HELANE L. MORRISON (CA BAR NO. 127752)
Attorneys for Plaintiff
UNITED STATES DISTRICT COURT
Plaintiff the Securities and Exchange Commission (the "Commission") alleges:
1. From at least May 1991 until March 2001, Fred Albert Schluep, an investment adviser, misappropriated more than $5 million from 26 of his clients. Schluep carried out his fraud by forging clients' signatures on checks and fund transfer authorizations. Schluep also lied to induce his clients to loan money or allow Schluep access to their investment funds. Schluep used the money he improperly obtained to invest primarily in local real estate and business ventures. He also used about $100,000 of improperly obtained funds to pay for his personal living expenses.
2. Schluep concealed his fraud from his clients by repaying some of them with funds that he stole from other clients, and by giving other clients bank checks drawn on accounts with insufficient funds.
3. As a consequence of Schluep's fraudulent conduct, his clients lost more than $3 million, including funds they now need to pay for housing, retirement, and medical expenses.
4. The Commission seeks to enjoin Schluep from future violations of the federal securities laws, obtain disgorgement of all funds that Schluep and Howard Sylvester ("Sylvester"), one of Schluep's former clients, received as a result of Schluep's violations of the securities laws, including prejudgment interest, and obtain civil monetary penalties against Schluep for the violations.
JURISDICTION AND VENUE
5. The Commission brings this action pursuant to Sections 21(d) and 21(e) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78u(d) and 78u(e)], and Section 209(d) of the Investment Advisers Act of 1940 ("Advisers Act") [15 U.S.C.§ 80b- 9(d)]. This Court has jurisdiction over the subject matter of this action pursuant to Sections 21(e) and 27 of the Securities Exchange Act of 1934 (the "Exchange Act") [15 U.S.C. §§ 77u(e) and 78aa] and Sections 209(d) and 214 of the Advisers Act [15 U.S.C. §§ 80b-9(b) and 80b-14].
6. Schluep directly or indirectly made use of the means and instrumentalities of interstate commerce, of the mails, or of the facilities of a national securities exchange in connection with the acts, practices and courses of business and transactions alleged herein.
7. This district is an appropriate venue for this action under Section 27 of the Exchange Act [15 U.S.C. §78aa] and Section 214 of the Advisers Act [15 U.S.C. 80b-14]. Certain of the transactions, acts, practices and courses of business constituting the violations alleged herein occurred within the Northern District of California.
8. Assignment to the San Francisco Division is proper under Local Rule 3-2(c) and (d) because a substantial part of the events or omissions which give rise to the claim occurred in San Mateo, California.
9. Fred Albert Schluep, age 43, is a resident of Red Bluff, California. From April 1989 to July 1997, Schluep was registered as an investment adviser with the Commission. From April 1989 to July 2001, he was certified to do business as an investment adviser with the State of California's Department of Corporations. In July 2001, the Department of Corporations revoked Schluep's certification.
THE RELIEF DEFENDANT
10. Howard Sylvester ("Sylvester"), age 65, is a resident of Berkeley, California. Sylvester operated a commercial property business in Berkeley. Sylvester was Schluep's client during at least a portion of the fraud alleged in this action. Schluep unlawfully transferred some of his clients' funds to Sylvester during the course of the fraud.
SCHLUEP'S FRAUDULENT COURSE OF CONDUCT
Schluep Misused The Funds in His Clients' Accounts
11. From April 1989 until July 2001, Schluep was the sole proprietor of an investment adviser business located in San Mateo, California, known as CRA Financial Planners. As of March 2001, Schluep managed approximately 244 client accounts with combined assets worth approximately $20 million. Schluep entered into a custodial agreement with Charles Schwab, Inc. to hold his clients' funds. Virtually all of Schluep's clients gave him written limited powers-of-attorney to effect securities transactions in their Schwab accounts, including the buying and selling of stocks, bonds, and notes. These documents also authorized Schluep to arrange transfers of the clients' funds only to another account held by that client. Schluep did not have authority to remove client funds or investments from Schwab's custody for any purpose without the clients' prior consent.
