Friday, November 24, 2017

Kokesh fails to save adviser from disgorging ill-gotten gains

By John M. Jascob, J.D., LL.M.

A former hedge fund adviser has been ordered to pay almost $2 million in disgorgement and penalties for fraudulently spending investors’ funds on luxuries and paying off investors from a prior scheme. The federal district court in Dallas summarily rejected the defendant’s contention that the Supreme Court’s decision in Kokesh v. SEC would make disgorgement an unlawful penalty in his case. The court also rejected the argument that a New Mexico court’s award of restitution against the defendant for his role in the prior scheme precluded an order of disgorgement in the present case (SEC v. Sample, November 20, 2017, Boyle, J.).

Lobo Fund scheme. The defendant, Matthew D. Sample, had raised $982,000 from investors in his hedge fund, Lobo Volatility Fund, LLC. The SEC charged Sample with using the invested funds for personal expenses while supporting his con by creating false IRS forms showing positive account balances and investment returns. In April 2014, Sample agreed to disgorge his ill-gotten gains, pay prejudgment interest on those gains, and pay a civil penalty. In a parallel criminal proceeding, a federal district court in New Mexico subsequently sentenced Sample to five years of probation and ordered him to pay approximately $1.1 million in restitution to the victims of the Lobo Fund scheme and a prior fraudulent scheme.

Kokesh unavailing. Although Sample had previously agreed to disgorge his ill-gotten gains, he responded to the SEC's motion for monetary remedies by arguing that the Supreme Court's June decision in Kokesh v. SEC would make ordering him to disgorge an unlawful penalty. Specifically, Sample’s argument hinged on footnote three of Kokesh, where the high court stated that nothing in its decision should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings.

The district court, however, flatly rejected Sample’s argument, noting that Kokesh had no effect on how courts apply disgorgement principles. Rather, Kokesh merely held that disgorgement claims are subject to 28 U.S.C. § 2462’s five-year statute of limitations. Moreover, the restitution ordered in Sample’s criminal proceeding did not prevent an order of disgorgement in his civil case. Accordingly, the court ordered Sample to disgorge an amount equal to $919,875 less what he pays the Lobo Fund victims in restitution.

Civil penalty. The court also granted the SEC's request for a third-tier civil penalty against Sample. Among other things, the court noted that Sample: (1) had misappropriated substantial amounts of his clients’ money for his personal use; (2) knew his conduct was illegal; (3) lied to his clients about losses he was incurring and created fake account statements; (4) was aware of the federal securities laws as a veteran of the securities industry; and (5) made Ponzi payments to pay alleged returns to an existing investor. Given the egregiousness of Sample’s scheme and the losses he caused his victims, the court imposed a civil penalty of $919,875.

The case is No. 3:14-CV-1218-B.

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