Florida Securities Fraud Lawyer Blog

On November 10, 2011, the SEC brought charges against a San Diego-based investment advisory firm and its president for securities fraud based on its failure to disclose a conflict of interest to investors and falsely represented the liquidity of a hedge fund they managed.

The SEC claims that Western Pacific Capital Management LLC and its president, Kevin James O'Rourke, encouraged investors to purchase a security without informing them that Western Pacific received a 10% commission. Western Pacific and O'Rourke also (1) failed to register as a broker, (2) failed to give required written disclosures to investors, (2) wrongly redeemed one hedge fund client's interest before another's, and (4) materially misrepresented to clients about the fund's liquidity.

According to Marshall Strung, an Assistant Director within SEC Enforcement Division, "Investment advisers have a fiduciary duty to act in the best interests of their clients and be forthcoming with them. Western Pacific and O'Rourke fraudulently breached that duty by failing to disclose the commissions they would receive for the recommended investments and lying to clients about the liquidity of the fund they managed."

Specifically, the SEC alleges that Western Pacific and O'Rourke acted as brokers in the non-public stock offering by Ameranth Inc. during 2005 and 2006. In return, Ameranth paid Western Pacific a 10% "success fee." Although Western Pacific and O'Rourke told investors to invest in Ameranth, they failed to advise each investor that they would make money off these investments, and failed to give investors the mandatory written disclosures as to their role in the offering.

Further, the SEC claims that from 2005-2008, Western Pacific and O'Rourke falsely represented the liquidity of The Lighthouse Fund LP, a hedge fund that they formed and managed. Western Pacific and O'Rourke always maintained that illiquid assets comprised only 25% of the Lighthouse Fund, when in reality 90 percent of the fund's assets were comprised of illiquid securities.

On August 31, 2011, the SEC announced it froze the assets of a Chicago-based money manager and his hedge fund advisory firm for lying to prospective investors in their startup hedge fund.

The SEC claims that Belal K. Faruki and his firm, Neural Markets LLC, solicited highly sophisticated individuals to invest in the "Evolution Quantitative 1X Fund," a hedge fund they managed that allegedly employed a proprietary algorithm to conduct an arbitrage strategy involving trading in liquid exchange-traded funds (ETFs). Faruki and Neural Markets misrepresented the amount of investor capital and that trading was creating returns when, in reality, it incurred losses. They defrauded at least one investor out of $1 million before admitting the losses, and were still seeking other wealthy investors prior to the SEC obtaining a court order to stop the scheme.

According to Bruce Karpati, the Co-Chief of the SEC's Asset Management Unit, "Faruki and Neural Markets lied throughout this elaborate scheme in order to attract capital from sophisticated investors. Even sophisticated institutional investors should be wary of unscrupulous hedge fund managers who cloak their misrepresentations in lofty pitches about a complex investment strategy."

The SEC's complaint filed in federal court in Chicago alleges that Faruki and Neural Markets informed investors that the hedge fund started trading in 2009. From January 2010 until approximately October 2010, Faruki and Neural Markets misrepresented the hedge fund's performance results, falsely claimed that wealthy investors invested $5 million into the fund, and misstated that it employed a top-notch auditor to help prepare the fund's financial statements. Faruki also misrepresented to investors that he invested his own funds into the hedge fund so that his own interests were the same as other investors.

On January 28, 2011, the SEC received a court order freezing the assets of a Stamford, Connecticut-based investment adviser and its principal, Francisco Illarramendi, claiming that both misappropriated over $53 million in investor money and used the funds for their own gain.

The SEC claims that Illarramendi defrauded investors in his managed hedge funds by wrongly diverting the investors' money into bank accounts controlled by him. Illarramendi then invested the money for his own benefit or for the benefit of the entities that he controlled, rather than for the benefit of the hedge fund investors.

According to David P. Bergers, the SEC's Boston Regional Office Director, "Illarramendi treated his clients' money like it was his own, diverting millions of dollars that did not belong to him. He abused his position of trust with his clients and breached his responsibilities as an investment adviser."

The SEC's complaint states that Illarramendi is the majority owner of the Michael Kenwood Group LLC -- a holding company for, among other entities, investment adviser Michael Kenwood Capital Management LLC. Via this adviser entity, Illarramendi manages several hedge funds, including a fund with over $540 million in assets. The SEC's complaint claims that Illarramendi misappropriated over $53 million in investor funds out of this particular hedge fund without the investors' authorization.