12. As an investment adviser with control of client funds, Schluep had fiduciary duties to exercise care in the management of client funds and assets, to carry out client instructions, to fairly disclose all material facts and not mislead his clients and to place his clients' interests ahead of his own. Schluep breached his duties to his clients in the following manner:
(a) From May 1991 to March 2001, Schluep made unauthorized withdrawals of investment funds of at least 26 clients' funds and used the funds to support real estate and business ventures in Berkeley, South San Francisco and Concord, California; to pay his personal expenses; and to pay other clients who complained about funds missing from their accounts;
(b) On at least 20 occasions from May 1991 to March 2001, Schluep caused client accounts to draw margin loans from Schwab, thus incurring interest charges without the clients' authorization;
(c) Schluep made false statements to induce two clients to loan funds to Schluep; he made false statements to two other clients to obtain their investment funds; and
(d) Schluep paid some clients with other clients' funds.
A. Unauthorized Fund Withdrawals
13. Between May 1991 and March 2001, Schluep forged client checks and authorization documents to withdraw investment funds belonging to least 26 clients, including a deceased client. On at least four occasions between 1999 and 2001, Schluep used electronic images of client signatures without authorization on checks and authorization documents to withdraw client funds. In each such instance, Schluep knew that he did not have authorization to forge or replicate his clients' signatures.
14. Between September 1991 and March 2001, Schluep transferred approximately $1.5 million of the funds he obtained without client authorization to Sylvester so that Sylvester could maintain a commercial property in Berkeley (the "Berkeley property").
15. In or about August 1999, Schluep used $538,000 of the funds he obtained without client authorization to acquire commercial property located in South San Francisco, California (the "South San Francisco property"). In December 2000, Schluep caused the property to be transferred to Sylvester. Sylvester did not pay any consideration for this property, but instead agreed to serve as a nominee owner for Schluep.
16. Between June 1999 and August 2000, Schluep transferred approximately $750,000 of the funds he obtained without client authorization to BXI Industries, Inc. BXI is an automotive brake company located in Concord, California. Prior to this transfer, two of the defrauded clients, W. Anderson and M. Avila, had refused to invest in BXI, rejecting Schleup's recommendation of the investment. BXI, which has little assets and revenue, and no income, has never repaid any of Schluep's clients for the funds that it received.
B. Unauthorized Loans From Schwab
17. Schluep arranged for his clients to have Schwab accounts that allowed the clients to draw loans from Schwab secured by the investments in their accounts. These are called "margin loans" or "margin accounts." Under this arrangement, Schwab advanced loans to the clients whenever the client withdrew cash in excess of the amount on deposit in the account. Schwab charged interest on such margin loans.
18. From approximately January 1997 to March 2001, Schleup caused at least five of his client's accounts to draw new or increased margin loans by making unauthorized withdrawals of cash from their accounts. These clients incurred interest expenses on the margin loans. The clients did not know about, or give consent to, the fund transfers and the resulting margin loans. At least one of these clients, a limited partnership called Jensen & Mayta, had previously instructed Schluep not to take margin loans under any circumstances. Contrary to this client's instruction, Schluep caused the Jensen & Mayta account to incur at least $5,000 in margin interest between November 2000 and March 2001.
C. Schluep Made Fraudulent Statements to His Clients
19. On or about June 16, 2000, Schluep solicited a $385,000 loan from his client, G. Pffafenbauer. On or about June 19, 2000, Schluep solicited a $165,000 loan from his client, V. Zugor. Schluep told G. Pffafenbauer and V. Zugor, separately, that he needed the funds to repay the estate of a deceased client. Schleup proposed to G. Pffafenbauer and V. Zugor, separately, that he would draw the loan funds from their respective Schwab accounts, pay the interest on the margin loans in their accounts and repay the withdrawn funds. Contrary to his representations to each client, Schluep failed to pay any interest or repay the loans.
20. Between January 1997 and March 2001, Schluep solicited 3 clients to make loans to Sylvester for the Berkeley property. Schluep knew, but failed to disclose to these clients, that there was a substantial risk that Sylvester would not repay the loans.
21. In November 2000, Schluep solicited the daughter of N. Polk to give Schluep $30,000 from her mother's account to invest in certain conservative securities. The daughter held a power of attorney for her mother, who was a mentally infirm nursing home patient. After the daughter gave Schluep $30,000, Schluep never produced evidence of the new investment, and he has refused to return Polk's investment funds. Contrary to his representations, and the daughter's authorization, Schluep transferred Polk's funds to another client's account.
