Feds Unfriend Facebook Fraud Fleecers

July 22, 2016

One of the things that I remember about early 2012 was the number of calls that I was getting asking my legal opinion about any number of deals whereby some group or individual purportedly had purchased thousands of shares before the Initial Public Offering of Facebook. Some callers told me about being approached by aggregators of pre-IPO Facebook shares who were supposedly putting together syndicates for investors seeking to get in on the opportunity. Then there were the deals involving some "big shot" who promised investors an "inside track" and participation in a piece of a massive allocation of thousands of shares of Facebook. Why was this purportedly well-connected fellow offering this opportunity, which, frankly, meant that he was giving up his shot at retaining all the pre-IPO shares for himself and making a killing? Well, the answer was simple: The guy organizing the syndicate was a great humanitarian. Yeah, lots of those folks running around.

After some three decades on the Street, I was skeptical -- highly skeptical -- of what struck me as too-good-to-be-true offers of pre-IPO Facebook shares. Yeah, I heard it all: they were restricted shares that would be piggy-backed on the offering; they were unrestricted Rule 144 shares; they were special shares sold to an offshore, early investor; someone was a major investor at a small broker-dealer and was being given that firm's entire allocation; and it went on and on and on. I warned as many investors as I could to run as far away and as fast as they could from this nonsense and to simply try and buy shares in the secondary if they were locked out of the pre-market.

As it turned out, my advice was golden because virtually all of the folks who participated in these pre-IPO deals (maybe scams is more appropriate) paid nearly $40-plus a share. On May 18, 2012, Facebook launched at $38 a share. Three months later, the supposed can't-lose IPO was not in the stratosphere but somewhere in a stinky sewer at $20 a share. Frankly, if you liked Facebook at $40, you were going to looooooove it at $20, right? All of which prompted lots of lawsuits and recriminations. Of course, patience is often a virtue and for those who lived with the early disappointment, they now own shares valued around $120. Unfortunately, as recent federal lawsuits and prosecutions show, some of those pre-IPO investors own nothing beyond a good fleecing by Facebook fraudsters.

The Masquerade Ball Begins

In ESG Capital Partners, a Delaware Limited Partnership and Limited Partners, Plaintiff-Appellant, v. Troy Stratos a/k/a Ken Dennis, Defendant, AND Venable LLP; and David Meyer, Defendants-Appellees (Opinion, 9Cir, No. 13-56684, 13-CV-01639, / July 11, 2016), the United States Court of Appeals for The Ninth Circuit ("9Cir") considered the appeal of ESG Capital Partners, L.P., which is described as "a group of investors formed to purchase pre-IPO Facebook shares."  In this legal drama, enter, stage right, Timothy Burns, the managing agent for ESG. Burns found himself in communication with Ken Dennis, who presented himself as someone who had an inside line of a trove of Facebook pre-IPO shares.  

Apparently, Burns and Dennis never physically met. Dennis was represented in his negotiations with ESG and Burns by the Venable LLP law firm and its law partner David Meyer, who was Dennis's principal contact at the law firm. Now, let's consider how the 9Cir Opinion fleshes out some of these preliminaries:

[I]n fact, "Ken Dennis" was an alias for Troy Stratos, an alleged con artist.

. . .

At the time Venable LLP was representing "Dennis" in the Facebook deal, Venable LLP, but not attorney Meyer, also represented Stratos in an unrelated suit for the theft of $7 million.

Attorney Meyer assisted Stratos in creating Soumaya Securities, LLC ("Soumaya Securities")-a company that Stratos could use to conduct business without detection. . .

Page 5 of the Opinion

Made Up. Not Real. Bogus

Oh boy, this is not going to end well.

Soumaya? Odd name, where did that come from, you might ask. As explained in the 9Cir Opinion:

Attorney Meyer and Stratos named the company Soumaya Securities after billionaire Carlos Slim's late wife, Soumaya, and attorney Meyer told managing agent Burns that "Dennis" was affiliated with Slim. "Dennis" was not actually affiliated with Slim. And Soumaya Securities was not authorized to do business in California, had no bank accounts, and filed no tax returns.

