UNITED STATES OF AMERICA
In the Matter of
FANAM CAPITAL MANAGEMENT, RICHARD J. ENNIS, and SETH MORGULAS,
ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER PURSUANT TO SECTIONS 203(e), 203(f), AND 203(k) OF THE INVESTMENT ADVISERS ACT OF 1940
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act"), against Fanam Capital Management ("Fanam"), Richard J. Ennis ("Ennis"), and Seth Morgulas ("Morgulas").
In anticipation of the institution of these proceedings, Fanam, Ennis, and Morgulas have each submitted Offers of Settlement (the "Offers") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and the subject matter of these proceedings, Fanam, Ennis, and Morgulas consent to the entry of this Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of 1940("Order"), as set forth below.
On the basis of this Order and Respondents' Offers, the Commission finds1 that:
1. Fanam was organized on June 30, 2000 as a Nevada limited liability company. Fanam was an unregistered investment adviser of a hedge fund and its assets under management never exceeded $25 million. Ennis, Morgulas, and Michael Beckford ("Beckford") were the Managing Members, officers, and principal owners of Fanam. Fanam managed Fanam Fund I LLC (the "Fund"). Fanam employed primarily three investment strategies for the Fund: (1) Fanam sought to identify covered call opportunities; it then bought stocks, held the positions for approximately one month, and wrote short-term call options against these stocks; (2) Fanam bought LEAP's, and wrote short-term call options against the LEAP's throughout the life of the positions;2 and (3) Fanam developed a statistical algorithm to identify temporarily mis-priced stocks that were likely to revert to their statistical mean, and traded the stocks accordingly. Fanam ceased operations, and now only exists as a corporate shell.
2. Ennis, age 37, is a resident of Pace, Florida. He was the President and Chief Executive Officer of Fanam, and a Managing Member. He served as Fanam's marketer and principal client contact. Ennis solicited the majority of Fanam's third party investors, and issued periodic statements and sent periodic performance updates to investors. Ennis was also a Fanam investor who lost money as a result of Beckford's fraud, and he contacted the criminal authorities after learning of Beckford's fraud.
3. Morgulas, age 33, is a New York, New York resident. He was an Executive Vice President, Portfolio Manager, and Managing Member of Fanam. Morgulas' responsibilities included strategic planning, and market strategy and analysis. In addition, Morgulas performed company specific research, and directed Fanam's trading strategies, which were executed by Beckford, Fanam's trader. Morgulas was also a Fanam investor who lost money as a result of Beckford's fraud. Prior to joining Fanam, Morgulas was a securities lawyer and financial research analyst.
4. Beckford, age 35, is a Schaumburg, Illinois resident. He was an Executive Vice President, Portfolio Manager, and Managing Member of Fanam. Beckford was responsible for executing Fanam's trades, and for managing Fanam's administrative operations, serving as both trader and accountant. Beckford was the only Managing Member who communicated with the initial clearing broker and Fanam's external accountant.
5. The Fund, was organized as a Delaware limited liability company on October 11, 2000. The Fund had less than 100 investors and was liquidated in June 2003.
6. Beckford gambled with investor money, traded outside of the Fund's objectives, and paid himself money to which he was not entitled, resulting in investor losses of $4,828,129.
7. Beckford started gambling with investor money in February 2001. Beckford used the Fund's money for gambling activities in Lake Tahoe, Las Vegas, and Henderson, Nevada, at horseracing tracks and off-track betting parlors around the country, and on sporting events over the internet. For example, on December 17, 2002, February 7, 2003, and March 7, 2003, Beckford wired $150,000, $243,000, and $307,000, respectively, to the Bellagio Hotel Casino in Las Vegas from Fanam's brokerage account. Beckford lost the majority of the money sent to the Bellagio by gambling at its casino and on its sports book, and he lost some of the remaining money gambling at other casinos. Beckford also used Fanam's money to finance his gambling trips. Investors paid for Beckford's airfare, rental cars, and hotel rooms. In total, Beckford lost $776,344 of investor money through his gambling losses and travel expenses.
