Pandemic Deemed 'Perfect Storm' For Fraud In The Markets

By Al Barbarino
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Law360 (March 20, 2020, 9:40 PM EDT) -- An array of U.S. financial regulators and attorneys are warning the industry about the proliferation of scams and abuses as volatility rips through the markets due to the novel coronavirus pandemic.

The U.S. Securities and Exchange Commission, Financial Industry Regulatory Authority and Financial Crimes Enforcement Network have all recently issued alerts addressing a range of illicit activities that target the financial industry and play on the fears of investors.

The legal profession, meanwhile, is echoing regulators' warnings that the current environment is ripe for abuses and that financial firms should remain hypervigilant against a long list of potential misconduct, such as Ponzi schemes, insider trading, pump-and-dump schemes and imposters.

"What we have here is a perfect storm that basically takes the usual government warnings about potential scams and puts them on steroids," said Emily Gordy, a partner with McGuireWoods LLP and former deputy of enforcement at FINRA.

"The opportunity for fraudsters and scammers is unprecedented, and the important thing right now is for the industry and the government to continue putting information out there."

A FinCEN statement released Monday warned of scams "similar to those that occur in the wake of natural disasters," including individuals or entities impersonating the U.S. government or government officials, investment scams claiming coronavirus-related medical breakthroughs, and schemes involving the sale of unapproved or dangerous medical products.

FinCEN also noted it had received reports regarding suspected insider trading related to COVID-19. While the bureau declined to elaborate on the insider trading reports or comment for this article, attorneys noted that publicly traded medical and infrastructure companies could find themselves at the center of insider trading schemes.

Individuals could attempt to exploit positive "material nonpublic information" about a company, such as those developing coronavirus treatments, or conversely could dump stock based on negative information, Gordy said.

Major stock indices have experienced extreme volatility in recent weeks, with the Dow Jones Industrial Average logging its largest one-week drop since 2008 at close Friday.

The question of insider trading around the coronavirus flared up publicly this week following reports that Sens. Richard Burr, R-N.C., and Kelly Loeffler, R-Ga., had unloaded millions of dollars of stock holdings prior to the recent market downturn.

Burr took to Twitter on Friday to say he relied solely on public information and has requested a Senate Ethics Committee review of the matter, while Loeffler tweeted that third-party financial advisers had made the trades without her knowledge.

"That could be an issue," said Brian Rubin, a partner at Eversheds Sutherland who heads up the firm's SEC, FINRA and state securities enforcement practice, regarding the reports. "If there were significant trades right before some of the public announcements and the huge volatility, I have no doubt that the regulators are looking at those."

A Feb. 4 investor alert from the SEC warned specifically about promotions falsely claiming that products or services of publicly traded companies can prevent, detect or cure the novel coronavirus.

Firms could face a steep task trying to identify illicit communications amid an increasing number of legitimate requests from concerned investors. For that reason, Rubin said firms should continually update relevant email review search terms to keep up with the pandemic while informing employees of all agency alerts.

"It makes sense for firms to send these regulatory notices to staff so that if they receive these types of emails, they can let their IT or compliance departments know and possibly send them to the regulators," Rubin said.

He added that scammers have become increasingly sophisticated when it comes to impersonating clients in an attempt to solicit funds.

"In this case, they would be calling or emailing as if they are a client saying, 'Hey, I have a real crisis going on right now, please send me my money, please sell everything,' or whatever the case may be," he said.

"We see that routinely, but I think we will see it more commonly now given the economic issues that I'm sure fraudsters will try to take advantage of."

The SEC notice also warned about pump-and-dump schemes, particularly using low-priced microcap stocks. Such schemes involve promoters and conspirators working to inflate stock prices through disinformation and then unloading their stock amid the hype.

Gordy said that regulators monitoring broker-dealers are typically most concerned with systemic, recurring issues rather than pursuing one-off technical misses or seeking "gotcha" moments.

She noted that more than a dozen enforcement cases brought by FINRA and the SEC last year involved broker-dealers that simply "looked the other way" of stock scams executed on their systems.

"Broker-dealers are one of the important gatekeepers to the market," she said, "and it's incumbent upon them to conduct trading surveillance, to appropriately staff their surveillance and review team and to follow up on red flags to protect customers, markets and their firms as well."

The U.S. Commodity Futures Trading Commission issued its own alert Wednesday asking the public to be on the lookout for fraudsters trying to profit from the recent market volatility.

The CFTC warned that while commodity futures and options, as well as over-the-counter digital assets and foreign exchange, allow traders to hedge against market risk, "there is no such thing as a risk-free strategy, and no person or program can guarantee future results." The agency's enforcement director, James McDonald, added a few choice words for potential offenders.

"We will aggressively pursue misconduct in our markets tied to the impact of the coronavirus pandemic," he said in a statement. "There is never an appropriate time to prey on innocent people's fears."

--Editing by Aaron Pelc and Emily Kokoll.

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