Enforcement News: SEC Charges Multi-level Marketing Company and its Principals and Promoters with $650 Million Crypto Fraud
Print Article- Posted on: Aug 14 2024
By: Jeffrey Haber
A multi-level marketing program is a relative of pyramid scheme. “[A] pyramid scheme is an illegal investment scam based on a hierarchical setup.”[1] In the classic pyramid scheme, “participants attempt to make money solely by recruiting new participants, usually where: [t]he promoter promises a high return in a short period of time; [n]o genuine product or service is actually sold; and [t]he primary emphasis is on recruiting new participants.”[2]
Promoters of a pyramid scheme often encourage investors to participate in the fraud through social media, company websites, group seminars, Internet advertising, YouTube videos, and other media. To lure recruits into the scheme, pyramid scheme promoters work hard to make the operation look legitimate. But, as discussed below, they are not and ultimately collapse because the promoter cannot raise enough money from new investors to pay earlier ones.
A pyramid scheme begins with an individual or a company who recruits investors, typically by promising high rates of return. As the earliest investors in the pyramid, these individuals typically receive high returns. These gains are paid for, however, by new recruits, not by a return on any real investment. Because returns are dependent upon investment by new recruits, ultimately the pyramid becomes too big for new recruits to fund returns for those at the top of the pyramid. For this reason, it is mathematically impossible for every investor in the pyramid to make money. For example, if each investor needs to recruit 10 people to recoup his/her initial investment, the bottom levels of the pyramid would have to recruit over one billion people to break even – i.e., make back the money initially invested.
[Ed. Note: In New York, “Article 23A of the General Business Law … § 359-fff sets forth the criminality of initiating and participating in pyramid schemes (also known as chain distributor schemes).” See N.Y. AG, “Don’t Get Caught in a Pyramid Scheme.” Here.]
As noted, a multi-level marketing program (“MLM”) and a pyramid scheme are cut from the same cloth. It is often difficult to tell the difference between a legitimate MLM and a pyramid scheme. Both share the same or similar business models of “multiple levels” of distributors and recruits.
A legitimate MLM relies on a network of distributors and recruits who sell the company’s product. Think of companies like Amway, Tupperware, Herbalife, Avon, and Mary Kay. The only way to make money in a legitimate MLM is by selling the company’s product directly to the consumer or by managing a team of salespeople. Managers receive a percentage of the sales made by each recruit under their management and supervision. A legitimate MLM does not require the recruit to buy a starter kit from which the earlier investor receives a commission or a recruiting “bonus” or require mandatory training and a non-refundable membership fee. In short, a legitimate MLM does not require investors to recruit new ones to earn money; the business is focused on selling the company’s products.
Stopping illegal MLMs and holding their promoters accountable is an important part of the SEC’s enforcement mission. In today’s post, this Blog looks at an SEC enforcement action against an MLM and its principals and promoters for bilking investors out of $650 million.
On August 12, 2024, the SEC announced (here) charges against the principals of an MLM (the “Principals”), along with their company, NovaTech Ltd., for operating a fraudulent scheme that raised more than $650 million in crypto assets from more than 200,000 investors worldwide, including many in the Haitian-American community. The SEC also charged numerous individuals for their roles in promoting the MLM to investors.
According to the SEC’s complaint (here), the Principals operated their company as a multi-level marketing and crypto asset investment program. The SEC alleged that from 2019 through 2023 defendants lured investors by claiming the company would invest their funds on crypto asset and foreign exchange markets. One of the Principals assured investors that their investments would be safe and promised that “[i]n this program, you are in profit from day one, because again you have access to that capital.” In reality, the company used the majority of investor funds to make payments to existing investors and to pay commissions to promoters, using only a fraction of investor funds for trading. The SEC further alleged that the Principals siphoned millions of dollars of investor assets for themselves. When the company ultimately collapsed, most investors were not able to withdraw their investments, resulting in substantial losses, said the SEC.
“NovaTech and the [Principals] caused untold losses to tens of thousands of victims around the world,” said Eric Werner, Director of the SEC’s Fort Worth Regional Office. “As we allege, MLM schemes of this size require promoters to fuel them, and today’s action demonstrates that we will hold accountable not just the principal architects of these massive schemes, but also promoters who spread their fraud by unlawfully soliciting victims.”
The SEC also alleged that the company’s top promoters each recruited a wide network of investors and promoters. The company paid them substantial commissions for the investors they and their networks recruited. According to the SEC, when the promoters became aware of certain red flags about the company, including regulatory actions taken against it by U.S. and Canadian regulators, they continued recruiting investors and downplayed the red flags.
The SEC filed its complaint in the U.S. District Court for the Southern District of Florida, charging certain defendants with violating the antifraud provisions of the federal securities laws and all the defendants with registration violations. The SEC sought permanent injunctive relief, disgorgement of ill-gotten gains, and civil penalties. Without admitting or denying the allegations, one of the defendants agreed to partially settle the SEC’s charges by consenting to a $100,000 civil penalty and to be permanently enjoined from future violations of the charged provisions, with the amount of other monetary remedies to be determined at a later date. The partial settlement is subject to court approval.
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Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.
This article is for informational purposes and is not intended to be and should not be taken as legal advice.
[1] See Investopedia.com, What Is a Pyramid Scheme? How Does It Work? (Updated June 3, 2024) (here).
