Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—E.D. Tex.: Summary judgment entered in Ponzi scheme where defendants failed to address SEC’s motion, (Jan 31, 2022)

By Jeffrey H. Brochin, J.D.

A default Judgment for securities fraud was entered against a Texas investment firm that failed to obtain new counsel after attorney withdrawal, where LLC was not permitted to proceed pro se in federal court.

A federal district court in Texas has entered summary judgment in favor of the SEC against the CEO and CFO of a Texas investment firm, KS Cartel, LLC, and a default judgment against the firm itself. Both officers proceeded pro se after their attorney withdrew, but they failed to offer responsive pleadings that sufficiently addressed the SEC’s allegations in their motion for summary judgment. A default judgment was entered against the firm because entities are not permitted to proceed pro se in federal court and the entity failed to obtain new counsel after the original attorney withdrew (SEC v. Silea, et al, January 27, 2022, Jordan, S.).

Parking lot solicitations. The CEO and CFO (collectively defendants) founded KS Cartel in July, 2017, and as alleged in the SEC complaint, from October 2017 through July 2020, they raised approximately $1,044,918.52 from investors by offering and selling membership interests—'Units’—in KS Cartel for cash. The offers and sales of these Units were not registered with the Commission. The CEO solicited investors by, among other means, approaching people he did not know in store parking lots and other locations. The CFO solicited investors by, among other means, communicating with people he did not know via the LinkedIn and Shapr networking platforms. Both men also personally met with prospective investors to solicit their investments and they offered and sold Units to investors in Texas, New Mexico, California, New York, and New Jersey, among other states.

Fraudulent ROI claims. The officers provided a ‘Private Placement Memorandum’ (PPM) to investors stating that KS Cartel would use investor funds to, at the investor’s election, either day-trade funds pooled from multiple investors through a so-called “mutual fund” or manage separate “private stock portfolios” for individual investors. KS Cartel and the investors would then supposedly split any profits from the trading, based on a percentage individually negotiated between KS Cartel and each investor.

According to the court, they also represented in the PPM that returns on KS Cartel’s “mutual fund” day-trading strategy “should be no less than 20 percent of total assets and investments a month,” and that the returns on its “private stock portfolio” long-term trading strategy “should be maintained at 30 percent a month.” Throughout the time that the defendants solicited investors via the PPM, they lacked a factual basis to project returns of 20-30 percent per month. In fact, during that time period, their average monthly return, when considering trading in all of their brokerage accounts, was -8.8 percent, and the median monthly return was -0.5 percent. The CFO falsely represented KS Cartel’s prior performance to prospective investors as an ROI averaging 70-90 percent monthly, and at another time that KS Cartel’s ‘ROI averages 30-60 percent monthly depending on the amount of risk.’ All such representations were false.

Ponzi scheme tactics. Despite the fact that KS Cartel did not achieve profits from trading, the defendants nevertheless caused KS Cartel to distribute money to investors on a regular basis. Those distributions were, in many cases, the transfer of principal invested by certain investors to other investors. They also systematically deceived KS Cartel investors about the profitability of KS Cartel by providing investors with fictitious account balances, conduct that was pervasive and directed at nearly every investor in KS Cartel. In one example, an investor invested a total of $35,000 between April 2018 and June 2018. In September 2018, withdrew $20,000 from his account, but by the end of 2018, the CFO reported to the investor that his account balance had grown to $136,874.22, which was the balance only for the high-risk trading strategy, and amounted a six-month gain return of 812.495 percent.

Pleading “the Fifth.” In 2020, during the Commission’s investigation that preceded the filing of this instant lawsuit, the CEO provided on-the-record testimony and at certain times refused to testify, citing the Fifth Amendment privilege. During the course of the litigation, the Commission took the CEO’s and the CFO’s depositions where both men refused to answer nearly every substantive question asked of them on the basis of the Fifth Amendment privilege against self-incrimination.

The court noted that courts consider the evidence in the light most favorable to the nonmovant in a summary judgment motion, yet the nonmovant may not rely on mere allegations in the pleading; rather, the nonmovant must respond to the motion for summary judgment by setting forth particular facts indicating that there is a genuine issue for trial. The court found that in the instant case, the defendants failed to meaningfully respond to the Commission’s motion. The CEO individually filed three documents that the court liberally construed as responses to the Commission’s summary-judgment motion, including a pleading titled “Motion in opposition of default Judgment and Summary Judgement cease and desist,” a “Cease and Desist dismissal with prejudice,” and a ‘[CEO] Affidavit’, each signed by the CEO alone. The court found all to be largely unintelligible, and that none met the requirements for a response to a summary-judgment motion.

Based on the foregoing, the court granted summary judgment in favor of the SEC and against the CEO and CFO, and, default judgment against KS Cartel.

The case is No. 4:20-cv-00737-SDJ.

Attorneys: Nikolay V. Vydashenko for the SEC. Sebastian Silea, pro se.

Companies: KS Cartel, LLC

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