Fleecing Grandma: A Regulatory Ponzi Scheme

Abstract

This Article examines the regulatory failure that allowed Medical Capital to engage in a Ponzi scheme to market over $2 billion in promissory notes as private placements. Utilizing a vast stockbroker network, Medical Capital sold the notes to more than 20,000 retail investors including vulnerable senior citizens. The Article explains how in spite of many warning signs, none of the potential gatekeepers, including the SEC, FINRA, the stockbrokers, the banks, the attorneys, or the independent due diligence analyst interceded to protect the investors.

Under current SEC rules, issuers can sell any dollar amount of private placement securities to an unlimited number of defined accredited investors with virtually no governmental oversight. The Article recommends that in line with its authority under the Dodd–Frank Act, the Commission tighten the standards for accredited investor status. The Article further argues that, coupled with untethered stockbroker activity, the current regulatory structure unduly favors small business at the expense of retail investors. This problem will be exacerbated by the 2012 JOBS Act, which mandates looser advertising rules for Rule 506 private placements. The Medical Capital fraud suggests that Congress and the SEC are misguided in their heavy reliance upon stockbrokers as effective intermediaries. The Article concludes with a modest proposal to rein in the activities of the brokers.

Keywords: securities, private placements, Rule 506, JOBS Act, Dodd-Frank, accredited investors, FINRA, stockbroker, Ponzi, Medical Capital

JEL Classification: K22