Stratos, the alleged con artist, masqueraded as "Ken Dennis" in connection with all Soumaya Securities transactions, yet Soumaya Securities' operating documents, which attorney Meyer prepared, listed Stratos as Soumaya Securities' manager and sole member and "Kenneth Dennis" as its CEO. Attorney Meyer maintained a client trust account only for Stratos. . .

Page 5 -6 of the Opinion

By way of recap, we got a made-up "Ken Dennis" disguising the identity of con man Troy Stratos. We got a Soumaya Securities named after the wife of famous billionaire Carlos Slim, who is depicted as some confidant of Dennis but for the fact that Dennis is bogus and there was no relationship with the Carlos Slim. The securities firm's CEO was none other than the non-existent Mr. Dennis. Ummm, due diligence anyone?

Email Address

During the negotiations between ESG and Dennis, managing agent Burns communicated with his counterpart via wpacquisitions@gmail.com, which was Troy Stratos's email address and the same address that law partner Meyer used to contact his client; moreover, Meyer had been copied by Burns on some emails sent to that address.

Ken Is Who He Says He Is

Purportedly between February and November 2011, Venable law partner Meyer met with Stratos 25 times in person and spoke to Stratos at least 100 times on the phone. Meanwhile, from March to April 2011, the fabricated Ken Dennis negotiated with ESG over his sale of pre-IPO Facebook shares.

On April 18, 2011, ESG managing agent Burns telephoned law partner Meyer in an apparent effort to get a status report on the transaction. The 9Cir Opinion asserts that:

During their phone conversation, attorney Meyer informed managing agent Burns that "Dennis" was in contact with Facebook executives and had access to millions of Facebook shares. Attorney Meyer told managing agent Burns that "Dennis" "is who he says he is." In addition, attorney Meyer assured managing agent Burns that "Dennis" and Soumaya Securities were Slim's affiliates, that the sale was legitimate, that attorney Meyer represented "Dennis" and Soumaya Securities in the sale, and that attorney Meyer would provide deal documentation. . .

Page 6 of the Opinion

The Deal Is On

After the April 18th call between Burns and Meyer, ESG wired $2.8 million into the law firm's trust account, receipt of which was confirmed by Meyer, who noted to the managing agent that the "deal is on." Indeed, something was "on," as the 9Cir Opinion explains:

[T]hat day, the entire $2.8 million was deposited into Stratos's personal client trust fund account, not to any account for Soumaya Securities. Also that day, attorney Meyer had an all-day meeting with Stratos at Venable LLP's offices.

. . .

In early May 2011, after ESG Capital had made its $2.8 million deposit, Stratos needed a bank account to deposit the funds. Stratos had been "black listed" from Citi and Wells Fargo due to his notoriety, his poor credit, and outstanding judgments against him. Venable LLP opened a bank account for Soumaya Securities at Bank of America. . .

Page 7 of the Opinion

We Need Another $7.2 Million

In early July 2011, Dennis informed Burns that given the imminent nature of the IPO, Soumaya Securities required an additional wire of $7.2 million. In order to conclude the transaction, law partner Meyer transmitted documentation to managing agent Burns, who had requested that the documentation confirm that the deposited funds would be refundable in the event of the non-closing of the transaction as a result of seller's or issuer's fault.

On July 12, 2011, the funds were wired into Soumaya Securities' Bank of America Account, and later that same day, Meyer emailed to Burns confirmation.

Bet You Didn't See This Coming

On December 20, 2011, Stratos was arrested by the Federal Bureau of Investigation and charged with defrauding a woman of at least $7 million by convincing her that he would manage the proceeds of her divorce by investing them overseas where they would earn a high rate of return. Los Angeles Man Indicted for Defrauding Woman Out of More Than $7 Million in Divorce Proceeds" (FBI Press Release, December 11, 2011).

Why let a little thing like an arrest, incarceration, and federal charges get in the way of a good sting? Notwithstanding his difficulties, Dennis (or should we call him Stratos?) continued to text and telephone Burns about the Facebook deal. It appears that Burns was unaware of this other criminal matter and Stratos (Dennis's) arrest.

What The Hell Are You Talking About?

