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Protecting the investing public

January 20, 2016 | Alumni

Hollywood producers looking for real-life inspiration may want to pay a visit to the Boston Regional Office of the U.S. Securities and Exchange Commission (SEC). There, Scott Richard Stanley ’06 spends his days conducting complex investigations into possible violations of the federal securities laws, such as the Securities Act, the Exchange Act, the Investment Advisers Act, and the Investment Company Act.

Lately, Stanley, who works as senior counsel in the commission’s division of enforcement, has devoted significant time and energy to investigating a massive pyramid scheme that was international in scope. On April 15, 2014, the SEC filed civil fraud charges against the Massachusetts-based operators of TelexFree, Inc. and TelexFree, LLC.

It’s a complex, far-reaching case involving fraud and approximately 1.9 million victims. In a nutshell, the SEC alleged that TelexFree, Inc. and TelexFree, LLC claimed to run a multilevel marketing company that sold “voice over Internet” (VoIP) technology, while in actuality running an elaborate pyramid scheme that mainly targeted Dominican and Brazilian immigrants in the U.S.

According to the SEC’s complaint, TelexFree sold securities in the form of “memberships,” that promised annual returns of 200 percent or more for members who promoted TelexFree by placing TelexFree advertisements on free Internet ad sites and recruiting new members. However, the SEC found that TelexFree’s VoIP sales revenues (approximately $1.3 million between August 2012 and March 2014) represented only about one percent of the more than $1.1 billion raised from investors (and a fraction of the estimated $4.3 billion in returns allegedly promised to earlier investors). That money didn’t come from VoIP product sales, but from the membership fees of newly recruited TelexFree investors, who paid in multiples of between $349 and $1,425 to buy into the company.

A December 28, 2014 article in the Boston Globe summed up the case this way: “In April, FBI agents raided an office in Marlborough occupied by TelexFree Inc. … Securities regulators said TelexFree, a purported seller of long-distance phone plans, preyed on the Brazilian immigrant community, luring participants to invest $90 million in Massachusetts alone. One owner, Carlos Wanzeler, fled to Brazil; the other, James Merrill of Ashland, is awaiting trial. Both could face 20 years in prison for their roles in the alleged fraud that started in Brazil and ensnared 2.1 million people from Boston to Uganda.”

While there is nothing illegal about directly selling goods and services through multi-level marketing, Stanley said, unscrupulous promoters may attempt to disguise illegal pyramid schemes as multi-level marketing arrangements. Pyramid schemes, however, have a fundamentally different focus than the actual selling of products or services to retail customers.

According to the SEC, in the classic “pyramid” scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same. The fraudsters behind a pyramid scheme may go to great lengths to make the program look like a legitimate multi-level marketing program. Despite their claims to have legitimate products or services to sell, however, these fraudsters simply use money coming in from new recruits to pay off early stage investors.

“Some companies set up schemes where the product they are selling is secondary to the recruitment of affiliates, members, or promoters, and they rely on the recurring chain of one person recruiting another, after another, to keep the scheme going. In other words, you recruit a member and get their money, and that money is used to pay out money to previous investors in the company,” Stanley said. “The company inevitably runs out of investors to recruit and the scheme collapses, leading to significant financial harm to victims.”

TelexFree, Stanley explained, started in Brazil in 2012, only to be shut down by Brazilian authorities one year later. Then, the scheme morphed and migrated to the U.S., where it became an affinity fraud, targeting immigrant communities in Massachusetts and beyond. When TelexFree executives realized that they were being investigated, they attempted to make the company’s compensation appear more legitimate, but, by doing so, Stanley said, they sealed their fate. TelexFree couldn’t pay back its investors and filed for bankruptcy in April 2014.

“At the same time we went to court to obtain an injunction to shut them down and get an asset freeze, the criminal and state authorities were also investigating the company,” Stanley said. “There was a parallel criminal investigation and criminal charges filed against the principals of the company by the District of Massachusetts.”

