The Continuing Problem of Fraudulent Investment Schemes

The Continuing Problem of Fraudulent Investment Schemes

Introduction

Last week saw the Solicitors Regulation Authority (SRA) issuing yet another warning to solicitors of the dangers of involvement in fraudulent investment schemes.

This is not the first such warning – there have been two previous warnings in September 2016 and September 2013 as well as a reference to the schemes in the December 2016 Risk Outlook report.  Despite these, however, it would appear that some within the profession are failing to heed the advice given and are involving themselves, and their clients, in these unlawful schemes.

The SRA have indicated that they have received 12 reports about potential investment scams in the nine months since the last warning notice with a corresponding increase in enforcement action taken as a result.

The Problem of Credibility

One of the main problems of involvement by solicitors in these schemes is that their very presence lends, for many, an element of authenticity or credibility to what could otherwise be perceived as being just another scam.  This is despite attempts by the SRA to warn the public of the dangers of becoming involved in “get-rich-quick” scams and of not placing any reliance on the involvement of a law firm in such schemes. Indeed, the SRA have pointed out that “the involvement of a law firm or solicitor does not mean security. In fact, it may be a warning sign because it is being used as a selling point,”

This issue of credibility was highlighted in one recent case where, the SRA reported, one investor stated that he had taken “reassurance from the fact that my monies were paid into a solicitor’s client account and would be dealt with in an ethical fashion. In fact, it was explained to me… that by paying the monies into a solicitor’s client account, this would be afforded the same safeguards as buying a house and using a solicitor.”

It is this credibility – one that is given not just by the presence of the solicitor but also of the safeguards provided by indemnity insurance and the compensation fund – that those who promote fraudulent schemes are seeking when they involve often unwitting firms of solicitors in their plans.  There is also the fact that the fraudsters involved in such schemes, as is also the case with issues such as money laundering and other forms of fraud, have a fondness for solicitors’ client accounts when dealing with the proceeds of fraud because it gives the appearance that monies have come from a regulated source.

Whilst not all investment schemes are fraudulent – and there are many solicitors involved in schemes which are legitimate – those solicitors who do not understand the processes and ramifications of the schemes they are being asked to become involved in should tread very carefully in case they are being set up in any way.

The Need for Strong and Decisive Action

Whilst the number of solicitors actually involved in these schemes is very small, nevertheless the impact which their actions have is significant – not only in terms of that which is lost by often vulnerable members of the public (potentially hundreds of millions of pounds the SRA estimates) but also in relation to the damage which news of such scams does to the reputation of the profession in general.

In a paper presented to the Board of the SRA in October 2016, it was stated that “the overall policy concern is to discourage ‘investment’ into schemes that are ‘too good to be true’ and not to provide a safety net for imprudent investment” and a stern warning has been issued by the SRA stating that firms involved in such schemes will be closed down “urgently”.

In the Warning Notice from September 2016, the SRA stated that some law firms are improperly providing a banking service through their client account and that in designing the schemes, law firms and fraudsters deliberately create a scheme that avoids raising the red warning flags that would normally alert others to the nature of the scheme.  This includes evading “rules preventing the improper movement of money” by manufacturing a “process which they claim means that the firm is acting in a genuine underlying transaction. The reality is that they are simply allowing their client account to be used to commit what is very likely to be a fraud – and to launder the proceeds.”

The SRA intends to get tough and will continue to close down firms and strike off solicitors who are involved in such schemes.  Criminal prosecution – potentially leading to imprisonment – is not to be ruled out in some cases.

The Regulatory Reasons for Not Becoming Involved in Such Schemes

Whilst there will always be firms for whom involvement in these schemes is a risk that they are prepared to take, there are also many who become involved either because they are duped into doing so in the belief that the scheme is legitimate or who simply do not realise that they are becoming involved in a fraudulent transaction – possibly because the request to act comes from a client for whom they have acted legitimately for some time.

Not becoming involved in these schemes is an issue which derives from the SRA Principles and the SRA rules of professional conduct.  It is also one of common sense. If an offer seems to be too good to be true then in probability it is.

So far as the Principles are concerned, firms need to be aware in particular of the principles relating to:

  1. Acting with integrity (Principle 2);
  2. Not allowing independence to be compromised (Principle 3);
  3. Acting in the best interests of the client (Principle 4); and
  4. Behaving in a way that maintains the trust the public places in you and the provision of legal services. (Principle 6)

So far as the SRA Code of Conduct is concerned, the precise nature of any breach will depend upon the solicitors actual involvement and to whom he or she is providing advice or services.

