UNITED STATES DISTRICT COURT
PLAINTIFF SECURITIES AND EXCHANGE COMMISSION'S
TABLE OF CONTENTS
This is an emergency motion to prevent defendants Stevin R. Hoover ("Hoover") and Hoover Capital Management, Inc. ("HCM") from engaging in ongoing misappropriation of investor funds in violation of the securities laws. The Securities and Exchange Commission ("Commission") has learned that Hoover and HCM are continuing to engage in conduct nearly identical to that alleged in the Amended Complaint in this action ("Am. Compl.").
Between May 2000 and September 18, 2001, Hoover and HCM misappropriated more than $470,000 of investor monies from the Chestnut Fund LP ("Fund"), a hedge fund that Hoover organized in April 2000.1 (Decl. ¶¶ 21-31).2 In many instances, Hoover used the misappropriated money to pay for personal expenditures, including rent payments on his personal residence and repayment of funds Hoover owed to HCM clients. (Decl. ¶¶ 23, 25-31).
Hoover's and HCM's withdrawals from the Fund were fraudulent and violated Sections 206(1) and (2) of the Investment Advisers Act of 1940 ("Advisers Act") because they were in violation of Hoover's and HCM's fiduciary duties to the Fund and contrary to the terms of the Fund's Limited Partnership Agreement ("LPA") and Confidential Private Placement Memorandum ("PPM").
A Temporary Restraining Order and Preliminary Injunction against Hoover and HCM arenecessary and appropriate because even after May 2, 2001, when the Commission filed its Complaint in this matter alleging that Hoover and HCM misappropriated money from clients between 1995 and 1998, Hoover and HCM have continued to engage in fraudulent conduct involving the misappropriation of investor funds. Accordingly, the Commission respectfully requests that this Court issue a Temporary Restraining Order barring Hoover and HCM from engaging in further fraudulent conduct and freezing the assets of HCM and Hoover. The Commission further requests that the Court schedule a hearing on the Commission's Motion for a Preliminary Injunction prior to the expiration of the Temporary Restraining Order and allow the Commission to take expedited discovery.
Since 1989, Hoover has been the sole shareholder, chief executive officer and portfolio manager of HCM, an investment adviser registered with the Commission. (Am. Compl. ¶¶ 6-7). In April 2000, Hoover established the Fund and Chestnut Management LLC ("Chestnut Management") and began selling limited partnership interests in the Fund to investors. (Decl. ¶¶ 8, 10, 17). HCM initially acted as the Fund's investment manager. (Decl. Ex. A at 4). Chestnut Management is the general partner of the Fund and by June 2001 had begun acting as the Fund's investment manager. (Decl. ¶¶ 8-11, Ex. B at 1). As sole owner and operator of both HCM and Chestnut Management, Hoover has made all of the investment decisions for the Fund since its inception. (Decl. ¶¶ 6, 7, 10).
II. The Fund's Offering Documents
The Fund's LPA and PPM (collectively "Offering Documents") govern the Fund's operations. (Decl. ¶¶ 8, 9, Exs. A, B). According to the PPM, the "objective of the [Fund] is to maximize returns . . . primarily through capital appreciation obtained from investment in securities" and "to generate superior profits for its limited partners under all market conditions." (Decl. Ex B at 1). The Fund's express investment strategy is to make purchases and sales of securities that fall into one of three categories: (i) "generally undervalued securities;" (ii) "ultra-contrarian securities" described as "out-of-favor securities that have declined by at least 60% from their most recent 52-week high;" and (iii) "short-term opportunistic, event-driven purchase commitments, including restructurings and work-outs, and short-sale commitments . . ." (Decl. Ex. B at 2, 4).
According to the Offering Documents, the Fund's investment adviser is entitled to "merit compensation" for its services consisting of an annual management fee of one percent of each limited partner's capital account balance and 20% of net profits in excess of 5%. (Decl. Ex. A at 11, Ex. B at 1, 4,12). The Offering Documents also state that the Fund's general partner and investment manager "pays all of its own operating and over-head costs" and that "[t]he [Fund] pays all other costs and expenses arising in connection with its operations." (Decl. Ex. A at 19). The Offering Documents, however, allow for reimbursement of the general partner for "salaries, office rent and other general overhead costs." (Decl. Ex. B at 13).