Picking up the thread of this unraveling mess, the 9Cir Opinion offers this glimpse into the chasm into which ESG and Burns were falling:

[D]ays after the wire transfer, Bank of America froze the Soumaya Securities account and then closed it on July 26. Venable LLP arranged to transfer the funds to a third party but never told ESG Capital.

In August 2011, "Dennis" told managing agent Burns that the deal was closing, and that he needed an additional $1.25 million to secure ESG Capital's shares. To receive this transfer, attorney Meyer opened a new bank account at UBS. Venable LLP listed Stratos-and not "Dennis"-as Soumaya Securities' "Beneficial Owner" on the UBS account. With this final transfer, ESG Capital's payments to Stratos totaled $11.25 million.

By December 22, 2011, ESG Capital still had not received the Facebook shares, and managing agent Burns threatened "Dennis" and attorney Meyer with legal action if its funds were not returned. In response, managing agent Burns received an email from Venable LLP's counsel, Stewart Webb, stating that "Venable received no transfer and has no knowledge of the alleged transfer." . . .

Page 8 - 9 of the Opinion

Likely in shock, managing agent Burns provided Venable with proof of the subject wires per the law firm's instructions and directions. In response, we are told that Venable counsel Webb replied that

[T]he contact information managing agent Burns provided for "Dennis" was filed at Venable LLP under the name Troy Stratos, whom Venable LLP believed to be related to "Dennis."2 Webb told managing agent Burns that Venable LLP did not represent any party in the transactions between managing agent Burns and Soumaya Securities. Attorney Meyer was terminated by Venable LLP in 2012.

After learning that ESG Capital had been defrauded, managing agent Burns panicked and hid the news from ESG Capital. ESG Capital claims it did not learn of the alleged fraud and that their money had been stolen until November 2012.

Page 9 of the Opinion

Let The Games Begin

Not surprisingly, on March 2013, ESG Capital sued Stratos, Venable LLP, and Meyer in the Central District of California ("CDCA") alleging eight causes of action: federal securities fraud, state law fraud, and six non-fraud state claims for conversion, breach of fiduciary duty, unjust enrichment, unfair competition, aiding and abetting fraud, and conspiracy to commit fraud.

SIDE BAR: Shortly after ESG filed its lawsuit, on May 23, 2013, the United States issued a Superseding Indictment against Stratos in connection with the Facebook fraud. More on this below.

In response to the motion of the Defendants in ESG's civil case, CDCA dismissed ESG's Complaint without prejudice on June 26, 2013. Thereafter, on August 15, 2013, CDCA dismissed with prejudice ESG's Amended Complaint and denied Plaintiff leave to amend. Can you imagine how the blood must have drained out of Burns's face and those of his investors when they learned that their claims were not only dismissed but that the resolution was with prejudice.

On appeal, 9Cir considered CDCA's finding and Venable LLP's arguments that:

  1. ESG had failed to plead that attorney Meyer made material misrepresentations or omissions;
  2. under Section 10(b) of the 1934 Securities Exchange Act, attorney Meyer must have been the "maker" of the cited misrepresentations; and
  3. if an attorney has a duty to disclose, the attorney is liable for failing to provide truthful, non-misleading information.

In addressing the issue of whether attorney Meyer had made false statements, the Court found that:

[A]ttorney Meyer made assurances to managing agent Burns on his own behalf. Attorney Meyer detailed his relationship to "Dennis" and made personal assurances regarding the Facebook deal and ESG Capital's deposit. Not only did attorney Meyer make false statements to managing agent Burns, he also made material omissions when he failed to reveal that there was no Facebook deal; that Stratos, not Soumaya Securities, was Venable LLP's client; and that ESG Capital's $2.8 million deposit would be immediately dispersed to Stratos.

Page 15 of the 9Cir Opinion

As to whether Meyer had a duty to disclose, the Court found that:

[V]enable LLP contends that Facebook was the seller of the pre-IPO securities while Stratos was merely a middleman. As the argument goes, since attorney Meyer represented a nonseller, attorney Meyer cannot be liable under the rule articulated in Thompson.

