 Boiler room frauds are not a new scam but they are more easily noticed during times of economic crisis. Regulators and enforcement agencies are stepping up their efforts to crack down on this sophisticated illegal activity. With both individuals and companies at risk from these scams, if and when a boiler room does strike, what can be done to prevent or minimise exposure and what powers do the authorities have to tackle this problem?
What is a ‘Boiler Room Fraud’?
A boiler room fraud typically occurs where a call centre is set up outside the UK consisting of groups of sales people who target individual investors and sell shares using high-pressure sales techniques. The leader of the boiler room will identify target companies whose shares they will sell, often start-up companies who are looking to raise capital. The companies’ shares will not generally be listed on any stock market. However, the call centre sales people will entice an investor with exciting promises that a company is about to float on the stock exchange.
This will often be done in an extremely sophisticated and impressive way, and a prospective investor will be told that they are getting the shares for a bargain price and that once the company floats, the price will rocket and the investor will see a massive return. The shares will in fact be overpriced and this price will incorporate huge commissions, often up to 90%, which will be paid to the boiler room, with only a minimal percentage of the sale price going back into the company.
The investor pays the money over, often to an escrow account. (An escrow account is one that is established by a broker, for the purpose of holding funds on behalf of the broker’s principal until the consummation or termination of a transaction, rather than to the company itself.) The investor will eventually find that when they come to sell the shares they are worth much less than they paid, or that they are worthless as there is no market.
Sophistication and Manipulation
The boiler room will employ certain tricks to fool even experienced investors. They will often be economical with the truth about whether or not they are regulated by the Financial Services Authority (FSA) and usually have impressive websites where investors can be directed to do their own ‘research’ to make sure that they are legitimate. They may have a registered company with a prestigious London address, such as Mayfair or Pall Mall, so that a potential investor has confidence that they are UK-based and assume that they can be held accountable. They may be based overseas but pay for UK landline numbers that are re-routed overseas, giving the investor the impression that they are based in the UK.
The boiler rooms are often based in countries such as Spain, Switzerland, Dubai or the US, and are not regulated by the FSA so the investor has no recourse to complain or obtain compensation. The FSA is usually unable to take direct action to shut them down. The average investor conned by these schemes loses £20,000, though some have lost over £100,000 and have been targeted more than once.
The effects of this type of fraud can be far reaching and it is not just the individual investor who can suffer. It is often publicised that vulnerable members of society are targeted, but a high proportion of investors duped are middle-aged, professional men such as lawyers and accountants who are experienced investors.
Companies Beware
It is not only individuals but companies that should also be wary of being targeted by boiler room frauds. The company whose shares are sold by the boiler rooms also suffer and may be unaware that the shares are being sold in such a manner until an investigation begins, and so will inevitably be drawn in. By then, the company’s bank accounts and assets may be frozen using the restraint procedures in the Proceeds of Crime Act (POCA) 2002.
It is often thought that boiler rooms sell shares that do not exist. Generally this is not the case. A boiler room may target small start-up firms often in progressive and groundbreaking areas attractive to investors. These firms may be vulnerable to the lure of the boiler room’s offer to raise capital for them by selling shares. An unsuspecting company may find this an attractive prospect and be misled as to what commissions the boiler room will take and what money will be put back into the company. Often a company will not be aware of what is happening until new investors start to contact them because they haven’t received their share certificates or are trying to find out when the company is going to float.
By the time suspicion has been aroused it may be too late and the company’s reputation will have been damaged. The FSA or the Serious Fraud Office (SFO) may have commenced an investigation and, as either body has the power to restrain a company’s bank accounts and assets under POCA 2002, the company will be prevented from conducting business while the investigation is ongoing. This can often result in a fatal blow to a company’s hopes of being listed on a stock market or have a dramatic effect on a company already being traded. Suspicion can fall on the company’s directors on the basis that they must have known what was happening in the boiler room and that they were complicit inthe arrangement.
There may of course be some companies who are not ignorant to this type of scam and have become involved in the boiler room in the hopes of raising money for their company, or for less altruistic reasons. The reality is, however, that even if they are totally naïve as to what is going on, the exposure for the company remains the same.
Law firms have also been targeted by fraudsters to assist them in their enterprise by providing an air of legitimacy. Some solicitors have been prosecuted for money laundering as a result.
What is being done?
The FSA is going to great lengths to make individual investors aware of these schemes. There is a wealth of information on their website about how to guard against being targeted by fraudsters. It has produced a leaflet entitled ‘Warning to shareholders: boiler room scams’, which is being sent out to individual shareholders. It has also produced a list of unregulated companies who are believed to be involved in these schemes so that a potential investor can check whether or not a company is regulated.
The FSA is also placing greater emphasis on prosecuting the organisers of the fraud. Operation Archway has been set up with the City of London Police, and the FSA provides links on its website so that a potential victim of the fraud can complete a questionnaire and submit it for the police to investigate.
