SmartRIA Compliance Alert
On February 4, 2021, the SEC charged three individuals and their affiliated entities with running an alleged Ponzi scheme that raised over $1.7 billion from securities issued by an asset management firm and Registered Investment Adviser (RIA). Approximately 4,000 of the 17,000 retail investors defrauded were seniors.
According to the SEC’s complaint, the defendants told investors that they would receive distributions from the profits of the portfolio companies. In fact, many of the payments came from the investors’ own funds.
The SEC’s complaint alleged that the owner and CEO of the RIA, as well as the owner of its placement agent, lied to investors about the source of money used to make an eight percent annualized distribution payment to investors. According to the complaint, these defendants, as well as others that marketed the RIA’s investments, told investors that the distribution payments were paid entirely with funds generated by the investment adviser’s portfolio companies.
The defendants made these misrepresentations in written materials, as well as during due diligence and marketing events. They lured downstream broker-dealers and investors with promises of monthly distributions that would be covered by cash flows from the investments. The defendants claimed the distributions were not drawn from underlying invested capital.
The SEC charged that the RIA used investors’ money to fund part of the annualized eight percent distribution payments. The defendants allegedly distorted the financial statements of certain limited partnership funds managed by the RIA and used them to deceive investors into believing that the funds’ income was higher than it actually was. In fact, the funds did not generate sufficient income to cover the distribution payments.
In addition, the SEC alleged that the RIA and its placement agent gave false information to investors stating that they received millions of dollars in fees and other compensation. The fraudulent scheme continued for more than four years, partially because the RIA kept investors in the dark about the limited partnership funds’ true financial condition. Furthermore, the RIA failed to deliver audited financial statements and register two of its funds with the SEC.
The SEC also charged the RIA with violating the whistleblower provisions of the securities laws. The firm included language in termination and separation agreements that kept individuals from reporting problems to the SEC. Furthermore, the RIA retaliated against a known whistleblower.
The SEC filed a complaint in federal court, charging the defendants with violating the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. The SEC also charged the RIA and its owner with violating the antifraud provisions of the Investment Advisers Act of 1940. In addition, the SEC charged the RIA with violating the registration and whistleblower provisions of the Exchange Act, as well as custody and compliance rules under the Investment Advisers Act.
RIAs that recommend private funds risk investing their clients’ money in investments managed by unscrupulous firms. Investment advisers should conduct extensive due diligence before recommending these investments. In this case, the RIA projected an aura of success to entice existing and prospective investors to invest in the firm’s limited partnership funds. Investment advisers should never take these marketing claims at face value and should conduct rigorous due diligence to ensure they are accurate.
RIAs must implement thorough due diligence policies and procedures. It is also imperative for RIAs to adhere to those policies and procedures. It is not sufficient for RIAs to rely on the due diligence materials supplied by the firm offering the private fund. In this case, those due diligence materials allegedly contained materially misleading information.
To provide greater transparency, RIAs should seek more information and data directly from the managers of alternative investments. They should also conduct quantitative analysis and risk assessment of alternative investments and their managers. Another course of action is for advisers to use third parties to supplement and validate the information provided to them. By doing so, RIAs and their clients can avoid being victimized by the next fraudulent scheme.
The SEC’s press release can be found HERE.

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