On August 10, 2016, the Securities and Exchange Commission (SEC) announced the initiation of enforcement proceedings against former Philadelphia Eagles Merrill Robertson Jr. (Robertson), his business partner, Sherman C. Vaughn Jr. (Vaughn), and the company they jointly operated, Cavalier Union Investments, LLC (Cavalier), for allegedly carrying out a $10MM Ponzi scheme that included senior citizens and former coaches, donors, alumni and employees of schools previously attended by Robertson.
How did the scheme operate?
According to the SEC, Robertson and Vaughn pitched themselves as experienced investment professionals, although neither was registered with the SEC during the time period in which they allegedly carried out the Ponzi scheme.
Robertson and Vaughn also presented Cavalier as a diversified company with a variety of divisions, funds and advisers, claiming they had investment advisers who managed funds that invested in restaurants, real estate, alternative energy and assisted living facilities and their investment portfolios were secured by tangible assets that generated a cash flow in excess of what was being paid on investments.
With this attractive picture painted, the Cavalier team solicited investment funds from prospective investors through promissory notes offered at 10-20 percent annually.
Although Robertson and Vaughn painted a rosy picture of Cavalier, the SEC claims the picture was other than how it was presented. Specifically, Cavalier didn’t have a diversified investment portfolio at all. Instead, the SEC complaint states all the representations were false, and Cavalier was relying on investment proceeds from new investors to pay back older investors who were asking for their money. (This is textbook Ponzi scheme in action.) The investments that Cavalier did make, which were in a couple of restaurants, suffered substantial losses and ended up closing, but despite these failures, the Cavalier team continued to actively seek funds from new investors by promoting these failed investments.
Drops, Inc.
One of the more egregious acts alleged to have been carried out by the Cavalier team revolves around a water-bottling company called Drops, Inc., which they claimed had a “unique” seven step process for energizing the water it bottled.
In order to entice investors to invest in this company, Robertson and Vaughn created fictional invoices and financial statements. Financial projections that showed Drops' revenue would increase to $30M over 5 years were also provided. Unbeknownst to investors, however, the financial projections were not based on any study, analysis, evaluation or practical methodology.
In its complaint against Robertson, Vaughn and Cavalier, the SEC further claims the Drops' offering materials misrepresented Robertson’s and Vaughn’s investment qualifications. In one of these documents, Robertson claimed to have managed a $250M portfolio and owned Black Bull Wealth Management, which managed a fund that included investments in apartment funds, opportunity funds, development funds and as real estate investment trusts (REITS). While it was true Robertson did own Black Bull Wealth Management, the SEC says the investment firm never had any clients or managed any funds.
If the misleading invoices, financial statements, financial projections and professional qualifications weren’t enough to entice investors, Robertson and Vaughn went as far as to create a bank confirmation letter that stated Cavalier had $11M in its bank account. In fact, not only did Cavalier not have $11M in its bank, it didn’t even have an account with that specific bank.
What type of investment product was used by Cavalier?
Cavalier used promissory notes that promised to pay a fixed rate of return between 10 and 20 percent annually as the primary investment product. (These interest rates alone should have been red flags for investors.)
To make the deal even sweeter, the Cavalier team falsely stated that the notes would be secured by a security agreement and perfected with UCC financing statements. Specifically, the Cavalier team claimed investors would have a security interest in the “equipment, fixtures, inventory and accounts receivable of the business known as Cavalier Union Investments.”
Not only did the Cavalier team not create any security agreements or financing statements, but since the company was effectively insolvent, a security interest in any asset would have been worthless.
What happened to the cash?
Generally, when the SEC alleges a Ponzi scheme was used by a group of defendants, claims of using investment proceeds for personal expenses arise. This Cavalier case is no different.
According to the SEC, Robertson and Vaughn used investment proceeds to purchase
cars,
personal debt repayment (such as mortgage debt and credit-card debt),
clothing,
entertainment,
family vacations,
spa visits,
luxury goods,
donations and gifts to alma maters and churches,
educational expense for family members, and
a luxury suite at a football stadium.
Approximately $6M of the $10M raised from more than 60 investors during 2010 to 2016 lined the pocked of both Robertson and Vaughn.
How can you make sure this doesn’t happen to you?
Check your advisors
Before you hand over any money, check out the background of your investment professionals by asking if they are registered with the SEC, Financial Industry Regulatory Authority (FINRA) or a state securities agency. If they say yes, you can verify the accuracy of their answers by searching for names in the SEC’s investment adviser database or FINRA’s BrokerCheck database or calling your state securities agency and asking them. All of these agencies are strong advocates for researching the background of your investment professionals, even if you think you trust them. I'm inclined to agree with them.
You can find more websites for checking your investment professional’s background by visiting this extensive list of websites here:
Check for red flags
Right now, we don’t know how much the Cavalier team pressured investors to purchase (if they did at all), but of the red flags on the McCauley Pre-Investment Checklist [PDF], the most obvious one is the touting of a low risk, high interest rate security.
Interest rates anywhere near 10+ percent annually just scream risky, which means more due diligence needs to be performed. In some circumstances, a security interest in assets pledged as collateral to a loan can be used to reduce some of the risk, but the security interest needs to be completed properly by both the creditor and the debtor.
As mentioned above, Cavalier didn’t actually complete any security agreements or file a financing statement that showed any claims to certain assets, which means those investors were not secured parties. So these investors may be S.O.L. on their investment funds.
While security interests deserve a separate post, the key point in this section is to go through the Pre-Investment Checklist [PDF] before investing. It won't cover all the red flags, but it'll give you a good start on sniffing out a potential scam in the making.
Chris McCauley, CPA, Esq. is the founder of McCauley Investment Risk & Legal Consulting PLLC, a Seattle-based law firm dedicated to helping professional athletes guard their earnings and investments. Chris is an attorney licensed to practice in Alabama and Washington and a CPA licensed to practice in Washington and North Carolina.