The ICO Is Dead. Did The Lawyers Get The Telegram?

The ICO Is Dead

Rewind to 2018

I spent a good part of 2018 reading the white papers for hundreds of Initial Coin Offerings (ICOs). More than 1,000 ICOs were offered to investors around the world that year.

I admit that I was intrigued. Many of these offerings were targeting US investors from overseas.  This type of cross-border finance has always existed but it has always been on the margin of the US securities market. ICOs seemed to want to bring it into the mainstream.

Big companies outside the US could always deposit their shares with a bank or custodian and issue American Depository Receipt (ADRs) to US investors. Financial advisors often tell their clients to diversify a portion of their portfolio into overseas investments.

Some people thought that the tokens issued by these ICOs were an entirely new asset class. Others, myself included, saw that they were being sold as investments and if they could be traded or re-sold, they were just another security.

As I published a few articles on the subject of cryptocurrency, I started getting calls from lawyers around the country who wanted to hear my thoughts on whether the tokens were a security or not and where the line might be drawn. There is nothing unusual about that. Lawyers seek advice from each other all the time. The discussions about ICOs naturally revolved around the Howey decision.  

During this period there were a lot of articles on crypto websites that re-printed the basics of the Howey test and argued why this or that cryptocurrency did not pass it.  Some people argued that the Supreme Court’s decision from 1946 should not be applicable to the new technology.

There had been several US Supreme Court cases on the same subject subsequent to Howey and opinions from other appellate courts as well.  The ultimate question: “is this financing the sale of a security?”, has been considered time and again.

I researched the question extensively in the 1970s.  At that time the marginal US tax rate on the highest wage earners was 70%. At the same time the tax code was full of special credits and deductions as incentives for various types of activities.

Smart Lawyers & Tax Breaks

There was an industry populated by some of the smartest and best credentialed tax lawyers and CPAs who created transactions that took advantage of those incentives to help high earners get relief from their income tax liabilities.  The “products” were remarkably innovative.

One of the incentives was accelerated depreciation on various types of tangible assets.  Using leverage, you might buy a piece of machinery for $1,000,000, depreciate it to zero in 3 years, and pay it off in 10 years. If you put $100,000 down, you got the benefit of the depreciation on the entire purchase price early and depending on your income, you might reduce you tax liability to zero for 3 years.

Of course if you were a high earning doctor you were not likely to be operating the machinery which was a requirement to obtain the deductions.  Many of these tax shelter programs were packaged as “turnkey” operations which raised the question: “are you buying the machinery which can be depreciated or a business which cannot?”  The latter might mean that the transaction involved the sale of an “investment contract” and thus the question: “is this a security?”

I researched and wrote opinion letters that concluded that particular transactions were not investment contracts. The answer to this question, then and now, centered on the economic realities of the transaction.

Judgement Day

Last week a US District Court Judge in NY looked at that same question regarding the tokens issued in an ICO from a Russian company called Telegram. Telegram claims to have raised $1.7 billion through its ICO world-wide, with only a fraction of the investors located in the US. There was no dispute that Telegram was promising investors that they could profit from re-selling their tokens at a later date.

The ICO Is Dead

The Judge’s decision was well reasoned, hit all the points, and really surprised none of the lawyers that are interested in cryptocurrency or ICOs. The SEC brief was full of cases that it had successfully relied upon for years.

Some of the lawyers with whom I spoke in 2018 were writing the paperwork for ICO offerings. Several of the best were on the phone with the SEC staff discussing each offering because they appreciated that they had an obligation to keep their client within the regulatory white lines. That is something that Telegram, apparently, never wanted,

I read yesterday that Telegram intends to appeal the Judge’s order which is to be expected, but they are also, apparently, thinking about defying it.  The Judge has ordered them not to distribute their new tokens and they may do so any way.

Let’s be clear. Telegram did not need to take money from US investors in the first place. If they wanted to they could have followed the rules and registered the tokens or sold them under an exemption to accredited investors only. They chose not to.

In all probability they could have settled with the SEC early on by simply returning the money to the US investors, but they chose to fight the SEC instead.  Nothing in the Judge’s opinion was new law. The facts in this case were not in dispute.

I would have advised Telegram initially that they were issuing securities, had they asked. I think most securities lawyers would have agreed. The investors were going to profit from the efforts of others. That was the economic reality of the transaction.

Some lawyers apparently disagreed and gave Telegram the green light to make its offering in the US in the first place.  After reading the Judge’s decision I find that troubling. What case law were they reading? Will their opinion letters to Telegram on this subject become public as that case continues?

During this time there were some lawyers who publicly stated that SEC’s rules regarding the issuance of cryptocurrency were unclear. I tried to throw cold water on them at the time. If you cannot define a security, or know one when you see one, how can you hold yourself out as a securities lawyer?  

As I was writing this story over this weekend I exchanged comments on LinkedIn with a university Professor who is a fan of Telegram and its platform. He told me that Telegram has over 300 million users. He assured me that Telegram does not sell user information. He reminded me that its founder had refused a request from the Russian government for a backdoor into its system.  I asked him why he thought that any of that was true.

I reminded him that Telegram has never disclosed what it did with the $1.7 billion it raised. Telegram has never disclosed any financial information whatsoever. It may have raised more or less, it may sell user data and it may be in bed with the Russian government. Auditors have never seen its books or its operations. Telegram’s self-serving public statements have no more value than did Madoff’s public statements.

The real issue here should be that if Telegram issued securities, then it failed to give US investors any of the information to which they were entitled. That, of course, is fraud.

As I said, this type of cross-border financing intrigues me. Going forward I expect to help more and more companies from around the world successfully reach US investors. Some amount of creativity may be needed to make the “economic realities” of these transactions attractive to US investors. But there is a difference between creativity and fantasy. Good lawyers know the difference. If your client wants to test the boundaries of the system, they should do it with their own money, not funds taken from investors who were never given all the facts.

If you’d like to discuss this or anything related, then please contact me directly HERE

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Power To The People

power to the people

I started this Power To The People article in longhand on a yellow legal pad which is something that I rarely do any more. I would have been doing something else but the utility company, Pacific Gas & Electric (PG&E) had made a business decision to turn off my power and 1 million of my neighbors throughout northern California.

There were, at that moment, several wildfires burning in northern California that started from sparks emanating from PG&E’s equipment. By turning off the power PG&E was saying that they did not trust that their equipment was not a threat to public safety. 

There was good reason for PG&E’s managers to lack trust in the equipment the company was using.  Much of PG&E’s equipment is worn out, outdated and has been failing frequently for years often with catastrophic results.  It cannot be reasonable for any company to know that its equipment is dangerous and allow that dangerous equipment to stay in use.

In 2010, a PG&E gas line that snaked through a residential neighborhood south of San Francisco, ruptured and blew up killing 7 people, injuring many others and causing hundreds of millions of dollars in property damage.  The regulator’s investigation revealed that the incident was caused by PG&E’s failure to follow accepted industry practice when constructing the section of pipe that failed which is pretty straightforward.   The regulator noted other specific deficiency’s and also “a systemic failure of PG&E’s corporate culture to emphasize safety over profits.”

Camp Fire

More recently, in 2018, the Camp Fire killed 85 people and caused as much as $20 billion in property losses. The town of Paradise California was all but destroyed.  It appears that this fire was ignited by a PG&E transmission line.  A number of other smaller fires have been ignited by PG&E equipment over the years.

power to the people

When the power went back on last week a lot of people had questions. Intentionally turning off the power to 1 million customers is a big deal. 

Early on the company was trying to pat itself on the back for avoiding a greater disaster. It claimed it was left with little choice given the “historic” winds that were blowing over its transmission lines. But that was not the whole story. 

Management 

It seems that PG&E’s management had identified the power lines most in need of intervention, developed a plan to deal with those areas and then failed to execute. Management knew that their failure to remove trees and brush from the vicinity of certain transmission and distribution lines significantly increased the likelihood that their equipment would spark and ignite a fire. 

The “official” reason for PG&E’s failure to remove the brush, that they knew they had to be remove, may change with time as the lawyers get involved. For now, it seems that the company is saying that it could not hire enough “skilled” labor to get “all” of the brush removed. 

In sum, PG&E turned off the power and now argues it was the correct course of action because it is “better to be safe, than sorry” even if they created the unsafe situation in the first place. If there was a real danger of additional fires because of defects in their equipment, then arguably, turning off the power was a reasonable act. But it would have been far easier just to cut the trees and remove the brush that the company knew it needed to remove.

