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Red Oak Blog

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Saturday, February 10 2018

SEC Files Federal Complaint Against Texas-Based Bad Actors

On December 5, 2017, the Securities and Exchange Commission (“SEC” or the “Commission”) filed a Complaint in the United States District Court for the Southern District of Texas against James Tao (“Tao”) and Donna Boyd (collectively referred to herein as the “Defendants”). The Complaint alleges that while both individuals were affiliated with a registered investment adviser and broker-dealer (the “BD/RIA”), they formed a private equity fund without their employer firm’s permission or knowledge. In addition, the Complaint alleges violations of the Securities Exchange Act of 1934 (the “Exchange Act”) and the Investment Advisers Act of 1940.

For more than three years, the defendants operated a branch office location under their affiliate firm. They were compensated for providing advice to advisory clients as to “the value of securities and the advisability of investing in, purchasing, or selling securities.” While affiliated with the BD/RIA, the Defendants started a private equity fund and convinced clients of the BD/RIA and other investors to invest in the fund. The Defendants never submitted the private equity fund to the BD/RIA for consideration and instead, solicited investments in the fund without the BD/RIA’s knowledge. These activities were hidden from the BD/RIA, as the Defendants knew they would get in trouble for “selling away”.

After initially raising funds for the private equity fund, James Tao and Donna Boyd had a personal disagreement which resulted in them no longer conducting business together. James Tao continued to raise money for the private equity fund for several more years, however. Approximately $860,000 was raised for the private equity fund from 25 investors in multiple jurisdictions. The Defendants contributed their own capital to the fund along with client investments which ranged from $5,000 to $200,000.

The Defendants created a private placement memorandum (“PPM”) which was used to solicit investors. The PPM contained misrepresentations and false statements, such as a claim that the fund had a 12% historical rate of return. James Tao determined that rate of return by conducting research via the internet and learning that 12% was the average rate of return for all private equity funds over the past 20 years.

The PPM also stated that investor funds would be used to invest in private companies and real estate developments, however, the funds were also invested in James Tao’s own companies or entities in which he had a personal stake. More than $200,000 was used to start or benefit said companies. Tao’s failure to disclose this as a conflict of interest prevented his clients from considering his lack of independence as it related to the fund. As a result of his failure to disclose these conflicts, Tao breached his fiduciary duty to his clients.

Tao misappropriated and misused investor funds when he used $40,000 contributed by investors to pay a $40,000 loan origination fee to the relative of a fund employee. The business loan of $4,000,000 was supposed to be used to increase the amount of money under management in the fund. The employee’s relative disappeared after receiving the $40,000 loan origination fee, without ever producing the promised loan. Tao then mislead investors regarding the reason for the loss of the $40,000.

Upon receiving a complaint from an investor, the BD/RIA learned about the private fund after an investigation, and terminated Defendants in March 2016. As a result of these summarized activities and others, the SEC filed a Complaint in federal court seeking an injunction against the Defendants, disgorgement of ill-gotten gains and an order imposing civil penalties against the Defendants. Click here to access the SEC’s full Complaint.

The SEC’s Complaint highlights the fiduciary duty investment advisers have requiring them to act in their clients’ best interest. Contact us regarding questions you may have related to your duties as an investment adviser including the required disclosure of conflicts of interests.