III. Information Received from a Former HCM Employee and Cause Exam
On November 2, 2001, a former HCM employee called the Commission's Boston District Office and stated that he believed HCM was engaged in illegal activity. (Decl. ¶ 12). OnNovember 5 and 6, 2001, members of the Commission staff interviewed the former employee. (Decl. ¶ 13). On November 7, 2001, the Commission's Boston District Office Regulation staff ("Examiners") commenced a cause examination of HCM's books and records ("cause exam") pursuant to Section 204 of the Advisers Act. (Decl. ¶ 14).
IV. Hoover's Misappropriations
A. Hoover "Borrows" from the Fund
The Fund's account statements and Chestnut Management's general ledger show that between May 31, 2000 through April 30, 2001, Hoover withdrew $442,348.93 from the Fund. (Decl. ¶ 21). Hoover has characterized these withdrawals as a loan. (Decl. ¶ 21, Ex. D at 4). During an interview with Commission staff, the former employee stated that, while he was employed at HCM, he had questioned Hoover about large withdrawals from the Fund, which he thought were suspicious. (Decl. ¶ 13c). According to that employee, Hoover told him those large withdrawals were "borrows" from the Fund that he intended to repay. (Decl. ¶ 13d). Additionally, in documents filed in his divorce proceeding in May 2001, Hoover admitted that he owes the Fund $230,000 which he characterized as "business loans" from the Fund. (Decl. ¶ 21, n.2).
In many instances, Hoover used funds that he claimed to have borrowed from the Fund to pay for personal expenditures. For example, on September 12, 2000, $100,000 was wire transferred from the Fund to UMB Bank, N.A. ("UMB") to open a Chestnut Management account. (Decl. ¶ 22). Over the next five days, Hoover withdrew $90,000 of the $100,000. The withdrawals included the following:
B. Hoover Used Fund Assets to Pay Rent on His Personal Residence
In addition to Hoover's misappropriation of $442,348.93 from the Fund through purported "borrows," Hoover also used Fund assets to make a single $30,000 payment for one year's rent on his personal residence in Kansas.
On or about September 12, 2001, Hoover asked the former employee, who was interviewed by the Commission staff, to transfer $30,000 from the Fund to NativeVision. (Decl. ¶ 13e). The former employee knew that NativeVision is a charitable organization affiliated with Nick Lowery ("Lowery"), former place-kicker for the Kansas City Chiefs. (Decl. ¶ 13e). He also knew that Hoover rented his personal residence in Fairway, Kansas from Lowery. (Decl. ¶ 13e). Suspicious of the propriety of the transfer, the former employee questioned Hoover. (Decl. ¶ 13f). Hoover told the former employee that the $30,000 transfer was for a charitable donation to NativeVision. (Decl. ¶ 13f). On September 17, 2001, the former employee again questionedHoover about the requested $30,000 transfer to NativeVision. (Decl. ¶ 13g). Hoover stated that he would take care of the transfer himself.3 (Decl. ¶ 13g).
Over the course of that day and the next day, Hoover transferred $30,000 from the Fund, through several accounts he controls, to Lowery for payment of his rent. (Decl. ¶¶ 26-31). Hoover effected this transaction by writing a check on the Chestnut Management account to HCM and then writing another check from HCM to Stevin R. Hoover. (Decl. ¶¶ 26-27). Hoover covered these checks by transferring $30,000 from the Fund's account to Chestnut Management. (Decl. ¶ 28). Hoover then endorsed and provided the $30,000 check from HCM to Lowery's assistant as payment for rent on his personal residence. (Decl. ¶ 29).
