Enforcement News: Former Race Team Owner and Investment Adviser Charged With Multimillion Dollar FraudPrint Article
- Posted on: Apr 26 2021
In today’s installment of Enforcement News, this Blog examines, among other things, the fiduciary duties of investment advisers, in particular, the duty of loyalty.
An investment adviser is a fiduciary, and as such is held to the highest standard of conduct and must act in the best interest of his/her client. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). This means, among other things, that an investment adviser has an affirmative duty of utmost good faith and full and fair disclosure of all material facts. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979). In broad terms, an investment adviser owes his/her client the duty of care, loyalty and candor.
The duty of care includes, among other things, the duty to provide advice that is suitable and in the best interest of the client. To meet this duty, investment advisers must (a) make a reasonable inquiry into a client’s financial situation, level of financial sophistication, investment experience, and investment objectives and (b) provide personalized advice that is suitable for and in the best interest of the client based on the client’s investment profile.
The duty of loyalty requires an investment adviser to put his/her client’s interests first. An investment adviser must not favor his/her own interests over those of a client or unfairly favor one client over another. In seeking to meet this duty, an adviser must make full and fair disclosure to his/her clients of all material facts relating to the relationship. Additionally, an investment adviser must seek to avoid conflicts of interest with his/her clients, and, at a minimum, make full and fair disclosure of all material conflicts of interest that could affect the advisory relationship. The disclosure must be clear and detailed enough for a client to make a reasonably informed decision to consent to such practices, strategies or conflicts or reject them. An adviser disclosing that he/she “may” have a conflict is not adequate disclosure when the conflict actually exists.
On April 23, 2021, the Securities and Exchange Commission (“SEC”) announced (here) that it charged Andrew T. Franzone (“Franzone”), the former owner of a race car team, and investment adviser FF Fund Management, LLC (“FFM”) with fraudulently raising and misappropriating tens of millions of dollars from the sale of limited partnership interests in a private fund, FF Fund I LP (the “Fund”).
In the SEC’s complaint (here), the Commission alleged that Franzone, the sole owner and principal of FFM, defrauded investors by making misrepresentations regarding the Fund’s strategy and investments, failing to eliminate or disclose conflicts of interest, misappropriating fund assets, and falsely representing the Fund would be audited annually. According to the SEC, from August 2014 through September 24, 2019, Franzone told potential and existing investors that his investment strategy for the Fund was to maintain a highly liquid portfolio primarily focused on options and preferred stock trading. Franzone allegedly raised more than $38 million for the Fund from approximately 90 investors through these representations.
In reality, alleged the SEC, Franzone diverted substantial Fund assets to an entity he owned and invested the Fund’s remaining assets mainly in highly illiquid private companies and real estate ventures. The SEC also alleged that Franzone’s management of the Fund was subject to numerous conflicts that he did not eliminate or disclose, and that he misused Fund assets. For example, Franzone took personal loans from the founders of at least two companies in which the Fund invested, pledged Fund assets to secure other loans for his own personal benefit, and misappropriated Fund assets for personal uses, including the purchase of a garage to store his private race car collection. Finally, the SEC alleged that Franzone and FFM removed a critical safeguard for investors by failing to have the Fund audited on an annual basis despite representations they would do so. The Fund filed for bankruptcy under Chapter 11 in the Southern District of Florida on September 24, 2019.
“Investment advisers must provide honest representations to investors, disclose or eliminate conflicts of interest with clients, and not abuse client assets,” said Adam S. Aderton, Co-Chief of the Enforcement Division’s Asset Management Unit. “We allege that Franzone and FFM violated federal securities laws by breaching these fundamental obligation.”
The SEC’s complaint, filed in United States District Court for the Southern District of New York, charges Franzone and FFM with violating the antifraud provisions of the federal securities laws and seeks disgorgement of ill-gotten gains, civil penalties, and permanent and conduct-based injunctive relief.
In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced (here) that it filed criminal charges against Franzone. According to the press release, Franzone was charged with securities fraud and wire fraud for bilking more than 100 investors out of approximately $40 million.
Commenting on the indictment, U.S. Attorney Audrey Strauss said: “Andrew Franzone allegedly promised his clients access to his successful liquid trading strategy and consistent, positive trading returns. As alleged, those promises were lies. Franzone lied about his fund’s investments and performance, and he lied in promising clients that they had could readily access their invested capital. While his investors lost money, Franzone enriched himself. We will continue to work with our law enforcement partners to protect investors from these types of deceptive practices.”
USPIS Inspector-in-Charge Philip R. Bartlett said: “Mr. Franzone allegedly misled investors to believe his fund was liquid and he could cover their redemption requests, in a scheme to lure them in to investing in his hedge fund. This should be a reminder that greed has no boundaries and does not care about a favorable portfolio. Postal Inspectors remind all investors to thoroughly check offers, and if they sound too good to be true, keep your money in the bank.”