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News March 5, 2018 Issue

SEC Charges Hedge Fund Manager with Misrepresentation, Freezes Assets

Misrepresentation is misrepresentation, but sometime misrepresentation can go so far that a federal court has to step in and put a stop to the alleged activity until the charges are resolved. That is the situation that a purported hedge fund manager found itself in earlier this month.

The SEC on February 2 charged Nicholas Genovese, his advisory firm, New York City-based Willow Creek Advisers, and one of his funds with a number of misrepresentations made since at least 2014 to at least six investors from whom he raised $5.32 million, according to the agency’s complaint filed with the U.S. District Court for the Southern District of New York. The court on February 16, at the agency’s request, issued a temporary restraining order against Genovese, and ordered his, his firm’s and his fund’s assets, frozen.

"Nicholas Genovese represented himself as a successful hedge fund manager with a sterling pedigree and track record," said SEC New York Regional Office director Marc Berger. "In truth, he was a recidivist convicted felon who lost or outright stole most of the money that investors entrusted to him. We quickly sought emergency relief to stop Genovese’s ongoing fraud and to prevent the further dissipation of investors’ remaining funds."

The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges against Genovese in the matter, according to the SEC, which is limited to filing civil actions. In addition, one of his investors in January filed a complaint against Genovese and Willow Creek, as well as the fund involved, alleging fraud and other violations, the agency said.

Among the misrepresentations listed in the SEC’s civil complaint that Genovese allegedly made were that:

  • He managed $4 billion of the Genovese Drug Store family’s assets;
  • His advisory firm had $30 to $49 billion in assets under management, when he had less than $10 million in AUM;
  • His advisory firm had between 42 and 60 employees, when it had fewer than 10;
  • His hedge fund had investment gains of 30 to 40 percent per year, when it had actually sustained losses.
  • He had been a partner at Goldman Sachs and a portfolio manager at Bear Stearns.

Genovese made these false statements not only orally, but in a distributed private placement memorandum, the agency said.

"Many of these claims were so incredible that they should have raised red flags to those who heard them," said Rogers & Hardin partner Stephen Councill. Several of them, he said, "could have been verified relatively easily. For example, if someone has worked at Goldman or Bear Stearns, FINRA’s broker check web site will confirm this. Similarly, the claim to manage $30 to $39 billion in AUM would require SEC registration, and this could be verified on the IARD’s adviser search. Some claims are more difficult to independently verify, but these were low-hanging fruit for good due diligence."

"This story, unfortunately, is not a new one," said Paul Hastings partner John Nowak. "It is yet another reminder of the importance of due diligence when considering investment opportunities."

The fund and the investors

Among the prospective investors for the fund, known as the Willow Creek Fund, approached by Genovese were a Manhattan chiropractor and yoga instructor, according to the agency complaint. "Genovese claimed to be a successful hedge fund owner, bragging that he managed a $30 billion fund with some of the largest U.S. public and privately-held companies investing in his fund," the SEC said. While that investor, identified in the complaint as "Investor 1," ultimately chose not to place money with Genovese, he introduced Genovese to a friend, Investor 2, who, along with his brother, did.

"Genovese told investor 2 and Investor 2 Brother that Genovese was an heir to the Genovese Drug Store family fortune and that he managed his family’s assets," the SEC said. As a result of this and other misrepresentation efforts, including some of those listed above, "between November 2015 and January 2016, Investor 2 and Investor 2 Brother each invested $2 million in Willow Creek Fund."

After Investor 2 and his brother each invested in Willow Creek Fund, Genovese provided them with a PPM that contained many of the same misrepresentations, the agency said.

Other investors followed, according to the SEC complaint. These included Investor 3, who invested $1 million into Willow Creek Fund, and Investor 4, a friend of Genovese’s who was an actor living in Los Angeles. Investor 4, his wife and his private company invested approximately $320,000 in the fund.

A matter of redemptions

Genovese received a number of redemption requests from his investors. Here are some of those listed in the SEC complaint, as well as how he handled them:

  • Investor 2 Brother in mid-2016 asked for a partial redemption of $1 million. Genovese fulfilled that request.
  • Investor 2 and Investor 2 Brother in May 2017 requested the redemption of the remainder of their investments. "Although Genovese initially promised to return their residual investments by January 2018, they have not yet received those funds," the SEC said. "Recently, on January 26, 2018, when Investor 2 complained to Genovese about not being fully redeemed, Genovese responded that he would redeem only after ‘the stars have aligned’ and further stated that unspecified trading positions made it impractical to unwind Investor 2’s portion of the Willow Creek Fund/s assets." Investor 2 complained again to Genovese on January 30. "In these conversations, Genovese did not disclose that he had lost the bulk of Investor 2’s remaining investment by incurring massive trading losses," the agency said.
  • Investor 3 requested a redemption of his initial $1 million investment in late January 2017. He requested the redemption, according to the SEC, a month or two after Genovese had solicited him for an additional unspecified investment of between $2 million and $10 million. "Shortly thereafter, Willow Creek Fund returned the $1 million investment."

Examination staff responses

Genovese in January 2018 responded to a December 2017 voluntary request from the agency examination staff with a two-page document that claimed that, among other things, the advisory firm’s total AUM was approximately $5.38 million. This was a significantly smaller sum than the $30 billion to $39 billion in AUM that Genovese allegedly claimed it managed when conducting solicitations, and was listed in the complaint as an example of when "the defendants knowingly, or with reckless disregard, lied about the size of Willow Creek’s operations and its assets under management."

Following this two-page response, "Genovese refused to be interviewed by the Commission’s examination staff," the SEC said. "He also failed to produce any documents or appear for testimony in response to the enforcement staff’s subpoena."

Misappropriation

On top of the misrepresentation allegations, the agency also charged that Genovese and Willow Creek "knowingly or recklessly misappropriated the investor funds that comprised Willow Creek Fund’s assets."

"It appears that investor funds were initially deposited into Willow Creek’s or Willow Creek Fund’s bank accounts and then transferred, partially or entirely, to a brokerage account in Genovese’s name," the SEC said. What happened to this money? Between 2015 and 2017, according to the agency, Genovese’s brokerage account "sustained trading losses of more than $8 million from primarily options trading. Genovese also withdrew from his brokerage account a total of approximately $263,000 to pay for, among other things, ATM cash withdrawals, food, hotel and transportation charges, including being chauffeured in a Bentley."

Charges

Genovese and his fund, Willow Creek Investments, were each charged with violating Section 17(a) of the Securities Act, as well as Section 10(b) of the Exchange Act and its Rule 10b-5, all of which prohibit fraud. In addition, Genovese and Willow Creek Advisers were charged with violating Section 206(1) and (2) of the Advisers Act, both of which prohibit fraud, as well as Section 206(4) and its Rule 206(4)-8, which also prohibit fraud. An attorney representing Genovese, his advisory firm or fund could not be located for comment.