VI. Other Possible Instances of Fraud
In addition to the misappropriation described above, there is substantial and credible evidence that Hoover has engaged in other instances of apparent illegal conduct. A review of bank records, brokerage statements, accounting records and correspondence suggests that:
This Court should issue a temporary restraining order and preliminary injunction against Hoover and HCM to stop continuing fraudulent conduct. Under Section 209(d) of the Advisers Act, the Commission may bring an injunctive action in the proper district court upon a "showing" that provisions of the Advisers Act have been, or are about to be, violated.4 15 U.S.C.§80b-9(d). To make such a "showing," the Commission must establish: (1) a substantial likelihood of success on the merits; and (2) a reasonable likelihood that the wrong will be repeated. SEC v. Margolin, 1992 WL 279735, *2 (S.D.N.Y. Sept. 30, 1992) (granting preliminary injunction in action brought pursuant to Section 209(d), Section 21(d) of the Exchange Act, and Section 20(b) of the Securities Act based on a showing of "substantial likelihood of success as to both a current violation and the risk of repetition"); see also SEC v. Pinez, 989 F. Supp. 325, 333 (D. Mass. 1997), remanded on other grounds sub nom. SEC v. Lehman Bros., Inc., 157 F.3d 2 (1st Cir. 1998) (applying the same standard in an action brought under Section 21(d) of the Exchange Act which contains similar language to Section 209(d)); SEC v. Mgmt. Dynamics, Inc., 515 F.2d 801, 807 (2d Cir. 1975) (same); SEC v. International Loan Network, Inc., 770 F. Supp. 678, 688 (D.D.C. 1991), aff'd, 968 F. 2d 1304 (D.C. Cir. 1992) (same); SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1100 (2d Cir. 1972) (same).
The Commission bears a lesser burden than private litigants in seeking a temporary restraining order or a preliminary injunction. Unlike private litigants, the Commission is not required to show irreparable injury or the unavailability of remedies at law. See, e.g., SEC v. Unifund SAL, 910 F.2d 1028, 1035-1036 (2d Cir. 1990); Mgmt. Dynamics, Inc., 515 F.2d at 808; Pinez, 989 F. Supp. at 333; Margolin, 1992 WL 279735 at *2 . This is because the Commission appears not as an ordinary litigant, but as a "statutory guardian charged with safeguarding the public interest in enforcing the securities laws." Mgmt Dynamics, Inc., 515 F.2d at 808; see also Hecht Co. v. Bowles, 321 U.S. 321, 331 (1944) (holding, in the context of another regulatory scheme, "the standards of the public interest, not the requirements of private litigation, measure the propriety and need for injunctive relief .")
When viewed under this standard, the compelling facts and circumstances of this case clearly establish that the Commission is entitled to both a temporary restraining order and other emergency relief sought against Hoover and HCM. This relief is necessary to preserve the status quo, prevent the defendants from continuing their fraudulent conduct, protect any remaining investor funds and protect documents and other evidence from destruction or alteration.
Hoover, directly and indirectly through Chestnut Management and HCM, has violated the antifraud provisions of Section 206 of the Advisers Act. Section 206(1) of the Advisers Act prohibits an investment adviser from employing "any device, scheme or artifice to defraud any client or prospective client." 15 U.S.C. §80b-6(1). Section 206(2) prohibits an adviser from engaging "in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client." 15 U.S.C. §80b-6(2). A showing of scienter is required to establish a violation of Section 206(1), but is not required for violation of Section 206(2). SEC v. Capital Gains Research, Inc., 375 U.S. 180, 191-92 (1963); SEC v. Steadman, 967 F.2d 636, 643 & n.5 (D.C. Cir. 1992); Messer v. E.F. Hutton & Co., 847 F.2d 673, 679 (11th Cir. 1988). In this Circuit, a showing of recklessness is sufficient to establish scienter. Greebel v. FTP Software, Inc., 194 F.3d 185, 198 (1st Cir. 1999).