Thus, if you are acting for a client who wishes to invest in a scheme then you must have regard to the Outcomes contained in the Code, in particular:

  • Outcome O(1.2) – you provide services to your clients in a manner which protects their interests.  In other words that the investment is one which is in the interests of the client and not those of the scheme provider.
  • Outcome O(1.4) – you have the resources, skills and procedures to carry out your clients’ instructions. Firms must not get involved in schemes that they do not understand or which are outside their normal sphere of practice and knowledge.
  • Outcome O(1.6) – you only enter into fee agreements with your clients that are legal. In other words that you do not become involved in transactions which are of questionable legality.
  • Outcomes O(3.4 & 3.5) – that you do not act if there is, or there is a significant risk of there being, an own interest conflict or a conflict with the interests of another client. Thus, if you are approached to represent someone offering an investment scheme you should not also attempt to advise those who wish to invest.
  • Outcome O(6.1 & 6.2) – that if you are referring clients to an investment opportunity, that the opportunity is in the best interests of the client, that your independence is not compromised and that clients are made aware of any financial or other interest you may have in the referral.
  • Outcome O(7.2) – that you identify and manage risks to compliance with the Principles – for example not compromising independence or acting so as to damage the reputation of the profession.
  • Outcome O(7.13) – you assess and purchase the level of professional indemnity insurance cover that is appropriate for your current and past practice, taking into account potential levels of claim by your clients and others and any alternative arrangements you or your client may make.  In other words, if you are likely to become involved in transactions involving large sums of money, individually or cumulatively, then it is essential that you ensure you have sufficient indemnity insurance. Be aware that your insurers might want to aggregate claims and you may find that you have insufficient cover.
  • Outcome O(11.1) – you do not take unfair advantage of third parties in either your professional or personal capacity. In other words, even if you are not acting for a person investing in a scheme in which you are involved, that you do not use your position as a solicitor to influence them or to make them think the scheme is more secure because you are involved. This would be especially the case where the party has not instructed a solicitor of their own.

Further, there are various provisions contained in the SRA Accounts Rules which could have a bearing upon investment schemes.  In particular, you must be aware of how you use client account in these transactions and not allow money to move through your accounts, or an account you control, unless there is an underlying transaction and you are doing so in the context of a genuine transaction about which you are providing legal services.

Rule 14.5 provides:

You must not provide banking facilities through a client account. Payments into, and transfers or withdrawals from, a client account must be in respect of instructions relating to an underlying transaction (and the funds arising therefrom) or to a service forming part of your normal regulated activities.

Bear in mind also that the money may be the proceeds of the defrauding of the investors.

Spotting a Fraudulent Investment Scheme

The overarching advice when it comes to investment schemes must be that “if it seems too good to be true then that is probably because it is”.

The SRA has provided some guidance on spotting the characteristics of fraudulent schemes which they have included in their warning notices.  In the case of high-yield investment schemes these include:

  • Very high rate of return and disproportionate rewards, often within a short time frame — this is also a common characteristic in Ponzi schemes which involve payments to investors from subsequent investors rather than from any ‘profit’ earned by the individual or organisation running the fraudulent operation;
  • Very large sums of money said to be involved or required for “entry” to the “programme”;
  • Confusing and complex transactions with obscure descriptions;
  • Unusual currencies;
  • Prime Bank Guarantees (PBGs), Promissory Notes or Letters of Credit being offered or being the ‘product’ underpinning the finance;
  • Obscure “security” such as famous paintings or speculative international developments;
  • Opinions or letters from law firms or others that support the scheme but do not make sense or are empty of genuine content;
  • Security being offered to “investors” includes an undertaking from a law firm or that money will be held by a law firm—sometimes including reference to indemnity insurance or the Compensation Fund;
  • Security to be issued by an obscure or offshore bank that is difficult to contact—particularly if there is pressure not to contact the bank (or any other person) on (what are in fact spurious) confidentiality grounds;
  • Poorly drafted documentation;
  • Overwhelming amount of documents supposedly explaining the transaction; or a lack of any coherent explanation of the investment;
  • Suggestions that the scheme is supported by, or operates under, the auspices of a major international body (e.g. IMF, UN, Federal Reserve or Bank of England);
  • Large projects that are difficult to verify, e.g. financing of a project in distant jurisdiction where it hard to verify its genuineness;
  • The need for speed and great confidentiality to secure the deal – usually intended to prevent proper due diligence;
  • Unusual letters from genuine banks (that often turn out to be forged or provided by a rogue employee)—contact the bank’s fraud prevention office for verification.

