Wednesday, April 27, 2016

Adviser official to pay $650K for soft-dollar manipulation, misuse

By Amy Leisinger, J.D.

A federal district court granted summary judgment in favor of the SEC in an action against an adviser executive who engaged in a long-term fraudulent scheme to collect bogus “research expenses” and higher fees from funds. According to the court, the defendant was aware of, and assisted in, the misuse of soft-dollars for his compensation and actively engaged in trading activities to artificially inflate the value of the funds’ assets. The court permanently enjoined the defendant from further violations and ordered payment of nearly $650,000 in disgorgement and penalties (SEC v. Markusen, April 25, 2016, Davis, M.).

Fraudulent activities. According to the court, Archer Advisors LLC, its principal, and another company insider perpetrated a scheme to misappropriate fund assets and artificially pump up the value of the hedge funds that Archer managed. The funds were only authorized to pay Archer in two manners: a monthly management fee and an annual performance fee. On Archer’s behalf, the individuals opened soft-dollar brokerage accounts in the funds’ names that could pay money generated from trade commissions to third parties who provided “research related services.” The insider was listed in offering materials as Archer’s chief operating officer and engaged in marketing, the court stated, but he issued monthly invoices for his work, classifying his efforts as “research provided for Archer,” and received the bulk of his pay from “soft dollars” from the brokerage firm.

When the soft-dollar balance fell too low to pay the fake invoices, the court stated, the individuals churned the stocks in the funds’ brokerage accounts to generate more, increasing the trade commissions paid by the funds. When they knew the funds would need to close due to poor performance, they continued to trade in the accounts to eliminate the deficit in the soft-dollar balance that Archer would have had to pay when it closed the soft-dollar accounts. The excessive trading was inconsistent with the funds’ stated investment strategy, the court noted.

In addition, the court found that the defendants traded significantly in a thinly traded stock, “marking the close” more than 20 times over the course of three years to artificially inflate the price of the stock. The particular stock was the funds’ largest holding, and the defendants’ knew that Archer’s performance and (and the related fees) were based on the funds’ value at the end of a given month. They continued to do this even as fund performance fell and the share price dropped, according to the court.

Antifraud violations. The SEC charged Archer and the individual defendants with 16 counts of violating the antifraud provisions of the federal securities laws and certain reporting provisions. The COO filed an answer in late 2014, but neither Archer nor the principal responded, and a default judgment was entered. In its opinion, the court concluded that permanent injunctions against Archer and its principal were appropriate given the repeated exploitation of investors. The court also ordered joint and several disgorgement of ill-gotten gains of just over $630,000, plus prejudgment interest, and a $100,000 civil penalty. The court, however, withheld entry of the default judgment pending resolution of the claims against the COO.

In the case at bar, the court found that the COO made material omissions in furtherance of the scheme and that his intent to defraud can be inferred from his active participation. In addition, the court stated, by attempting to manipulate the price of the stock, he violated the scheme liability provisions of the Exchange Act and the Securities Act. The COO also aided and abetted Archer’s and the principal’s violations of the Advisers Act, the court found, and, given the breadth of the fraudulent scheme, a permanent injunction against him is warranted. Entering summary judgment in favor of the SEC, the court also ordered the COO to pay disgorgement of nearly $550,000 ($449,784 in soft-dollar payments and $99,500 in research fees from Archer), plus prejudgment interest, and a $100,000 civil penalty.

The case is No. 14-3395 (MJD/TNL).

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