Friday, October 9, 2015

Pension Purchase Agreements; The worst “investment” in the world?

By Brian Henderson PhD, CFA and Craig McCann PhD, CFA

In recent years, platforms for buying and selling pension benefit payments have been created and gained traction. Voyager Financial Group (VFG) operated one of the largest and most active exchanges for buying and selling pension payments. There is limited information available on the size of this market because these firms have operated under the radar of securities regulators.

In pension benefit agreements, a pensioner agrees to turn over a specific number of their future pension benefit payments to an investor in exchange for an upfront lump-sum payment. Typically the seller and buyer do not meet, although some limited information about the seller is disclosed to the buyer. Keeping the seller and buyer segregated means the two parties do not know the compensation to, and therefore the incentives of, the intermediaries. This means the seller does not know the price paid by the buyer, and the buyer does not know the price received by the seller. Why do the two prices differ? Because a series of intermediaries gleans hefty commissions and fees for making the arrangement.

Increased Regulatory Scrutiny

Pension purchase agreements have drawn increased scrutiny in recent years as securities regulators catch onto these schemes. Several states, including California (available here), Arkansas (available here), and New Mexico (available here) have issued orders preventing the sale of pension benefits. New York State, at the direction of Governor Cuomo, has initiated an investigation into these activities (story available here).

The U.S. Securities and Exchange Commission (available here) and FINRA (available here) have released bulletins and investor alerts highlighting the important factors to consider prior to participating in the sale or purchase of pension payments.

Perversely, the increased attention and scrutiny on pension purchase agreements in the popular press has likely exacerbated the losses to investors. The press coverage has helped inform pensioners that the contracts are often unenforceable, which has given many the idea to cease forwarding their checks or divert their pension payments back to their own accounts.

Failure to Disclose High Fees and Conflicts of Interest

According to the Arkansas Consent Order, VFG pocketed nearly 20% of the investor’s capital ($6.7 million from $34.2 million proceeds). In addition to VFG’s take, they paid commissions to other distribution agents. It appears the investor’s financial advisor was typically paid a commission of approximately 7% of the price paid by the investor, which is itself large relative to the typical commissions on mutual funds or exchange-traded funds.

The fees and commissions are typically not disclosed in pension purchase agreements. The pension benefits seller does not know the price paid by the buyer. The commissions, plus other profits to distribution agents, come from the difference between the investor’s purchase price and the amount paid to the pensioner. These high costs are undisclosed to the buyer and seller. Also undisclosed in these deals are the conflicts of interest and interests of affiliated parties.

Beyond the High Fees, Pension Investments are Unsecured Claims

What motivates the buyers and sellers to enter into these agreements? The pensioner may be willing to exchange a number of their pension payments for the immediate lump-sum if they have an unexpected expenditure such as medical bills or to purchase other investments.

Pension investors are attracted to the seemingly secure payments that they expect to receive regularly over time. For example, an investor may pay approximately $100,000 to purchase 10 years of $1,160 monthly payments, cumulating to approximately $139,000 in payments. Unfortunately for many investors, they receive only the first two years of payments after the pensioner took steps to divert the pension payments to another account.

Often, the pensioner ceases to surrender their pension payments soon after receiving the investor’s lump-sum payment. Diversion of the payments may be accomplished by simply failing to forward the checks they receive or by redirecting the funds to another account. In many cases the agreements are legally unenforceable and they are left to suffer large losses. For example, by law U.S. military pension and disability payments are non-transferrable, rendering these agreements unenforceable. The majority of contracts that SLCG has analyzed entail an investor purchasing the U.S. military retirement pension payments of a former service member. Not surprisingly, all of those payments ceased within a year or two of the agreement, leaving investors without the stable income streams they expected.

The critical flaw in pension purchase agreements is that the investor does not acquire the underlying asset, they only acquire a tenuous, unsecured claim on the cash flows. In fact, the pension payments are made to an escrow account opened in the pensioner’s name, over which they assign control rights to a trustee. The Achilles heel in the structure is that the pensioner has the ability to divert the payment away from the escrow account. As time passes, the seller’s willingness to continue forwarding the checks diminishes as the lump-sum payment amount upfront has likely been used for other purposes. It is not surprising that so many sellers simply stop forwarding their payments.

On the surface, a secondary market for structured payments may appear to improve allocative efficiency by providing an opportunity for pensioners to capitalize their payments while providing other investors who seek yield opportunities an opportunity to purchase annuity payments.

In reality, this is an opaque market where unregistered intermediaries have operated below regulators’ radar. The firms facilitating these transactions circumvent regulatory oversight by falsely claiming the pension contracts are not investments.


