Recently, the Securities and Exchange Commission (SEC) settled an administrative action against Yosemite Capital Management, LLC (“Yosemite”), a registered investment advisor, and its managing director Paul H. Heckler (“Heckler”), because it failed to disclose to clients that the promised due diligence that they conducted had encountered significant problems. Yosemite, through Heckler, placed $3.25 million of four of its clients’ funds through a “feeder fund,” Ashton Investments LLC (“Ashton”), into purported bridge loans arranged by Norman Hsu (“Hsu”) and Next Components, Ltd. (“Next”). Instead of being placed in bridge loans, however, the moneys were part of Hsu’s and Next’s $60 million Ponzi scheme.
According to the SEC, in January 2007, prior to placing his clients’ investments with Ashton and Next, Heckler promised to conduct due diligence to at least two clients prior to placing his clients into the Ashton investment. Although Heckler asked Ashton representatives several key questions, he received incomplete, contradictory, and evasive responses. He received no financials. Investors were promised a high rate of return, effectively 24% per year, and received a post-dated check shortly after investing in the amount of their principal plus interest. In response to Heckler’s requests for information, he was told that Hsu was a private person and no information was available. He also received an eight-page brochure from Ashton replete with misspellings, and was told that the bridge loans were safer than stocks or bonds. Because Ashton had no offices, Heckler met the three Ashton representatives — one of whom Heckler believed was a UPS truck driver or deliveryman — at local restaurants to discuss the investment.
Despite these red flags, Heckler placed four Yosemite clients into the Ashton investment without disclosing to clients that his due diligence process had been thwarted.
The SEC also found that, for referring investors to Ashton, Heckler received a two percent commission. He received the commission at the time the bridge loan matured. Accordingly, Heckler received a total of $26,000 in commissions from the $1.3 million of bridge loans that matured. Heckler remitted this $26,000 to Yosemite. He then received a portion of the $26,000 per his compensation agreement with Yosemite. Additionally, Heckler also invested $275,000 of his own money in Ashton, realizing a $150,000 loss.
The SEC determined that Heckler and Yosemite willfully violated Section 206(2) of the Advisers Act, which prohibits any investment adviser from engaging in any transaction, practice, or course of business, which operates as a fraud or deceit on any client or prospective client, and Heckler caused Yosemite’s violations of Section 206(2) of the Advisers Act.
Granted, the failures of due diligence by Heckler and Yosemite are an extreme case; nevertheless, investment advisers must take heed of the fact that due diligence promises must be kept and must be documented properly, or you take the risk being accused of fraud.
Call Jeffrey Wittenberg at 877-352-2010 if you have questions about this matter or due diligence in general.