By: Dana M. Grimes, Esq.
The FOREX Market
Of the various types of fraud cases that we see in criminal practice, foreign exchange fraud stands out as the type of case in which the
investors have no chance from day one, because of the zero-sum nature of foreign exchange trading. The investor is convinced to become involved in an investment with the foreign exchange market (“FOREX,” the decentralized, global financial market which determines the relative values of different currencies). The investor is lured in by the fact that the FOREX market is the most liquid market in the world, and the use of leverage in the market can theoretically wildly enhance profit margins with respect to account size.
The investor is passed off to an “introducing broker” (“IB”). The IB houses the money and (in theory) sends it to a futures commission merchant (“FCM”). Sometimes the fraud is simple enough that the money is never sent to an FCM. It is simply spent and reported back to the investor as lost in the volatile market. But if it is sent to the FCM, the IB and the FCM have a contractual relationship. A trader then gets involved in the picture. He facilitates trades through a bank (often a foreign bank) to purchase commodity pairs.
For example, if the investor is convinced to trade the dollar versus the peso, the trader buys that pair. In the typical trade, when a trader buys a pair of dollar versus the peso, he is buying the dollar and selling with the peso,or vice versa. In the foreign exchange market, there is no chance of a rising market. In every trade, there is a winner and a loser, that is why it is zero-sum. It is actually less than zero-sum when you account for the commissions of the traders, which are often substantial and, in many fraud schemes, hidden from the investors. Often con-men promise victim investors wild returns and claim to be able to minimize the risk of the market because of sophisticated trading techniques and abilities to stop or cap losses at a certain level. However, because of the volatility and liquidity of the market, these purported risk-minimizing techniques are usually not actually possible to have in place.
Compounding the risk, individual retail traders are by definition under-capitalized such that even if it were a level playing field between an investor and a multinational bank, when two traders continue trading until one trader goes bankrupt, the investor with less capital has a higher probability of going bankrupt first. The retail investor is playing against the enormously capitalized market as a whole (daily turnover is estimated at $2 trillion, 20 times the value of equities traded on the world’s stock exchanges), so in the long run he will almost certainly go bankrupt.
Also, even though extreme leverage makes FOREX trading very risky, regulation of the industry is limited. That is another part of the reason the industry is ripe with fraud. The Commodities Futures Trading Commission (“CFTC”) is the federal watch-dog tasked with regulating the futures and commodities markets. The CFTC, along with the SEC, oversee the National Futures Association (“NFA”), a self-regulated federal entity that regulates the futures and commodities markets. None of these U.S. organizations have the investigative ability or manpower to closely monitor the industry and no international body regulates this global commerce.
FOREX Fraud vs. Other White Collar Fraud
Real estate fraud comes in various forms. Sometimes the investors are attempting to invest in an equity position in the purchase and construction of real estate projects and the loss of their funds becomes a criminal case when the principals in the company make material misrepresentations to the investors and then spend the money on yachts and trips to Europe instead of on the project sold to the investors. In mortgage fraud, lenders are often the victims of fraudulent loan applications and/or appraisals. In either scenario, however, a rising real estate bubble can protect both the victims and the perpetrators. In a rising real estate market, if nobody loses money, criminal misrepresentations are less likely to be uncovered and prosecuted.
There are likewise a variety of species of stock market fraud. Some cases involve misrepresentations by corporate officers of assets and liabilities, even of large companies on the major exchanges, such as Enron. In Skilling v. United States (2010) 561 U.S. 358, the Supreme Court read the “honest services” portion of the federal fraud statutes in a way which has deterred prosecutors from bringing honest service fraud charges against corporate executives whose conduct did not involve the receipt of bribes or kickbacks.
Although the regulators of the exchanges are often asleep at the switch (as was the SEC in the Bernie Madoff case), there is even more stock fraud in the pump and dump cases of Penny Stocks, which are not traded on the major exchanges. There is also widespread insider trading, a good example of which is the Galleon Group Hedge Fund case. Its president, Raj Rajaratnam, was already a billionaire, but the United States Attorney for the Southern District of New York proved that to increase his wealth (and that of his investors), he was paying a network of insiders to trade on companies including Google, Goldman Sachs, and Hilton Hotels. There have been about 50 other convictions of insider trading in that case alone, and some observers feel that it is representative of just the tip of the iceberg in the lightly regulated hedge fund field.
Federal law enforcement typically works up FOREX cases. They can originate in a CFTC complaint and wind up on the desk of the FBI. Depending on the amount of loss involved, the FBI may take the case to either state or federal prosecutors. Federally, these cases are usually charged as wire and mail fraud.
On the state side, we have seen these cases prosecuted in a very straightforward way as grand theft cases. Penal Code § 487 in essence criminalizes taking the property of another with the intent to permanently deprive them of the property. The crimes of larceny, embezzlement, larceny by trick and device, and obtaining property by false pretenses are all varieties of grand theft. See, People v. Creath (1995) 31 Cal.App.4th 312, 318. The main issue in these cases is the intent of the defendant, i.e., was he a bad or reckless trader with a high commission arrangement, or a con-man who made material misrepresentations to investors with the intent to permanently deprive them of their money rather than the intent to gete them a return on their investment?
These cases can be charged as conspiracies to defraud, which occurs when “two or more persons conspire . . . cheat and defraud any person of any property, by means which are in themselves criminal, or to obtain money or property by false pretenses or by false promises with fraudulent intent not to perform those “promises” pursuant to Penal Code § 182(a)(4). Along with grand theft, the prosecutor may allege “great taking” enhancements, under Penal Code §§ 186.11(a)(2) and 12022.6(a)(3). Attorneys defending these cases should also take note of the California Corporations Code, which has defined within its somewhat dense and dry language a plethora of ways in which a person can commit commodities fraud. Of particular noteworthiness is Corporations Code § 29536, which in essence criminalizes a defendant’s direct or indirect involvement in the sale of a commodity with the intent to defraud.
At the outset of these criminal cases, brokers and traders in FOREX cases usually assert that the claims of angry investors are, if anything, a civil matter. They may contend – somewhat indignantly – that a variety of carefully-crafted out-of-state corporations shield them from any personal civil liability, and certainly any criminal individual liability. However, officers, directors and managers of corporations are criminally liable for the crimes they personally commit, authorize, or ratify on behalf of the business entity. See, Horse Ranch, Inc. v. Superior Court (1994) 24 Cal.App.4th 456-458; see also, People v. Mathews (1992) 7 Cal.App.4th 1052, 1062.
The real battleground in these cases almost inevitably concerns the evidence of the defendant’s promises, projected returns, and clarity (or lack thereof) regarding the commission structure with the named victims. Evidence of misrepresentations, combined with sometimes devastating losses to victims, can make taking these cases to trial a risky proposition for the defense. Not nearly so risky of a proposition, however, as getting involved in the FOREX market as an individual retail investor. Even when sophisticated equity traders engage in these trades, they realize that they are not truly investing, they are speculating. There is no chance for the average investor to make money in these transactions, competing as they do with such an information disadvantage to banks, major corporations and hedge funds that make up the vast majority of the players in the market, and especially after the various commissions are subtracted by unscrupulous brokers from any winning transactions.