It would be even more reasonable for PG&E to replace or bury the transmission and distribution lines so they could not spark in the first place.  That would require a multi-year, multi-billion dollar solution that does not seem to be on the table even though it is long over-due. 

Monopoly

What makes PG&E different from other companies is that it is a sanctioned and regulated monopoly. If you live in its service area, they are the dominant regional source of gas and electric power. There is no competition. You pay what they charge.

Public utilities are regulated. PG&E must operate within the guidelines of multiple regulators. The California Public Utilities Commission approves the rates it can charge.

At the same time, PG&E is a public company owned by its shareholders. Shareholders have expectations that management tries to satisfy. In this case, the shareholders want steady dividends.

The current problem at PG&E can be summed up in one sentence: The management deferred maintenance and new equipment costs so that they could maintain profitability and continue to pay dividends to its shareholders.

In the traditional view, power utility company shares were suitable investments for “widows and orphans” because they paid a steady dividend and because they were selling electric power which was always in demand. That traditional view may no longer be sustainable. 

The funds that PG&E had allocated for brush removal, but did not spend, went directly to its bottom line. But for its current bankruptcy status, those funds would have been available to pay shareholder dividends. In the last 10 years aggregate dividends paid out to PG&E shareholders are in the neighborhood of $7 billion.  

PG&E’s monopoly to provide power was granted by the State with the expectation that PG&E would deliver the power while at the same time taking the proper steps to do so without ruptured gas pipes or electrical fires.  When you are dealing with fires that cause death and destruction, the standard of care exercised by the management should be very high.

I can appreciate that the 85 deaths at the Camp Fire last year were on the minds of the managers who pulled the plug this year. But who has taken responsibility for those deaths?  PG&E’s response to the Camp Fire deaths and its liability from it has been to file for bankruptcy.

If that same fire had been started by an arsonist, incarceration of the arsonist would be the desired result. Who will go to jail for the Camp Fire 85?    

Law students learn that corporations are legal “fictions”; entities created by law that can own property or operate a business in its own name while shielding the shareholders from personal liability for the corporation’s acts.  But that does not free the managers of any corporation from penalties if they are grossly negligent and people get killed.  

PG&E managers know that its equipment sparks fires. They know that they can reduce the fire danger by cutting trees and clearing brush.  They failed to execute this in the year after the Camp Fire because they refused to throw enough money at it to get it done. Instead they just turned the power off.  

Forgive my choice of words, but if killing 85 people last year doesn’t light a fire under management’s ass to get it right this year, then what will?   There is no way to look at this and not understand that whatever else it has done, management has demonstrated that it lacks what it takes to run this company. 

To understand the immediacy of the problem, consider that the fire season in northern California has just begun and will run into next spring. PG&E equipment can and in all probability will spark dozens of fires in the next few months.  More lives may yet be lost this year and no one from PG&E is confident that they have a fix for the problem next year. The fix costs money and PG&E is in bankruptcy.

The massive prophylactic blackouts are certainly no long term solution. Repeated outages and business disruptions hit smaller businesses and their employees the hardest. If thousands of small businesses are repeatedly closed for a week at a time, many will not survive. Many employees taking that much unpaid time off are going to have difficulty paying their rent.

Obviously a long term solution is necessary.  The need for natural gas and electricity in California will continue to increase with its population in the next 20-30 years. However California generates electric power in the future, that power will still need to be distributed and it is the distribution system that is already over worked and failing.  

The management, the shareholders and the customers all have skin in this game. Because PG&E’s problems will be resolved in the bankruptcy court, it is logical to believe that the senior managers who are most culpable for the losses will get golden parachutes or large, unearned bonuses. The shareholders will get what is left over of the business, and the customers will get nothing and pay the costs of any restructuring. That is how bankruptcies work. Something more is needed. 

If part of the problem has been paying dividends to shareholders with money that should have been used for maintenance, then it makes sense to eliminate the shareholders. I am still a free market capitalist, but this is a monopoly, a market aberration caused by government intervention, so a free market solution is not necessarily wise. 

PG&E might come out of bankruptcy owned by the State, or as a quasi-private corporation modeled after other government owned power companies like the Tennessee Valley Authority (TVA).  The TVA is a one example of a how the government generates and sells electric power. Its business model clearly works at least to the point that it delivers power without causing massive fires in its service area.

The TVA is a product of the Great Depression. It was intended to be an integral part of the economic development of the area.  And yes, detractors claimed it was Socialism when it began.

PG&E might also emerge from bankruptcy as a co-op which would essentially be owned by its customers.  Those customers want cheap, consistent power without interruptions or fires.  They are more likely to take a longer view than any managers looking at paying a dividend to shareholders every quarter.

Both of these ownership models have been used successfully by power companies in other parts of the country.  Either would be a reasonable approach for a company that should be spending money on maintenance and infrastructure rather than dividends.

I suspect that a lot will be written about these outages and their effect on the economy and on the residents both in the fire zones and the blackout zones.  In my mind one obvious truth is that the managers of PG&E are really not up to the task. The search for their replacements should be the first order of business.

If you’d like to discuss this or anything related, then please contact me directly HERE

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Hey FINRA- Look Over Here

Finra

FINRA, the stockbrokerage industry’s regulator, often does an absolutely atrocious job of policing its members. It was not always so, but in the last few years FINRA has clearly turned a blind eye to some really outrageous conduct that is going on right under its nose.

There are two distinct types of scams that have been prevalent in the stockbrokerage industry for decades. The first involve bad investments that come down to the registered representatives from the corporate level. These scams would never be sold to investors if the firms had conducted an adequate due diligence investigation.

FINRA has a fairly high bar for its member firms when it comes to due diligence on a private placement. It tells its member firms that they may not rely blindly upon the issuer for information concerning a company, nor rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation.

In the late 1980’s and early 1990’s a company called Towers Financial was selling pools of consumer debt through dozens of FINRA firms. It was ultimately revealed that the company never owned the debt and it was just a Ponzi scheme. About 200,000 investors lost close to $250 million.

The lesson of Towers Financial was that it is virtually impossible to conduct a due diligence investigation on a company claiming to hold large amounts of consumer debt without a full audit of its books.   Most companies of that size would have an audit as a matter of course. Towers was an exception. A lot of people suffered because of it. FINRA (the NASD back then) never suggested (or mandated) that its members should have been concerned about the lack of an audit. 

Fast forward to the mid-2000s. A company called Medical Capital also claimed to have pools of consumer debt which it really did not have. FINRA members helped the company raise over $1 billion from thousands of unsuspecting customers. It too was a Ponzi scheme and it too was unaudited.

FINRA did very little in the way of enforcement and again refused to simply direct its members to require an audit of any pool of consumer paper. An audit is the only way any firm can verify what the issuer is claiming.  Several of the state securities administrators raised the same questions but the brokerage industry refuses to get the point.

Last week I looked at another company for whom about 60 FINRA member firms raised a little over a $1 billion. Was it audited? No. Is it a Ponzi scheme?  No one has said so officially yet, but there are red flags everywhere. I would hope that FINRA would be all over it, but I know that they will not.  FINRA refuses to see these types of scams even when you rub their noses in them. When public customers keep losing a billion here and a billion there the regulator is clearly asleep.

Case on point.

When I was filing claims on behalf of public customers with FINRA for arbitration, it was never my practice to send a copy of the complaint to FINRA’s enforcement division.  I would only do so if I thought the offending conduct on the part of the broker or the firm was particularly obvious, onerous or both. The very last time that I sent a copy of an arbitration claim to FINRA enforcement they bobbled the ball.

The claim was on behalf of an elderly investor who had forked over about $600,000 to purchase interests in a private placement which would own an office building in the mid-West. Within a year the investors discovered that the roof leaked and that they were on the hook to replace it.  The FINRA member firms that sold the offering had not bothered to have the building inspected as part of their due diligence investigation. Most people would never buy a home without an inspection report.

The offering also described the sponsor as a “successful” developer when in fact his only prior development had ended in bankruptcy with many of the sub-contractors unpaid. The sponsor did not even hold a degree from the school listed in the private placement disclosure documents.

I documented all of this in the claim with appropriate exhibits and sent a copy to FINRA’s enforcement department.  The FINRA staffer who responded told me that the due diligence that the firm had conducted was just fine and that he felt no further action against the firm was necessary. 

I composed a response that expressed my feelings that the FINRA staffer was a ****** idiot. My partner at the time correctly decided that he would not allow me to send the letter because, in his words, you can’t fix stupid. 

Another case on point. 

