On Advice

Massive investment fraud fueled by slick marketing, hot dinners

When advisers make the claim that an investment product has no risk and is crash proof, it is a clear, almost blazing red flag that the investment is a potential fraud

Jan 5, 2018 @ 1:53 pm

By Bruce Kelly

For almost five years, the SEC said the Woodbridge Group of Companies operated a billion-dollar Ponzi scheme, taking advantage of 8,400 investors, many of them elderly. What is striking about the alleged fraud is that it operated in plain sight.

On behalf of Woodbridge, hundreds of insurance agents and brokers, some with checkered careers in the securities industry, sold notes supposedly backed up by mortgages, which the Securities and Exchange Commission last month claimed were the foundation of a massive, $1.2 billion Ponzi.

The Woodbridge sales force was formidable, according to the SEC lawsuit. "Woodbridge employed a sales team of approximately 30 in-house employees that operated within Woodbridge's offices," the SEC claimed. "Woodbridge also utilized a network of hundreds of external sales agents to solicit investments from the general public by way of television, radio, and newspaper advertisements, cold calling campaigns, social media, websites, seminars and in-person presentations."

According to the SEC's complaint, the Woodbridge business model was to borrow money from investors in exchange for promissory notes, maturing usually in 12 or 18 months. The notes had an annual interest rate of 5% to 8% payable monthly. The investors' money was supposed to be issued to lenders in the form of securitized mortgages, but rarely was, according to the SEC.

Near the start of December, Woodbridge declared bankruptcy after it failed to make interest payments to investors. In its bankruptcy filing, the company cited "increased operating and development costs" that were "exacerbated by the unforeseen costs associated with ongoing litigation and regulatory compliance."

To make matters worse for Woodbridge clients, the SEC said in the fall that it had been investigating Woodbridge for the past year to determine whether the company was operating as a fraud. Why didn't the SEC attempt to stop this alleged scheme any sooner?

Ryan White, a spokesman for the SEC, declined to comment.

However, the SEC twice last year subpoenaed Woodbridge and its founder, Robert H. Shapiro, for documents and emails they did not produce. That very well may have delayed the SEC's lawsuit in December against the company.

While the Woodbridge mortgage investments were sold nationwide, south Florida looks like it was a big focus.

For example, one insurance salesman and former broker, James H. Gilchrist, promoted the loans at dinners in Jensen Beach. The invitation encouraged potential attendees to "learn how to earn 6% fixed interest" a year, touting "monthly income checks" and "no market risk" along with an entree of chicken alfredo, salmon or shrimp scampi. "How to make your retirement savings CRASH PROOF," the invitation declared. Mr. Gilchrist did not return calls for comment.

Jeff Sonn, a plaintiff's attorney, said he had recently been contacted by six clients of former broker Andrew G. Costa, who collectively bought $475,000 in Woodbridge mortgage notes.

"The pitch was that they were investing in mortgages, they were short-term loans, and it was a safe return on their money that was secured by real estate," Mr. Sonn said. "What they were actually getting were liens on properties loaned to an affiliate of Woodbridge, which was essentially moving the money from its right pocket to its left pocket."

Insurance agent Al Klager of Vero Beach, in newspaper ads also promoted the 6% annual yields from the Woodbridge investment: "Your Principal and Interest are 100% Secured," read one ad from June 2016. "You are not linked to the Stock Market."

Mr. Klager, who said he is also an investor in the Woodbridge notes, stated that he was confident that his clients will get money back. "It is real estate," he said. "I have a lot of my money in Woodbridge, too."

When asked how many of his clients had invested in Woodbridge or how much of his own money was invested in the mortgages, he declined to comment.

Investors should have learned at least one lesson from the 2008 financial crisis and the revelation of hundreds of Ponzi schemes, assorted investment scams and mortgage frauds. When advisers make the claim that an investment product has no risk and is crash proof, it is a clear, almost blazing red flag that the investment is a potential fraud.

The most notable example is Bernie Madoff. For years, Mr. Madoff promised investors steady, annual returns of close to 10% before revealing in 2008 that he was running a $50 billion Ponzi scheme.

Some of the Florida promoters selling Woodbridge did not have the most sterling of backgrounds.

"Many of [the Woodbridge] sales agents were not associated with registered broker-dealers or investment advisory firms," the SEC's lawsuit alleges. "Several of these sales agents, including some of the highest producers, had been censured or barred by the commission, Finra or state securities regulators. Woodbridge did not disclose this to investors."

For example, the Financial Industry Regulatory Authority Inc. barred Mr. Costa and expelled his firm from the securities industry in 2008 for failing to respond to Finra's requests for information and documents during an enforcement investigation into a private placement offering, according to his BrokerCheck report. He has 19 disclosure events on his Finra profile.

