Federal and State Securities Fraud and Misrepresentation Litigation and Arbitration Lawlyer, Russell L. Forkey, Esq.
Securities and Exchange Commission v. James N. Fry, Michelle W. Palm, and Arrowhead Capital Management LLC, Civil Action No. 0:11-CV-03303 RHK/JJK (D. Minn.)
SEC CHARGES TWO MINNESOTA-BASED FUND MANAGERS WITH FACILITATING PETTERS PONZI SCHEME
The Securities and Exchange Commission (SEC) recently charged two Minnesota-based hedge fund managers and their firm with fraudulently funneling more than half a billion dollars of investor money into a Ponzi scheme operated by Minnesota businessman Thomas Petters. This is the fourth case that the Commission has brought against hedge fund managers in connection with the Petters fraud.
The SEC alleges that James N. Fry of Long Lake and Michelle W. Palm of Edina falsely assured their investors and potential investors that the flow of their money would be safeguarded by collateral accounts and described a phony process for protecting their assets. When Petters was unable to make payments on investments held by the funds they managed, Fry, Palm, and their firm concealed it from investors by secretly executing note extensions with Petters. The SEC previously charged Petters and froze the assets of an Illinois-based hedge fund manager who was a $2 billion feeder to his scheme, charged two Florida-based fund managers who facilitated the scheme, and blocked an attempt by a Connecticut-based hedge fund manager to divert funds from victims of the scheme.
The SEC’s complaint, filed in the U.S. District Court for the District of Minnesota, alleges that Fry, Palm, and Fry’s firm, Arrowhead Capital Management LLC (“Arrowhead”) invested more than $600 million in hedge fund assets with Petters while Arrowhead collected more than $42 million in fees. Petters promised investors that their money would be used to finance the purchase of vast amounts of consumer electronics by vendors who then re-sold the merchandise to such “Big Box” retailers as Wal-Mart and Costco. In reality, Petters’s “purchase order inventory financing” business was merely a Ponzi scheme. There were no inventory transactions. Petters sold promissory notes to a number of hedge funds like those controlled by Fry, Palm, and Arrowhead and used some of the note proceeds to pay returns to earlier investors, diverting the rest of the cash to Fry’s own purposes.
Among other things, the SEC’s complaint alleges that Fry and Palm (individually and through Arrowhead):
- Falsely assured investors that the inventory financing transactions were structured in such a way that after the retailers received their merchandise from vendors, they would send their payments for the merchandise directly into the funds’ collateral accounts to pay off the notes held by the funds. In reality, money for the repayment of notes held by the funds always came directly from Petters and never came from any retailers. Fry and Palm did not disclose this material fact to investors in the funds, and instead continued to lie about the operation of the collateral accounts.
- Hid the fact that Petters was on the verge of defaulting on certain of the notes held by the funds by engaging in a series of secret note extensions with Petters beginning around February 2008. While holding the Petters notes out as 90-day notes, the funds were holding a group of notes that were so far past due that they were on the verge of their 182-day default date. In order to hide that fact, and to help Petters avoid default, Fry, Palm, and Arrowhead secretly extended the due dates on these notes without ever informing investors in the funds.
- Distributed pitch books to investors and potential investors that falsely represented that independent accountants were conducting quarterly examinations of the funds’ transaction procedures. In reality, no such examinations were conducted and Fry, Palm, and Arrowhead knew it.
The SEC’s complaint charges Fry, Palm, and Arrowhead, with violations of Section 17(a) of the Securities Act of 1933 and aiding and abetting violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; charges Fry with direct violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; charges Arrowhead LLC with violating Section 206(4) of the Investment Advisers Act of 1940 and Rule 206-4(8) thereunder; and charges Fry and Palm with aiding and abetting violations of the Investment Advisers Act of 1940 and Rule 206-4(8) thereunder. The SEC seeks entry of a court order of permanent injunction against Fry, Palm, and Arrowhead, as well as an order of disgorgement, including prejudgment interest and civil penalties.
Both Fry and Palm have already been charged criminally in connection with the same conduct. On April 8, 2011, Palm pleaded guilty to one count of securities fraud and one count of making false statements to Commission staff during investigative testimony. Fry has pleaded not guilty to multiple counts of securities fraud, wire fraud, and making false statements to Commission staff during investigative testimony.