Enforcement News: SEC Seeks Emergency Relief Against Investment Adviser Targeting Senior Investors “in a Classic Ponzi Scheme”

• Posted on: May 25 2020

Elder financial exploitation is a significant problem. Everyone reading this article may be affected in some way. Family, friends, neighbors, colleagues, and/or customers can fall victim to financial exploitation. All of us are at risk of being financially abused and/or exploited as we grow older.

Seniors are Particularly Vulnerable to Financial Abuse and Exploitation

“Scam artists prey on seniors who are too polite and have difficulty saying ‘no’ or feel indebted to someone who has provided unsolicited investment advice.” (See SEC Guide, “Before You Invest”, here.)  Research indicates that as seniors grow older, they become too trusting and fail to recognize false or misleading claims, suspicious intentions and evidence of risky behavior. One study of senior adults found that many exhibited risky behaviors, such as believing deceptive and misleading advertisements and buying falsely advertised products (here). Other researchers have found that older persons possess a “doubt deficit,” in which false and misleading claims fail to trigger doubt in the listener (here). Such persons are often unable to detect the intentions of others, including those with the intent to deceive. As a result, the inability to doubt “provide[s] a compelling rationale why highly knowledgeable and intelligent older people are often susceptible to deception and fraud.” (Id.)

The Financial Costs of Elder Financial Abuse and Exploitation

As the incidence of financial exploitation and abuse increases, so do the costs to its victims. An oft-cited study by the MetLife Mature Market Institute, the National Committee for the Prevention of Elder Abuse, and the Center for Gerontology at Virginia Polytechnic Institute and State University, titled “Broken Trust: Elders, Family & Finances,” estimates that about one million seniors lose approximately $2.6 billion annually from financial exploitation and abuse. (Here.) In 2011, MetLife updated its estimate to at least $2.9 billion. Other, more recent studies estimate the losses to exceed $36 billion a year, 12 times the MetLife estimate. (Here.)

Seniors and Pyramid Schemes

Ponzi schemes remain a familiar and unfortunate risk for investors, especially the elderly. (Here.) Because Ponzi schemes purport to offer high returns with little or no risk, and rely on inflated credentials of a financial professional, investors are attracted to the investment products these scammers offer.

“A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. With little or no legitimate earnings, Ponzi schemes require a constant flow of money from new investors to continue. Ponzi schemes inevitably collapse, most often when it becomes difficult to recruit new investors or when a large number of investors ask for their funds to be returned.” See https://www.sec.gov/spotlight/enf-actions-ponzi.shtml.

Many Ponzi schemes share common characteristics. These include, among others: high returns with little or no risk – i.e., “guaranteed” investment opportunities; overly consistent returns – i.e., investments that consistently generate positive returns regardless of overall market conditions; unregistered investments – i.e., investments that are not registered with the SEC or with state regulators; unlicensed sellers – i.e., investment professionals and firms that are not licensed or registered with state and federal regulators; secretive, complex strategies – i.e., investment strategies that are locked away in a black box or are the scammer’s “secret sauce”; and difficulty receiving payments – i.e., difficulty cashing out or obtaining redemptions.

Shutting down Ponzi schemes and holding the organizers accountable for such frauds is an important part of the SEC’s enforcement mission. Recently, the SEC announced an emergency action against a Ponzi scheme organizer allegedly responsible for bilking seniors out of millions of dollars.

SEC v. Paul Horton Smith, et al.

On May 22, 2020, the SEC announced (here) that it filed an emergency action and obtained a temporary restraining order and asset freeze against a California-registered investment adviser and his entities to stop an ongoing Ponzi scheme targeting senior citizens in Southern California.

According to the SEC’s complaint (here), from at least January 2018 through the present, Paul Horton Smith Sr. (“Smith”) offered and sold securities in his company Northstar Communications LLC (“Northstar”), and used his investment advisory firm eGate LLC (“eGate”) and insurance and estate planning company Planning Services Inc. (“Planning Services”) to market the securities.  Smith and Northstar through free workshops and other investor events allegedly promised investors guaranteed annual interest payments of between 3% and 10.5% if they invested in “private annuity contracts.”  The SEC alleged that, in reality, Smith did not invest the funds raised in any securities and instead used new investor funds to pay investor returns “in a classic Ponzi scheme.”  According to the SEC, Northstar raised more than $5.6 million from at least 35 investors and paid out $5.2 million to those investors as interest payments or principal returned.  Smith also allegedly used investor funds to settle investor fraud lawsuits.

Smith allegedly perpetrated the fraud by holding himself out as a trusted fiduciary through his position as an investment adviser with eGate and a licensed insurance agent with Planning Services. Smith allegedly touted himself to potential clients as a “veteran of the financial services industry” with years of experience, at free financial workshops and free meal seminars. Through his promotion of advisory, tax, and financial planning services, said the SEC, Smith created a trusting relationship he then used to solicit investors to purchase securities issued by Northstar. Smith allegedly told investors during a February 2020 workshop, “your pockets aren’t going to get picked, okay? . . . We are all fiduciaries.” In fact, alleged the SEC, “clients’ pockets were getting picked clean through his Ponzi scheme.”

According to the SEC, Northstar’s bank records for the period January 2018 to April 2020 showed investor deposits of approximately $5.6 million into its bank account, representing approximately 95% of total deposits during that period. During the same period, said the SEC, over $5.3 million was paid to investors as interest payments or return of principal, or approximately 89% of the total disbursements from the Northstar account.

“As alleged in our complaint, Paul Horton Smith Sr. raised millions of dollars by touting his purported investment expertise and guaranteeing returns,” said Michele Wein Layne, Director of the SEC’s Los Angeles Regional Office. “Investors should be wary of investments promising no risk and high returns, which are classic warning signs of investment fraud.”

The SEC charged Smith, Northstar, eGate, and Planning Services with violating the antifraud provisions of the federal securities laws. The SEC seeks injunctions, the return of ill-gotten gains plus interest, and civil penalties.

On May 20, 2020, in addition to granting a temporary restraining order and an asset freeze, the court ordered an accounting and appointed a temporary receiver.  The court scheduled a hearing for June 3, 2020, to consider continuing the asset freeze, issuance of a preliminary injunction, and appointment of a permanent receiver.

In a parallel action, the U.S. Attorney’s Office for the United States District Court for the Central District of California announced (here) on May 21, 2020 that it filed a criminal complaint against Smith. According to the DOJ, the alleged fraud occurred “from at least 2013 until the present”. Over that time, Smith allegedly bilked investors, mainly seniors, out of more than $10 million.

One victim, a 70-year-old woman who had known Smith from their mutual church association in the 1990s, sold a home in Arizona in August 2016 and wrote a $175,000 check to Northstar for investment. Instead of investing the victim’s money, the DOJ claimed that Smith transferred her funds to other investors, and used her money to pay off the other investors’ tax bills with the IRS and the Franchise Tax Board.

In November 2019, another victim, an 86-year-old woman who had known Smith for many years, allegedly invested approximately $169,126 in Northstar from the sale of a rental property. The following day, charged the government, Smith took $134,863 of the victim’s money to pay off another victim investor.

According to the DOJ, a review of bank records showed that Smith’s victims transferred more than $10 million to Smith’s business entities since 2013.