SEC Charges Advisor With Fraudulently Overcharging Clients
Traditionally the Enforcement Division’s case load centered on corporate and disclosure cases along with a mix of others. In recent years that mix has included a number of offering fraud actions whose victims are often small retail investors. More recently that mix seems to be more heavily weighted with cases involving investment advisers. Many of those cases focus on the failure of the advisory to follow disclosed procedures, although a number are simple fraud actions. The Commission’s most recent case in this area falls into the latter group. SEC v. Alar, (N.D. Ga. Filed July 18, 2019).
Defendant Paul Alar is the owner and operator of West Mountain, LLC, also a defendant, which has acted as an investment adviser for years. West Mountain advises two pooled investment vehicles which each paid a management fee and a second fee based on the value of the assets. Each essentially acted as a fund of funds until 2016.
In 2016 the investments of the two funds were shifted by Mr. Alar. The funds were directed to make direct investments into subsidiaries of two privately held companies. One, a Petroleum Company, was attempting to develop petroleum emulsification products. A second, an Aircraft Company, was trying to manufacture aircraft.
The next year Mr. Alar was appointed to the board of each fund. Subsequently, Mr. Alar and the advisor directed each fund to recorded its investment in either the Aircraft or Petroleum Company as an unrealized gain. As a result, 44% of one fund’s assets and 22% of the other fund’s assets were invested in either the Aircraft or Petroleum Company.
Defendants relied on two previously prepared valuation reports in directing the funds to record the unrealized gains. Those reports were based on cash flow projected provided by each firm. Each was based on untested assumptions which lacked support. Each report also stated that it was not an “independent valuation” and did not constitute a “formal opinion of value.”
Requests by the investors for a copy of the reports were denied. Yet the financial records of the funds collectively reported an unrealized gain of $18.6 million. This permitted Defendants to collect about $900,000 in advisory and performance fees.
In June and July 2017, West Mountain’s independent audit firm “disclaimed opinions” to the funds because of the valuations regarding the Aircraft Company and Petroleum Company. The auditors “indicated that it had evaluated the procedures established by West Mountain to estimate the fair values of the direct investments and believed they were unreasonable.” A follow-up letter to Defendants stated that the valuation procedures were not appropriate and were “inconsistent” with GAAP.
Nevertheless, during 2016 and 2017 Defendants continued to rely on the valuations to collect fees. During the period they also continued to tout the two investments with baseless claims of about to be realized profits by the Petroleum Company and the Airplane Company. The amount of excess fees collected approximated the amounts owed by Mr. Alar under an adverse divorce decree entered during this period. The complaint alleges violations of Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending.