Offering Fraud: An SEC Enforcement Staple

 One of the new staples of SEC enforcement is offering fraud cases. When coupled with Ponzi scheme or investment fund fraud actions, they constitute a significant portion of the day to day work load of the reorganized Enforcement Division.

Two recent examples of these cases are SEC v. Detroit Memorial Partners, LLC, Civil Action No. 1:13-cv-01817 (N. D. Ga. Filed May 30, 2013) and In the matter of Scuderi Group, Inc., Adm. Proc. File No. 3-15344 (Filed May 30, 2013). The former centers on a scheme implemented by defendant Mark Morrow and his controlled entity, Detroit Memorial. It involved selling interests in Detroit Memorial which supposedly operated cemeteries. The latter focuses on a years long unregistered note offering by the Massachusetts based family run company and its President and CFO, Salvatore Scuderi.

Mr. Morrow and his company are alleged to have raised just under $25 million from investors who purchased either notes or what were called equity interest in Detroit Memorial Partners. The entity had a 49% interest in an entity which owns and operates 28 cemetery properties in Michigan.

In 2007 Mr. Morrow decided to bid for 28 cemeteries in Michigan that were in receivership. To implement the plan he formed Detroit Memorial. Initially Mr. Morrow, who had been in the securities industry since 1987 and was associated with a broker dealer, raised investment funds from a wealthy business man whose wife was a client of his long time business associate Angelo Alleca and his firm, Summit Wealth Management, Inc. Mr. Allecca and his firm are defendants in another Commission enforcement action, SEC v. Alleca, Civil Action No. 1:12-cv-0361 (N.D. GA.). That case alleges that the defendants operated a Ponzi scheme.

From October to December 2007 Mr. Alleca and others at Summit sold about $9.5 million of Detroit Memorial promissory notes. Virtually all of the purchasers were clients of Summit. The notes were unregistered and by early January 2009 Mr. Allecia lost much of the proceeds in risky investments, according to the complaint. To make up for the losses, he sold more Detroit Memorial notes in 2008 and 2009. Those notes were also unregistered. In addition, the offering materials contained a series of misrepresentations including claims that: the notes would be secured by real property; that the company is in the business of owing and managing cemeteries; and that it recently purchased 28 cemeteries.

In 2012 another offering of Detroit Memorial notes was made. This time 18 investors purchased about $1.3 million in notes. Again the notes were unregistered. Again the offering materials contained misrepresentations.

Finally, Detroit Memorial raised an additional $4.5 million from four investors in return for a combined 61% equity interest in the entity. Mr. Morrow told some investors that the company was debt free - a misrepresentation since it had substantial debt from the note offerings. The complaint alleges violations of Securities Act Sections 5(a) and 5(c), each subsection of Section 17(a) and Exchange Act Section 10(b). The case is in litigation.

Scuderi Group is based on a series of private placements made over a six year period. The Order claims the offerings were effectively one continuous offering.

Scuderi Group has been in the business of developing a new internal combustion engine design. The firm funded its operations from individual investors and investment clubs, raising about $80 million in six offerings which sold what were called "preferred units" to about 415 investors. While Respondents claimed that the offerings were exempt from registration, in fact they did not qualify under Section 4(2) or Regulation D Rule 504 because they exceeded the investor limits, failed to provide investors with audited financial statements and effectively engaged in a plan to evade the registration statements.

The offering materials furnished to potential investors also misstated the use which would be made of the funds. The placement memoranda told investors that the funds would be used for general corporate purposes and working capital. In fact portions of the investor money went to the family for non-business purposes. For example, large bonus payments were made to family employees to cover personal expenses; payments were made to family members who provided no services; undocumented loans to family members; family life insurance policies were funded; and family estate planning services were purchased with offering funds. Overall about $3.2 million, representing just over 4% of the offering proceeds, funded these items.

To resolve the proceeding, Respondents agreed to implement undertakings which require them to inform investors of this proceeding and document the loans. They also consented to the entry of a cease and desist order based on Securities Act Sections 5(a), 5(c) and 17(a)(2). Mr. Scuderi agreed to pay a civil money penalty of $100,000.

ABA Seminar: Fifth Annual FCPA Update: Protecting Your Business in the Future: Lessons from the New DOJ-SEC FCPA Guide, June 19, 2013 from 1:00 -2:30 p.m. EST. The discussion will focus on building effective compliance systems and conducting M&A due diligence. Co-moderators: Thomas Gorman and Frank Razzano. Panel: John Buretta, Principal Deputy to the Assistant AG, DOJ; Charles Cain, Assistant Director, FCPA Unit, SEC Division of Enforcement; Catherine Razzano, Assistant General Counsel, General Dynamics Corporation; Steve Siegal, Senior Counsel, Northrop Grumman Corporation; Ryan Ong, President, U.S. China Business Counsel. Live in Washington, D.C at 600 14th St. N.W., Penthouse (no charge for ASECA members attending live in Washington who pre-register by sending an e-mail to cvitko.diane@dorsey.com). Webcast nationally by the ABA and available in other Dorsey & Whitney offices. For further information please click here.

For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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