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A Private-Market Deal Gone Bad: Sketchy Brokers, Bilked Seniors and a Cosmetologist

The Wall Street Journal. logo The Wall Street Journal. 5/8/2018 Jean Eaglesham and Coulter Jones

Ray Kay, who works as a financial adviser in Beverly Hills, Calif., advertised on the radio a purportedly low-risk, high-income investment.

There were a few points Mr. Kay omitted. He used to be called Raymond L. Kotrozo. Under that name, he was barred from the securities industry for allegedly running a fraud, according to public records, and later fined $5,000 for breaking that ban.

One more thing: Regulators say the investment he pushed was a Ponzi scheme, one of the biggest in recent years.

The investment involved a private placement, a kind of deal that has boomed amid a fervor for private capital markets. Businesses use private placements to raise money for a wide range of projects, from real estate to oil and gas development, so much so that more money is being raised privately now than in the public markets. Most private placements appear legitimate. For typically sophisticated investors such as pension funds they offer the potential for better returns than in the public markets.

In recent years, however, hundreds of billions of dollars in private placements have been sold each year by stockbrokers, often to individuals. And the brokers who sell them are far more likely than other brokers to have sketchy records, a Wall Street Journal analysis has found.

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One in eight brokers marketing private placements had three or more red flags on their records, such as an investor complaint, regulatory action, criminal charge or firing, the Journal found in a review of data including Securities and Exchange Commission records from September 2008, when they became electronically available, through 2017. That compares with one in 50 among all active brokers.

Brokers selling private placements also are six times as likely as the average broker to report at least one regulatory action against them, the Journal analysis found.  The figures suggest a sharp expansion in brokered sales of private placements over the past decade has created heightened risks for individual investors.

“It’s one of the most abused areas of finance today,” said Jeffrey Sonn, a Miami lawyer who represents investors in disputes with brokers. “We get more cases from private placements than any other type of investment.”

In 2017 alone, private placements using brokers totaled at least $710 billion, according to the Journal’s analysis—a nearly threefold rise from 2009.

Among individual investors, sales of private placements are typically restricted to those who are “accredited,” meaning they have annual incomes of over $200,000 or have more than $1 million of assets besides their homes. It’s up to brokers to make sure clients meet this test.

Many seniors were among the thousands facing losses from the troubled investment linked to private placements that was advertised by Mr. Kay and other sales agents, according to the SEC. Mr. Kay, who is 75 years old, according to public records, declined to comment on why he changed his name.

He said he didn’t know whether he was still barred from the securities industry—he is, according to public records—and he also said the investment he advertised wasn’t a “security,” something he wasn’t licensed to sell. Although advertising it, he said, he didn’t end up selling any. One investor’s lawyer said Mr. Kay sold the investor a $500,000 investment late last year. Mr. Kay’s lawyer declined to comment on that.

Mr. Kay wasn’t aware of the alleged Ponzi fraud when he advertised the investment, said his attorney.

The investment involved Woodbridge Group of Companies LLC, a California-based firm that was raising money, much of which it said it would use for loans to a variety of commercial real-estate ventures.

Instead, the SEC alleged in a lawsuit five months ago, Woodbridge lent mostly to businesses owned by Woodbridge’s owner, Robert H. Shapiro.

Those businesses purchased real estate, including luxury Southern California property such as the lavish Owlwood estate, once owned by pop duo Sonny & Cher. The investments didn’t produce enough revenue to pay investors the returns they were promised. The result was a “business model built on lies” that was kept afloat, Ponzi-like, only by the constant infusion of new money from investors, the SEC said when it sued Woodbridge and Mr. Shapiro for fraud in federal court in Miami. The suit labeled the business a “massive Ponzi scheme.”

The suit also said Mr. Shapiro spent at least $21.2 million of Woodbridge’s money on himself, including $1.2 million for alimony and $130,000 for country-club fees, leaving investors “with substantial losses, as they are owed at least $961 million in principal.”

Woodbridge filed for Chapter 11 bankruptcy protection in December 2017, shortly before the SEC filed suit. Unsecured creditors estimated in a court filing that investors could recover 45% to 76% of what they are owed, depending partly on how much Woodbridge could realize by selling a property portfolio worth several hundred million dollars.

On April 23, Woodbridge agreed to settle the SEC civil suit without admitting or denying its allegations. A possible penalty remains to be determined. Adam Schwartz, a lawyer for the company, said it is cooperating with the SEC and state regulators.

Mr. Shapiro didn’t settle and is fighting the SEC suit. He “continues to vigorously deny the mischaracterization of…Woodbridge as a Ponzi and he looks forward to defending those baseless allegations in the appropriate forums,” said his lawyer, Ryan O’Quinn.

Archie Beckett Jr., a 63-year-old former petroleum engineer in Katy, Texas, retired last summer expecting steady income from $3.6 million he put into Woodbridge. Now, he and his wife will “have to change our whole plan of what we were going to do,” including providing college funds for four grandchildren. “It will certainly take its toll,” Mr. Beckett said.

Another investor was George Stephanopoulos, the ABC newsman and former Clinton White House official. “Like many others, I was a victim of Woodbridge and now must deal with the consequences of its bankruptcy,” he said.

Sales agents began marketing Woodbridge investments six years ago, the SEC said. Investors could buy notes maturing in 12 months or more, secured by property liens, or buy units in funds owned by Woodbridge. Ads appeared in newspapers and on the radio.

