The U.S. Securities and Exchange Commission (SEC) enforces acts of fraud committed against investors and the public. The specific duties of the SEC are (1) to ensure full and fair disclosure of all risks, (2) require the maintenance of adequate books and records, (3) inspect and audit all securities and securities-related firms, (4) oversee other regulatory agencies and (5) enforce Federal securities laws.
The SEC was created to regulate the behavior of investment firms and companies to prevent investors from being defrauded. One of the most powerful tools available to the SEC is Rule 10b-5 of the Securities Exchange Act of 1934. Known as the anti-fraud provision, it deals with fraudulent, deceptive and manipulative practices that have been committed, placing the burden on the shoulder of the violator to prove the contrary. Below is a discussion of three prominent cases of investment fraud that gained notoriety.
Charles Ponzi, Father of the Ponzi Scheme
In 1921, Charles Ponzi of Boston, Massachusetts, was sentenced in federal court to three years in prison for his involvement in a massive scheme to defraud investors through an international postal reply coupon (IRC) scheme. Ponzi convinced investors that his company (ironically named the Securities Exchange Company) could take advantage of the difference in exchange rates between lower-rate IRCs purchased in Italy and exchange them for higher-rate coupons in the United States. Ponzi was much better at sales than he was at finances. To keep up with the higher payouts promised to investors, Ponzi used monies from newer investors to pay promises made to older ones.
Predictably, as new monies began to dry up, the pyramid fell apart. In addition to being sentenced to federal prison, he received a nine-year sentence from the State of Massachusetts. He jumped bail and escaped to Florida and Texas, where he was caught fleeing to Mexico after a series of failed real estate schemes. He was then returned to Massachusetts to finish his sentence and deported to Italy in 1934 (when immigration officials realized that he failed to become a U.S. citizen).
Ponzi died in 1949 at the age of 59 in Rio de Janeiro, Brazil, penniless and impoverished. His name has lived on to describe the form of investment fraud he invented, the Ponzi scheme.
Martha Stewart received a three-month prison sentence in 2001 for her connection with the ImClone insider trading scandal. ImClone was a pharmaceutical company where Stewart was a shareholder. She learned that the FDA was about to decline the company’s application for a cancer drug called Erbitux. Stewart immediately sold her holding in the company with information that the public did not have (in violation of the Insider Trading and Securities Fraud Enforcement Act of 1988), earning a profit while others lost money.
By the way, she happened to be friends with the CEO of ImClone, Samuel Waksal, who received a $4.3 million fine and seven-year prison sentence. Stewart lost her company due to bad publicity.
One of the most infamous cases of investment fraud that has ever taken place was that of Bernie Madoff. Madoff’s scheme (which would have made Charles Ponzi envious) defrauded investors in his hedge fund of $65 billion dollars over a series of years. The hedge fund managed by Madoff, who ironically served as a chairman of the NASDAQ securities market, lost $50 billion. When he was no longer able to cover prior investors with new monies, Madoff lost his company, family and freedom as he was sentenced to 150 years in prison.
[box_light]Norville Henderson writes on Securities Litigation, Banking Law, Financial Regulation and other associated topics.[/box_light]