An irreverent Wall Street Blog
SEC Sends Second Valentine Message Not Filled With Love
October 28, 2016
You only get so many rolls of
the dice at the crap table. You only get so many chances -- and second chances
-- in life. At some point, you either make your point or crap out. You either
walk away with your pockets filled with winnings or with a bit less cash than
you started out with. Some folks seem wiser for having taken a beating at the
tables. Some not. Consider a recent Securities and Exchange Commission
settlement involving a Registered Investment Adviser and its guiding light.
Case In
Point
John Leo Valentine was the
President and owner of Valentine Capital Asset Management, Inc. ("VCAM), which
was a Securities and Exchange Commission ("SEC") registered investment adviser
from 2006 until it ceased operations in May 2016. In its April 2015 Form
ADV, VCAM disclosed that it had about 300 advisory clients with $367
million assets under management. On May 25, 2016, VCAM filed for Chapter 7
bankruptcy. Valentine made all of VCAM's investment decisions and his client
bases consisted largely of the retired employees of an oil and gas producer in
Northern California. From 1986 to November 2011, Valentine was also a
registered representative with various broker-dealers.
Flick of the
Switch
In 2010, the SEC had settled
administrative and cease-and-desist proceedings against Valentine and VCAM for
failing to disclose a financial conflict of interest in connection with recommending
to his clients an exchange of Series A of a managed futures fund (20% invested
in commodities futures) for Series B (30% invested in commodities futures)
limited partnership units of VCAM. The fund at issue
charged investors a 4% annual commission, which maxed out at 10% after about
2.5 years, at which time the fund ceased passing further commissions to the
selling agent.
The SEC alleged
that the switch recommendations were prompted by the fact that many of the
clients would soon reach the 2.5 year commission cap and Valentine's and VCAM's
payments would end. In anticipation of the institution of proceedings by the
SEC but without admitting or denying the findings, VCAM and Valentine submitted
an Offer of Settlement, which the federal regulator accepted.
In
the Matter of Valentine Capital Asset Management, Inc. and John Leo Valentine,
Respondents (Order
Instituting Administrative And Cease-And-Desist Proceedings, Making Findings,
And Imposing Remedial Sanctions And A Cease-and-Desist Orders; '34 Act Rel. 63006; Invst. Adv. Act Rel. 3090;
Admin. Proc. File 3-14072 September 29, 2010) (the "2010 Order") As alleged in the 2010
Order:
11. Valentine was aware that his advice to his clients to exchange Series A shares for Series B shares would increase the brokerage commissions he received. Valentine's clients expected VCAM and Valentine to act as fiduciaries in connection with these investment recommendations. However, despite this, VCAM and Valentine failed to fully disclose their conflict to their clients.12. The Fund's Prospectus and exchange paperwork disclosed information about the switches. For example, the Fund's Prospectus stated that once an investor reached the 10% cap on commissions, the investor would receive rebated units from the Fund equal to the value of the monthly commissions. Similarly, the Fund's Series Exchange Subscription Agreement contained language informing investors that they would be charged the maximum 10% commissions for Series B regardless of any previous investment in Series A. Each client who made the switch signed the Series Exchange Subscription Agreement. However, VCAM and Valentine were still required to make full and clear disclosures about any conflict of interest in recommending the exchanges
In accordance with the terms of
the 2010 Order, Valentine and VCAM were censured and ordered
to cease-and-desist from further Advisers Act violations. VCAM was ordered to
pay its clients a $394,710.82 disgorgement with $37,296.71 prejudgment
interest. Valentine was ordered to pay a $70,000 civil money
penalty.
2016
Order
After getting hit with nearly a half a million in
disgorgement and penalties, you'd sort of think that Valentine had learned a
painful lesson disclosure and conflicts of interest. Alas, that was not the
case.
In anticipation of the institution of
proceedings by the SEC but without admitting or denying the findings, Valentine
submitted an Offer of Settlement, which the federal
regulator accepted. In
the Matter of John Leo Valentine, Respondent (Order
Instituting Administrative And Cease-And-Desist Proceedings, Making Findings,
And Imposing Remedial Sanctions And A Cease-and-Desist Order; '34 Act
Rel. 79126; Invst. Adv. Act Rel. 4557; Admin. Proc. File 3-17638 / October 20,
2016). (the "2016 Order").
Buy and Hold
As alleged in the 2016 Order,
from 2007 through the fourth quarter of 2011, Valentine recommended that
clients purchase and hold shares of a managed futures fund, Bridgeton Global
Directional Fund, LP ("Bridgeton"). Bridgeton paid monthly trailing commissions
on invested client assets the various broker-dealers where Valentine was
registered, and those firms paid to him about 90% of the commissions received.
Valentine purportedly used that commission stream to pay VCAM salaries and
expenses. Between 2010 and 2011, the trailing commissions of about $1 million
per year made up a significant percentage of Valentine's and VCAM's
income.
