The Commission prevailed and secured the entry of a permanent asset freeze as well as a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b) in an action centered on a fraudulent note offering. SEC v. Evolution Capital Advisors, Civil Action No. 4:11-cv-02945 (S.D. Tx. Filed Aug 10, 2011).

The complaint named as defendants Damian Valdez who controlled defendant Evolution Capital Advisers, LLC and its subsidiary, defendant Evolution Investment Group I, LLC or EIGI. Beginning in early 2008 and continuing through mid- 2010 the defendants raised about $10.1 million from over 80 investors through two fraudulent offerings of redeemable secured notes, according to the complaint. One series was issued by Evolution Capital. It promised a 9% return for a three year investment or 10% for a five year investment. The second series was issued by EIGI. It promised a 7% return for a three year investment or 7.5% for five year investments.

The offerings were made as private placements. The private placement memoranda represented that the notes would be backed by the full faith and credit of the U.S. Government. In fact defendants purchased Small Business Administration interest only strips. Those entitled holders to a portion of the interest paid on an SBA loan or group of loans. If the borrower defaults on or prepays the loans the interest payments stop and the strip has no value. Although the U.S. government guarantees repayment of the loan principal, only a small portion of the interest is guaranteed from default. These facts and the related risks were not disclosed. In fact about 19% of the underlying loans defaulted. The claim in the PPM that “substantial leverage” would be used to maximize the returns was also false since efforts to secure financing failed and none was obtained.

Defendants also paid themselves about $2.4 million for management fees and expenses. Many of those expenses appear to be unrelated to the business, according to the SEC. In addition, defendants took about $2.7 million from one group of investors to pay off others in Ponzi like payments. This left the two entity defendants in dire financial condition with about $1.1 million less than was owed to note holders. The complaint alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) & (2).

Following a contested evidentiary hearing the Court found that:

  • The defendants mislead investors into believing that the notes were safe and guaranteed by the U.S. Government;
  • The claims regarding the use of leverage were false;
  • The assets securing the notes were subject to significant undisclosed default and prepayment risks;
  • The defendants paid themselves over $2.4 million in fees and expenses;
  • Defendants used about $2.7 million from the second note offering to make Ponzi like payments;
  • Defendants lacked the resources to repay investors in accord with the notes;
  • Defendants would have continued to take all monies from the account each month as profits had the Commission not brought this action; and
  • Defendant Valdez acted with fraudulent intent.

Issues concerning disgorgement, prejudgment interest and penalties are pending before the Court.

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