Pre-IPO Investment Scams: Report to the SEC

A pre-IPO investment scam is a type of financial fraud that targets individuals and investors with the false promise of substantial profits through early investments in a company before it goes public via an Initial Public Offering (IPO).

These scams exploit the allure of emerging companies, particularly those in industries such as technology or biotech, which are perceived as having high growth potential. The scam typically involves the sale of shares or investment opportunities in companies that are either non-existent, have no plans to go public, or whose future public listing is highly uncertain.

Insiders aware of a pre-IPO scam can report it to the SEC and potentially receive rewards, protections, and other benefits for their whistleblowing efforts. Continue reading to learn more about this illegal activity, and how you can become a whistleblower to expose it.

Central to these scams is the misrepresentation of the investment opportunity, where fraudsters provide misleading or outright false information about the company’s financial status, business operations, and growth prospects. They often fabricate documentation, create sophisticated marketing materials, and develop convincing narratives to lure investors.

High-pressure sales tactics are frequently employed, emphasizing the urgency and exclusivity of the investment, and asserting that the opportunity will yield significant returns once the company is listed on the stock market.

Victims are often inexperienced in financial matters or lack the resources to perform adequate due diligence.

The investments offered in these scams are usually unregistered and illegal, bypassing regulatory oversight and investor protection laws. As a result, investors often find themselves unable to sell their shares or recover their funds, especially when the anticipated IPO does not materialize.

While legitimate offerings of pre-IPO shares in a company are not uncommon, unregistered offerings may violate federal securities laws unless they meet a registration exemption, such as restricting the private offering to “accredited investors” – investors who meet certain income or net worth requirements.

Special Purpose Acquisition Companies (SPACs) and pre-IPO investment scams, while operating in distinct domains, can occasionally intersect, especially in scenarios involving fraudulent activities.

SPACs are companies with no commercial operations formed solely to raise capital through an Initial Public Offering (IPO) to acquire an existing company. They typically have a limited timeframe, usually around two years, to complete an acquisition, failing which they must return the invested funds to shareholders.

SPACs are legal entities and offer a legitimate alternative to the traditional IPO process. The connection between SPACs and pre-IPO scams can manifest in various ways:

1. Misrepresentation and Overpromising: Scammers may exploit the SPAC structure by misrepresenting the potential of the SPAC or the target company. They might make unrealistic or fraudulent claims about the target company’s value, growth prospects, or the potential returns on investment.
2. Lack of Transparency – in a pre-IPO scam involving a SPAC, there might be a lack of transparency about the SPAC’s acquisition targets or its financial health. Investors may be misled about the due diligence performed on the target company.
3. Targeting Uninformed Investors – just as with pre-IPO scams, SPAC-related scams often target investors who lack experience or knowledge in these types of investments, capitalizing on the hype and the complex nature of SPAC transactions.
4. Regulatory Risks – while SPACs are regulated, scammers might use this structure to bypass some of the more stringent regulatory requirements of a traditional IPO, exploiting loopholes or engaging in non-compliant practices.

It is crucial to distinguish between legitimate SPAC investments and fraudulent schemes that misuse the SPAC model. Legitimate SPACs operate within legal and regulatory frameworks, performing proper due diligence and communicating transparently with investors. In contrast, fraudulent schemes using the SPAC guise are characterized by deceit, opacity, and often, violation of securities laws.

In the context of combating pre-IPO investment scams, the U.S. Securities and Exchange Commission (SEC) has established a whistleblower program under the Dodd-Frank Act. This program incentivizes individuals to report securities law violations by offering monetary rewards and legal protections.

To be eligible for a reward, whistleblowers must provide original, credible, and timely information that leads to a successful SEC enforcement action with monetary sanctions exceeding $1 million. Importantly, whistleblowers have the option to report anonymously if they are represented by an attorney, which can help protect their identity and career. The SEC may award whistleblowers between 10% and 30% of the money collected in cases where their information leads to a successful enforcement action. The exact percentage of the award depends on several factors, including the significance of the information provided and the degree of assistance offered by the whistleblower.