In a status report issued on Feb. 26, 2015, the bankruptcy court-appointed trustee of TelexFree confirmed that the company was, in fact, running a pyramid scheme, stating, “The Debtors purported to be operating a multi-level marketing company engaged in the sale of voice over internet protocol services, but they were, in actuality, perpetrating a pyramid scheme involving as many as a million or more participants.”

The results from the TelexFree matter, he added, “have been very satisfying as we were able to secure hundreds of millions of dollars of funds taken from victims and prevented the further dissipation of investor assets. This kind of scam victimized our most vulnerable investors.”

Practical applications

Many of the things that Stanley learned while in law school have stuck with him, but few more so than how to use the four-part Howey Test to determine whether something is an actual investment contract. Stanley and his colleagues used the test to help determine that TelexFree was fraudulent, which then allowed the SEC to move quickly and freeze the company’s assets.

“When pyramid schemes first start, everybody tends to get paid because the money is flowing in,” Stanley said. “Over time, as the scheme mushrooms, it becomes more difficult for them to pay out, so we start hearing complaints, not necessarily from victims, but from people in the community.”

That’s how the TelexFree case ended up on Stanley’s desk. After receiving complaints from multiple sources, a supervisor asked Stanley if he would be interested in working on the case. “I jumped at the opportunity and we moved rapidly and worked to gather evidence,” he said.

Stanley, who is from Norwood, Massachusetts (a suburb of Boston), and has worked at the SEC’s Boston office since 2011 (he transitioned from staff attorney to senior counsel in June 2014), has been passionate about economics for as long as he can remember, although the path to his current job came about somewhat circuitously.

He earned an undergraduate degree in economics and American studies from Fairfield University in Fairfield, Connecticut, in 1990, followed by an MBA in finance and marketing from the Stern School of Business at New York University in 1999, and worked for 13-years in telecommunications. He worked as a regulatory specialist for Verizon Communications for a decade and as a senior product manager at XO Communications for three years.He initially enrolled in law school with the goal of one day working in telecommunications law, and participated in Moritz College’s Washington, D.C., Summer Program after his first year, interning for the chairman of the Federal Communications Commission (FCC).

“From that experience, I decided against that path,” he said. “I just didn’t find the FCC to be very impactful. It was a very policy-oriented place and I felt like the work at the FCC, while important – I just didn’t see the direct impact on people’s daily lives.” Instead, he opted to explore a career in the finance and securities industries.

After graduating from Moritz in 2006, he began working as a regulatory analyst in the derivatives markets at FINRA, a private corporation that serves as the financial industry’s regulatory authority, in Rockville, Maryland. While there, he investigated business conduct violations, and his work led to suspensions and million dollar fines for some of Wall Street’s biggest inter-dealer brokers.

“I took kind of a nontraditional approach, and I think my story is a valuable one,” he said of his career path. “I think I can speak to people who aren’t necessarily in the top 10 percent of their class, and don’t have all the major law firms knocking on their doors. With a little creativity and persistence, you can find your way with your Ohio State law degree into very exciting and very important positions.”

And major awards

In January 2015, Stanley received the Ferdinand Pecora Award, the highest honor given to an enforcement attorney at the SEC “in recognition of [his] exceptional tenacity, creativity, and efficiency as [he] overcame significant obstacles to enforce the federal securities law.” He was nominated for his work on the TelexFree case, which inspired Stanley and his colleagues to form the SEC’s Pyramid Scheme Task Force in 2014.

Stanley and his colleagues came up with the idea of a task force after talking with colleagues about how they could take a more proactive – rather than reactive – approach to tackling this national and international problem.

“We set out to form the Pyramid Scheme Task Force in the fourth quarter of last year, and it’s being operationalized now,” he said. “There’s hard work going on behind the scenes to make it a reality. There are approximately 55 members from the SEC headquarters and 13 regional offices involved.” The task force also includes a large assortment of state and federal law enforcement, consumer protection, and securities regulatory authorities.

Receiving the Ferdinand Pecora Award “was the culmination of several years of hard work and perseverance,” he said. “This award is confirmation, in my mind, that the work I am doing is making a valuable contribution to society, on a daily basis.”