Adviser Facing Jury Trial for Securities Laws Violations

WHAT HAPPENED?

An exempt reporting adviser (“ERA”) and related private fund were recently investigated by the SEC for a variety of securities laws violations, including misappropriation of funds, making material misstatements, and failing to disclose conflicts of interest, among other infractions.

The trouble began when, over the course of several years, the firm owner told its investors the fund’s primary investment strategy consisted of highly liquid investments. However, the actual investments were highly illiquid and consisted of equity in start-up companies, real estate, and similar ventures. The firm owner continued to make statements that represented the fund was a liquid investment, which was increasingly false as the fund acquired more and more illiquid assets.

Misstatements about the fund’s portfolio were also made in its private placement memorandum, which was distributed to investors and prospective investors for over 3.5 years. At the same time, the fund raised nearly $40 million from investors who believed the fund was highly liquid. The owner then lied to investors about the fund’s performance.

While the misleading marketing took place, the owner misappropriated funds and failed to disclose major conflicts of interest to investors. These violations included the owner moving large sums of money into a separate company he owned, but that the fund had no ownership in, and him moving funds into his personal bank account to pay for things like a private airplane hangar for his racecar collection.

The fund also represented that it engaged an outside firm to conduct an annual audit. The fund did not complete the audit or engage an accounting firm for this purpose. In 2019, the fund filed Chapter 11 bankruptcy, at which time almost all its assets were illiquid, non-tradeable investments.

Although the adviser was not actually registered and only filed as an ERA, the SEC still was able to hold the adviser and its owner accountable for violations of federal securities laws. The SEC filed a civil action, and the U.S. Postal Inspection Service further investigated the misconduct. Recently, the adviser owner was arrested and charged with securities fraud and wire fraud. He faces up to 40 years in prison if found guilty.

WHAT DOES THIS MEAN FOR ME?

Despite the firm not being formally registered with the SEC, the Commission was still able to enforce federal securities laws as the firm is still subject to the anti-fraud rules. If a firm engages in conduct that is not typically subject to an outside regulatory body, the firm is still responsible for complying with all applicable federal and local laws. Any regulatory or law violations could lead to enforcement by applicable government agencies.

If you have questions about your compliance obligations, Fairview is available to help. Contact us today for more information.

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