A little more than a year ago I was asked to look at a series of arbitration claims that were being filed at FINRA against a small group of small brokerage firms located in the New York, Long Island and New Jersey metro area.  The attorney who sent them to me wanted my help in preparing the claims for hearing and my testimony as an expert witness (yes, I still do that) regarding the substance of the claims and the supervision of the brokers. What I discovered was conduct that was obviously intentional and truly disgusting on the part of the brokers and the firms.

There are apparently dozens of disparate customers voicing the same complaints against these firms. It was obvious that the brokers were cold-calling older businessmen and retirees in the mid-West. Quite a few listed their occupations as farmers.

The customers were complaining that the brokers had sold them on the idea that they were superior stock pickers who were and who would continue to make substantial returns for their clients.  Yes, I know that most readers of this blog would not fall for that, but apparently hundreds of public customers did.

Once the accounts were opened each customer complained that they had lost money because the brokers had churned their accounts and had made unauthorized trades. Of all of the claims that customers can make against their stockbrokers, these two in particular, excessive and unauthorized trading are the easiest allegations to prove or disprove. 

In the stockbrokerage industry a broker cannot enter a trade in a customer’s account without the customer’s prior approval. In the normal course of business a broker will get permission from the customer to buy or sell a security, hang up the phone and enter the order.  So there should always be a record of the phone call showing the time it began and the time it ended and also a time-stamped record of when the order was entered and when it was executed.

I asked the attorney if the firms had produced records of the phone calls where the brokers and customers had spoken prior to every trade. Not a one.  Obviously the firms and especially the Compliance Directors know that the trades were not authorized.

Churning or excessive trading has been a problem in the brokerage business for at least as long as my tenure in it.   If you are “investing” in a company then you are betting that the share price will move up as the company’s earnings improve. In the normal course it will take until the company’s next quarterly report before you and the market know if you were correct, often longer.

Investors will usually buy a stock and hold it for three or six months or longer. If your portfolio is worth $1 million, then you might turn over (buy and sell) its value two or three times a year. More than that is always suspect.

Traders, on the other hand, buy and sell stocks every day. That is why they gravitate to firms that charge very low commissions per trade. When you see a customer at a full commission firm turning their account over more than once every other month, they are either really foolish or the broker is crooked and taking advantage of them. In the records that I reviewed the customers were paying hundreds of dollars in commissions for each trade.

According to FINRA’s own Brokercheck™ reports there are today ten or so firms in New York, Long Island and New Jersey that have multiple brokers with multiple claims from public customers whose accounts may have been turned over more than 50 times a year, generating millions of dollars in commissions. FINRA tells customers to always look at the Brokercheck™ reports, but apparently its own staff fails to do so.

I see all these scum brokers ripping off unsuspecting customers just by reading the arbitration claims. The Compliance Directors and owners of these small firms certainly see them. The clearing firms are getting paid for every trade so they must see it too. Some of these claims are from 2015 and the brokers are still at their desks churning accounts every day.

Back in the mid-1990s the NY Attorney General published a report on small firms in NYC, Long Island and New Jersey that were churning accounts. The report suggested that several were associated with organized crime. Different firms are involved today, but the ones that allow these brokers to make unauthorized or excessive trades are still stealing money from public customers. They may or may not be “organized” but they are certainly criminals.

What will it take for FINRA to take its head out of the sand and close down these firms and bar these brokers, compliance directors and firm owners from the securities business? FINRA gives a lot of lip service to enforcement. This repugnant conduct calls for action.

(PS- If FINRA enforcement or any state securities administrator would like a list of these miscreant firms and brokers, just let me know). 

If you would like to discuss this or any other related topic, then please book a time with me here

Crowdfunding after ICOBox

Crowdfunding after ICOBox

SEC Complaint: ICOBox and Nikolay Evdokimov

I have been a huge fan of the potential of investment crowdfunding since the SEC’s first experiments in the late 1990’s allowing issuers to use the internet to sell their securities directly to investors.  There was a lot of discussion among issuers, regulators, and the traditional Wall Street firms at the time. However, very few investors were included in those discussions.  There was a clear consensus that investors were entitled to the same “full disclosure” that the purchasers of any new issue would receive. 

The JOBS Act in 2012 codified the use of the internet as a way of offering new issues of securities to the public. Nothing in the Act, or the subsequent regulations suggested that investors who purchased securities on a crowdfunding platform would not be entitled to the same disclosures.  The SEC’s very first enforcement action against an offering done on a crowdfunding platform, SEC. v. Ascenergy, confirmed this. 

The SEC has been doling out sanctions against people associated with the Woodbridge Group of Companies, a high end real estate developer and apparent Ponzi scheme. Woodbridge claimed to have a wealth management company in its group that raised money for mortgages and bridge loans.  The wealth management company hired dozens of highly commissioned salespeople.  Many of these salespeople claimed to operate “financial” firms that looked like legitimate financial firms.  The salespeople were telling investors on their websites that these investments were “safe” and “secure”. 

SEC Complaint: ICOBox and Nikolay Evdokimov

In all, Woodbridge raised more than $1 billion from several thousand individual investors. The SEC noted that one of the salespeople they sanctioned was a self-described “media influencer” who made frequent guest appearances on radio, television and podcasts nationwide touting the safety, security and earning potential of Woodbridge securities to unsuspecting investors. He also touted Woodbridge’s securities on the internet through his own website.

Crowdfunding After ICoBox

The JOBS Act clearly anticipates that securities offerings will be posted on

SEC Complaint: ICOBox and Nikolay Evdokimov

The JOBS Act clearly anticipates that securities offerings will be posted on platforms and websites and investors will be solicited by e-mails. What those postings and e-mails say is regulated. There are things that you can and cannot say to potential investors. There are also things that you must say.

Regulators understand the difference between “posting” and “touting”.  Unfortunately, not everyone in the crowdfunding industry understands this.  Regulators are beginning to take action against the crowdfunding platforms that do not follow the rules. 

This month the securities regulator in Kentucky entered a Cease and Desist Order against a company called Kelcas Corporation which was making false claims about oil wells it was drilling. The Kentucky Order calls out a specific string of e-mails with a representative of the company selling the investment to a potential investor. 

The Order repeatedly notes that the company was using LinkedIn to identify and connect with potential investors. It refers to a post on LinkedIn, specifically seeking investors for an “oil well investment opportunity”. Posts like these are common on LinkedIn and other social media platforms.  No one is suggesting that LinkedIn has any liability for allowing this post or others like it, at least not yet.

Crowdfunding after ICOBox

A day or two after the action in Kentucky against Kelcas, the SEC brought an enforcement action against a crowdfunding platform called ICOBox.  According to the SEC’s complaint, ICOBox raised funds in 2017 to develop a platform for initial coin offerings by selling, in an unregistered offering, roughly $14.6 million of “ICOS” tokens to over 2,000 investors.

The complaint further alleges that ICOBox failed to register as a broker but acted as one by “facilitating” initial coin offerings that raised more than $650 million for about 35 companies that listed their offerings on its platform.

The investors who put up their funds to invest with Woodbridge, Kelcas and ICOBox and the 35 companies listed on ICOBox were sold unregistered securities issued under the same SEC rules. In each case the internet was the primary vehicle by which investors were solicited and the primary vehicle used to provide the fraudulent information to the investors.

What separates LinkedIn from ICOBox or any other website or crowdfunding platform that connects private placements with potential investors? In reality, and as a matter of law, not very much.

It comes down to the SEC’s use of the word “facilitate”.  It does not mean that the facilitator actually sells the securities. Both federal and state statutes govern not just the sale of securities, but specifically how they are offered and to whom they are offered.

In the case of ICOBox the allegations are that the platform was actively involved in marketing of the offerings that they listed.  ICOBox promised to pitch the offerings to their media contacts, develop content for promotional materials and promote the listed companies at conferences.  The SEC included this in the complaint because the SEC thinks these acts constitute “facilitation”.

ICOBox is not the only crowdfunding platform that has helped to promote the offerings it lists. I get e-mails all the time from platforms inviting me to look at specific listings.  A lot of those e-mails and a lot of the offerings they promote make outrageous claims and promises.

The SEC also complained that ICOBox claimed it was “ ensuring the soundness of the business model” of the listed companies. Other crowdfunding platforms claim to “vet” or “investigate” the companies they list.  Many of those platforms have no idea what they are talking about. These platforms are lending their reputation to each offering. That also facilitates the offerings.  

Where does that leave LinkedIn? LinkedIn does not claim to investigate any offerings posted on their site.  It does however sell paid advertising.  Does LinkedIn have a duty to refuse to carry ads for securities offerings that it thinks are fraudulent?  What if LinkedIn ads generated the most sales leads for an offering or if the ads were specifically targeted at people LinkedIn identified as “real estate investors”? 