The SEC requested an asset freeze because it claimed that Illarramendi was about to place more investments using the investor funds without their authorization. Since the filing of the complaint, the U.S. District Judge for the District of Connecticut has held several hearings relating to the SEC seeking emergency relief against Illarramendi and Michael Kenwood Capital Management. The Court then entered an order freezing the assets of the defendants.

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On October 14, 2010, the Securities and Exchange Commission brought a civil action against two Florida-based hedge fund managers and their funds for defrauding investors out of approximately $1 billion. The SEC charged Palm Beach Capital Management and fund managers Bruce Prevost and David Harrold with committing federal securities fraud by misleading investors about the quality and nature of their investments with Thomas Petters, who was convicted of running a $3.65 billion Ponzi scheme.

The SEC complaint alleges that the fund managers were paid $58 million in fees from 2004 to 2008 when investing with Petters. According to the director of the SEC's Division of Enforcement, Robert Khuzami, "Prevost and Harrold portrayed themselves as guardians of their hedge fund investors while in fact they facilitated Tom Petters' fraudulent scheme through lies and deceit."

The SEC claimed that investors with the Palm Beach fund thought they were funding consumer electronic goods to be sold to big-box retailers and that the retailers, in turn, would pay the funds directly. In reality, the funds were supplied by Petters, which was raised from new investors. "Prevost and Harrold did not disclose this material fact to investors in the funds and instead continued to lie about the operation," according to the SEC.

The SEC also claimed that by 2008, as the Ponzi scheme was collapsing, Prevost and Harrold started to exchange old loan documents from Petters with new documents to make it appear that the business remained successful, while simultaneously telling investors that the funds were generating "the same steady profits" as before.

The SEC seeks permanent injunctive relief against Prevost and Harrold, disgorgement of illegal profits and an undisclosed financial penalty.

FINRA has barred a former advisor from Deutsche Bank from the securities industry for manipulating the stock price of Monogram Biosciences (MGRM). The purpose of the scam was to enrich himself and a hedge fund client.

Edward S. Brokaw engaged in trading designed to decrease the price of MGRM stock and increase the value of contingent value rights (CVRs) on that stock.

The MGRM CVRs were created and issued in December 2004, in connection with the merger of two firms to form MGRM. The CVRs were to be valued during a 15-day pricing period scheduled for 18 months after the merger.

Brokaw's hedge fund client held approximately 18.5 million CVRs - nearly 30 percent of the 64.8 million MGRM CVRs outstanding.

The FINRA hearing panel decision notes that the hedge fund owned 3 million shares of MGRM and told Brokaw that it wanted to sell those shares during the pricing period. Deutsche Bank's compliance group reviewed the orders and decided it would no longer execute MGRM sales for the hedge fund's account. Deutsche Bank first suspended, then terminated Brokaw based on his MGRM sales orders for the hedge fund.

The FINRA panel found that Brokaw violated Deutsche Bank's policy requiring the individual accepting a client order to create an order ticket "immediately upon receipt of an order." Instead, Brokaw's sales assistant completed one "booking ticket" each day, each showing a single 100,000-share order to sell, each with a false notation that the order was given by the client directly to the trading desk rather than to Brokaw - bypassing branch office compliance review of the orders.

FINRA says that a brokerage firm it recently expelled committed securities fraud. MICG Investment Management LLC of Newport News, Virginia, committed fraud in the management of a proprietary hedge fund. FINRA is also suing the firm for misusing investors' funds and causing false account statements to be issued to investors.

FINRA had shut down MICG when the firm failed to meet its net capital requirement. The hedge fund -- MICG Venture Strategies LLC -- was organized and managed by MICG. FINRA's complaint charges that MICG and its owner, Mr. Martinovich, improperly assigned excessive asset values to two non-public securities owned by the hedge fund, and then used the excessive asset values as the basis for paying unjustified management and incentive performance fees.

Mr. Martinovich was also charged with fraudulently inducing an elderly, non-accredited MICG client to invest $75,000 in the hedge fund.

Mr. Martinovich and MICG received a management fee of $337,000 from the hedge fund. FINRA says the other overvalued investment was a stake in a soccer club, Derby County FC, which plays in the second tier of England's professional league.

Mr. Martinovich allegedly sent an e-mail to staff members in December 2008 instructing them to change the value of the hedge fund's interest in the shares of the club to $7.6 million. FINRA claims MICG had purchased the shares about a year earlier for $5 million.

While this was a Virginia broker dealer, FINRA appears to be doing an increasingly more vigilant job in enforcing the net capital requirement against firms, including those in Florida. This likely can be attributed to the scathing criticism regulators have taken since the Madoff crisis broker in December 2008.