The Court has already held that Hoover and HCM are "investment advisers" under the Advisers Act. See November 1, 2001 Order at 4-5. The Fund is Hoover's client because Hoovermakes all investment decisions for the Fund through Chestnut Management. It is also a client of Hoover's because he owns and controls the two entities that have been identified as the Fund's advisers, HCM and Chestnut Management. Just as this Court stated that "HCM's clients are Hoover's clients," (Order at 5) so too, is Chestnut Management's client, the Fund, a Hoover client. That Chestnut Management's actions in connection with the Fund are within the jurisdiction of the Advisers Act is made clear by Section 208(d) of the Act, which states that a person cannot do indirectly that which he is prohibited under the Advisers Act from doing directly. Thus Hoover cannot do indirectly through Chestnut Management, i.e., misappropriate client funds, what he and HCM are prohibited from doing directly.
As set forth above, Hoover violated the antifraud provisions by misappropriating investor funds from the Fund. Although Hoover has attempted to characterize these misappropriations as "borrows" from the fund, even if the improper withdrawals were "borrows," they are fraudulent because such transfers violate Hoover and HCM's fiduciary obligations not to misuse client assets and are contrary to the express representations Hoover made in the Fund's Offering Documents.
Investment advisers, such as Hoover and HCM, owe their clients a fiduciary duty "to exercise the utmost good faith in dealing with clients, to disclose all material facts and to employ reasonable care to avoid misleading clients." SEC v. Moran, 922 F. Supp. 867, 895-96 (S.D.N.Y. 1996); see also Capital Gains, 375 U.S. at 191-94 (1963) (investment advisers owe "an affirmative duty of utmost good faith, and full and fair disclosure of all material facts . . ."); SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985) (investment adviser violated Rule 10b-5 andSections 206(1) and (2) where he failed to disclose his financial interest in transactions he recommended).
Courts have found violations of Sections 206(1) and (2) where the conduct was very similar to that alleged against Hoover and HCM. See, e.g., SEC v. Saltzman, 127 F. 2d. Supp. 660, 670 (E.D. Pa. 2000) (allegations that general partner of an investment fund organized as a limited partnership fraudulently took personal loans in violation of the partnership agreement stated a claim under Sections 206(1) and (2) of the Advisers Act); Sheldon Company Profit Sharing Plan & Trust v. Smith, 828 F. Supp. 1262, 1284 (W.D. Mich. 1993) (holding that an investment adviser violated Sections 206(1) and (2) of Advisers Act when he instructed a brokerage firm to issue checks from client accounts to companies controlled by the adviser); SEC v. Gotchey, No. 91-1855, 1992 WL 385284, *2 (4th Cir. 1992) (affirming final judgment and permanent injunction under Sections 206(1) and (2) against investment adviser who misappropriated client funds).
Hoover's misappropriations from the Fund violate the antifraud provisions of the Advisers Act. Nothing in the Offering Documents gives Hoover license to take the Fund's assets for his own purposes. Although Hoover claims that certain withdrawals from the Fund were loans, nothing in the Offering Documents authorizes Hoover to make loans to himself. The Fund's investment objective is clear - to "maximize the [Fund's] investment returns." (Decl. Ex. B at 1). Hoover cannot contend that loans to himself of more than $440,000 of the Fund's assets will maximize his client's investment returns. Moreover, Hoover has not made any repayments on his "borrows," nor does it appear that Hoover has the financial ability to make anyrepayments. (See Decl. ¶ 24, Ex. E at 18, 20-21).5
Additionally, the Fund's Offering Documents contain numerous material misrepresentations. Specifically, Hoover falsely represented that:
Contrary to those representations in the Offering Documents, Hoover misappropriated approximately 14% of total amounts invested in the Fund. Hoover cannot claim that unauthorized transfers constitute management or performance fees because he himself has treated them as loans and the amount of the unauthorized transfers far exceed 1% of Fund assets plus 20% of profits.6
Hoover acted with a high degree of scienter. Hoover intentionally used the hedge fund heestablished to collect investor monies and intentionally took those investor monies for his own personal use.
Hoover is a recidivist. As set forth in the Amended Complaint, Hoover's history of misappropriation dates back to at least March 1995. Hoover has continued to commit fraud even after the Commission filed its Complaint against him on May 2, 2001. Indeed, Hoover has committed additional fraudulent acts as recently as September 2001. Hoover's ongoing misappropriation of client funds and high degree of scienter, conclusively establish a high likelihood that the violations will be repeated in the absence of relief from the Court. Simply put, unless stopped, Hoover will continue to steal client funds.