LinkedIn joined the ban on ICO ads by the major social media platforms in 2018, not because ICO ads caused cancer, but because they were largely fraudulent.  Would LinkedIn refuse to accept an ad from a small real estate syndicator if they had a reasonable belief that the sponsor did not own the property they were selling? 

What would a jury tell the “little old lady” investor who handed a few hundred thousand dollars to a scam like Woodbridge if the investor was introduced to the company on LinkedIn and testified that the company was brought to her attention by a LinkedIn “influencer” whom she followed? 

I read the ICOBox case as a clear warning from the SEC to the crowdfunding platforms to get their act together.  If the platform stays within the regulatory white lines, then regulators should leave it alone.

Unfortunately, it is apparent that many crowdfunding platforms have no idea what the rules require. They are setting themselves up to be defendants in enforcement actions by regulators or civil actions by disgruntled investors. Platforms that do not have a securities lawyer on staff or on retainer will be easy targets.

If you would like to discuss any of this article further with me then please contact me directly here

Crowdfunding After ICOBox

Are All Lawyers Stupid Like You?

I remember when I was asked that question and who asked it.  We were in a very small hotel room at the Dallas-Fort Worth airport.  The speaker was trying to sell my client 3 pieces of real estate and was objecting to what I thought were some pretty standard clauses in the purchase contract that I was insisting upon.  He was way too loud and sitting just across this tiny table in this tiny room. 

I was already tired, frustrated and annoyed. I had flown to Dallas with my client on an overnight flight. My back was sore. I did not think that my client was all that determined to buy these parcels in the first place.

My only reaction to the asshole’s question was to give his lawyer a dirty look. The intended message was “he is your client, you calm him down.” The lawyer said nothing; he just reached into his pocket for a roll of antacids. 

Over the years I have seen many lawyers pull out a roll of antacids. I carried them myself for a great many years. They spent the night on my dresser, next to my watch and wallet, ready to go into the pocket of my suit jacket the next day. There was always a back-up roll in my desk.

Lately I have read a lot of articles about stress and lawyers. Much of it addresses young lawyers who are trying to balance their personal and professional lives. Lawyers tell ourselves that we have to work longer and harder to be successful.  If you make that decision, then I see no reason to stress about it. 

You would expect high levels of stress in some professions, like surgeons and police officers. In my experience for many lawyers the stress seems to come from one of two places: paying the bills or the interactions with other lawyers.  

Most lawyers do not work in big law firms in big downtown high rise offices. Most lawyers work alone or in small practices.  The “average” yearly income for a lawyer in the US was under $120,000 per year which means that a great many lawyers earn a lot less.

Law school does not really prepare you for the business side of a small law practice.  There is often a disconnect between what an attorney would like to charge and what the market will bear.  Most of the really important things that I learned about the economics of a successful small firm, I learned from other lawyers by watching what they were doing successfully.   

The business side of a law practice is an omnipresent reality that lawyers at both small firms and large ones cannot escape. If the cash register is not ringing, or ringing enough, it can certainly add to any lawyer’s stress.

Sometimes I think that lawyers view too much of the practice of law to be basically adversarial. Too often an attorney will look at the attorney on the other side of the case or negotiation as an enemy combatant.

I could usually tell in the first phone call or meeting with opposing counsel whether they were seeking common ground to settle or staking out their turf.  Sometimes the decision is client driven; more often I think it is the lawyer’s personality that dictates their approach. 

I understand that litigators can be somewhat combative by nature.  Every time two lawyers oppose each other in a courtroom one of them will be the loser. And nobody wants to be the loser, ever. They do not cover losing very well in law school either.

Sometimes an opposing counsel can be just a pain in the ass. They do not respond to e-mails or return phone calls. They are just time wasters who slow down and back-up cases and that also adds to the stress.

Lawyers shoulder a lot of responsibility. Clients count on lawyers to keep them out of jail, get their taxes right, plan their estate, secure custody and visitation rights for their children and a lot more. These are weighty matters and add to the stress that so many lawyers seem to feel.

As I said, I seem to be reading more and more articles lately on the subject of lawyers and stress. Lawyers do recognize the problem of stress and the effect that it has on their practice and their lives. Stress at work can cause stress at home and when they overlap they often feed on each other.

Some lawyers exercise to deal with the stress. I frequently went out and swam for a while the day before a hearing. Swimming is good for stress and if you are doing laps you can tune out everything but your own thoughts.  I also did Tai Chi for a while, but I could not shed my type-A personality enough to get real benefits from it.

Despite the rise in articles about lawyers and stress, there seems to be a deafening silence about the way a great many lawyers actually deal with it; self medication. 

In 2016 the American Bar Association together with the Hazelden Betty Ford Foundation published a study that indicated that one in three practicing lawyers are problem drinkers, based on the volume and frequency of alcohol consumed. That is more than double the amount of problem drinkers among surgeons and other “high stress” positions.

And before you dispute that one in three lawyers is much too high, consider that this study does not include lawyers who self-medicate with marijuana, cocaine, uppers, downers or opioids. If the number of lawyers who are “impaired” every day is less than one in three it is not much less.   

The ABA and state bar associations publish information about the problem on their websites and will make referrals to treatment programs.  Some states have programs for other lawyers to step in and take care of an attorney’s cases and clients if an attorney checks into an alcohol or drug rehab program.  But that is just a band-aid and it does not deal with the real problem.

People who have a drug or alcohol problem lie. They lie to their family, clients and partners.  That may sound obvious, but I could not find articles that seemed to treat this fact with appropriate alarm when applied to lawyers. 

What happens when an in-house counsel gets a lengthy memo on a potentially expensive tax issue from an attorney who just copied a memo he wrote two years ago without checking to see if the rules or regulations had changed, because he was too “impaired” last night to do the research?  

What is the potential liability to a 100 partner law firm if 30 of the 100 are “problem drinkers”?  And how does the stress the attorneys feel flow down to paralegals and support staff?

On any day in many courthouses around the country there may be 100 cases on the morning motion calendar. That might necessitate the appearance of 200 lawyers. If 60 out of those 200 lawyers are “impaired” is it any wonder that the calendars are crowded and cases move along at a snail’s pace?

Like a lot of people with a drinking problem the legal profession as a whole is in denial about this. There was some press when the ABA study was released in 2016, but very little in the way of action since. 

Alcoholism and drug addiction are treatable. I would have thought there would have been more of an affirmative outreach for lawyers to get lawyers who need help into treatment, rather than just posting a phone number for a treatment center.  Lawyers should see the effects of the drinking in their colleagues more than anyone else.

Aside from the pure human decency of helping people in need of help, the fact that so many impaired lawyers may be practicing every day and the impact it must surely be having is mind boggling. If lawyers do not act to clean up their own profession, then the most important part of any law practice, clients’ trust, will be lost. 

It would be foolish for lawyers to allow that to happen because they failed to address the “problem drinkers” among them squarely and practically. It would be so foolish that people might start calling lawyers as a whole “stupid”.

Two Years of Crypto Market Memories

I first looked at bitcoins in the Spring of 2017 because a friend asked me for my thoughts.  The price of a single bitcoin had run up sharply and the ICO craze was proceeding at full speed.   Up until that point I knew very little about either blockchain or cryptocurrency. 

I spoke with people who were actually developing blockchain projects for the big tech companies. I read a lot of articles which they thought would help me and a lot of other articles that I found through my own research. I spoke with traders, regulators, and with a lot of people who thought that they had cryptocurrency all sorted out.  There seemed to be a wide spectrum of thought about cryptocurrency, how it might be regulated (if at all) and whether it would augment or supplant the established financial order.  

I concluded that the bitcoin market was in a classic bubble, the price rising only because of hype, and the new money that hype always attracts. I was not alone in that opinion.  Still some intelligent sounding people were making an argument for continued price appreciation to ridiculous levels.  And that was what a lot of people wanted to hear. 

I wrote an article about my research, my thoughts and predictions for bitcoins.   http://laweconomicscapital.com/2017/06/the-bitcoin-bubble/   The article got the attention of a lot of people who were also trying to understand cryptocurrency and ICOs.

The article ends with an invitation to the securities lawyers who were writing the disclosure documents for ICOs to contact me for a professional conversation.  I would have had difficulty preparing those documents.  I confessed my professional curiosity to any and all that might satisfy it. 

A lot of lawyers and other professionals did contact me.  Many of the lawyers were doing what lawyers are supposed to do, marshaling the facts and applying the law as they saw it.  But it was clear that there was not a unified position as to what the facts regarding any cryptocurrency actually were. 