Venable LLP's argument fails for two reasons. First, Venable LLP mischaracterizes the rule in Thompson, which explicitly states, "That [the attorney] may have an attorney-client relationship with the seller of the securities is irrelevant under Section 10(b)." Id. Second, it is true that Stratos was not the original seller of the securities, but Stratos was the seller for ESG Capital's purposes. ESG Capital dealt only with Stratos and paid Stratos for the pre-IPO stocks. Facebook took no part in the sale between ESG Capital and Stratos and therefore cannot be considered the seller. What's more, taking ESG Capital's allegations as true-as we must at the pleading stage-there was no actual seller, certainly not Facebook. It thus defies logic to shield Venable LLP and attorney Meyer from liability under the theory that they did not represent Facebook, whom they consider the true seller, when they did represent Stratos, who acted as the seller.

Pages 16 - 17 of the 9Cir Opinion

As to the issues of what attorney Meyer knew and whether he was being truthful, the court found that:

ESG Capital sufficiently pled facts supporting a strong inference that attorneyMeyer knew that Stratos was using the alias "Dennis" and that ESG Capital believed it was communicating with "Dennis," not Stratos. Attorney Meyer emailed Stratos at Stratos's wpacquisitions@gmail.com email address. ESG Capital emailed "Dennis" at this same email address. Attorney Meyer was copied on emails from ESG Capital to "Dennis" at that email address.

ESG Capital also provided facts sufficient to support the inference that attorney Meyer knew Stratos's identity and scheme. Between February and November 2011, attorney Meyer and Stratos had more than 100 phone conversations and 25 in-person meetings. ESG Capital pled that attorney Meyer held an all-day conference with Stratos after ESG Capital wired its $2.8 million deposit. Attorney Meyer then consistently authorized payments from Stratos's client trust account between April 20, 2011, through July 2011. Venable LLP opened bank accounts for Stratos, since he was "black listed" and unable to open bank accounts in his own name. Venable LLP also performed thousands of dollars' worth of nonlegal services for Stratos, such as buying office supplies and car insurance. Certainly, ESG Capital has pled facts sufficient to show a cogent and compelling inference of scienter.

Pages 18 -19 of the 9Cir Opinion

In considering the final prong of the appeal as it related to the federal securities claims, the Court addressed the issue of ESG's reliance on the words and deeds of the Defendants:

[A]lthough negotiations between ESG Capital and Stratos were underway before attorney Meyer became involved, ESG Capital had not wired any money to Stratos prior to attorney Meyer's involvement. ESG Capital pled that after attorney Meyer told managing agent Burns that the "deal is on," ESG Capital wired the $2.8 million deposit. Notably, this first transfer was made the day after attorney Meyer assured managing agent Burns that "Dennis" was who he said he was and that the deal was legitimate. In addition, ESG Capital pled that it wired $11.25 million to Soumaya Securities in direct reliance on attorney Meyer's assurances and involvement. Since ESG Capital showed that it wired funds to ESG Capital only after attorney Meyer's assurances, it established the causal connection necessary for reliance.

Page 19 of the 9Cir Opinion

In addressing the sufficiency of ESG's pleading a parallel state fraud claim, the Court found that:

ESG Capital sufficiently pled its federal fraud claim; it therefore also sufficiently pled its parallel state fraud claim. Only one of ESG Capital's state nonfraud claims, breach of fiduciary duty, is barred by § 340.6's one-year statute of limitations. Its aiding and abetting and conspiracy claims are not barred by the Agent's Immunity Rule. ESG Capital sufficiently pled its state law claims for conversion, unjust enrichment, unfair business practices, aiding and abetting fraud, and conspiracy to commit fraud.

We therefore affirm the district court's dismissal of ESG Capital's breach of fiduciary duty claim as time-barred and reverse the district court's dismissal of all other claims under Rules 12(b)(6) and 9(b).

AFFIRMED in part, REVERSED in part, and REMANDED.

Page 28 of thw 9Cir Opinion

SIDE BAR: For a rare glimpse behind the judicial scenes, watch the 9Cir Oral Argument:

USA v. Stratos

You may recall that on December 20, 2011, Stratos was arrested by FBI in connection with his efforts to defraud a woman into an overseas investment. On May 23, 2013, a federal grand jury returned against Stratos a  a 20-count superseding indictment, which included the ESG claims, and charged him with 3 counts of mail fraud, 12 counts of wire fraud, 4 counts of money laundering, and 1 count of obstruction of justice. READ the Stratos Superseding Indictment.