“CALL NOW to receive 8% for 1 year on what people are calling the greatest short term, safe investment available today!” said an ad from a firm called Position Benefits LLC in Plymouth, Mass. How much Position Benefits sold isn’t clear, but a Massachusetts regulator said the firm and its founder, Charles Nilosek, made at least $607,000 in commissions.

Mr. Nilosek said he simply used Woodbridge’s marketing materials in his ads. “We would do the same thing for a pizza place,” he said. “We were just doing marketing for them.”

Woodbridge paid agents “substantial commissions,” totaling $64.5 million, to sell its investments, the SEC suit said.

The highest-earning external agents for the investments were a firm called Knowles Systems Inc. and its chief executive and co-owner, cosmetologist Lynette Robbins, according to an SEC lawsuit filing. Knowles, which is in The Villages, Fla., one of the country’s largest retirement communities, received at least $8.1 million in commissions, the filing said.

Ms. Robbins, 72, has a license qualifying her to advise on hair and makeup, according to public records. A search didn’t turn up any financial qualifications. She isn’t registered as a broker or investment adviser with either the SEC or Finra, the Financial Industry Regulatory Authority. Ms. Robbins and her attorney didn’t respond to requests for comment. Her lawyer said in a recent motion to dismiss that she “had no knowledge and did not intend to place individuals in sham investments.”

Knowles Systems filed for Chapter 11 bankruptcy last month, saying it lost two-thirds of its revenue when Woodbridge collapsed and it is exposed to a potential “multi-million judgment” in investor litigation against sales agents. Knowles “denies it was negligent in providing leads to Woodbridge,” it said in a court filing. Its lawyer, Scott Shuker, said Knowles just referred people to Woodbridge. Also, “this wasn’t a security,” he said. The SEC says it was.

One way investors found Knowles and Ms. Robbins was through a personal-finance journalist named Jordan Goodman, whose website styles him as “America’s Money Answers Man.” He regularly promoted Woodbridge on radio programs, according to investors’ testimony to the SEC and to an order against Woodbridge by Colorado securities regulators.

It was on the radio one day in 2014 that retired airline pilot George L. Sims Jr. of Parker, Colo., heard Mr. Goodman talking “about the safety and security of the Woodbridge investment,” Mr. Sims told the SEC.

Mr. Sims told the agency that when he called in to ask about the deal, he was referred to Ms. Robbins, who “touted Woodbridge as a safe and secure investment.” He said he had $100,000 invested in Woodbridge.

Mr. Goodman declined to say how much, if anything, he was paid for referrals. Knowles said in its bankruptcy filing it paid “influencers” who gave it Woodbridge leads 1% of new money invested.

Mr. Goodman, who doesn’t face any regulatory action, said he merely referred investors to Knowles and didn’t sell anything. “I’m very sorry at the way this has turned out,” he said. “From what I understand, there was no Ponzi, this is all an SEC fabrication.”

Several sales agents who marketed Woodbridge investments had disciplinary histories, including at least three who had been barred from the securities industry, according to investor lawsuits and Finra and court records. Among them was Donald Anthony MacKenzie, who runs Old Security Financial Group Inc. in Spring, Texas, a firm federal district courts have twice ordered to repay commissions from illegal sales of unregistered securities.

The Texas commissioner of insurance sanctioned Mr. MacKenzie, known as Tony, in 2012 for selling investments without a license. That was the same year he was convicted of misdemeanor “disorderly conduct—firearm” for threatening another driver with a pistol, according to state and court records.

In 2015, the Texas State Securities Board took emergency action to stop Mr. MacKenzie and Old Security from selling investments in Woodbridge. The agency said Woodbridge and the sales agents weren’t complying with steps required to sell unregistered securities, including verifying that any investors were accredited. It also said Old Security and Mr. MacKenzie were misleading investors by not disclosing the risks or their disciplinary history. Mr. MacKenzie, his firm and another of the firm’s principals were fined a total of $100,000 in a settlement the next year.

Mr. MacKenzie didn’t respond to requests for comment.

Years ago, Congress tried to root serial offenders out of private-placement brokerage by barring felons and people with certain securities offenses. But rules adopted to implement this action in 2013 didn’t target many advisers who had past infractions. “It almost grandfathered in recidivists,” said Joe Rotunda, the Texas securities regulator’s enforcement chief.

To help investors cope with selling agents who aren’t registered as brokers or investment advisers, the SEC this month launched a public database that includes unregistered individuals who had recent SEC actions against them.

Lawyers for investors say the Woodbridge matter raises questions about the SEC’s effectiveness in policing the market. State regulators took action as early as 2015, when Massachusetts and Texas sent cease-and-desist letters or imposed fines.

The SEC didn’t begin an investigation until September of 2016, and it wasn’t until December 2017, shortly after Woodbridge’s bankruptcy filing, that the SEC sued the firm and froze its assets. The Journal identified $350 million Woodbridge sought to raise in private placements in the period after the first state enforcement action.

A spokesman for the SEC said its investigation was made harder by “protracted efforts” of Woodbridge and certain employees to interfere. “Despite these roadblocks, the staff moved quickly to put a stop to the alleged fraud,” the agency said.

SEC investigators last year interviewed one sales agent who was barred from the securities industry but continued marketing the Woodbridge investments, without being stopped by the agency, until the bankruptcy, according to court filings and lawyers representing investors.

Mr. Kay, the Beverly Hills former broker who advertised the Woodbridge investment on the radio, published a book online in 2014. “Anecdotes for a Better Retirement” listed what it called the 10 biggest retirement planning mistakes.

Top of the list: “selecting the wrong advisor.”

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