Some lawyers approached ICOs as if they were issuing securities and some as if they were issuing anything but securities.  Before the SEC issued its DAO Report, (July 2017) I was of the mind that a token offering might be structured so as not to be a security. Once the DAO Report was issued, it was clear to me that the SEC saw tokens as securities and would look at an ICO as the sale of securities with all that entailed.

The DAO Report led to a robust discussion, on line and off, with those same lawyers and professionals and more.  The discussion became somewhat convoluted as many non-lawyers often in other countries felt comfortable discussing the finer points of US securities law. A great many of those commentators had interesting takes on the Howey decision that no competent US lawyer would ever present to a judge.  Many of those “experts” just ignored the dozens of other cases cited by the SEC in the DAO Report and many other cases that should have been germane to the discussion. 

There was an interesting undercurrent of lawlessness in the cryptocurrency world.  It was impossible to search for articles about cryptocurrency without coming across many quoting regulators around the world who were reporting cases of money laundering and fraud.  That has not changed.  Fans of cryptocurrency were often happy to ignore these transgressions even though it was obvious that regulators would not.

By now I have read several hundred white papers for ICOs. Some were written by lawyers; other white papers were written by either monkeys or idiots. Some of the latter were using templates because the thought of actually hiring a lawyer to prepare documents for a multi-million dollar financing did not make sense to them.

These white papers are supposed to tell potential investors what they needed to know so they could make an informed decision whether or not to send their money.  That was rarely the case. I recall one white paper where the principals of the firm refused to disclose their last names. 

People were claiming to have advanced degrees they never completed and to have worked at firms where they were never employed.   Quite often, outrageous claims were made about the size of the market to be served and the profits to be made.  If these same founders had been sued by investors in a prior company for fraud, investors in this new company would never hear about it. 

I had my bio and picture hijacked and included in a white paper. So did many other people.  There was no way for any investors to know if what they were being told was true.  Very often, it wasn’t.

These ICOs were being sold by networks of unregulated, self-validating crypto “experts and advisors”.  They traveled in packs to frequent crypto conferences around the world.  They cross-validated each other in articles on websites that had popped up and which reached many thousands of people around the world. Some crypto “experts” developed 6 and 7 figure lists of social media followers.

An issuer could engage any number of these crypto gurus and just pay them in the tokens to be issued.   The “advisors” would notify their followers about the token sale and urge those followers to cough up real fiat money to buy them.  Along the way the advisors were selling tokens that they had gotten for nothing in exchange for their sales efforts.  

Several otherwise intelligent people tried to convince me that this was not just a dressed up pump and dump scheme playing out over and over again. The results were certainly the same because most people who bought the tokens in these ICOs were left holding the bag.

A significant number of the ICOs were out and out scams which, sadly, many people refused to see.  Fifty million dollars raised here; one hundred million there, all going down the toilet of financial history.  It got so bad that several of the large social media platforms banned ads for ICOs. Several countries banned the sale of ICOs altogether.

Many of the ICOs claimed that they were not selling securities but “utility” tokens instead.  That died down significantly after the SEC published its Cease and Desist v. Munchee toward the end of 2017.  http://laweconomicscapital.com/2017/12/sec-v-munchee-will-the-crypto-currency-community-listen/

Along the way some really bright lawyers thought that ICO offerings might be structured as SAFTS. I saw it as an attempt to solve a valuation problem by promising to set the value down the road.  They were touted as making the ICO market less risky. To me they looked to be a riskier “derivative” and began to write an article that said so. But I never finished that article. 

In short order one of the NYC laws schools published their research and pulled back the curtain on SAFTS. After that most securities lawyers stopped talking about them.  SAFTS were a financial flash in the pan and not a very good one at that.   

I also had conversations with a number of groups that wanted to develop a realistic scheme to regulate ICOs and cryptocurrency trading across borders.  Each failed because most of the participants had never worked at or had dealt with any market regulator.  I wrote e-mail after e-mail trying to explain that transparency is only useful if everyone in the market was honest and that without significant penalties for dishonesty no regulatory scheme can work.  All that fell on deaf ears and each of those groups disbanded.

I also spoke with several people who wanted to create trading platforms for cryptocurrency but most of whom had no idea what a trading platform does or how it operates.  I would ask questions like: What would be the minimum standards for listing on your trading platform?  It was apparent that they had not even worked out that simple, basic and necessary issue. When I asked about market-makers and liquidity I got a series of blank stares.

Today, at least in the US, most lawyers have accepted the fact that any ICO sold here will be the issuance of a security and that US securities laws will have to be followed.  

To sell securities to investors in the US the securities must be registered with the SEC or specifically exempt from the registration requirement.  Registration is an expensive and often lengthy process. By mid-to-late 2017 a number of lawyers were reporting that they were filing registration statements for ICO offerings with the SEC. Apparently, many never got approved.

Securities offerings in the US do not have to be registered if they comply with regulations which provide guidelines for un-registered offerings. Un-registered offerings are generally sold only to institutions and wealthier investors who have no real interest in owning crypto currency.  These unregistered securities are not intended to be traded.

More than one lawyer has reminded me in the last few months that unregistered securities can be transferred after 12 months if the company is putting financial information into the market or if the tokens are listed on a crypto exchange outside the US.  I am not certain that they have thought that idea through.

Investors in an unregistered offering in the US are usually required to attest to the fact that they are making a long term investment and not intending re-sale.  That is why most companies in the US that sell unregistered securities provide those investors with income from dividends or interest.   So if you are selling unregistered securities with the promise of liquidity and re-sale, you are likely to confuse everyone, except perhaps the judge who will ultimately set you straight.

Companies from around the world have always wanted to tap the US for capital investment.  It is often a difficult process for any company and especially for start-ups and smaller companies.  In the ICO market, it became apparent that political borders and local regulations were not considered to be important by the issuers.

Investors who should have seen the shoddy disclosures as a problem seemed happy to invest, convincing themselves that if the offering “complied” with the laws of the country of origin, then protections afforded to them by US law were unnecessary.   A lot of people who were touting blockchain because it was supposed to promote transparency were willing to invest in crypto offerings that provided none. 

Today, people are spending money to “tokenize” real estate, fine art and many other tangible items as if there was a market for those tokens or if it made any sense to create one.  If I can buy 1/10,000,000 of a Picasso, do I get to hang it over my fireplace for 20 minutes? 

If you are selling shares in a building that you call “tokens” and tell me that you believe that all of the laws pertaining to real estate syndications would not apply, I would suggest that you really need to re-think what you are doing.  There are established rules for selling “asset backed” securities in the US.  Not surprisingly, most of the articles I read about “tokenizing” this or that fail to mention those rules and most of the people with who I am now speaking who are preparing to “tokenize” this or that offerings do not seem to be considering them.

Back in 2017 a lot of regulators told me that the ICO boom came upon them suddenly and that they did not have the staff or budget to deal with them.  They do now and there is every indication that the leniency some regulators have exhibited is about to come to a screaming halt.  

Re-visiting Prohibition

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Next January will mark the 100th Anniversary of the start of Prohibition. It is one of the least talked about and poorly studied events in US history. Very little has been written about it, especially by economists, but I have always found the subject to be interesting.

Americans have always had “issues” with the consumption of alcohol.  Laws restricting its manufacture and sale go back to the colonial period.  The temperance movement of the 19th Century is most often seen as a “moral crusade” or political battle.  Prohibition itself is often viewed through the lens of the speakeasy lifestyle.  As with most great movements much of the forces behind it were based in more practical issues.  

The real issue about alcohol in US politics and economics has always been about taxes. The very first tax levied by the brand new US Government in 1791 was a tax on the manufacture of alcoholic beverages. .The new Congress thought it was a good way to raise money to pay off the Revolutionary War debt.The tax was not well received especially by the people who were making and selling the product. 

Farmers in Western Pennsylvania and Kentucky were growing grain, distilling it into whiskey and shipping it east. Even back then it was a very profitable business. They saw the tax as the governments’ attempt to put its hand into their pockets.The farmers’ response to this tax was an armed rebellion against the United States. 

How big was the rebellion? The US Government sent 13,000 troops to quell it. There were no armed battles and the rebels disbursed. But many people still refused to pay the tax and more than one tax collector was physically assaulted.

The whiskey excise tax was the largest source of tax revenue in the early years of the U.S. and a substantial and reliable source of tax revenue throughout the 19th Century.  As the population grew, total consumption also grew and the total tax revenue collected each year kept going up with it.