One of my favorite revelations in the Superseding Indictment was the explanation about how Stratos managed to keep his ESG fraud working even though he was arrested on December 20, 2011, and incarcerated. As explained in the Superseding Indictment:

23. After STRATOS's arrest on or about December 20, 2011, STRATOS caused an acquaintance, S.S., to send text messages using STRATOS's cellular telephone to T.B. on December 25 and December 16, 2011, in which STRATOS: apologized for the delay in responding to T.B., stated that he was in a "remote" location with limited cellular service and would be traveling through January 2, 2012; falsely represented that the deal was still in progress and that the shareholders of "Soumaya Securities" were meeting to resolve the issues; and falsely represented that T.B. could have his money refunded in requested.

Not surprisingly, on May 19, 2015, a federal jury found Stratos guilty 4 counts of wire fraud and 2 counts of money laundering. Managing agent Burns seems, at best, a somewhat mild player in this drama -- someone duped and played. In reality, that's not an accurate depiction. On May 22, 2013, Burns was charged in an Information in the Eastern District of Pennsylvania "Phoenixville Man Charged In Multi-Million Dollar Fraud Scheme" (Press Release, Department of Justice, May 22, 2013)

[D]efendant Burns was the sole owner of ESG Family Services, among other businesses. ESG Family Services provided billing paying and other personal services to clients. To facilitate his work and, as it developed, his alleged fraud, defendant Burns induced many of his Family Services clients to add him as a signatory to their bank accounts. He also allegedly represented to clients and others that he could acquire shares of Facebook and other social media stock before their public offerings at favorable prices. 

According to the information, between at least May 2007 and September 2012, Burns converted money entrusted to him by more than 50 clients and would be investors for s personal gain. In 2011, without their knowledge or consent, Burns allegedly used his clients' and investors' money to buy a shore home in Avalon, New Jersey for more than $4 million and to make a down payment on a commercial office building in Conshohocken, Pennsylvania. In 2012, he allegedly misrepresented to a bank that he had acquired stock, when he had not, to obtain a $6 million mortgage loan on the commercial office building. It is further alleged that he used the fraudulently acquired shore home as collateral on a second loan of $1.5 million issued to him by the same bank to buy the office building. . ..

In United States of America v. Timothy D. Burns (Information, Eastern District of Pennsylvania, May 22, 2013) t sheds some interesting light on what actually went down among ESG, Burns, and Dennis/Stratos:

7. By in or about March 2011, defendant TIMOTHY D. BURNS raised from about 50 investors approximately $13,000,000 to purchase Facebook shares 

8. Initially, through an intermediary internet site , defendant TIMOTHY D. BURNS negotiated to purchase about 500,000 shares at $27 each through a Facebook employee known here as D.W. On or about March 21, 2011, defendant TIMOTHY D. BURNS called the capital from Fund I investors to close the deal. However, just before closing, D.W. changed hismind and walked away from the deal. It was defendant BURNS' understanding that D.W. wanted a higher price for the shares. The deal fell through 

9. Shortly thereafter, the intermediary told defendant TIMOTHY D. BURNS that he had found 2,000,000 shares of Facebook that BURNS could buy for $27 per share. The person who defendant BURNS was told controlled the shares was known as "Ken Dennis." This name was a pseudonym for a man named T.S.

10. Through the intermediary internet site, defendant TIMOTHY D. BURNS was introduced to T.S. T.S. represented that for an advance fee of approximately $11.2 million,he would provide defendant TIMOTHY D. BURNS with 20 million Facebook shares.

11. Defendant TIMOTHY D. BURNS created a second limited partnership entity for the purpose of selling shares of Facebook and issued a prospectus for it, as he had for the first. This second partnership was called Fund II

After pleading guilty on June 25, 2015, to mail fraud, wire fraud, and loan fraud, on September 16, 2015, Burns was sentenced to 60 months in prison plus five years of supervised release and ordered to pay $11,038,923.60 in restitution"Phonenixville Man Sentenced For Multi-Million Dollar Fraud Scheme" (Press Release, Department of Justice, September 16, 2015)