This Court may order ancillary relief to effectuate the purposes of the federal securities laws and to ensure that wrongdoers do not profit from their unlawful conduct. SEC v. Drexel Bunham Lambert Inc., 837 F. Supp. 587, 613 (S.D.N.Y. 1993); Unifund SAL, 910 F.2d at 1041; Manor Nursing Centers, Inc., 458 F.2d at 1103. Such ancillary relief may include a temporary freeze of assets to assure that any final judgment which might ultimately be ordered can be satisfied. Pinez, 989 F. Supp. at 336; Unifund SAL, 910 F.2d at 1041; SEC v. International Swiss Investments Corp., 895 F.2d 1272, 1276 (9th Cir. 1990); SEC v. Current Financial Services, Inc., 783 F. Supp. 1441, 1443 (D.D.C. 1992). The courts have recognized that adisgorgement order may be rendered meaningless unless an asset freeze is imposed prior to the time of entry of final judgment. See SEC v. Lauer, 52 F.3d 667, 669 (7th Cir. 1995) (affirming preliminary injunction "designed to freeze the defendants' assets with a view to eventual disbursement to the ultimate victim of the fraud"); Pinez, 989 F. Supp. at 336 (court may impose an interim asset freeze to preserve a basis for remedies such as disgorgement). See also United States v. Cannistraro, 694 F. Supp. 62, 71 (D.N.J. 1988), aff'd in part and vacated in part on other grounds, 871 F.2d 1210 (3d Cir. 1989); SEC v. Vaskevitch, 657 F. Supp. 312, 315 (S.D.N.Y. 1987).
The Commission respectfully requests that this Court freeze all accounts and assets over which Hoover and HCM: (i) have a direct or indirect beneficial interest including the accounts of Chestnut Management, or (ii) exercise direct or indirect control, except for client accounts over which Hoover or HCM have discretionary authority. The Commission's proposed asset freeze order is necessary and appropriate to prevent further misappropriation or dissipation of assets and to ensure that funds are available to satisfy an eventual judgment for disgorgement or penalties.
The Commission also respectfully requests that this Court order an accounting of all assets of Hoover and any entity that Hoover directly or indirectly controls, including HCM and Chestnut Management. In light of Hoover's commingling of his personal assets with those of HCM and Chestnut Management (Decl. ¶¶ 32-33), such an accounting is necessary to identify the location of all proceeds of the fraud and the relevant custodians of additional assets on whom the proposed freeze order should be served.
The Commission seeks to depose Hoover and other witnesses, request documents and answers to interrogatories, subpoena documents from third-parties and take other discovery on an expedited basis prior to the preliminary injunction hearing. Fed R. Civ. P. 30, 33, and 34 expressly give district courts the power to order expedited discovery where, as here, the normal pace of pre-trial proceedings will irreversibly prejudice the just and efficient determination of the action.
Such discovery is necessary to present a complete evidentiary record to the Court and will sharpen and focus the issues to be decided at such hearing. Accordingly, the Commission requests that expedited discovery be permitted in the manner described in the proposed order.
To protect all documents necessary for full discovery, the Commission seeks an order preventing the alteration or destruction of documents. Given the serious nature of the violations in this case such relief is especially important. An order preventing alteration or destruction of documents is thus necessary and appropriate to protect the integrity of this litigation.
For the foregoing reasons, it is respectfully requested that the Court grant the relief requested herein.
Certificate of Service
I, Ian D. Roffman, hereby certify that on November 15, 2001, a true and correct copy of the foregoing Plaintiff Securities and Exchange Commission's Memorandum of Law in Support of its Noticed Motion For a Temporary Restraining Order, Preliminary Injunction, Order Freezing Assets and Order for Other Equitable Relief was served by hand delivery upon John F. Sylvia, Esq., Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., One Financial Center, Boston, MA 02111.