Women were at the forefront of the temperance movement for a number of reasons. They were rarely the bread winners in their family and having the male breadwinner too drunk to work or injured because they were drinking on the job was not in women’s financial interests. Time spent at the local pub meant time away from the family and drinking has always been associated with gambling and prostitution, neither of which enhanced marital life. Drunken husbands also had a way of physically and mentally abusing their wives. For. many women Prohibition was a practical remedy for a practical problem.

The temperance movement was an amalgam of women’s groups and mostly Protestant churches or affiliated religious organizations. The movement was well organized. It claimed millions of supporters across the country. The goal was to outlaw the manufacture and sale of alcohol everywhere in the US.

By 1856 they had succeeded in doing so in 12 states and dozens of rural counties. It was a remarkable political feat for a group of like-minded citizens the majority of which were women and could not vote.

As the country moved west after the Civil War and new communities grew along the railroad right of way, saloons were often the first structures built and always a fixture in any new town. Many of those towns had more saloons than churches and many communities in America still do. 

As the 19th Century went on, there were more and more immigrants from Germany who began brewing beer in the mid-west grain belt. These brewers also developed a new business model.The breweries often would help to build or finance a local saloon in exchange for being the only beer offered in it. It was an early version of franchising.

Especially in urban areas, saloons were often a focal meeting place of the local immigrant communities. Saloons or taverns had always been places to drink and discuss politics. They also became known as places where politicians could meet and do business with voters and constituents.   Given that saloons were so prevalent, it is somewhat remarkable that the “drys” prevailed.  

By the turn of the 20th Century there were “wets” and “drys” in both political parties. Neither of the major political parties took a formal position one way or another but momentum for prohibition was growing. Competing products, like soft drinks, began lobbying for prohibition especially at the state and local levels. Eventually there were more “drys” than “wets” in the US Congress and the die was cast.

What actually paved the way for the ultimate success of the prohibitionists was the income tax which was enacted specifically to replace the excise tax on whiskey. Once that was in place, Congress in 1918 passed the 18th Amendment to the US Constitution, it was ratified in 1919 and the enabling legislation, the Volstead Act, began to put Prohibition into action in January 1920. 

The social benefits of prohibition derive from a reduced consumption of alcohol. They include a reduction of alcohol related health issues, less public disruption caused by inebriated citizens, and probably some additional domestic peace. Productivity at work rose as work related injuries and absenteeism decreased. But a lot of people never stopped drinking.  

Whatever romanticized image of Prohibition you may glean from Hollywood, it was not just fashionable people partying in a fashionable speakeasy near Times Square. During Prohibition thousands of poorer people died drinking homemade alcoholic concoctions.Manufacturing and bootlegging turned intolarge,  and profitable, albeit illegal ,businesses.

Still most people bought one bottle at a time from a family member or acquaintance. Everyone knew that they were breaking the law and no one really cared.

Overall enforcement was very difficult. Corrupting judges, politicians and law enforcement was part of the business model for the larger players. Small, person to person, transactions were almost impossible to detect.  It demonstrated to a lot of people that if you were willing to break the law, you were likely to get away with it.  

The Depression killed Prohibition. Roosevelt came into office in 1933 with big spending plans and declining revenue from the income tax as millions of people were out of work. Repealing Prohibition to allow all of the existing illegal transactions back into the mainstream and re-instating the excise tax was a no-brainer. And that is exactly what Congress did.

The post-WWII baby boomers have had alcohol integrated into mainstream family life.   Alcohol is a significant part of the socializing that the baby-boomers do. A drink after work or a beer around the barbeque is modern day normalcy.

The social issues today are the same as always. Excessive drinking frequently shows up in studies of marital problems, spousal abuse and petty crimes. According to the CDC: “Drinking too much can harm your health. Excessive alcohol use led to approximately 88,000 deaths and 2.5 million years of potential life lost (YPLL) each year in the United States from 2006 – 2010, shortening the lives of those who died by an average of 30 years. Further, excessive drinking was responsible for 1 in 10 deaths among working-age adults aged 20-64 years. The economic costs of excessive alcohol consumption in 2010 were estimated at $249 billion, or $2.05 a drink.”

Today most alcoholic beverages are served up by large multi-brand, multi-national conglomerates.   Mass media advertising has made them ubiquitous. It is virtually impossible to watch a sporting event and not see ads for alcoholic beverages.

The US government still collects a tax on every can and bottle. The tax on alcohol today makes up about 12% of the total excise tax revenue and a very small amount of the US Government’s overall income.  Not even the tax collector really cares any more.

Most studies of Prohibition overlook the seemingly constant demand for the product, even when the consumers knew that it was illegal to purchase and consume it.  The simple truth is that banning anything is not a viable policy.  America prides itself as being a nation of laws. Prohibition demonstrated that a wide swath of the population was willing to say: let the laws be damned.  

FINRA vs. the NARs- Round 3; Same Old Nonsense


A simple question: If a “bad” stockbroker rips you off, can a “bad” lawyer help you recover your losses? The answer should be obvious; but for some people, especially some lawyers, it is not.

For the third time in the last 20 years FINRA has asked the SEC to allow it to restrict an aggrieved customer’s right to have the representative of their choice at FINRA sponsored arbitration.  The previous two attempts were dead on arrival because there was no compelling reason to enact that limitation. The same is true this time. Let’s hope that the Commission staff is not asleep.

The issue is whether or not you must be an attorney to represent a party in a non-judicial arbitration proceeding. There have always been non-attorneys (NARs) representing parties in securities industry arbitration. Member firms would often send branch office managers into arbitration to collect a margin debt from a recalcitrant customer or to defend against a customer claim. Non-attorney representatives in securities arbitration was never an issue until the lawyers realized that they could make a lot of money for a lot less effort than they would put into resolving the same disputes in Court.

In the early 1990s, as real estate took a dip in various parts of the country and the value of real estate backed securities fell, a lot of people who were promised appreciation and steady income from these investments wanted their money back.  It was shown that Prudential Securities and other firms had sold billions of dollars’ worth of questionable real estate backed securities to 10s of thousands of investors around the US. 

The number of arbitration claims skyrocketed.  A lot of attorneys and others saw an opportunity to represent these investors on a contingency basis and an industry of customer representatives, both lawyers and non-lawyers was born. 

As these claims wound their way through the arbitration system the number of new claims began to slow down.  Appalled that they might make less money because there were fewer claims to file, the lawyers started a turf war with the NARs, seeking to get the latter barred for an ever-changing number of reasons.

At that time, the vast bulk of labor arbitrations around the country were being handled by shop stewards because they knew the shop floor rules.  Other state and federal government agencies permitted non-attorney representation in their arbitration forums. The trend was to leave the courtrooms to the attorneys and view arbitration as an alternative system where disputes could be resolved quickly and efficiently with or without lawyers.

Notwithstanding, the lawyers claimed that by representing customers in an alternative dispute resolution system, the non-attorney representatives were engaged in the un-authorized practice of law.  This was absurd on its face, especially since they did not think that true if a non-lawyer represented a member firm.

Admission to practice law is governed state by state.  Out of state lawyers need permission to appear in local courts and then usually with a local lawyer beside them. The same lawyers who claim that you must be a lawyer to represent a party in FINRA arbitration do not seem to care if you are not a lawyer in the state where the customer lives or where the arbitration is being held.  There are many lawyers who specialize in securities arbitration who are admitted in one or two states, but who have a national practice.  If NARs are practicing law in states where they are not admitted to practice law then so are these lawyers.

The lawyers also know that the large wirehouses often send inhouse lawyers to defend these claims and the wirehouses do not have lawyers licensed in every state on staff.  So not being admitted to practice law in the state where the customer resides has never been an issue to either the customers’ lawyers or the industry, unless they are referring to NARs.

The current iteration of the proposed rule allows non-attorneys to continue to represent customers in smaller cases. That is like saying: okay, you can be a little pregnant, because it is not the un-authorized practice of law if you only handle the smaller claims. The “unauthorized practice of law” argument, which never made any sense in the first place, seems dead.

Because of the continuing complaints by lawyers, in 1994 the NASD commissioned a study of its arbitration system chaired by former SEC Chair David Ruder. The report specifically looked at non-attorney representatives and left them in place. It called for more study on the subject and called the complaints against the non-attorney representatives “anecdotal”.  The actual complaints against the non-attorneys were never disclosed and more than one person at the time questioned if those “anecdotal complaints” had any substance.