Pension purchase agreements are simple fraud. They present unsophisticated investors with stable, dependable cash flows but investors invariably suffer large losses as the underlying circumstances which led the pensioner to sell their future pension payments cause them to stop forwarding the pension checks.

Unfortunately, the critical flaws in the agreements’ design, and that are insurmountable given the illegality of transferring or assigning most pension payments, combined with the lack of regulatory oversight, have saddled investors with huge losses when they depend on income and capital preservation to provide for their living expenses.

Monday, September 21, 2015

Enforcement Actions: Week in Review


SEC Obtains $30 Million from Traders who Profited on Hacked News Releases
September 14, 2015 (Litigation Release No. 191)
Ukrainian-based firm Jaspen Capital Partners and their CEO Andriy Supranonok have agreed to settle charges that they profited off of hacked, nonpublic information. The SEC have charged 34 people in a scheme that allegedly hacked into newswire services and transmitted the stolen data to international traders. The traders allegedly generated over $100 million in illegal profits over a five-year period. Jaspen Capital and Supranonok in particular made about $25 million trading contracts-for-differences (a type of derivatives that allow highly leveraged bets on a stock’s price movement) based on the hacked data. The Director of the SEC’s Enforcement Division, Andrew Ceresney, claimed the victory over Jaspen should be seen as a warning to anyone using stolen information, even if they are operating internationally.

SEC Charges Medical Diagnostics Company Chairman and Two Others behind Scheme to Manipulate Company Stock
September 14, 2015 (Litigation Release No. 192)
Edward Withrow III, chairman of penny stock company Endeavor Power Corp, allegedly conspired with Marco Babini and Samuel Brown, a stock promoter in Idaho, to conduct a pump-and-dump scheme using the stock of Endeavor. Both Withrow and Babini used foreign accounts to conceal their ownership of around 40 million shares of Endeavor. They then hired various people to send blast emails promoting their stock. Additionally, Withrow and Babini misled investors with inaccurate public filings and press releases, including Babini double counting his trades to exaggerate demand for Endeavor stock. The SEC suspended trading in Endeavor before Babini and Withrow could dump their stocks.

SEC Removes References to Credit Ratings in Money Market Fund Rule and Form
September 16, 2015 (Litigation Release No. 193)
The SEC decided to amend money market fund rule 2a-7, a rule that restricted the kinds of securities a money market fund can invest in. Formerly, money market funds could only invest in securities with one of the two highest short-term credit ratings and 97% of their assets had to be invested in securities with the highest short-term credit rating. The new amendments with remove these restrictions, limiting money market funds to investing in securities that the fund determines presents minimal credit risks.

SEC Charges Clearing Firm Officials for Improper Margin Loans, Accounting and Disclosure Failures
September 17, 2015 (Litigation Release No. 194)
An SEC investigation found broker-dealer firm Penson Financial Services, under the publicly traded holding company Pension Worldwide, failed to disclose a series of extended credit offerings that eventually caused the company’s bankruptcy in 2013. Penson Financial offered nearly $100 million in margin loans backed by mostly unrated municipal bonds. A significant portion of these loans went to fund a horse racetrack in Texas, which suffered heavily during the financial crisis. Instead of liquidating the collateral and disclosing the losses as mandated by the SEC, Penson provided more loans hoping their customers’ financial situation would improve. In particular, Penson was betting on a proposed law passing that would allow slot machines at horse racetracks in Texas. However, the law didn’t pass and Penson suffered nearly $60 million in losses as a result. Philip Pendergraft (Director and CEO of Penson Worldwide), Kevin McAleer (CFO of Penson Worldwide), Thomas Johnson (Director of Penson Worldwide and the company that operated the horse racetrack), and Charles Yancey (Director and CEO of Penson Financial) have agreed to settle the case with the SEC.

SEC Charges Florida-Based CPA with Fraud for Issuing Bogus Audit Opinions
September 17, 2015 (Litigation Release No. 195)
Terry L. Johnson has agreed to settle the SEC’s fraud charges against him for conducting deficient and fraudulent audits of eight publicly traded companies. Johnson’s audit deficiencies included failing to properly plan audits, obtain audit evidence, and maintain audit documentation. He also created back-dated documents to appear as though he conducted a thorough audit once he learned of the SEC’s investigation. One of Johnson’s clients, Primco Management, employed convicted felon and former CPA Stephen P. Corso as their CFO. Corso was convicted of wire fraud and tax evasion and was consequently barred from practicing as an accountant. Johnson has agreed to pay back his auditing fees, plus interest, and pay a penalty of $50,000.