Up until
the onset of the Great Recession, Bridgeton allegedly
performed well but in 2009, its performance dropped about 20%, was inconsistent
in 2010; and in the first six months of 2011 was down 10%. In response to the somewhat dismal
performance, Valentine's clients raised concerns but he persisted with his
buy-and-hold strategy; and, few VCAM clients sold their shares with some adding
investment funds. By mid-April 2011, Bridgeton was VCAM's second largest client
position based on dollars invested.
Valt-ing
Ahead?
Starting in late 2010 and continuing through 2011,
Valentine formed Valt LP ("Valt"), which was another commodities fund that was
structured to utilize 11 commodity trading advisers to achieve better diversification.
Valentine was Valt's President and sole member of the General
Partner.
On November 10, 2011, in response to a request that
he terminate his registered representative status with his broker-dealer,
Valentine resigned and, as a result, was unable to receive further Bridgeton
commissions. At this point, Valentine recommended that clients sell Bridgeton
and purchase Valt. Although some clients had sold prior to Valentine's
resignation, between the date of his resignation and February 2012, 70% of his
clients sold their Bridgeton shares; and 36% of the VCAM clients who sold
during that period bought Vale as a replacement. The 2016
Order alleges:
11. Valentine knew that he lost his ability to continue earning Bridgeton commissionsafter resigning as a representative of his latest broker-dealer firm on November 10, 2011. Nevertheless, when recommending that clients switch their shares of Bridgeton for shares of Valt after that date, Valentine failed to disclose that he had a financial incentive to make the recommendation because he could earn money from Valt, but not Bridgeton.12. After just a few months of operations, Valt ceased nearly all trading activity whenits primary clearing broker and custodian declared bankruptcy in connection with a fraud conducted by the clearing broker's CEO. Valentine did not profit from Valt. He advanced money for certain Valt accounting, audit, legal, administrative and offering expenses, which, under the terms of Valt's offering and governing documents, were expenses that should have been reimbursed by Valt. The money Valentine advanced to Valt was never reimbursed, and it exceeded the amount of fees he received from Valt during its existence.
About That Custodial
Change
At this point, we need to do something of a rewind
and go back to the SEC's 2010 Order, which prompted VCAM's
custodian to terminate its relationship in March 2011. As more fully explained
in the 2016 Order:
15. As a result, Valentine needed to transfer VCAM's clients' assets to another custodian. Valentine did not, however, inform clients that the prior custodian had severed ties with VCAM. Instead, in a September 2011 letter to clients, Valentine claimed that it was his and VCAM's choice to change custodians based on a purported independent review that began in 2010: "As part of our Business Planning effort conducted late 2010, we established an initiative to review our relationships with all vendors, suppliers, and custodial service providers. . . . As a result of that initiative, earlier this year we selected and established a formal relationship with three new banks and two Custodians. . . .Our decision to move away from [the prior custodian] was not made lightly or without a complete review and analysis of benefits to both clients and [VCAM]." These statements were materially misleading. By misrepresenting that he had initiated the change in custodial firms, Valentine concealed the fact that the prior custodian had actually terminated the relationship between it and VCAM, and that the custodian had specifically identified concerns about the 2010 Order as a reason for the termination decision. The fact that a large, well-established financial institution like the custodian had concerns about the 2010 Order was important information because Valentine and other VCAM personnel previously minimized the significance of the order by telling clients that everyone who followed the recommendation underlying the earlier action made money. In December 2011 and February 2012, Valentine sent two additional letters to clients continuing to falsely characterize the move from the prior custodian to a new firm as the result of an independent decision made by VCAM after completing a business enhancement initiative.16. In these September 2011, December 2011, and February 2012 letters to clients, Valentine failed to employ reasonable care to avoid misleading his clients about the change in custodial firms. Among other things, Valentine and VCAM received written notice from the prior custodian in March 2011 stating that the custodian was terminating its relationship with VCAM. Additionally, an employee of the custodian told Valentine that the custodian's termination decision was based in part on concerns about the 2010 Order.
Two
Strikes And Yer Out
In accordance with the terms of the 2016
Order, Valentine was found to have willfully violated Section 206(2)
of the Advisers Act, which prohibits an investment adviser from engaging "in
any transaction, practice, or course of business which operates as a fraud or
deceit upon any client or prospective client." Accordingly, Valentine was ordered to
cease-and-desist further Advisers Act violation and was
(1) barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization with the right to apply for reentry after two (2) years to the appropriate self-regulatory organization, or if there is none, to the Commission;(2) barred from participating in any offering of a penny stock, including: acting as a promoter, finder, consultant, agent or other person who engages in activities with a broker, dealer or issuer for purposes of the issuance or trading in any penny stock, or inducing or attempting to induce the purchase or sale of any penny stock. Respondent Valentine has the right to apply for reentry after two (2) years to the appropriate self-regulatory organization, or if there is none, to the Commission.
Bill Singer's Comment
Compliments to the SEC for staying the course and
coming back for a second bite. Both the 2010 and the 2016 Orders are
well crafted and provide a compelling rationale for the sanctions imposed.