8. Beckford also failed to follow Fanam's stated trading objectives. Beckford, among other things, held unhedged stocks, bought unhedged LEAP's, and traded unhedged equity and index options. For example, in February 2002, Beckford lost $46,500 in a single unhedged index option trade. Later that month, Beckford bought large unhedged quantities of March NASDAQ index puts for $126,000 and $392,000, respectively, and these puts expired worthless. Beckford continued to increase the size of his index option trades throughout 2002 to attempt to recoup Fanam's losses. On December 6, 2002, Beckford bought $505,000 worth of NASDAQ index calls, and these calls expired worthless. On January 14, 2003, Beckford placed a larger bet on the next month of the same options series for $1,976,000, and these calls also expired worthless. In total, Beckford lost $3,876,775 trading outside of the Fund's objectives.
9. Beckford also misappropriated investor funds for his personal use. Beckford paid himself a monthly draw of approximately $5,000 from July 2001 through March 2003 and reimbursed himself for expenses. The Managing Members agreed that Beckford could take a monthly advance against his percentage of the 1.0% management fee and the 20% incentive fee (the "Fees"). Because Fanam failed to make any money during this time, Beckford was not entitled to a monthly draw or personal expense reimbursements. In total, Beckford misappropriated $175,010 of Fanam's money for his personal use.
10. Beckford issued false documents to Ennis, Morgulas, and Fanam's investors to cover-up his fraudulent conduct. He prepared and sent false spreadsheets to Ennis and Morgulas regarding Fanam's trading, holdings, and performance. Beckford also forged auditor statements and prepared false K-1's. He furnished copies of these documents to Ennis and Morgulas, fully aware that Ennis would use these documents to solicit investors. The returns Beckford listed in these documents did not include his gambling losses, trading losses, and improper draws. The investor statements issued to Fanam's investors, based on Beckford's misrepresentations, stated that the Fund's annual returns were approximately 25% to 30%. In reality, the Fund lost money during the entire time it operated.
11. Beckford was subject to Morgulas' supervision. Morgulas was responsible for managing the Fund's positions, and he had the authority to direct Beckford's trading to manage the Fund's portfolio. Morgulas regularly communicated with Beckford regarding the Fund's portfolio. Beckford was Fanam's sole trader, and managed Fanam's administrative operations. Only Beckford communicated with Fanam's initial clearing broker and external accountant. Morgulas never independently reviewed Beckford's trading activity or independently confirmed the Fund's positions or distributions. Morgulas never contacted the initial clearing broker or the accountant to confirm the Fund's holdings. Instead, Morgulas relied on spreadsheets supplied by Beckford to monitor the trading, holdings, and performance of the Fund.
12. Morgulas failed reasonably to supervise Beckford with a view to preventing violations of the federal securities laws. Morgulas failed to take reasonable supervisory action, which could have included maintaining accurate records of the Fund's transactions, reviewing daily trading activity, valuing the Fund's positions, and separating trading and administrative operations. Morgulas' reliance on Beckford's spreadsheets, without independently verifying their accuracy, enabled Beckford to continue his fraudulent activity.
13. Unrelated to Beckford's fraud, from November 2001 through November 2002, Ennis overstated Fanam's assets under management to institutional investors. In the Fall of 2001, Fanam entered into negotiations with an international bank to manage certain holdings of the bank. Ennis and representatives of this bank discussed Fanam managing $13 million to $20 million of the bank's assets in an offshore account, but the money never came into Fanam's account. Nevertheless, Ennis told investors that Fanam managed $13 to $20 million in an offshore account. For example in November 2001, Ennis told a potential institutional investor that Fanam managed $13 million in an offshore account, and this investor subsequently invested $800,000. On November 30, 2001, Fanam's actual assets under management were only $139,565. In November 2002, Ennis solicited a large "fund of funds" to invest with Fanam, and he told this investor that Fanam had "total firm assets" of $25.25 million. The investor subsequently invested $8,000,000 with Fanam in December 2002. On October 31, 2002 and November 29, 2002, Fanam's actual "firm" assets under management were $1,282,112 and $1,545,945, respectively.
14. As a result of the conduct described above, Fanam willfully violated Sections 206(1) and (2) of the Advisers Act, which prohibit an investment adviser from employing any device, scheme, or artifice to defraud or to engage in any transaction, practice, or course of business, which operates as a fraud or deceit upon any client or prospective client.
