Adviser, Co-founder, Settle SEC Breach of Duty Proceeding
The Commission filed settled administrative proceedings against an investment adviser and its co-founder based on a claimed breach of fiduciary duty. The Order alleged violations based on negligence, citing Securities Act Section 17(a)(2) and Advisers Act Section 206(2) and, in addition, Advisers Act Section 207. In the Matter of Clean Energy Capital, LLC, Adm. Proc. File No. 3-15766 (October 17, 2014).
Clean Energy Capital, or CEC, was a registered investment adviser until 2012 when the firm determined it was no longer eligible to register with the Commission because of the amount of assets under management. Respondent Scott Brittenham is the co-founder of the adviser and holds an 89% ownership interest but only has a 50% voting interest. He managed the business.
CEC marketed 19 separate private equity funds to investors using Ethanol Capital Partners, L.P. Each fund was marketed as a separate series, labeled by a letter such as Fund A. Respondent also marketed the Tennessee Ethanol Partners, L.P. Collectively the 20 CEP Funds raised $64 million from hundreds of investors.
The Order alleges a series of violations:
Expenses: Beginning in 2008, and continuing to the present, Respondents misallocated certain CEC expenses to the ECP Funds. Specifically, the ECP Funds, each of which is a separate entity, paid CEC a management fee and a portion of the dividends received by the Funds from portfolio companies and portions of the proceeds from sales of portfolio company stock.
The expenses were divided into three groups: 1) CEC only expenses; 2) ECP Fund only expenses; and 3) expenses split between CEC and the Funds. For the split expenses, typically 70% were allocated to the Funds, divided equally among them. Part of those expenses included Mr. Bittenham’s $1.1 million in compensation from 2008 to 2011 and his bonus.
Neither the PPMs nor the LPAs for eight of the funds disclosed the payment of the split expenses. Likewise, CEC’s Forms ADV filed in July 2011 and March 2012 did not disclose those expenses. In addition, the allocation of Mr. Brittenham’s compensation to the funds constituted an undisclosed conflict of interest. Mr. Brittenham benefitted from these transactions since he received distributions from CEC’s profits.
Conflicts/principal transactions: Beginning in September 2012, and continuing for the next four years, CEC issued loans to 17 of the Funds which had insufficient cash reserves to pay the expenses after closing. The LPAs for 14 of the Funds did not permit borrowing money to pay expenses. Promissory notes were issued for the loans and the assets of the funds pledged. Mr. Brittenham unilaterally, and without notice to the investors, amended the documents. The loans represented a conflict of interest. The pledges represented principal transactions between CED and the Funds which require written notice and consent that was not obtained.
Distributions: Beginning in 2011 CEC and Mr. Brittenham altered the manner in which CED calculated distributions. The new methodology was to the detriment of the Funds. The new methodology also adversely affected the dividends received by investors in Series A, B and C. The changes were not adequately disclosed.
Misstatements: During the offering for Series R in 2009, misrepresentations were made to an investor regarding the investment of Mr. Brittenham and the co-founder in the offering. Specifically, the investor was told that each invested $100,000. In reliance on that representation the investor put $250,000 into the fund.
Custodian: From August 2010 through September 2013 CEC kept the Funds’ cash assets in a single master bank account that was comingled, failing to segregate the client assets. In addition, CEC did not have a qualified custodian for original stock certificates it held that were owned by the Funds.
Compliances: The compliance procedures for CEC incorrectly described the private offering exception of the custody rule. Specifically, the procedures failed to specify that audited financial statements needed to be prepared and distributed – and they were not.
Prior violations: The PPMs for three series of offerings for the Funds failed to disclose the co-founder’s prior disciplinary settlement with the Commission. That 2012 settlement was based on violations of the antifraud provisions of the Securities Act, the Exchange Act and the Advisers Act and included a cease and desist order and a civil penalty.
The Respondents resolved the action and entered into a series of undertakings. Those included the retention of an independent consultant whose recommendations will be adopted. In addition, each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, to a censure and to pay disgorgement of $1,918,157.00 along with prejudgment interest. Respondents will also pay a penalty of $225,000. Portions of the disgorgement will be returned to certain Funds.