Great periods of economic instability often lead to increased fraud. We saw this after the stock market collapse of 2008, and we saw it again as the pandemic shook up markets across the world. We even noted this fact last year when the Securities and Exchange Commission (SEC) warned investors to be wary.
Recent events have reinforced this warning. Moreover, they remind us that the fraudsters aren’t just small-time scammers with local Ponzi schemes. Sometimes they’re high-ranking officials with the world’s largest financial institutions. The volatility from crises like the recent pandemic affects us all.
Allianz Global Investors agrees to multibillion dollar fraud settlement
The SEC recently filed criminal charges against Allianz Global Investors (AGI) and three senior portfolio managers for securities fraud. Two of the managers have already plead guilty, and AGI has agreed to pay $1 billion to the SEC and $5 billion to its victims.
According to the SEC’s press release, the portfolio managers had hidden the risks associated with their “Structured Alpha” trading strategy. When COVID-19 hit, the Structured Alpha funds lost roughly $7 billion. AGI sold the funds to institutional investors, but those investors managed accounts like pension funds. That meant these losses hit teachers, bus drivers, clergy and engineers.
The case also illustrates a few important issues with securities fraud:
- How hard it can be for victims to identify and confront such fraud
- How easily it can reach a massive scale
- Why it’s essential that attorneys understand the materials
Confronted by the same volatility that hit accounts everywhere, the portfolio managers at AGI chose to falsify their risk reports. These risk reports exist so that investors can make informed decisions. However, the AGI portfolio managers did things like downplay the risk of a market crash from -42.15% to -4.15%. They did this simply by removing the “2” in the actual risk data. Similarly, they falsified performance data. When the funds lost 18.26% in one day, the AGI portfolio managers decided to halve the 18 and report a loss of merely 9.26%.
However, as the SEC noted, this fraud “would have gone undetected if it weren’t for the persistence of SEC lawyers” who kept working until they pieced the whole puzzle together.
Concealed risks a rising concern amid pandemic instability
Securities fraud can take a wide variety of forms. However, falsified risk reports don’t typically rank among the most common types of fraud. Thanks to the pandemic, that may be changing.
A report from Harvard Law School noted several trends in pandemic-related securities fraud:
- Early litigation typically focused on fraud that inflated share prices
- The scope of the pandemic drew a lot of attention toward responses, and companies frequently misrepresented their products, treatments or services to win backing
- Over time, the focus has shifted more toward the ways that companies misled investors with fraudulent risk disclosures
- Simultaneously, a number of cases have challenged directors for failing to provide proper oversight as per their fiduciary duties
Notably, the Harvard report pointed out that this last strategy has historically faced steep hurdles. Such cases typically need to prove a director utterly failed to establish reporting or controls to alert the company to risks. Or that the director completely ignored the information from these reports or controls. Since the pandemic, however, the courts have reviewed these cases more closely, and attorneys have taken note.
Some losses are unavoidable, some are fraudulent
The truth is that every investment comes with a measure of risk. That said, the SEC exists to protect investors from undue risk. Companies create and file risk reports so that investors can make informed decisions.
Accordingly, companies that file misleading risk reports can lure in unsuspecting investors and lead them to ruin. Such losses may be influenced by the market, but they’re not strictly the result of market forces. They’re the result of decisions others made to circumvent the laws. And the wrongdoers should be held accountable. The victims deserve compensation for their losses.