In the Courts

New York Brokerage and Two Executives Ordered to Pay $1.58 Million for Misleading Investors In High-Yield Securities Case

On Sept. 23, 2019, New York brokerage firm, Portfolio Advisors Alliance Inc. (Portfolio), along with two of its senior executives, were ordered to pay a combined total of $1.58 million in civil penalties, disgorgement and interest after being found guilty of fraud for lying to investors by a Manhattan federal jury in May 2019. Howard Allen, Portfolio's indirect owner, and Kerri Wasserman, its president and one-time Chief Compliance Officer were found guilty of aiding and abetting Portfolio's violations as well as being liable as control persons who operated the brokerage. The trial proceeded before Judge Kimba M. Wood in the U.S. District Court for the Southern District of New York.

The fraud related to approximately $860,000 in commissions earned by the defendants between 2011 and 2013 as they sold $9 million of shares in lender American Growth Funding II LLC (American Growth) while making material misrepresentations and omissions about the fact that it hadn't been audited. In fact, the lender was not audited until 2014. American Growth raises capital from investors to provide higher-risk, high-interest loans to businesses that are not supported by more traditional lenders. American Growth and its principal, Ralph Johnson, had earlier settled with the SEC, with Johnson agreeing to pay $75,000 in civil penalties without admitting or denying the SEC's allegations.

At trial, the SEC alleged that the defendants, American Growth and Johnson had assured more than 80 individual investors that they would receive 12% annual returns on their purchased shares and misrepresented in a private placement memorandum that the lender had been audited when in fact it had not. In addition, a substantial loss in value on American Growth's primary asset was concealed from investors. The SEC contended that Portfolio knew of material omissions in the offering documents but failed to correct or notify clients as to these inaccuracies.

In closing arguments, the SEC alleged that the defendants were motivated by greed for higher commissions from the sale that were a vital source of revenue for the brokerage. Allen and Wasserman had a duty to correct the audit misrepresentations but failed to do so — with the SEC noting that Allen himself held an ownership stake in American Growth and that Wasserman had served as the brokerage's Chief Compliance Officer in 2011 prior to his appointment as President. Portfolio denied liability on the basis that it was up to American Growth to audit itself, characterizing the audit representations in the offering documents as a harmless mistake that in any case did not cause the investors to lose any money. The jury deliberated for approximately six hours before finding the brokerage, Allen and Wasserman liable on all counts brought by the SEC.

Following the jury's verdict, Judge Wood ordered the defendants to pay a combined total of $1.58 million — including disgorgement and interest of over $1 million to be paid by Portfolio (relating to the amount earned in commissions on the sale) and imposing a $200,000 civil penalty on the brokerage. Allen was also found jointly and severally liable for Portfolio's disgorgement and pre-judgment interest as an owner of the brokerage who had sold the majority of the American Growth investments. The defendants had earlier disputed the disgorgement calculation, relying on a statement by Wasserman as to her review of Portfolio's books and records that was rejected by the Judge as containing "no citations or supporting documents to substantiate her fact-bare assertions." Allen was also required to pay around $400,000 in disgorgement and interest with a civil penalty of $120,000. Finally, Judge Wood ordered that Wasserman pay a $100,000 civil penalty.

While Judge Wood mostly granted the relief sought by the SEC (including permanent injunctions barring the defendants from committing future securities fraud), the amount in civil penalties was less than the maximum allowable penalties sought by the agency. The Judge found that applying the maximum penalties would be "unduly penalizing" given that the fraud had not resulted in "substantial losses" to investors.

According to the Judge: "The violations continued over a period of years, and were not simply an isolated occurrence of bad judgment," with the defendant's "continu[ing] to dispute their blame for the illegal conduct." Allen and Wasserman remained employed as registered broker-dealers at Portfolio at the date of the Judge's Order, with Counsel indicating that they intend to appeal the decision.

The case is SEC v. American Growth Funding et al., in the U.S. District Court for the Southern District of New York (No. 1:16-cv-00828).

— Juliet Gunev, Mayer Brown LLP