SEC Files Misrepresentation Charges Against Adviser Raising Money to Flip Real Estate
Flip or flop? Advisers seeking to raise money from clients and investors for the declared purposed of flipping residential properties would be wise to ensure that the dollars raised go to that purpose. The SEC has filed charges against an adviser and others for allegedly failing to do just that.
California-based Hoplon Financial Group, a state-registered adviser, and its chief executive officer, Daniel Vazquez, Sr., and its former chief operating officer, Gilbert Fluetsch, were charged by the SEC in U.S. District Court for the Central District of California on January 12 with misusing more than $780,000 of $2.18 million raised from investors, many of whom were advisory clients. The raised dollars were pooled in a fund to purchase and flip residential real estate properties, according to the complaint.
"Between 2011 and 2014, Hoplon and Vazquez sold membership units in the fund, raising $2.18 million from 27 investors, primarily from individual retirement account funds, based on misrepresentations about how much compensation they would take," the SEC said. The two, with the assistance of Fluetsch, then "misused most of the funds to pay unrelated business or personal expenses, including approximately $780,000 that was misappropriated since January 2013."
The agency is now seeking a permanent injunction against the firm, as well as disgorgement of any ill-gotten gains, and civil money penalties.
"If you represent that you are doing one thing with the money, but you instead do something else with it, you are in trouble," said Mayer Brown partner Richard Rosenfeld. "This settlement is a perfect example of the fact that the SEC, regardless of administration or politics, will always bring fraud cases. It’s the bread and butter of the Enforcement Division."
The advisory firm and what happened
Hoplon was a California state-registered adviser from 2010 through early 2015, when, according to the SEC complaint, its registration was revoked for failure to pay its annual registration renewal fee. The firm was founded by Vasquez, who also previously held both broker-dealer securities licenses and a state insurance license. The firm currently has no officers or employees other than Vazquez, no known ongoing business operations, and no known assets in its name, the agency said. Attempts to reach Hoplon and Vazquez, or an attorney representing them, were unsuccessful. An attorney representing Fluetsch did not respond to a voice mail or email seeking comment.
In 2010, shortly after Hoplon began business, Vasquez established a fund under Hoplon’s management that would pool investor funds to buy, refurbish and resell residential properties, the SEC said. The fund’s original private placement memorandum, according to the complaint, proposed offering membership units (referred to in the offering as "securities") that would be sold for $50,000 each, anticipating total offering proceeds between $2 million and $10 million, although the fund also reserved the right to sell less than the minimum subscription to investors. Distributions to investors would be made "’no less frequently than semiannually,’" the agency said, quoting from the PPM.
As for compensation to Vasquez and Fluetsch, neither of the two executives was to receive a salary from the fund, the agency said. Instead, Hoplon would be paid via a fee structure that provided three different forms of compensation:
An annual management fee calculated as 2 percent of the total capital raised from investors, plus the maximum amount of debt available to the fund;
An acquisition fee of 3 percent of the price of each new property purchased by Hoplon; and
A percentage of any "cash available for distribution," starting at 10 percent, but going up to as much as 45 percent, based on fund investors receiving a certain amount of capital.
Between 2011 and 2014, the SEC said, Vasquez raised about $2.18 million from 27 individual investors, 23 of whom were either current or former customers of his, including Fluetsch, who invested approximately $100,000 in the fund.
"A majority of [the fund’s] investors financed their ownership shares with retirement funds, purchasing their [fund] shares through a self-directed IRA administrator at Vazquez’s direction," according to the agency.
The statements made in the PPM and accompanying operating agreements were "false and misleading," the SEC said. The PPM "did not state that most of the money raised, along with all of the modest profits generated in any real estate transactions, would be diverted for the benefit of Hoplon and its principals."
"Vazquez and Fluetsch misappropriated . . . funds starting as early as mid-2011," the agency said. "They diverted funds from [the fund] to pay for Hoplon’s business expenses and Vasquez’s personal expenses and to make payments directly to themselves. These payments were far in excess of the maximum amounts set forth in the [fund] offering documents as compensation to Hoplon for managing [the fund]. Vasquez and Fluetsch also used . . . funds to perform renovations for their own homes."
The fund bought eight properties in Southern California between April 2012 and July 2013, according to the SEC. "However, the amount of money spent on these properties never came close to matching the total amount of investment funds raised."
"[The fund’s] investment activities rapidly declined over the subsequent months, even as [the fund] continued to raise additional funds from investors, and even as proceeds from the sale of earlier-purchased properties were supposedly retained to be reinvested into new properties," the agency said. "Between June 20, 2012 and July 24, 2013, [the fund] sold six properties, but bought only four. Meanwhile, during this same time, it raised an additional $1.18 million in new investments, including approximately $160,000 that came in after [the fund] had ceased buying properties altogether."
As it turned out, the fund’s real estate transactions did make a small profit, the SEC said, generating more than $917,000 in net proceeds. This amount was not enough, however, to cover the amounts that were diverted to Hoplon, Vasquez and Fluetsch.
Treatment of investors
In addition to allegedly diverting money for their own use, Vasquez and Fluetsch "also made materially false and misleading statements regarding [the fund] to prevent investors from withdrawing their money," the SEC said.
Several investors complained to Vasquez about the lack of reporting on their investments, according to the complaint. In response, the agency said, Vasquez prepared and sent financial statements to some investors in 2013 and early 2014 that "purported to show, for each property owned by [the fund], a calculation of the net income to [the fund] from the purchase and sale of that property, as well as the portion of the profits from each property that were supposedly assigned to the individual investor receiving the statement."
Unfortunately, these statements "failed to disclose that investor capital and profits were simultaneously being spent on unrelated business and personal expenses and the payment of excessive fees," the SEC said.
After some investors began asking Vasquez to withdraw their investments, the complaint said, he responded with "a series of excuses for why he was unable to return the money, never informing them that the . . . funds were by that time completely gone. To others, he simply never responded at all. With the exception of one small payment of purported profits to a single investor, none of the [fund] investors ever received any profits or principal from [the fund] or Hoplon."
"If there is a lesson for advisers here," said Faegre Baker Daniels partner David Porteous, "it may be that funds formed to invest in real estate may still give rise to securities laws implications by both selling interests in the funds that are securities and acting as unregistered broker-dealers, specifically with regard to when they act outside the scope of their registrations with their existing broker-dealer firms."
Hoplon, Vasquez and Fluetsch were each charged with violating Section 17(a)(2) of the Securities Act for their allegedly false and misleading statements in the PPM and operating agreements, as well as their alleged misrepresentations to investors as to how the funds were performing.
Hoplon and Vasquez were additionally charged with violating Section 10(b) of the Exchange Act and its Rule 10b-5 for much the same alleged conduct. Fluetsch was charged with violating Section 10(b) and its Rule 10b-5 for aiding and abetting Hoplon and Vasquez in their alleged violations of the same Section and Rule.