David Blaine is an illusionist, often referred to as a modern-day Houdini. So may be David Blaine Welliver, an investment advisor and operator of a mutual fund based in Buffalo, Minnesota, if the SEC is to be believed.
The SEC filed a complaint in Minnesota federal court against Welliver and his eponymously named Dblaine Capital for borrowing $4 million and and placing a portion in worthless securities, as a requirement of the lending, and not disclosing this to investors.
That, of course, was against the Dblaine Fund’s investing guidelines, the SEC noted in its action in U.S. District Court.
So was spending “at least $500,000 of the $4 million” for Welliver’s personal benefit. The regulator alleges that Welliver bought himself a new car, vacations, meals, home improvements, jewelry and paid some back taxes. He also tried to educate his son, paying for his college tuition, the SEC said.
The SEC is seeking permanent injunctions against Welliver and his Dblaine Capital to prevent future violations of securities laws and is asking the court to force Welliver and his advisory firm to pay back “all ill-gotten gains.”
But Welliver’s legal counsel says he will be cleared of the charges.
“We fully expect to clear Mr. Welliver’s good name,’’ said James Masella, a partner with the New York law firm of Blank Rome.
Here’s how Welliver’s illusion worked, according to the SEC’s complaint.
In 2009 and 2010, the firm had “only a handful of advisory clients” and generated less than $7,000 per year in advisory fees. But Welliver, according to the SEC, paid himself a six-figure salary and spent an additional $500,000 on travel, liquor, meals and the like. Funds placed in Dblaine Capital were “Welliver’s only significant source of income.”
In an effort to grow Dblaine Capital’s business, Welliver decided to create a mutual fund that Dblaine Capital would advise, the Dblaine fund.
A prospectus describes the Fund as a diversified fund with an investment objective of growth and income. The fund would invest primarily in equity securities trading below their fair value.
According to the prospectus, the Fund’s adviser, Dblaine Capital, employed a proprietary model that used “exhaustive fundamental and technical analysis, and company-by- company research” to identify potential investments.
Among restrictions: The fund would not invest more than 25 percent of its assets in a particular industry, 5 percent in securities of a single issuer or 15 percent in “illiquid securities.”
According to the SEC, Welliver tried to increase the size of the fund’s net assets by merging it with two other mutual funds.
Dblaine would pay $200,000 to acquire the funds from another investment adviser. But, as of June 30, 2010, Dblaine Capital had less than $10,000.
Enter Lazy Deuce Capital, a lender of “hard money.”
Under the agreement, Dblaine Capital agreed to invest Fund assets in securities recommended by Lazy Deuce that are “considered to be alternative investments.” In exchange, Lazy Deuce agreed to provide loans to Dblaine Capital.
Between October 2010 and May 2011, Dblaine Capital borrowed $4 million from Lazy Deuce through 27 promissory notes. The notes each were for a term of one year with an annual interest rate ranging from 15% to 18%, with the interest payments for each note due within the first three months.
By December 13, 2010, following a $100,000 payment from Dblaine Capital, the merger was accomplished. The assets of the Dblaine Fund increased from about $500,000 to more than $9 million.
But after buying a $40,000 new car and paying for tuition, among other things, the SEC said Welliver began to invest the fund’s money in “an illiquid private placement recommended by Lazy Deuce.’’
That “alternative investment” was in Semita Partners, LLC, founded in August 2010, and “ controlled by several principals of Lazy Deuce,’’ according to the complaint.
The Semita investment, whose value the Fund reported at $900,000, constituted at one point 26% of the Fund’s reported net assets, which exceeded the Fund’s investment restrictions.
By April 1, 2011, Dblaine Capital was again running low on money and needed additional loans from Lazy Deuce, the SEC said. However, Lazy Deuce was unwilling to loan Dblaine Capital more money unless the Fund purchased additional Semita units.
The fund put $825,000 more into Semit and got another $1.1 million from Lazy Deuce.
By June 22, 2011, Lazy Deuce told Dblaine Capital that “the Semita units were worthless, Semita had no operations, and all of the money Semita had received from the Fund had been transferred to Lazy Deuce, which in turn distributed the funds to Lazy Deuce’s shareholders.”
At that point, this fund’s only asset other than the Semita units was approximately $3,000 in a money market fund.
The fund’s Board of Trustees failed to take any impairment on the Semita holding until July 18, the SEC contends, at which point the value of the Semita holding was placed at zero.
-- This article first appeared on Securities Technology Monitor.