the target or victim in return for a big favor: “I’ll give you a break on my commission if you buy now.”
[Ed. Note: The SEC and FINRA, as well as state securities commissions, have written about the foregoing scams and tactics, including suggestions on how to protect against being a victim of such frauds and tactics (e.g., here, here, here, and here).]
As FINRA notes, “[a]lmost anyone who invests is a potential fraud target.” FINRA, Avoiding Investment Scams, http://www.finra.org/investors/alerts/avoiding-investment-scams. The reason, says FINRA, is the psychology behind the pitch. “[F]raudsters are masters of persuasion, tailoring their pitches to match the psychological profiles of their targets.” Id. Because of their ability to identify the risk profile of their victims, fraudsters are adept at fleecing investors out of their money. In this regard, some of the risk factors identified by FINRA include: investing in or owning high-risk investments, such as start-up companies and penny stocks; relying on friends, family, co-workers for investment advice; attending investment seminars; failing to perform any type of check or due diligence on the fraudster; and an inability to detect that something is amiss. Id.
SEC v. Alexander
Recently, the SEC charged the founder and principal of an online digital sweepstakes company with conducting a $9 million securities fraud that involved some of the foregoing risk factors.
On February 7, 2019, the SEC announced that it had charged Robert Alexander (“Alexander”) with fraudulently raising approximately $9 million from approximately 53 individuals by selling investments in Kizzang LLC (“Kizzang”), a purported “new media sweepstakes company” that offered digital sweepstakes entertainment on mobile devices, via social media, and on the web. (A copy of the SEC’s press release can be found here.)
Shortly after Kizzang’s incorporation on January 10, 2013, Alexander allegedly solicited friends and business associates, among others, to invest in Kizzang. According to the SEC’s complaint (here), he did so by, among other representations, (1) telling investors how their money would be used by Kizzang and how much had been raised previously, (2) guaranteeing that Kizzang would break even within three years, (3) telling investors they would make a minimum of 10 times their investment, (4) telling investors that he had personally invested millions of dollars in Kizzang, and (5) telling investors that he had led the creation of a prominent video game. As alleged by the SEC, these and other representations were materially false and misleading.
For example, rather than using investor funds for Kizzang’s business, Alexander misappropriated at least $1.3 million, including spending more than $450,000 on gambling sprees. Alexander also used investor funds to finance his daily living and other personal expenses, including credit card bills, shopping and entertainment, and expenses for his daughter, including culinary school tuition and luxury car payments.
On November 13, 2017, Alexander informed shareholders that Kizzang had been inactive for five months and that the company was “hopelessly insolvent.”
The SEC filed the complaint in the U.S. District Court for the Southern District of New York. The SEC charged Alexander and Kizzang with violating the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. The SEC is seeking a permanent injunction, civil monetary penalties, and disgorgement of ill-gotten monetary gains, plus interest.
Commenting on the charges, Carolyn Welshhans, Associate Director in the SEC’s Division of Enforcement, stated: “As alleged in our complaint, Alexander promoted Kizzang as an opportunity for investors to profit from the early success of a technology start-up. In reality, Alexander brazenly converted investor proceeds for his personal use, sometimes within days of receiving investor funds.”
In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Alexander (here). The charges were based upon the same conduct alleged in the SEC complaint, to wit: “ALEXANDER solicited and maintained investments in the Company through numerous false representations, including concerning his own professional background, the Company’s financial condition, expected returns on investment, and assurances to investors that their investments would be used solely for the Company’s business purposes.”
Commenting on the allegations, U.S. Attorney Geoffrey S. Berman, stated: “As alleged, Robert Alexander lied to investors in his online gaming company, fabricating information about his professional background and promising to use investor money solely to further the aims of the business. Instead, Alexander allegedly used more than $1.3 million in investor funds on, among other things, gambling excursions, entertainment venues, and other personal expenses. As this arrest demonstrates, fraud on investors is no game, and we will continue to partner with the FBI to investigate and prosecute those who defraud investors.”
FBI Assistant Director-in-Charge William F. Sweeney, Jr. also commented on the allegations, stating: “Time and time again, we come across evidence of investment funds being misappropriated to pay off personal debts or fund extravagant lifestyles. As evidenced by today’s arrest, those who allegedly use these funds for other than their intended purpose are taking a gamble – the bigger the risk does not always mean the greater the reward.”
Alexander was charged with one count of securities fraud and one count of wire fraud. If convicted, the securities fraud count carries a maximum sentence of 20 years in prison and a maximum fine of $5 million or twice the gross gain or loss from the offense, and the wire fraud count carries a maximum sentence of 20 years in prison and a maximum fine of $250,000 or twice the gross gain or loss from the offense.
The SEC’s stated mission “is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” See SEC website (here). “Crucial to the SEC’s effectiveness in each of [the foregoing] areas is its enforcement authority.” Id. In that regard, the SEC commences “hundreds of civil enforcement actions against individuals and companies for violation of the securities laws.” Id. Typical violations fall within the categories of fraud identified above – e.g., insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them.
Since investor protection is one of the tripartite components of the SEC’s mission, the Commission has identified investor protection as one of its five core principles. See Division of Enforcement Annual Report for Fiscal 2018 at 6 (here). In furtherance of this principle, the SEC has devoted resources and initiated programs to protect retail investors. These efforts have resulted in more than half of the SEC’s stand-alone enforcement actions in FY 2018 to involve wrongdoing against retail investors. Id. Alexander is an example of the SEC’s efforts to protect Main Street investors.