Attorney and Auditors Settle Charges in Microcap Scheme Involving Purported Mining Companies
September 18, 2015 (Litigation Release No. 196)
John Briner and audit firms De Joya Griffith LLC and M&K CPAS PLLC have settled their cases with the SEC for engaging in a microcap scheme. John Briner is a Canadian attorney and stock promoter who organized the scheme that would have created twenty shell companies supposedly exploring mining activities. The companies had no plan to actually explore mining, they were only going to be used to raise money. Briner was previously suspended from practicing before the SEC, so he recruited others to become CEO’s of the shell corporations and register them with the SEC. Briner hired the two audit firms to conduct audits of his shell companies. The audits were so deficient and missed several red flags that they amounted to no audits at all. The auditors agreed to monetary penalties and the partners have been suspended from practicing before the commission.

Saturday, September 5, 2015

Enforcement Actions: Week in Review


SEC Halts Ongoing Fraud in Minnesota
September 2, 2015 (Litigation Release No. 176)
James M. Louks and FiberPop Solutions Inc. are being charged with fraud and are being ordered to stop raising money from investors. Fiberpop was founded in 2003 as a builder and operator of fiber optic networks and data centers. The SEC alleges that although almost 100 investors were convinced to purchase notes to fund the company’s business, Fiberpop has no operators or employees. Louks and Fiberpop have agreed to comply with the SEC’s order.

SEC Charges Advisory Firm With Fraud for Improperly Retaining Fees
September 2, 2015 (Litigation Release No. 177)
Philadelphia investment advisory firm Taberna Capital Management have agreed to settle charges with the SEC by paying over $21 million. Taberna was found to be retaining fees from collateralized debt obligation (CDO) clients that were not disclosed or allowed by CDO documents. The fees were charged for restructuring transactions, causing a conflict of interest as Taberna had an incentive to guide clients to restructure. Taberna labeled these exchange fees as “third party cost incurred” in order to disguise them and, from 2009 to 2012, retained millions in exchange fees.

SEC Charges Seattle-Area Hedge Fund Adviser With Taking Unearned Management Fees
September 4, 2015 (Litigation Release No. 178)
Chris Yoo and his investment advisory firms Summit Asset Strategies Investment Management and Summit Asset Strategies Wealth Management have agreed to settle fraud charges for a combined $1.3 million. According to the SEC, Yoo and Summit Asset Strategies Investment Management manipulated the assets of the Summit Stable Value Fund so that nearly $900,000 of purported fees could be withdrawn. It is also alleged that Yoo and Summit Asset Strategies Wealth Management did not disclose significant fees they withdrew for referring clients to invest in Summit Stable Value Fund. Summit Stable Value Fund’s external auditors, Raymon Holmdahl and Kanako Matsumoto, were found to have inadequately performed their duties, allowing the fraud to continue, and have agreed to settle their charges by being barred for three years from serving as accountants for any entity regulated by the SEC.

Friday, August 28, 2015

Enforcement Actions: Week in Review


SEC Announces Asset Freeze against Alleged EB-5 Fraudster in Seattle Area
August 25, 2015 (Litigation Release No. 173)
Lobsang Dargey, owner of multiple “Path America” companies including Path America SnoCo and Path America KingCo, is accused of defrauding Chinese investors who were seeking American citizenship through the EB-5 Immigrant Investor Pilot Program. The EB-5 program states foreign citizens may qualify for U.S. residency if they make an investment of $500,000 or more that goes to a specified project that creates or preserves at least ten American jobs. In order for a project to qualify for the EB-5 program, the company must submit a business plan that must be approved by the U.S. Citizenship and Immigration Services (USCIS) department. If the company deviates from the approved plan, the USCIS can deny investors citizenship. Dargey misled investors with promises of U.S. residency and failed to inform investors when he deviated from the approved business plan. Of the $125 million Dargey raised, he diverted $14 million for unrelated real estate projects and $3 million for a personal home and personal cash withdrawals.

SEC Charges Former Investment Bank Analyst and Two Others with Insider Trading in Advance of Client Deals
August 25, 2015 (Litigation Release No. 174)
J.P. Morgan investment analyst Ashish Aggarwal is charged with allegedly informing his close friend Shahriyar Bolandian about two, nonpublic acquisition deals that J.P. Morgan was working on. Bolandian traded on the illegal information in accounts belonging to him, his father, and his sister. Additionally, Bolandian tipped off another friend Devan Sadigh, who also traded on the insider information. Bolandian and Sadigh made more than $672,000 in the week leading up to the two acquisitions: Integrated Device Technology’s acquisition of PLX Technology in 2012 and’s acquisition of ExactTarget in 2013.

Fee Rate Advisory #1 for Fiscal Year 2016
August 27, 2015 (Litigation Release No. 175)
The SEC announced that the fees public companies and other issuers to register their securities with the SEC will decrease from $116.20 per million dollars to $100.70 per million dollars. The rate change will go into effect on the first of October, the start of the 2016 fiscal year. The commission projects it will generate $550 million for 2016.