Time between appeal and decision - 10 months, 21 days.
Time between last brief and decision - 7 months, 26 days.
Pages - 21.
Summary
The control person of an investment adviser who claimed inflated assets under management and performance results will be barred. A bar and cease and desist orders are appropriate despite the fact that there was no misappropriation of investor funds.
Warwick, an investment adviser and its president Lawrence appeal an initial decision by an ALJ. The law judge found respondents: 1) violated Section 203A of the Advisers Act by maintaining its registration with the Commission despite having less than $25 million under management; 2) respondents violated Advisers Act Sections 206(1) and (2) and Warwick violated and Lawrence aided and abetted violations of IA Section 206(4) by falsely representing total assets under management and publishing false performance data. The ALJ barred Lawrence and entered cease and desist orders against both respondents.
After 1997 when advisers needed $25 million under management to qualify for Commission registration, Warwick reported between $26 and $37 million under management. This was a sharp increase over the $5 million it had reported 8 months earlier. Warwick's registration was cancelled by the Commission in January 2002 and it never filed to withdraw its registration. Warwick continued to hold itself out as registered with the Commission after that date. Further, Warwick continued to publicly claim it had assets under management of between $26 and $94 million through early 2004.
Lawrence admitted in sworn testimony to the Commission staff that between 1998 and 2003 he had only between $2 million and $10.5 million under management. Although Lawrence claimed to have managed substantial other assets, the ALJ found those claims to be not credible and unsupported by credible evidence.
Warwick also published inflated performance return data, claiming annual returns as high as 77 percent. Lawrence admitted in testimony the actual return was about 25 percent. He claims to have sent a correcting letter to a data service changing the returns he first claimed, but the service never received his purported letter.
At the hearing, Lawrence claimed various records were destroyed in a fire. Unfortunately for him, he had previously testified the records were destroyed in a flood. Apparently he never got around to claiming the destruction was by a horde of locusts.
In upholding the finding that Lawrence aided and abetted violations by Warwick, the Commission noted that recklessness satisfies the knowledge requirement for aiding and abetting, citing the formulation in Sundstrand Corp v. Sun Chem. Corp., 553 F.2d 1033, 1044-1045 (7th Cir. 1977). Lawrence's aiding and abetting was established because he signed documents with the false performance data. Because he was solely responsible for managing Warwick, the Commission found Lawrence must have known that the claimed amount of assets under management was inflated.
Inflated performance data and size of assets under management are material because they gave an erroneous impression of the firms size and abilities. Investors routinely consider an adviser's past performance and attractiveness to other investors when making investment decisions. Respondents are liable for misrepresentations made to a data service because they knew that those statements would be repeated or otherwise conveyed to investors.
Conduct occurring more than five years before the proceedings were instituted maybe the basis for imposing sanctions or civil penalties (see 28 U.S.C. 2462). However, such evidence may be considered to establish motive, intent, or knowledge in committing violations within the limitations period. And, no statute of limitations applies to consideration of the cease and desist remedy.
Comment
The Commission will require advisers to prove with credible evidence claims that they meet the asset test in order to maintain registration.
Over the years, some of the Commission ALJ's have been unwilling to admit prior sworn testimony by respondents as substantive evidence, despite authority for doing so. Here, the Commission considered prior inconsistent sworn testimony by a respondent. Note, Commission case law also admits as substantive evidence for all purposes prior sworn testimony of non-respondents, a practice that is contrary to the federal rules of evidence. See, Allesandrini & Co., 45 S.E.C. 399 (1977).
The Commission rejected the Division of Enforcement's request for second tier penalties, with very limited explanation. It concluded that the bar and cease and desist orders were sufficient remedies primarily because Warwick only had two clients at the time of the hearing and because Warwick would have to cease operations due to the bar imposed on Lawrence.
