Corporate fraud may leave investors holding the bag while their pockets are emptied

Corporate fraud is a major concern for both companies and individual investors, who may face significant losses due to regulatory violations or outright fraud. There is no shortage of examples and cautionary tales in the news – Charlie Javice, founder of financial aid startup Frank, has been charged for allegedly defrauding a financial institution during a $175 million acquisition; Peloton faced an investigation by the Securities and Exchange Commission (S.E.C.) and Department of Justice (D.O.J.) in connection with its alleged knowledge of and response to alleged injuries involving its treadmills; Elizabeth Holmes, founder of blood-testing startup Theranos, was convicted of defrauding investors and is now serving time in prison; and Samuel Bankman-Fried, founder of the now-bankrupt FTX Trading Ltd. cryptocurrency exchange and hedge fund, now sits in jail awaiting trial for various fraud charges and is accused of misappropriating billions of dollars of customer funds. While these examples are high-profile, there are many other more common circumstances where investors may be defrauded that may not be reported, including investments in hedge funds that fail to make appropriate or accurate disclosures or purchases of company stock from opportunists immediately prior to a company’s initial public offering.

There are various reasons why businesses and their executives may find themselves on the receiving end of government investigations, criminal charges, and civil suits. For example, young founders of startup companies may not have the experience or tools to appropriately guide their companies through unexpectedly rapid growth, and may not have sought regulatory advice early enough or at all. A lack of appropriate advice and internal protocols to ensure compliance can have severe legal ramifications for those companies, their investors and lenders. While some of these legal predicaments may be the result of inadvertent mistakes, others are the result of embezzlement, fraud, insider trading, intentional misrepresentations, and other self-dealing. Investors may be tricked into handing over significant sums of money or other assets through the use of forged notes or certificates, high-pressure tactics, time-sensitive “opportunities,” or promises of high-return and low-risk investments. Such malfeasance commonly includes pyramid schemes, high interest promissory notes, real estate loans that involve greater risk and would not otherwise be funded by a bank, cryptocurrency investments, or other unregistered investment vehicles. Because of these issues, investors may find that their once-significant funds and investments have been commingled with others, substantially devalued, or outright stolen and secreted away. To make matters worse, the responsible parties may also attempt to hide or flee the country.

Wronged investors may turn to regulatory agencies for assistance, but government prosecutors are focused on protecting the public through convictions and plea deals, not necessarily making victims whole. For example, assuming that the S.E.C. elects to bring an enforcement action against the wrongdoers, the S.E.C.’s website still warns victims that “not all harmed investors will be able to recover money,” may “receive substantially less than their losses,” and that distribution of any money may “take a long time.” Indeed, prosecutors may negotiate plea deals with fraudsters that involve repayment as restitution significantly less than what they took from investors. Additionally, while the plea deal could involve an agreement to pay substantial restitution, there is no guarantee that the full amount would be paid or that funds remain available to compensate investors. Thus, investors may only see a fraction of the millions that they may have initially invested years after these violations come to light. By the time that government actors disburse victim funds, if any, investors may suffer practical consequences like the loss of their businesses, homes, retirement funds, or children’s college funds, among other things. Unfortunately, investors may also find that they are effectively competing with one another to recover what remains of their investments, whether through victim funds or otherwise.

Given the difficulties navigating both the losses suffered as a result of fraud or regulatory violations as well as government investigations and prosecutions, there are important steps for individual investors who have invested substantial sums to consider. In fact, through a civil suit, investors may be able to recover more than they otherwise would through the disbursement of government controlled victim funds, and in a more expedient manner. Regardless of what path investors may ultimately choose to seek recovery, there is no substitute for good legal advice, especially early in the process.