The Ruder Commission Report did express its concern that “the increasingly litigious nature of securities arbitration has gradually eroded the advantages of SRO arbitration.”  FINRA has always advertised arbitration as a quick, inexpensive way to resolve a dispute with your stockbroker.  When I started doing arbitrations in the 1970s, a dispute could usually be resolved with one day of testimony or less. Now they often take weeks because lawyers have complicated a system that should be easy.   

There was another study and a similar request to limit NARs in 2007. The SEC staff asked FINRA to withdraw that request because the Commission staff thought it not in the customers’ best interest.  That reality has not changed.  

Over the years there were a lots of problems in the arbitration system specifically caused by lawyers. After the “tech wreck” claims went through the system in the early 2000s a significant number of the member firms were sanctioned for repeated violations of the arbitration rules specifically because they intentionally hid documents that the customers sought. Several of the member firms were fined $250,000 and FINRA noted that the practice of hiding documents occurred in multiple claims. 

In virtually every claim where a FINRA firm had been sanctioned for discovery violations the firm had been represented by an attorney. It was attorneys who time and again stood before different panels of arbitrators stating, falsely, that their client had no more documents to produce.  Were any of these lawyers sanctioned for lying to arbitrators? (No). Were any attorneys barred from representing parties again? (No.) Are the “anecdotal” problems with NARs worse than this? (Not by a long shot.)

I think that the SEC staff would be appalled to read the pleadings and briefs that a lot of attorneys present to FINRA arbitrators. Many will cite case law that is not applicable and often out of context. FINRA does not provide arbitrators with law clerks or even a law library. Briefing can be a useless exercise that often obfuscates more than it clarifies.    

Arbitrators are fact finders, not judges. They should examine the actions and utterances of the brokers and compare them to industry rules and regulations.  In many claims the panel is examining a transaction that began with an order to purchase a particular security.  In industry parlance, the question that the arbitrators consider is often the same: is this a “good” order? Did the order comply with the industry rules? Was the broker correct in submitting this order and was the supervisor correct in approving the order for execution?

Industry rules can be nuanced and complex. But every day, in every brokerage office, managers, supervisors and compliance personnel review and approve orders written by stockbrokers and ask and answer that question.  If you have a dispute with your broker because you believe your broker broke those rules, why should you not be allowed to be represented by a retired branch office manager or someone else who has worked with those rules and who can explain them to a panel of arbitrators better than most lawyers?  

It is comical that anyone would think that just because you went to law school you can competently represent a party in securities arbitration.  I have lectured at one of the law school securities arbitration clinics.  Students get taught the arbitration procedures but not what they need to know about the investments or the transactions that are at issue.   

Over the years I worked with a number of attorneys who represented public customers and with several of the large and small NAR firms. The simple truth is that you either know how the securities industry works or you don’t.The best arbitration lawyers often started their careers in house at one of the large brokerage firms where they learned how the firms operate and why.  

Over the years NARs have successfully handled thousands of claims. If the NARS were so bad you would think that there would be stacks and stacks of complaints from their clients about them but there aren’t.

I know that there are arbitrators and industry lawyers who have referred their family and friends to NARs. I know that there are professional traders, fiduciaries, sophisticated investors, lawyers and government officials who have sought out and hired NARs to represent them at FINRA arbitration. They do so specifically because the NARs understand how the rules are actually applied and how firms and brokers are supposed to act.

The lawyers’ current beef with NARs is that the NARs charge investors too much which is a sick joke coming from lawyers. No one really knows what NARs charge because no one asked.  And I suspect that the lawyers would object to disclosing their fees for a meaningful comparison.

When the Ruder Report came out suggesting further study of the NARs, there was some hope that the research would tell the investors what they really wanted to know: which representatives get the best results for their clients. That never happened.

FINRA could break down that data so that consumers might also see which representatives have handled more claims involving annuities or options and what percentage of the amount of the claim was actually returned to the investors through awards or settlements.  We live in a time of almost too much data. Why not collect the data and let the consumers decide?

This issue has come up again because the rising market has substantially reduced the number of claims that are being filed. There were over 10,000 claims being filed in the years after the 2008-2009 crash. I expect the number of claims filed in 2018 will be closer to 4000.  That is the only reason that anyone is talking about banning NARs from arbitration, again. The lawyers do not want any more competition.

I do know that this time out,several of the NARs are thinking about litigating any restrictions that the SEC approves.  That should provide fodder for a lot more articles going forward.

More On Internet Stock Manipulations; SEC v. Lebed (2000), revisited


I was reminded recently of the story of Jonathan Lebed, a 14 year old kid from New Jersey who was investigated by the SEC for stock manipulation using the internet back in 2000.  This case was a big deal at the time, garnishing a segment on 60 Minutes and some interesting discussions in the financial and legal press.

Even though he was underage, with the help of his parents, Lebed had managed to open an account at one or two of the discount brokerage firms. He was apparently trading his accounts in low price stocks when the SEC came knocking on his parents’ door. 

It seems that in the course of trading Lebed liked to post positive comments about what he was buying on various websites, bulletin boards and chat rooms where people who might be interested in purchasing these stocks would see them.  This was in 2000 when the chat rooms were not sophisticated and the web reached a fraction of the people it reaches today. 

Lebed would buy a low priced stock and then say something nice about the company in a message that he posted in a chat room. Using multiple e-mail addresses he might get that same, positive message posted in 200 chat rooms.  Some of the people who saw his posts would re-post them again. 

Lebed knew that his simple postings would create significant interest in these shares and that the price would move up.  He commented that posting the messages with key words in all capital letters would actually get even better responses. 

Bringing a lot of attention to a more obscure, low priced stock can, indeed, lift the price. The SEC called it an intentional market manipulation.  Lebed said that he was only doing what the research analysts at the big firms did, publish their opinions about companies whose share price they wanted to go up. 

Lebed did all this out in the open. Several of his classmates and school teachers followed his leads and invested with him. They were willing to take a chance of doubling their money if the share price of one of these companies went from $.30 to $.60. 

Many of these investing neophytes did understand the positive effect that Lebed’s postings and his quasi investor relations campaigns had on these stocks.  They wanted to buy before he posted and get out as the buyers reacting to his posts pushed up the price.  

Lebed was not the only person or group at that time that was using the internet to enhance the price of shares of small public companies.  But he demonstrated that in the year 2000 the power of the internet to sell investments directly to investors was underrated.  In the almost 20 years since, the use of the internet to sell almost anything, including investments, has become much more powerful and pervasive. 

In the regulated financial markets the dissemination of information is encouraged, but it is also controlled.  Regulations require that information be accurate and complete. Public companies are required to report specific information about their business, to present that information in a specific manner and to release that information on a regulated schedule. 

For a licensed stock broker or investment advisor every e-mail, tweet, posting, comment and utterance about any investment is subject to the scrutiny of his/her employer and by regulators. The SEC depends on the market professionals and market participants to play by the rules. There are significant penalties for non-compliance. 

But Lebed was not a market professional. He was an outlier. He was an independent investor, not a licensed participant in the marketplace.  In the end the SEC let Lebed keep most of the money that he made from his trading as long as he promised to stop.  

At the time, no one really questioned the SEC’s jurisdiction over Lebed or what he was doing. Lebed was a US citizen, operating out of New Jersey. His posts were about US companies whose shares traded in the US markets. Many of his posts were made through a US based internet company (Yahoo Finance). 

In the ensuing 20 years, social media and on line platforms, publications and unregulated “experts” have demonstrated that they can easily sell investments directly on line to millions of investors.  Moreover they have demonstrated that they can disseminate information about public companies and new issues without regard to the truth of the information.  And they can do so without regard for regulations or national borders.

In the “direct to investors” investment world, social media “followers” has replaced “assets under management” as a measure of how many investors’ dollars a person can bring to an investment or new offering.  And you can buy people who have a lot of followers.

If I wanted to hype a stock, either a new issue or one that is already trading, I can make a financial arrangement with any number of independent “experts” who have a lot of social media “followers”.  Some may write articles for financial publications, some write books and blogs and many can be found going from conference to conference and podcast to podcast. 

Any financial “expert” can purchase the right to give the keynote speech at a conference and purchase any number of other speaking slots and sponsorships as well.   Anyone can buy interviews on financial websites, blogs and podcasts or pay for the right to create and distribute positive content on these sites.   

If you look at the numbers you can get an idea of how this works.  I can hire a financial “expert” to tout any stock that I wish. The “expert” will send his/her followers a series of e-mails, appear at a series of conferences and write a series of articles about that company. An expert with 1 million followers might reach 2 million other investors who see re-prints and references to it.

If only 10,000 investors of those followers invest an average of $1000 a new issuer can raise $10,000,000. That much new money coming into a thin trading market can often raise the trading price of the shares of a smaller company.  