15. As a result of the conduct described above, Ennis willfully aided and abetted and caused Fanam's violations of Sections 206(1) and 206(2) of the Advisers Act by knowingly and substantially assisting Fanam in employing any device, scheme, or artifice to defraud or to engage in any transaction, practice, or course of business, which operates as a fraud or deceit upon any client or prospective client by overstating Fanam's assets under management.
16. As a result of the conduct described above, Morgulas failed to reasonably supervise Beckford, with a view to preventing violations of the federal securities laws while Beckford was subject to his supervision, within the meaning of Section 203(e)(6) of the Advisers Act. A person is a "supervisor" if, under the facts and circumstances of a particular case, that person has the requisite degree of responsibility, ability, or authority to affect the conduct of the other individual whose behavior is at issue. In the Matter of John H. Gutfreund, Thomas W. Strauss, and John W. Meriwether, Exchange Act Rel. No. 31554, 51 S.E.C. Docket 93 (December 3, 1992). A supervisor with an unregistered investment adviser has a duty to reasonably supervise individuals subject to his supervision with a view towards preventing violations of the federal securities laws. See Robert T. Littell and Wilfred Meckel, Advisers Act Rel. No. 2203 (December 15, 2003).
Ennis has submitted a sworn Statement of Financial Condition dated April 23, 2004, and other evidence, and has asserted his inability to pay a civil penalty.
In determining to accept the Offers, the Commission considered the remedial acts promptly undertaken by Ennis and Morgulas, and the cooperation afforded the Commission staff.
In view of the foregoing, the Commission deems it appropriate, and in the public interest to impose the sanctions specified in the Offers.
Accordingly, it is hereby ORDERED:
A. Pursuant to Section 203(e) of the Advisers Act, Fanam shall be censured;
B. Pursuant to Section 203(f) of the Advisers Act, Ennis and Morgulas shall be censured;
C. Pursuant to Section 203(k) of the Advisers Act, Fanam shall cease and desist from committing or causing any violations and any future violations of Sections 206(1) and (2) of the Advisers Act;
D. Pursuant to Section 203(k) of the Advisers Act, Ennis shall cease and desist from committing or causing any violations and any future violations of Sections 206(1) and (2) of the Advisers Act;
E. Pursuant to Section 203(f) of the Advisers Act, Ennis shall be, and hereby is, suspended from association with any investment adviser for a period of six months, effective the second Monday following the entry of this Order.
F. Pursuant to Section 203(f) of the Advisers Act, Ennis shall be, and hereby is, prohibited from, directly or indirectly, soliciting, marketing, or advertising for any investment advisory clients or accounts for six months, commencing the day after the expiration of the six month suspension discussed in Section IV.E.;
G. Ennis shall provide to the Commission, within 10 days after the six-month prohibitions described in Section IV.F. above, an affidavit that he has fully complied with the sanctions described in Section IV.F.;
H. Pursuant to Section 203(f) of the Advisers Act, Morgulas shall be, and hereby is, suspended from association in any supervisory capacity with any investment adviser for a period of six months effective on the second Monday following the entry of this Order;
I. Based upon Ennis' sworn representations in his Statement of Financial Condition dated April 24, 2004 and other documents submitted to the Commission, the Commission is not imposing a penalty against Ennis; and
J. The Division of Enforcement ("Division") may, at any time following the entry of this Order, petition the Commission to: (1) reopen this matter to consider whether Ennis provided accurate and complete financial information at the time such representations were made; and (2) seek an order directing payment of the maximum civil penalty allowable under the law. No other issue shall be considered in connection with this petition other than whether the financial information provided by Ennis was fraudulent, misleading, inaccurate, or incomplete in any material respect. Ennis may not, by way of defense to any such petition: (1) contest the findings in this Order; (2) assert that payment of a penalty should not be ordered; (3) contest the imposition of the maximum penalty allowable under the law; or (4) assert any defense to liability or remedy, including, but not limited to, any statute of limitations defense.
By the Commission.
Jonathan G. Katz
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