In addition, firms should be aware that unusual investments abroad can prove to be problematic, being difficult to verify and, if things go wrong, the chances of recovering money can be very low and legal systems in other countries may be very different.  Firms should also be wary of being invited to be part of schemes where the promotor wants them so as to provide security or assurance. As the SRA stated, “An honest or safe investment scheme does not need to involve a solicitor to give it credibility”.

Firms should also be wary of schemes where:

  • they act for the promotors of the scheme and investors are expected to seek their own advice;
  • they know very little about the details – especially those involving overseas investments;
  • there is no good reason why money being paid into the scheme should be going through client account
  • they come under pressure to release money paid to them quickly – possibly before they have had the chance to verify the transaction.

What Should Firms be Doing to Avoid Involvement in Unlawful Schemes?

There are a number of steps that firms can take to avoid becoming involved in unlawful schemes.

The advice from the SRA is that firms:

  • Avoid investment schemes they do not fully understand, or have not independently and rigorously verified;
  • Refuse to permit client account, or any other account controlled by them, to receive funds that could simply have been sent to the investment company;
  • Not create fictitious underlying processes, or move money through other accounts, to get around rule 14.5 of the SRA Accounts Rules – the firm will still be facilitating the scheme and might be helping launder the proceeds of crime;
  • Not assume they can avoid liability in law or in conduct simply by warning investors that the firm does not act for the investor and in particular to bear in mind Outcome O(11.1) which provides that even if the firm does not act for the investor it still has a duty not to take unfair advantage of them and to act honestly and with integrity;
  • Do not draft or facilitate the use of contracts that are unfair to the investors – promulgating a contract with unfair terms may be part of an overall case that the firm has taken unfair advantage, whether or not consumer protection legislation applies;
  • Do not give undertakings as “security”;
  • Do not allow their involvement to be used to promote the scheme in any way – bear in mind that the Solicitors Disciplinary Tribunal (SDT) has made it clear in many cases in the past that solicitors must not add credibility to dubious financial schemes;
  • Should regularly check the internet to ensure that their involvement is not being used to promote the scheme in any way and if it is to take action to stop or correct this – the firm’s name might not be mentioned, but if the firm is acting in some way and there is reference to the involvement of a law firm, the firm may still need to take steps to stop it;
  • Be particularly alert to any mention, directly or indirectly, of the firm’s insurance or the Compensation Fund;
  • Undertake thorough research into the investment company and any intermediaries – ideally by reference to official sources such as regulators and Companies House but also paying appropriate attention to media or other commentary that might exist on the Internet;
  • Take steps to monitor whether those within the firm are involved in an investment scheme, to ensure that those concerned fully understand it and, if necessary, take urgent steps to cease involvement;
  • Be particularly careful about acting for an investment company, ceasing to act and then acting for the investors – that gives rise to concern the firm is still looking after the interests of the investment company (particularly if someone who acted for the investment company leaves the firm to join the company or to be associated with it);
  • Bear in mind that in helping an investment company to carry out one of these schemes the firm may be facilitating a fraud and laundering the proceeds.

In addition to these factors, firms should also ensure that:

  • they are acting within their specialist field of practice. Fraudsters may target their existing network of solicitors, and ease them into involvement in such schemes, on the back of legitimate instructions;
  • they fully understand the investment scheme in which they are involved. Fraudulent schemes often make no sense, use jargon and are unnecessarily complex – sometimes solicitors convince themselves that as their involvement is minimal they need not understand it fully; and
  • take all other steps possible to avoid the risk of fraud including always verifying fully the identity of those with whom the firm is dealing and ensuring that full due diligence is carried out.

Conclusion

Many of the schemes through which solicitors have experienced problems have relied upon firms who either do not understand the nature of the scheme, do not care whether they understand the nature of the scheme or have been naïve in their involvement in the scheme.

Those who wish to perpetrate complex and high-level frauds are sophisticated at drawing people in and see solicitors as an added bonus which gives “respectability”.

Only by being alert to the dangers can firms hope to stay on the right side of the regulations.

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