22. In December 2000, Schluep recommended that M. McKey allow Schluep to invest $31,725 of McKey's investment funds in certain conservative securities. McKey agreed to the proposed investment. Contrary to his representations, and the client's authorization, Schluep transferred the funds to another client's account.
D. Schluep Gave His Clients Fraudulent Payments to Lull Them
23. Between approximately April 1998 and approximately March 2001, Schluep made payments to at least 15 of his clients to prevent them from taking action against him for misappropriating their funds. Schluep made some of these payments by transferring funds from the accounts of other clients who did not know, or consent to, these fund transfers. In other instances, Schluep made the payments with checks written on accounts that had insufficient funds. At the time he made these latter payments, Schluep knew that the accounts lacked sufficient funds to cover the checks.
SCHLUEP AND SYLVESTER WERE UNJUSTLY ENRICHED
24. During the period of fraudulent conduct described above, Schluep and Sylvester were unjustly enriched by Schluep's fraudulent conduct.
25. In total, Schluep wrongfully transferred to Sylvester in excess of $1.5 million of Schluep's clients' funds. Sylvester used a portion of these funds (approximately $417,495) for personal expenses, and the balance for improvements on the Berkeley property. Sylvester had no legitimate claim to these funds.
26. In addition, Schluep used Sylvester's accounts to "park" funds. First, Sylvester transferred money from client accounts and Schluep's business account to Sylvester's accounts. Then, Schluep withdrew these "parked" funds from Sylvester's account and moved the money to accounts held by other clients or by Schluep. Schluep made the withdrawals primarily by signing Sylvester's signature on account checks.
27. Schluep used $538,000 of his client's funds to purchase the South San Francisco property in Sylvester's name. Sylvester did not have any legitimate claim to this money and property.
28. Schluep used approximately $100,000 of misappropriated client funds to pay for his personal living expenses. Schluep also gained collateral benefits from misappropriating client funds and transferring them to Sylvester, BXI, and other clients.
FIRST CLAIM FOR RELIEF
Violations of Section 10(b) of the
29. The Commission realleges and incorporates by reference Paragraphs 1 through 28 above.
30. By engaging in the conduct described above, Schluep, directly or indirectly, in connection with the purchase or sale of securities, by use of the means or instruments of interstate commerce, or of the mails, or of a facility of a national securities exchange, with scienter: (a) employed devices, schemes, and artifices to defraud; (b) made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and (c) engaged in acts, transactions, practices, and courses of business which operated or would operate as a fraud or deceit upon the purchasers of securities and upon other persons, in connection with the purchase or sale of a security.
31. Schluep violated and, unless restrained and enjoined, will continue to violate Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)] and Rule 10b-5 [17 C.F.R. § 240.10b-5].
SECOND CLAIM FOR RELIEF
Violations of Sections 206(1) and
32. The Commission realleges and incorporates by reference Paragraphs 1 through 28 above.
33. At all relevant times, Schluep acted as an investment adviser to his clients. Schluep, for compensation, engaged in the business of advising his clients, either directly, or through publications and writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities.
34. Schluep, by the use of the mails or any means or instrumentality of interstate commerce, directly or indirectly: (1) with scienter, employed devices, schemes, or artifices to defraud clients or prospective clients; and (2) engaged in transactions, practices, or courses of business, which operated as a fraud or deceit upon clients or prospective clients.
35. By reason of the foregoing, Schluep violated Sections 206(1) and 206(2) of the Advisers Act [15 U.S.C.§§ 80b-6(1) and 80b-6(2)].
PRAYER FOR RELIEF
WHEREFORE, the Commission respectfully requests that this Court:
Permanently enjoin Schluep from acts or practices that violate, directly or indirectly, Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)], Rule 10b-5 [17 C.F.R. § 240.10b-5], and Sections 206(1) and 206(2) of the Advisers Act [15 U.S.C. §§ 80b-6(1) and 80b-6(2)];
Order Schluep to disgorge all wrongfully obtained client funds and benefits, including prejudgment interest;
Order Sylvester to disgorge all wrongfully obtained client funds benefits, including prejudgment interest;
Order Schluep to pay civil penalties pursuant to Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)] and Section 209(e) of the Advisers Act [15 U.S.C. §80b-9(e)]; and
Grant such other and further relief as this Court may determine to be just and necessary.
Dated: September 3, 2002