There is no limit to the number of experts I can hire or the size of the e-mail lists I purchase for their use to augment their own list of followers.  If I hire multiple experts to hype the same stock, other experts who have not been paid may mention the company independently.  And before you say that this type of scheme using paid experts to hype the stock may be questionable under US law, who said that US law applied?   

If you solicit investors in the US for a new issue the offering is subject to US law.  That would require full and fair disclosure to investors in the US and provide for government penalties for non-disclosure.  But what if you donot make the necessary disclosures and you only solicit investors in other countries? 

The capital markets are regulated country to country.  Each country has its own rules which apply to financial transactions involving its citizens and issuers.  Each has rules governing transactions executed on the exchanges domiciled in their country. The laws of the country where the issuer is domiciled, the exchange is located and where the investors reside may all apply to a single transaction.  An overriding question with the direct to investor market is which country has jurisdiction and over what actions and activities.

If an article about a company’s share price or prospects from a European website gets republished or re-distributed in the US is the author subject to US law? What if the author knew the information in the article was false; do US investors have any recourse?  Does it matter if the author got a royalty for the re-print?

Would the answer be different if the false information originated with just one shareholder who bought a large block of shares cheap and now wants to pump up the price?  Does it matter if that person is in a country other than where the shares trade or the articles originate? 

I recall that when the Lebed case was discussed a lot of people thought that the internet would change and globalize the capital markets. It clearly has.  

I think that there is still a lot of discussion that needs to be had and a lot of questions that need to be asked and answered.  In the meantime, it should be obvious that the current international regulatory scheme does not overlap as well as it could.   

The current and expanding global reach of social media create opportunities and but also highlights problems.  The flow of capital and information continue to globalize. At the same time I am certain that it would is a lot easier today for a 14 year old to manage a single successful, global stock manipulation.    

Cannabis Stocks and the Old Pump and Dump

People seem to hate me when I state the simple truth that cannabis  is illegal everywhere in the US. The Obama Administration decided to focus its drug enforcement budget on the cartels and large suppliers and not on small retail dealers.  Deciding not to bust small dealers did not make cannabis legal anywhere in the US.  Just because the federal government will not spend money to send 20 officers to kick down the door of a small dealer, they will still charge you with “intent to sell” if they find a few pounds of cannabis in the trunk of your car.

The former US Attorney General, Jeff Sessions was fairly clear that he wanted to keep cannabis illegal. What the incoming Attorney General will do is anyone’s guess.  The one clear truth is that action by states purporting to make cannabis legal within their borders does not actually make it legal anywhere under federal law.

Notwithstanding,many people seem to believe that there is a “legal” market for cannabis and a lot of people are finding ways to cash in believing that the federal government will continue to look the other way. That has encouraged the flow of a lot of new money into the “new” cannabis marketplace. As these cannabis companies are new, small and somewhat precarious given they often cannot get a bank account,some companies have sought funding in the microcap stock market where small companies can go public.  

Few investors come in contact with “microcap” or “penny stocks”.   Many of the very large brokerage firms will not touch very low priced shares and certainly will not recommend them.  Fewer investors are the victims of the “pump and dump” schemes that plague this portion of the marketplace. Even fewer investors actually understand how a pump and dump works or how to spot one.

The  blueprint for these pump and dump scams is often the same. These scams will often start with a “shell” corporation, a public company with few assets and minimal operations.  In a typical scenario a public “shell” corporation would acquire a private, ongoing business in exchange for stock.  There would be a press release, often several over the first few months that would begin to tell the story that the promoters wanted to tell, especially how this company was going to grow and grow.

The story would be told to thousands of investors through the stockbrokers who would be on the phones, cold calling people around the US with this week’s“tip”.  They would stay at it until enough people bought the stock to make the share price go up. There would often be subsequent acquisitions, subsequent press releases and subsequent hype.  All of the hype caused more people to buy the stock and the price to go further up.  As the price moved up, the insiders who bought for very little when the company  was still a shell could dump their shares.

This can be very lucrative for the people who bought the shares in the shell for pennies a share. It can also be lucrative for the brokers because getting the stock price up and then selling it to unsuspecting members of the public can mean a lot of transactions and a lot of commissions and mark-ups.  It is not unusual for even a small pump and dump scheme to net the promoters and brokers $10-$20 million or more. Consequently, people who pump and dump the shares of one company (often a team of promoters and stockbrokersfrequently do it repeatedly.

Organized crime settled into the stock brokerage industry in a big way by backing or owning a number of small brokerage firms in the 1980s and 1990s. Many of the firms were the quintessential boiler rooms like the ones depicted by Hollywood in The Wolf of Wall Street or BoilerRoom. By the early 1990s these boiler rooms proliferated in lower Manhattan, Long Island, New Jersey and Florida.  By 2000, the SEC was telling Congress that several of these firms were owned by or worked with the Bonanno, Gambino and Genovese crime families.  

A significant amount of regulatory scrutiny and regulatory actions followed,but that did not stop the billions of dollars of profit that was skimmed off by the miscreants.  The SEC closed down a few of those firms, barred a few people from the securities business and put a few of the people in jail.  But the beat goes on. 

Boiler  rooms are still active today and still working out of Manhattan, Long Island, New Jersey and Florida. They are still cold calling unsuspecting retail investors around the country. They are still using press releases and more recently “independent” fake investment newsletters to pump up what are essentially shell companies. 

In the 1990s the companies were “exciting” because they were going to capitalize in some way on the internet, a new and exciting technology that a lot of people believed could make a lot of money. People were happy to invest in every “internet” company that came along.Today, the pump and dumps have found cannabis stocks as a perfect substitute.   Which brings us to Aphria (NYSE:APHA). 

Aphria is a Canadian cannabis company that is trying to rapidly stake out its territory in new foreign cannabis markets. It traded over the counter in the US until November when it up listed to the NYSE.   The stock price has moved up as the company made a series of acquisitions and announcements in the last year. 

Last week it was the subject of a fairly scathing report by a research company and short seller that questioned whether the company had grossly overvalued some of those acquisitions.  Aphria has retorted that the company’s acquisitions were fine and properly valued and essentially that short sellers cannot be trusted.

Personally I thought that the research report was well written and seemed to have been well researched. There were photos of the headquarters and operations of some of the acquired companies that left a lot to be desired. There were copies of documents that supported the idea that insiders may be guilty of undisclosed self dealing. I thought that the valuations are clearly questionable and that alone was a big red flag. 

What got my interest and what troubled me the most was the discussion of who was involved with Aphria.The report goes out of its way to set out the facts and affiliations surrounding Andrew DeFrancesco who was apparently a founding investor and strategic advisor to Aphria. The report ties Mr. DeFrancesco to  several pump and dump schemes and affiliations with several pump and dump schemers.

These schemers include Paul Honig, John Stetson and John O’Rourke. The SEC brought an action against these three in September specifically charging them with operating pump and dump schemes in the shares of three companies.  I suspect there were other companies whose shares were manipulated by this group as well.  The report points out that in at least one company DeFrancesco’s wife was an early holder of cheap stock.

The report also ties DeFrancesco with a gentleman named Robert Genovese. In 2017,the SEC charged Genovese with operating a separate pump and dump scheme.  So if Aphria’s founding investor has connections with 2 separate pump and dump operators,, and has set himself up to benefit handsomely if Aphria’s stock price should be pumped up, what inferenc e would you make? 

The research report was published by a company called Hindenburg Investment Research. I have no affiliation with them whatsoever and I have never traded shares of Aphria either long or short.  Not surprisingly, a lot of market “experts” refuse to accept any information put into the market by any short seller.  That would be a mistake.

In addition to providing liquidity for the markets, short sellers provide a valuable service because the investment world is grossly overpopulated by“longs”.  The prospects for every company cannot always be rosy. If standard analysis can tell us when the price of a stock is likely to go up, that same analysis can tell us when the price is likely to come down. 

Short sellers truly love to spot scams. If this report is correct about Aphria and the company has grossly overvalued its acquisitions and is being pumped up only to have the insider’s shares dumped into the market, then sooner or later the stock may go to zero or very close to it. That is a win for any short seller.

There is more than enough information in the research report for any small investor who wants to invest in a cannabis company to make an intelligent decision not to invest in Aphria. But please do not think that Aphria is the only cannabis stock whose price may be the pumped up not because its prospects are actually good,but because someone has a lot of stock to dump into the market. As I was researching this article I saw at least a half dozen cannabis related microcap stocks that did not pass the smell test. There are undoubtedly more.