Alongside these monetary incentives, the Dodd-Frank Act also provides robust anti-retaliation protections. These protections prohibit employers from retaliating against whistleblowers who report to the SEC. This encompasses protection against discharge, demotion, suspension, threats, harassment, or any other form of discrimination. If retaliation occurs, whistleblowers have the right to file a federal lawsuit and seek remedies such as reinstatement, back pay with interest, and compensation for litigation costs, attorney’s fees, and other expenses.

The SEC ensures the confidentiality of whistleblowers to the fullest extent possible under the law, disclosing their identity only under certain circumstances, such as to other regulatory or law enforcement agencies. The reporting process involves the submission of tips using the SEC’s online system or by mailing a Form TCR (Tip, Complaint or Referral). Following this, the SEC investigates the provided information and, if the tip leads to a successful enforcement action, posts a Notice of Covered Action. Whistleblowers then have 90 days to apply for an award.

There have been several major cases involving pre-IPO scams that the Securities and Exchange Commission has dealt with, some of which involved whistleblowers.

1. Charges Against Unregistered Brokers and Companies: The SEC charged Raymond J. Pirrello, Jr., Marcello Follano, Robert Cassino, Anthony DiTucci, Joseph Rivera, and their companies Prior 2 IPO Inc., Late Stage Asset Management, LLC, Pre IPO Marketing Inc., and JL Rivera Enterprises Ltd. for fraudulent offerings related to investments in pre-IPO companies.They employed a nationwide network of unregistered sales agents to raise at least $528 million from over 4,000 investors globally. Investors were falsely told that there were no upfront fees, but were charged undisclosed upfront markups, sometimes as high as 150 percent, from which the defendants and their network pocketed more than $88 million​​.
2. Emergency Relief Against Pre-IPO Stock Fraud Scheme: In another case, the SEC obtained emergency relief against StraightPath Venture Partners LLC, StraightPath Management LLC, Brian K. Martinsen, Michael A. Castillero, Francine A. Lanaia, and Eric D. Lachow.They were charged with allegedly selling pre-IPO shares they didn’t own, pocketing undisclosed fees, and commingling investor funds, resulting in Ponzi scheme-like payments. They raised at least $410 million from more than 2,200 investors, deceiving investors about the pre-IPO shares they held, their fees, and who was controlling the business, while paying themselves more than $75 million​​.
3. SEC Charges Vika Ventures in Pre-IPO Scam: The SEC charged Vika Ventures LLC and its CEO, George Iakovou, with fraudulently offering and selling over $6 million in securities to at least 46 individual investors across states such as California, Georgia, and New York.Vika Ventures, a boutique investment firm based in New York, and its CEO engaged in a scheme where they offered investors securities in coveted pre-IPO companies, without the actual intention of buying shares for these investors. The SEC’s action against the firm led to a nearly nine million dollar final judgment, emphasizing the seriousness of the fraudulent activities and the legal repercussions for such deceptive practices in the securities market.

These cases highlight the SEC’s efforts to combat pre-IPO investment scams, often with the help of whistleblowers who come forward with critical information. The involvement of whistleblowers in these specific cases, however, is not detailed in the sources. Whistleblowers play a huge role in bringing these fraudulent activities to light, enabling the SEC to take swift action.

Whistleblowers play a pivotal role in safeguarding the public from harmful conduct, especially in the realm of pre-IPO investment scams. By alerting authorities to fraud, whistleblowers not only contribute to the public good but also stand to receive financial compensation for their crucial information.

The process of blowing the whistle on such scams can be strengthened by engaging experienced SEC counsel, which enhances the likelihood of the SEC initiating an investigation based on the provided information. For those wishing to maintain anonymity while reporting, it is mandatory to be represented by an attorney. The attorney will handle all submissions on behalf of the whistleblower, ensuring confidentiality throughout the process.

Kohn, Kohn, & Colapinto is a law firm that specializes in representing whistleblowers in securities law violations, including pre-IPO investment scams. We offer strong guidance to investors and employees who are aware of federal securities law violations and are considering reporting fraud to the SEC Office of the Whistleblower. Our firm also works on a contingency fee basis, meaning there are no upfront costs for their services.

Individuals interested in obtaining more information about pre-IPO scams and the steps to report such scams can submit an intake to Kohn, Kohn, & Colapinto to get in touch with one of our experienced attorneys. By encouraging insiders or those with knowledge to report fraudulent activities, the SEC can more effectively intervene and safeguard investors.