RIA Compliance Blog
The Securities and Exchange Commission (“SEC”) recently brought an administrative proceeding against unregistered fund manager Steven Zoernack and his firm, EquityStar Capital Management, LLC (“EquityStar”), for engaging in allegedly fraudulent conduct in violation of federal securities and investment adviser laws. Mr. Zoernack and EquityStar allegedly concealed Mr. Zoernack’s criminal history, used false identities, and distributed false and misleading marketing materials, among other things, in their bid to lure investors.
As alleged, Mr. Zoernack created EquityStar in May of 2010 to serve as the investment adviser for two private investment funds, Global Partners and Momentum. Between 2011 and 2014 Mr. Zoernack actively sought investors for the two funds, managing to sell approximately $5.6 million of interests in Global Partners and Momentum. As EquityStar’s managing member and sole employee, he handled all activities of the firm and drafted all marketing and offering materials. In the furtherance of these activities, Mr. Zoernack allegedly made many material misrepresentations to investors and prospective investors regarding himself and EquityStar.
According to the SEC, these misrepresentations were particularly rampant in EquityStar’s marketing materials. In an effort to create the illusion that EquityStar had more than one employee, Mr. Zoernack allegedly used several false identities in communications with investors and prospective investors. In addition, he allegedly claimed that the fund’s manager had “an impeccable and unblemished past record” with the SEC. This claim was false, as Mr. Zoernack in fact had two criminal convictions for fraud and had various money judgements and liens against him. He also had previously filed for bankruptcy. Mr. Zoernack allegedly attempted to hide this information by hiring an Internet search engine manipulator to make negative information about his criminal history and financial past appear less prominently in his search results.
The SEC also alleged that in order to get a five-star investment fund rating, Mr. Zoernack provided false and misleading performance data to Morningstar, an independent investment research firm that compares a fund’s past performance with other similar funds. His performance data allegedly misrepresented that Momentum had a history of high returns dating back to 2009, and that it had more than $120 million in funds under management. In fact, Momentum was not created until 2012 and the data provided was merely hypothetical performance data based on a back-testing algorithm. In addition, the SEC alleged that the fund never had more than $3 million in funds under management.
Mr. Zeronack also allegedly used misleading performance data in marketing and solicitation materials provided to investors and prospective investors. He calculated hypothetical performance data using his own back-testing algorithm; however, the materials generally did not contain required disclosures that the performance data did not portray actual results. When a disclosure was included, it was placed in a small footnote that the SEC alleged was misleading and confusing.
The misrepresentations were so rampant that EquityStar’s fund administrator and outside auditors and lawyers all resigned. Nevertheless, Mr. Zoernack continued to misrepresent in solicitation emails that EquityStar used outside auditors and an independent fund administrator, as well as being five-star rated. He also made more than $1 million unauthorized withdrawals from the investment funds, in addition to the fees and expenses authorized by the funds’ offering memoranda. This money was used by Mr. Zoernack for personal expenses. Although he attempted to characterize them as loans that he would repay, Mr. Zoernack never repaid the loans or paid any interest.
As a result of these actions, the SEC charged Mr. Zoernack and EquityStar with violations of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940.
This matter is a strong reminder of the emphasis the SEC places on misrepresentations in investment fund marketing and offering materials. Performance data, in particular, must always be accompanied with appropriate disclosures that are not misleading or confusing, especially if hypothetical results are used.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Visit our website for more information.