SEC Fines Registered Investment Adviser and Officers for Failure to Disclose Financial Condition to Clients
The SEC has ordered a total of $100,000 in civil penalties to be paid by AmericaFirst Capital Management (“Adviser,” “Firm,” “AFCM”) and related persons, Rick Gonsalves (CEO) and Robert Clark (President and COO). The order stems from disclosures violations committed by the AFCM, Gonsalves, and Clark during their ill-fated attempt to rescue the Investment Adviser from financial distress.
At the end of 2012, AFCM found itself struggling financially, with ongoing expenses (approximately 2.3 million) exceeding the revenue generated by advisory fees ($1.4 million) by nearly 65%. In order to pay the Firm’s bills, AFCM CEO Rick Gonsalves determined to raise money through the issuance of unsecured promissory notes to retail investors at a 12 percent interest rate. All such promissory notes bore maturity terms of a year or less.
During the relevant period, Gonsalves directed AFCM President and COO Robert Clark, to solicit friends, family members, and AFCM Advisory clients to invest in the promissory notes. During his conversations with prospective noteholders, Clark represented that AFCM was profitable and that the notes on offer would provide predictable, high-interest income. Although Clark had disclosed that revenue generated from the promissory notes would supplement AFCM’s cash flow, he failed to disclose that AFCM actually required the additional cash to cover ongoing expenses or that noteholders might not be repaid without significant long term growth in other firm revenues.
Upon issuing or renewing the promissory notes, AFCM further failed to disclose in writing, or otherwise, the degree of risk investors faced in purchasing or renewing the notes. According the SEC, Gonsalves assumed his staff would provide financial statements to noteholders but did not follow up to ensure any such disclosure actually occurred. At all relevant times, Gonsales and Clark were aware of the Firm’s poor financial condition.
At the time of issuing its order, the SEC found that AFCM currently held a promissory note balance of more than $2 million. Although the Firm had so far managed to remain in operation and make timely interest payments to noteholders, the Firm had not achieved significant revenue growth from any other sources.
Section 17(a)(2) of the Securities Act prohibits individuals, “in the offer or sale of securities, to obtain money or property by means of any untrue statement of material fact or any omission to state a material fact necessary…to make the statement…not misleading.” Additionally, Section 206(2) of the Advisers Act prohibits Investment Advisers from “directly or indirectly engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” Because Gonsalves and Clark’s failed to disclose AFCM’s financial condition to investors and prospective investors in the promissory notes, the AFCM officers caused AFCM to willfully violate the above anti-fraud provisions of both the Securities Act and Advisers Act. For their part, Gonsalves and Clark were both ordered to pay separate civil penalties in the amount of $25,000. Meanwhile, the Firm itself was ordered to pay an additional $50,000.
Although AFCM’s failures to disclose were rather egregious, most disclosure obligations (imposed by securities law and related rules) are neither obvious not straightforward. If you have any questions regarding your disclosure obligations or require any assistance to ensure that such disclosure obligations are met, please call us at 888.302.4594 or email us at email@example.com and we will be happy to assist.