The SFO is stepping up its efforts to investigate and prosecute these frauds and is currently engaged in several prosecutions. The FSA has been carrying out prosecutions since 2007, following the implementation of the Financial Services and Marketing Act (FSMA) 2000. Recently, the financial regulator announced that it will boost its ability to combat boiler room scams by recruiting 20 additional investigators to its enforcement division. Although this is reassuring for victims and potential victims, the fact that it is planning to recruit several additional investigators indicates that its workload is increasing and the problem is not going away.
In addition to traditional criminal prosecutions, which generally encompass such offences as conspiracy to defraud and fraudulent trading and attract terms of imprisonment, there are several other methods that the authorities can use to target boiler rooms.
The FSA has powers under s367 of the FSMA 2000 to apply for a winding-up order of a company found to be involved in boiler room activities. In February 2007 the Inertia Partnership was subject to such an order, following its participation in introducing investors to boiler rooms. Under s367 of the FSMA 2000, where a firm has carried on unauthorised regulated activities, the FSA may petition the court to wind up that firm on the grounds that the firm is either insolvent or that it is equitable to do so.
The SFO has recently started exercising its power to implement the Serious Crime and Prevention Order (SCPO). As recently as March, the first SCPO was implemented by a judge at Luton Crown Court against a fraudster who was convicted for two boiler room frauds. The SCPO was created under part 1 of the Serious Crime Act 2007. It is a civil order aimed at preventing serious crime. The order can place stringent restrictions on a person’s involvement in investment and financial management. In this case it was ordered that for a period of four years following release from prison, the offender must not, without giving notice to the SFO:
- directly or indirectly sell or offer to sell shares, investment opportunities or financial products of any sort (irrespective of whether it is lawful or authorised), or facilitate the introduction of third parties for such business;
- manage assets belonging to another person, give or offer any advice or assistance in respect of any investments; and
- engage in business dealings with any of his co-defendants.
The offender was also disqualified from acting as a company director for ten years.
The powers that the SFO have are therefore far-reaching: not only does it have the power to carry out criminal prosecutions, it can instigate confiscation proceedings under POCA 2002 to recover the losses of the victim, which can lead to a loss of assets such as the family home and other property. It can impose an SCPO, which has long-lasting effects on a person’s business following release from prison, and can also prevent a person from acting as a company director for up to ten years, again imposing restrictions on the type of business a person can conduct in the future.
In addition to companies being directly involved by way of their shares being targeted, the FSA has targeted enforcement action against UK firms and professional individuals that have assisted boiler room operations. In November 2005 a solicitor and his law firm were ordered to pay £360,000 to 63 investors involved ina boiler room share scam. A boiler room used a legitimate organisation’s client account for investors to pay the purchase money to. The technique was designed to give an air of legitimacy to the process. The High Court found that the firm knew that the boiler room was acting without authorisation and ordered the money to be repaid accordingly.
Boiler Room Fraud:A Business Risk Issue
Companies need to appreciate that the threat posed by boiler rooms does not just affect individual investors. Companies can be targeted and damaged where its shares are sold by the boiler room, or can be targeted to assist the boiler room in its operation to give it an air of legitimacy. Companies, therefore, need to be aware of this threat, take legal advice when suspicions are aroused and take appropriate action to notify the relevant authorities to prevent suspicion falling on the company.
Companies drawn into this type of scam, even innocently, can face financial loss, business disruption, and damage to both reputation and shareholder confidence if there is even a suggestion that they were complicit in the fraud.
To minimise the risk of exposure to this type of fraud, compliance and risk teams should review policy and procedure, and company directors need to keep a watchful eye on what is happening with shares. Some practical considerations include:
- if a large quantity of shares are bought, who has bought them, what was the reason for purchasing the shares and what does the purchaser plan to dowith them;
- awareness of inflated commissions and brokerage companies wanting to buy large amounts of shares with the promise of raising capital or the share price;
- whether the purchaser is authorised by the FSA;
- if the company is not listed, the fact that its shares may not be suitable for a small individual investor; and
- if there is any suspicion that something is amiss, it may be wise to contact the FSA or Operation Archway to notify them to avoid suspicion falling on the company.
Legal advice at the earliest opportunity, or even as part of a business risk review, assessment or investigation, can also help to minimise exposure and/or help the company to respond more effectively if approached by a regulator.
By Nick Holroyd, partner, and Joanne Stephens, solicitor, Russell Jones & Walker.
E-mail: n.b.holroyd@rjw.co.uk; j.stephens@rjw.co.uk.
Useful links
Operation Archway: http://www.cityoflondon.polic.uk/CityPolice/ECD/Fraud/boilerroom.html
Financial Services Authority: http://www.moneymadeclear.fsa.gov.uk/new/scams/share_scams.html
CPS – Information on SCPOs: www.cps.gov.uk/legals/s_to_u/serious_crime_prevention_orders_(scpo)_guidance/index.html
