On a regular basis, the Securities and Exchange Commission (SEC) will publish its claims against alleged violators. The frequency in which the SEC and whistleblowers uncover investment fraud is high and happens with advisors, brokers and money managers that were once trusted professionals. As a result, vigilance and the willingness to blow the whistle should never end for an investor. In this post, we'll go over an investment fraud that proves being skeptical about what you're investing in is wise.
What were the investment opportunities? John Clifford Williams (JCW) founded two entities that he controlled by himself. Those two were Energy Operations Trust (EOT) and American Hydraulic Power, LLC (AHP). JCW set up EOT through Renewable Utility Development, LLC, which was another entity JCW founded and controlled alone. EOT offered investment units that were supposed to return revenue derived from mineral rights for gold and manganese out of Central America back to the investor. AHP offered an opportunity to be a part of the development and commercialization of energy efficiency technology licensed from the U.S. Environmental Protection Agency. JCW also promoted opportunities to invest in the development of an island off the coast of Panama (Bona Island) and to gain access to a large bank account in the Netherlands (Namasta). How much was invested? JCW raised $8,144,850 from Anonymous Investor between 2009 and 2014. Approved investment amounts are as follows:
$2,603,850 invested in EOT
$5,500,000 invested in AHP
$36,000 invested in Namasta
$5,000 invested in Bona Island
What went wrong?
The Securities and Exchange Commission (SEC) claims JCW did the following:
Told Anonymous Investor that all of the investment proceeds would go exclusively to the investment ventures, but some proceeds actually went to JCW's personal expenses.
Failed to disclose he was the sole owner of EOT.
Misrepresented the legitimacy of the ventures by hiring more expensive large, reputable professional firms to prepare deal documents and sharing correspondence with such firms.
Told Anonymous Investor there were other investors in the EOT venture when Anonymous Investor was the only one.
Used investment proceeds for travel and salary expenses. Proceeds were not authorized to be used for these expenses.
Failed to disclose actual reasons for failure of EOT.
Failed to pay fees to an engineering firm for AHP as promised, resulting in operations being discontinued.
How much was misappropriated? According to the SEC, JCW misappropriated at least $3,148,308, or roughly 39%, of the investment proceeds provided by Anonymous Investor. How were the funds used? This securities enforcement action accounts for approximately $1,800,000 of investment proceeds in the list below. At the time of this writing, the remaining misappropriated $1.4 million has not been allocated to any specific expenses yet.
$10,000 for JCW's daughter's wedding.
$67,500 to JCW's domestic partner for household expenses.
$32,000 to a JCW-owned bank account shared with his daughters.
$150,000 in cash withdrawn.
$437,500 to pay for credit card bills, restaurant and grocery bills, healthcare expenses, holiday gifts and entertainment expenses.
$340,200 for domestic and international travel not approved by Anonymous Investor.
$389,000 to an unapproved, separate venture involving a California-based water engineering firm.
$100,000 to an unapproved, separate venture that turned out to be a fraudulent scheme.
$271,000 in an investment that went beyond the $36,000 investment approved by Anonymous Investor.
How could this loss been mitigated or avoided? 1. Interview other investors If the business owner has had other ventures, ask to talk with any investors who may have funded those ventures. If business owner refuses, alarms should go off in your head. 2. Regularly examine accounting books In your deal documents (such as an operating agreement, subscription agreement, stock purchase agreement, etc.), give yourself the right to examine all accounting books and related work papers, including, but not limited to, bank statements, invoices, checkbook register, financial statements and tax returns, at any reasonable time and without notice required. I suggest omitting a notice requirement (such as, "investor must provide company with a minimum of 30 days notice prior to examining accounting books"), so if something is going on, the business owner doesn't have time to clean it up. You could required audited financial statements, but this would increase your professional expenses. Depending on the project, this expense may not be warranted. 3. Meet other investors Find out if other investors are investing in the same project as you. If you are the only one, ask why. While being the only investor isn't necessarily a red flag, you should find out why the business owner or promoter/broker could not find any other potential investors. If there are others, ask to meet other investors that will be participating in the investment with you. Any hesitation by the business owner or promoter/broker to let you meet other investors should be a red flag. 4. Review venture documents in detail Depending on the type of venture opportunity, you may have a variety of documents to explain the business model, business, investment and marketing strategy, expected returns, etc. These documents may include an offering document, such as a prospectus, or a business plan. These documents should be reviewed in detail by you or a trusted advisor, such as a financial advisor, CPA or attorney. If these documents claim rights to certain assets in domestic or foreign locations, you should review and validate these claims, especially if the business depends on these rights. For example, if a business owner claims ownership of certain real estate properties, check out the deeds in the record books in county where the property is located and look at appraisals from an independent, certified appraiser. 5. Require Use of Proceeds Disclosure As an investor, an itemized list of the use of proceeds would be extremely beneficial. This list will help both parties understand exactly how the investment proceeds will be allocated. A use of proceeds list may look like the following: Purchase Real Estate Property $1,000,000 Attorney's Fee 25,000 Appraisal Fee 1,000 Total $1,026,000 6. Use BrokerCheck by FINRA If someone other than a business owner is offering you investor opportunities, you can use BrokerCheck by FINRA check to see if they are registered to sell securities and whether there are any red flags in their FINRA profile.
McCauley Thoughts: What else could Anonymous Investor have done to prevent these losses? At what point do you stop trusting words from a business owner or promoter and start asking for verifiable details?
Disclaimer: The U.S. Securities and Exchange Commission alleges the claims stated above in this blog. JCW may not be found liable for any of the claims alleged in the SEC complaint. Source: U.S. SEC v. John Clifford Williams No.15-CV-819 (W.D. Mo. October 20, 2015)