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Tuesday, June 18, 2024 | Back issues
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Judge Stops $10 Million Ponzi Scheme in Texas

HOUSTON (CN) - A federal judge granted the SEC's request to stop a Ponzi scheme that took more than $10.1 million from 80 investors by falsely claiming it would put the money in "safe government guaranteed assets."

The SEC sued Evolution Capital Advisors, its subsidiary Evolution Investment Group I and owner Damian Valdez in August, on securities charges.

Evolution Capital Advisors is based in the Houston suburb The Woodlands.

The judge did not buy Evolution's argument that it's not running a Ponzi scheme because early investors have been paid. He pointed out that that is the very nature of a "quintessential Ponzi scheme. And it is of no moment that the investment strategy has not yet collapsed of its own accord."

The SEC claimed the defendants solicited investors for two "secured note offerings" by using confidential private placement memoranda.

Evolution Capital issued the first offering, referred to as the "C1/D1" offering, which promised 9 percent returns for 3-year investments, or 10 percent returns for 5 years.

Evolution Investment Group I issued the second offering, called the "C2/D2" offering, which promised returns of 7 percent for 3-year investments, and 7.5 percent for 5 years.

The SEC says Valdez reeled in investors by falsely claiming he would use their money to buy a portfolio of Small Business Administration loans "guaranteed by the full faith and credit of the United States."

The SBA guarantees small-business loans for up to 75 percent of the principal. Banks making SBA-backed loans can sell the 75 percent of the loan that is guaranteed on the secondary market while keeping the remaining 25 percent, which is not guaranteed.

Banks then sell the guaranteed portion of SBA loans to investors at a profit, giving the investor the entire guaranteed portion of the loan, and the right to both principal and interest payments on it, according to the ruling by U.S. District Judge Gray Miller.

However, "Instead of investing the funds as promised, defendants purchased Small Business Administration interest only strips ('SBA IO Strips'), which entitle holders to only a portion of the interest paid on an SBA loan or groups of loans," the SEC said in its complaint. "That is, the asset underlying the strips is interest paid on the loans, not the guaranteed principal. If the borrower prepays or defaults on the SBA loan underlying the strip, interest payments stop and the value of the strip in effect falls to zero.

"Although the U.S. government guarantees repayment of the principal of SBA loans, it only guarantees a small amount of interest from the date of default - typically 120 days or less. Thus, SBA IO Strips are not guaranteed by the U.S. government or anyone else, and are subject to significant prepayment and default risks. Defendants did not reveal these significant risks to investors."

According to Judge Miller's ruling: "At the point of default, interest payments will be guaranteed by the SBA only for another few months, usually about 6 months. If a loan prepays, interest payments are guaranteed for only 60 to 90 days. After prepayment or default, and the expiration of the limited guarantee period, an SBA IO Strip becomes worthless and no further guarantee applies."

The SEC claimed: "Defendants further harmed investors by using offering proceeds to pay themselves more than $2.4 million in so-called management fees and expenses."

The SEC also sought to freeze the defendants' assets.

Miller granted the SEC's request to freeze assets and to permanently enjoin the defendants from violating the Securities and Exchange Acts.

Miller pointed out that the defendants did not disclose to investors that their money would be used to purchase risky SBA IO strips, and chided them for refusing to admit they were running a Ponzi scheme.

"Defendants view the current status of their Note offerings differently than does the SEC. The C1/D1 investors have been paid back in full, making that offering a 'success' in defendants' view.

"As for the fact that investment principal from the second offering was used to fund the pay-off of the first offering (which the SEC terms 'Ponzi' payments), defendants view this as an indication that the investment strategy has not yet been brought to full fruition," Miller wrote.

He continued: "Of course, it is the very nature of a Ponzi scheme that early investors are often provided with the promised return on their investments - it is only when the costs and losses outstrip the defendants' ability to obtain new funds from investors that a Ponzi scheme results in actual losses to investors.

"Thus, the mere fact that the C1/D1 investors have been paid back is not necessarily a point in defendants' favor, nor does this repayment disprove the SEC's allegations. Indeed, as the SEC suggests, it is the source of the payments to the C1/D1 investors that identifies the dangerousness of the 'investment strategy' at play in this case. Defendants were able to make those promised payments only because they obtained funds from new investors.

"The SEC has presented compelling evidence that EIGI's current financial situation will permit the current investment strategy to succeed only if new investors are found whose money can be used to fund payments to the prior investors. This is the quintessential Ponzi scheme. And it is of no moment that the investment strategy has not yet collapsed of its own accord."Miller also ordered the SEC to submit the name of a proposed receiver to oversee the liquidation of assets.

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