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Regulation and Compliance > Federal Regulation > SEC

Enforcement: SEC Unmasks Fund Manager’s Criminal Past; RIA Ordered to Hire CCO

By Marlene Y. Satter

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Among recent enforcement actions, the Financial Industry Regulatory Authority (FINRA) barred a broker and fined him for making fraudulent misrepresentations about unsuitable investments to customers, many of whom were retired.

In addition, the SEC ordered an RIA to hire a dedicated chief compliance officer, in addition to other measures, on charges of client overbilling; charged an unregistered fund manager with fraud in hiding a criminal past; and won a settlement from a tech company after it misled investors.

SEC Charges Fund Manager With Hiding Criminal Past

The SEC announced fraud charges against an unregistered fund manager accused of hiding his checkered past while providing false and misleading data to investors and an independent research firm.

According to the agency, Zoernack and his firm EquityStar Capital Management fraudulently offered and sold at least $5.6 million of interests in a pair of private investment funds (Global Partners Fund and Momentum Growth Fund) to more than 40 investors from May 2010 to March 2014. In addition, Zoernack secretly made more than $1 million in unauthorized withdrawals from the funds’ accounts without informing investors.

Zoernack and EquityStar went to great lengths to hide Zoernack’s background, which included two felony fraud convictions, a bankruptcy filing and other money judgments and liens against him. He even hired a firm to manipulate search results on his name by flooding the Internet with phony information that painted him as a successful fund manager, investor and philanthropist. This made it tougher for investors to uncover Zoernack’s criminal past and other negative information in Internet searches.

Zoernack also used at least three false identities in communicating with investors, so that Equity Star looked like more than a one-man operation. One of those phony identities was the nonexistent Amanda Sutton, with the lofty title of “investor relations professional.”

Both Zoernack and EquityStar provided phony data to Morningstar Inc., so the Momentum fund could become a “Morningstar Five-Star-Rated Fund,” under false pretenses; that way Zoernack could market the fund as highly rated. Zoernack claimed to Morningstar that the fund had been around longer and had 40 times more assets than was actually the case. They also created and distributed phony investment marketing materials that hid the fact that results were hypothetical and not based on actual fund performance.

In addition, neither Zoernack nor his funds were registered with the SEC or any state regulator.

RIA Ordered to Hire CCO by SEC

An RIA and its CEO have settled with the SEC after charges of overbilling clients.

According to the agency, Marco Investment Management, LLC, of Atlanta, Georgia, and Steven Marco, its chief executive officer, overbilled clients, charging asset management fees on total asset balances that did not deduct the proceeds of securities sales from margin balances.

For approximately 25 clients with margin accounts, Marco and MIM, acting through Marco, calculated the quarterly management fees without adjusting for sales proceeds or other credits applied against the margin balance by the custodial broker-dealer. This occurred since at least 2005.

Marco said he had an understanding with these clients that each wanted to use the margin available within their custodial accounts, but at the same time wanted to maintain a level of assets with MIM that would remain essentially fixed, despite margin use, so that sales proceeds or other credits were contemplated to be reinvested in the portfolio to be managed by MIM.

However, there were no written amendments on record to modify the terms of the clients’ management agreements. And for those clients, the custodial broker-dealer’s actual application of the proceeds from sales and other credits to the accounts’ margin balance was inconsistent with MIM’s internal records and the MIM appraisals sent to clients. As a result, MIM statements overstated the balances in those clients’ accounts, and the management fee was calculated on the “total portfolio” value, which included investment proceeds.

Both the firm and Steven Marco, the firm’s chief executive officer, have been censured. The firm must hire a dedicated CCO and bring in an independent compliance consultant, and Marco has agreed to undergo compliance training. In addition, the firm has agreed to pay $124,750.44 in disgorgement, as well as prejudgment interest of $7,595.94, and a penalty of $100,000; Marco, who cannot serve as a compliance officer for three years, is to pay a penalty of $50,000.

FINRA Bars, Fines Broker on Unsuitable Recommendations

FINRA has barred broker David Joseph Escarcega and fined him $52,270, the total commissions involved in the transactions, after finding that he made materially false and misleading statements to seven customers in connection with securities purchases, and for making unsuitable recommendations to 12 customers, primarily retirees.

According to the agency, Escarcega, an independent contractor working out of a Phoenix, Arizona, office and registered with Center Street Securities, conducts his securities business through a company he formed early in 2010 called Strategic Financial Partners LLC.

Via investment seminars that he hosted in Arizona and California, Escarcega solicited clients to invest in registered debt instruments called renewable secured debentures that were issued by GWG Holdings, Inc., which describes itself as a licensed viatical settlement provider.

But Escarcega’s client base is primarily retirees, and those debentures were unsuitable for such clients. In fact, according to FINRA, “The [d]ebentures were high-risk securities suitable only for investors with sufficient financial resources who could afford to lose their entire investment. The 12 customers were not such investors.”

That didn’t stop Escarcega, who not only orally misrepresented the investments to prospective investors, FINRA said, but also personally filled out parts of switch letters that he was required to file if customers sold an existing investment in order to buy the debentures. In doing so he again misrepresented the safety of the debentures, and had his customers sign the switch letters.

Of the 18 customers, none was younger than 61 and the two oldest were 81; all but one were retired. All had indicated that their investment objectives were conservative, while the debentures were high risk. And while there are limits on how much of a client’s net worth could be placed in investments such as the debentures, Escarcega put as much as 33% of one client’s net worth into the investment.

According to FINRA, “Escarcega did not accept responsibility for his misconduct and expressed no remorse for his actions. Escarcega’s failure to appreciate his obligations as a registered representative and the gravity of his misconduct warrants a bar.”

Tech Company Settles for $750,000 on Misleading Investors

Uni-Pixel Inc., a developer of technologies for touchscreen devices, has agreed to pay $750,000 to settle charges that it misled investors about the production status and sales agreements for a key product.

In addition, two former company executives face related charges in an SEC complaint filed in U.S. District Court for the Southern District of Texas. The SEC has entered into a deferred prosecution agreement with the company’s former chairman of the board, who has agreed to cooperate and be barred from serving as an officer and director for five years.

According to the SEC, Uni-Pixel began publicly touting sales of a touchscreen sensor product supposedly in speedy high-volume commercial production when in fact only a few samples had been manually completed.

The news made the stock price more than double, and that allowed then-CEO Reed Killion and then-CFO Jeffrey Tomz to make more than $2 million in personal profits from selling their own shares of company stock. The pair were aware that the manufacturing process was still incapable of mass-producing sensors in commercial quantities.

In 2012 and 2013, the company announced “multimillion-dollar” sales agreements that focused on potential revenues and hid material conditions necessary for the revenue to come in.

In April of 2013, Uni-Pixel declared that its high-volume production line was “qualified and production ready” and its capacity “started at fifty moving to hundreds and then thousands over the next several months.” In actuality, the company had produced no functional sensors via its high-speed process.

And in November of 2013, the company sent out a press release trumpeting a “purchase order” for its sensors that expected to ship an initial “commercial run” of sensors by year-end. The order, however, was for a pittance: $10 worth of sensors as samples for the customer. Of course this was not mentioned.

The firm has neither admitted nor denied the charges, but has consented to the sanctions—which are subject to court approval. The SEC’s litigation continues against Killion and Tomz.

– Related on ThinkAdvisor: Ex-JPMorgan Broker Blew $20M of Client Money Gambling, Gets 5 Years

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