Enforcement News: Investment Adviser Charged with Operating a Fraudulent Scheme and Misappropriating Investor AssetsPrint Article
- Posted on: Aug 25 2021
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.1 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.2
An investment adviser’s fiduciary duties are made enforceable under Section 206 of the Investment Advisers Act of 1940 – the Act’s anti-fraud provisions.3 Though Section 206 is an antifraud provision, unlike Section 10(b) of the Securities Exchange Act of 1940 (the “Exchange Act”), it is not limited to fraud in connection with the purchase or sale of a security.4 It is much broader – it extends “to all services undertaken on behalf of the client.”5
In the context of fraud, an investment adviser has an affirmative duty to make full and fair disclosure of all material facts, as well as a duty to avoid misleading his/her clients.6 Accordingly, an investment adviser is obligated to refrain from engaging in fraudulent conduct, whether that conduct encompasses the making of false statements or the failure to disclose material facts when such failure would operate as a fraud or deceit upon a client.
In addition to the foregoing, investment advisers, like other professionals charged with caretaking another person’s money, cannot misappropriate a client’s assets or property. Misappropriation occurs when a person uses another person’s money without authorization. It mirrors the crime of embezzlement, which is committed by a person having a relationship of trust or fiduciary duty to another person and who steals that person’s money or property for his/her own personal gain. Both the Securities and Exchange Commission (“SEC”) and FINRA have numerous rules governing how corporate actors and financial professionals must act to safeguard and protect the handling of investor and customers monies.
Unfortunately, many victims of the foregoing are seniors and vulnerable adults. This was so in the SEC enforcement action we examine below.
SEC v. Mueller
On August 20, 2021, the SEC announced (here) that it filed an action against a San Antonio, Texas-based investment adviser for operating a years-long fraudulent scheme that raised approximately $58 million from nearly 300 investors in two investment funds – the deeproot 575 Fund, LLC (the “575 Fund”) and the deeproot Growth Runs Deep Fund, LLC (the “dGRD Fund”) (collectively, “the Funds”).
According to the complaint filed by the SEC (here), Robert J. Mueller and his company deeproot Funds, LLC (“deeproot”) persuaded investors, many of whom were retirees, to cash out the annuities and individual retirement accounts they held with other investment companies and invest in the Funds. Defendants allegedly told investors the Funds would invest in life insurance policies and deeproot-related businesses to provide relatively safe returns to investors.
Defendants allegedly told investors that the 575 Fund would invest the majority of its assets in life insurance policies. In reality, said the SEC, the 575 Fund purchased interests in life insurance policies indirectly, by investing in the dGRD Fund, which itself invested the majority of its assets in life insurance policies purchased for the Funds by another company owned by the individual defendant.
According to the SEC, defendants commingled the money raised from investors in affiliated bank accounts and spent less than $10 million to purchase life insurance policies for the Funds. They also purported to include life insurance policies as assets of the Funds that defendants had purchased for the individual defendant’s earlier investment funds. Notably, alleged the SEC, defendants purchased no new insurance policies for the Funds after September 2017, despite raising approximately $43 million for the Funds after that time.
The SEC alleged that defendants used the vast majority of the Funds’ assets – virtually all of which came from investors in the 575 Fund and the dGRD Fund – to fund the individual defendant’s deeproot-affiliated businesses. “Indeed,” said the SEC, the individual defendant “funneled more than $30 million of the Funds’ assets to the Relief Defendants in non-arms-length transactions whenever he determined the Relief Defendant businesses had expenses that needed to be paid, and he did so without any analysis as to whether such transfers constituted suitable investments for his client Funds.” Further, alleged the SEC, the individual defendant “made these transfers to Relief Defendants without obtaining anything of substance in return for the Funds and without memorializing the transactions in any way.”
According to the SEC, since 2015, neither the life insurance policies nor the “capital” investments in affiliated businesses have yielded significant revenue or cash flow for defendants or the Funds. This caused the individual defendant and one of his entities “to default on the purchase of one $10 million face value life insurance policy, losing nearly $3.5 million of the Funds’ money in the process,” the SEC claimed. It also allegedly caused defendants to make more than $820,000 of Ponzi-like payments to earlier investors in the Funds using money raised from new investors and make at least $177,000 in payments from money borrowed on a short-term basis using the life insurance policies as collateral.
Despite making statements suggesting he took no compensation from the Funds, the SEC alleged that the individual defendant commingled assets of the Funds in affiliated bank accounts and used them to make ad hoc salary payments to himself whenever investor money was available, totaling roughly $1.6 million from 2016 through 2020.
The individual defendant also allegedly misappropriated more than $1.5 million of the Funds’ assets to pay hundreds of personal expenses.
The SEC filed its complaint in federal district court in San Antonio. The SEC charged the investment adviser and his company with violating the antifraud provisions of Sections 206(1), (2), and (4) of the Act and Rule 206(4)-8 promulgated thereunder, Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. The SEC charged another defendant with violating the antifraud provisions of Sections 17(a)(1) and (3) of the Securities Act, and Section 10(b) of the Exchange Act and Rules 10b-5(a) and (c) promulgated thereunder. The SEC is seeking civil penalties, disgorgement of ill-gotten gains with interest, and permanent injunctions.
Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.
This article is for informational purposes and is not intended to be and should not be taken as legal advice.
- SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963).
- Transamerica Mortg Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979).
- SEC v. Lauer, 2008 WL 4372896, at *24 (S.D. Fla. Sept. 24, 2008).
- Proxy Voting by Investment Advisers, Adv. Act Rel. No. 2106 (Jan. 31, 2003).
- See Arleen W. Hughes, Exchange Act Rel. No. 4048 (Feb 18, 1948), aff’d. sub. nom., Hughes v. SEC, 174 F.2d 969 (May 9, 1949).