"I really don't want to talk about it," Mr. Costa said, when reached for comment.

And then there is Barry Kornfeld, a former broker who was barred by the SEC from the securities industry for selling high-risk collateralized mortgage obligations from 2004 to 2007 in the run-up to the credit crisis. Mr. Sonn, the plaintiff's attorney, and a client of the ex-broker whose family invested almost $1 million in Woodbridge notes, said Mr. Kornfeld sold​ the Woodbridge loans through his firm, Financial Tax Group in Boca Raton, Fla.

Mr. Kornfeld did not respond to emails sent to him seeking comment.

Needless to say, clients should shun buying investment products from brokers who have been kicked out of the industry.

"My clients have been greatly disappointed to learn about the back story and history of many of the advisers selling the Woodbridge notes," said Scott Silver, a plaintiff's attorney who has over 100 clients who bought Woodbridge mortgages and have $50 million in claims.

When the SEC sued the Woodbridge Group, along with Mr. Shapiro, it alleged that from July 2012 through December 2017 they ran a real estate scheme and that investors are owed at least $961 million in principal.

Mr. Shapiro allegedly diverted at least $21 million for his own benefit, and spent some of the money on personal expenses such as charter planes, country club fees, luxury vehicles and jewelry, according to the SEC.

When Woodbridge declared bankruptcy, it initially said Mr. Shapiro would be paid $175,000 monthly fee, according to Bloomberg News. Now, Woodbridge says it wants nothing to do with Mr. Shapiro.

Woodbridge's new executive management team "has taken a number of steps to protect investors and maximize the value of the estate for the benefit of all stakeholders," according to a spokeswoman for Woodbridge, Kristen Cole.

"These actions include immediately ceasing all fund raising, removing Robert Shapiro from all involvement in the company's business, and implementing a process to protect the value of the company's assets," she added.

"Mr. Shapiro is cooperating with the bankruptcy to protect the assets held for the benefit of Woodbridge's stakeholders," said Ryan O'Quinn, an attorney for Mr. Shapiro. "He denies any allegation of wrongdoing and looks forward to his opportunity to defend himself in a court of law."

Mr. Shapiro promised investors they would be repaid from the high rates of interest that the Woodbridge companies were earning on loans they were purportedly making to third-party borrowers, according to the SEC.

But nearly all the borrowers were actually limited liability companies owned and controlled by Mr. Shapiro and had no revenues, according to the SEC, which claims that he and his companies generated less than $14 million in interest income from truly unaffiliated third parties.

"Woodbridge and Shapiro required a continuous infusion of new investor funds and needed existing [mortgage investors] to rollover their investment into a new note at the end of the term, so as to avoid having to come up with the cash to repay the principal," the SEC alleges.

It would be tough to write a clearer description of a Ponzi scheme than that.

The sales agents were paid well. According to the SEC complaint, "Woodbridge offered its [mortgage] product to its external sales agents at a 9% wholesale rate, and the agents in turn offered the [mortgage notes] to their investor clients at 5% to 8% annual interest — the external sales agent received a commission equivalent to the difference," the SEC asserted.

"Any time you can make up your own commission, it's not a good sign," said Keith Singer, an adviser affiliated with Investacorp Inc. in Boca Raton, Fla. Mr. Singer had warned listeners on his radio show a year ago about the kind of investments that Woodbridge was promoting.

"Although virtually none of these sales agents were registered with any regulatory agency, Woodbridge paid them more than $64.5 million in transaction-based compensation in the form of commissions for selling investments in Woodbridge securities," the SEC alleges.

Two sources told InvestmentNews that they reached out to regulators about Woodbridge and the warning signs of claims that the mortgages had no market risk and were secured but got little response in return.

"More than a year ago, I sent a copy of [Mr. Klager and Atlantic Financial Services'] advertising to the state," said Bob Anderson, an adviser with Harbor Financial Services and clears with Raymond James & Associates. "Florida responded that it had no jurisdiction. I don't understand the response, and unfortunately investors have lost over a billion dollars."

"The inquiry submitted was general in nature and did not indicate a suspicion of unlawful activity by the agent," wrote Anna Farrar, a spokeswoman for the Florida Department of Financial Services. "However, a complaint has been filed by Mr. Anderson as of December 28, 2017, and would solely be investigated by the [office of financial regulation] due to the products and areas involved."

Some regulators in other states have taken action. Since 2015, regulators in eight states have filed administrative actions against Woodbridge and other defendants, along with certain sales agents, alleging they have engaged in the unregistered offering of securities and have unlawfully acted as unregistered investment advisers or broker-dealers, according to the SEC.

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