On March 12, 2015, the Financial Industry Regulatory Authority, Inc. (“FINRA”) announced that, as part of a proposed settlement, it ordered Brookville Capital Partners, LLC (“Brookville”) to pay a $500,000 fine and return more than $1 million in customer funds fraudulently invested in a pre-IPO stock scam involving private placements in a company purportedly holding Fisker Automotive, Inc. (“Fisker”) stock. In addition to the fine, FINRA barred Brookville president Anthony Lodati (“Lodati”) from the securities industry. FINRA issued a press release on its enforcement action against Brookville and Lodati that may be found here.
Founded in 2007, Fisker was one of the companies leading the recent electronic car renaissance through the development of green vehicles. A green vehicle is an automobile that is powered by alternative fuels, rather than diesel or gasoline. By 2009, Fisker stood poised to take on the automotive industry as one of the first producers of green vehicles after it received a near $600 million loan from the United States Department of Energy, and over $1 billion in funds raised through private investment. However, in March 2013, after lawsuits, missed government benchmarks resulting in a freeze of its line of credit, a costly recall of its batteries and the subsequent bankruptcy of its battery supplier, Fisker too filed for bankruptcy.
While Fisker generated significant private investment during its heyday, the company never went public through an initial public offering (“IPO”). Recently, the Securities and Exchange Comission (“SEC”) has fined, sanctioned and barred brokers for selling illiquid Fisker shares to retail customers as part of a pre-IPO fraud.
Generally, a securities offering must either be registered with the Securities and Exchange Commission (“SEC”) be exempt from registration under the federal securities laws. In a pre-IPO fraud, the customer is sold unregistered and illiquid securities in a company under the false pretext that an approaching IPO will soon make the shares liquid and result in dramatic profits for the investor. These unregistered shares are often called “private placements” and can be very risky investments because absent an IPO, the investor may never be able to sell their shares on the open market. However, even if the company in question goes public, some investors may still not be able to sell their shares through the IPO because these private placements could have lock-up provisions preventing the customer from participating in the IPO or from selling the shares until a fixed period of time has passed after the IPO.
FINRA found that from January to October 2011, Brookville and Lodati defrauded Brookville customers through the sale of a private placement offering named Wilshire Capital Partners Group LLC (“Wilshire”). Wiltshire was a special purpose vehicle (“SPV”) designed to hold Fisker private placements. Wilshire’s managing director and CEO was John Mattera (“Mattera”), a convicted felon whom the SEC prosecuted for securities fraud in 2010. FINRA stated that Lodati knew or should have known of Mattera’s criminal past and nonetheless recommended that at least 29 customers purchase fractional interests in Wilshire, resulting in the transfer of over $1,000,000 in customer funds to Wilshire and Mattera. For his role in the fraud Lodati and Brookville received approximately $104,000.
FINRA found that Lodati ignored numerous red flags and failed to perform adequate due diligence with respect to the Wilshire investment. On June 10, 2011, at least two months after Brookville and Lodati began recommending the Wilshire investment to their customers Fisker’s counsel informed Lodati that Wilshire held Fisker shares, but that the shares had significant limitations on transferability. The stock purchase agreement between Wilshire and Fisker potentially prevented Wilshire from selling an interest in the shares through a SPV to Brookville customers. If Wilshire violated the terms of the purchase agreement, Fisker had the ability to rescind the sale of shares to Wilshire or deny a transfer of ownership of the Fisker shares from Wilshire to Brookville’s customers. Shockingly, neither Lodati nor Brookville disclosed this fact to Brookville’s customers.
In November 2011, the SEC prosecuted Mattera for a related fraud involving the escrow company used to process the Brookville customer’s investments in Wilshire. Mattera was subsequently charged criminally by the United States Attorney’s Office for the Southern District of New York, pled guilty to the criminal charges, and sentenced to 11 years in prison. As a result of the SEC investigation, the Wilshire assets have been frozen and Brookville customers still cannot access their purported investments in Fisker stock.
FINRA found that from April to October of 2011 Brookville and Lodati made false and misleading statements in connection with the sale of securities in violation of the Securities and Exchange Act of 1934 § 10(b), Rule l0b-5 promulgated thereunder, and FINRA Rules 2020 and 2010. According to FINRA, Lodati knew about Mattera’s criminal background and his involvement with Wilshire, but failed to explain Mattera’s involvement with Wilshire to Brookville customers. Furthermore, Lodati and Brookville distributed a private placement memorandum to customers that failed to mention Mattera, his criminal background and his involvement with Wilshire.
FINRA also found that Lodati and Brookville made unsuitable recommendations of the Wilshire investment in violation of NASD Rule 2310 and FINRA Rule 2010. Under these rules, a broker-dealer and its registered representatives must satisfy a “reasonable basis” suitability requirement, pursuant to which they must understand the recommended security or strategy and the risks involved and determine whether the recommendation is suitable for at least some investors. However, instead of performing the required due diligence, Brookville and Lodati ignored several red flags, and falsified reports stating that they performed due diligence on the Wilshire investment.
NASD Rule 3010 requires each member to establish and maintain a system to supervise the activities of its businesses and associated persons that is reasonably designed to achieve compliance with applicable securities laws and regulations and NASD/FINRA Rules. However, Brookville either did not have adequate supervisory systems in place, or Lodati used his position as principal of Brookville to ensure that those supervisory procedures were not followed.
If you have any questions about private placement investments, pre-IPO fraud or believe that your broker may have engaged in other misconduct in your account, please contact Lax & Neville LLP today at (212) 696-1999 to schedule a consultation.