U.S. Securities and Exchange Commission
Litigation Release No.18392 / October 6, 2003
Securities and Exchange Commission v. National Financial Systems, Inc. and Terese Herwick, Civil Action No. (CV 03-6908 SVW (JTLx)) (C.D. Cal.)
Securities and Exchange Commission Files Action Charging Southern California Investment Adviser With Fraud
The United States Securities and Exchange Commission announced today the filing of an action alleging a multi-million dollar securities fraud by a Santa Monica, Calif. investment adviser that for over three years deceived its clients and prospective clients by concealing a massive decline in the value of their assets, providing clients with false and misleading account statements, and taking over $1.2 million in undisclosed management fees.
Named in the SEC's complaint, filed on September 25, 2003 in United States District Court in Los Angeles, are National Financial Systems, Inc. (NFSI), an unregistered investment adviser that also acts as a third-party administrator for retirement plans and other employee benefits programs, and Terese Herwick, age 51, of Santa Monica, Calif., the owner and president of NFSI.
The SEC's complaint alleges that in 1999, NFSI assumed management of the "Fixed Fund," an unregistered pool of assets consisting of real estate, equity securities, mutual funds, and bonds. Although Herwick knew that a significant number of Fixed Fund assets had not performed for years or had been foreclosed upon, neither NFSI nor Herwick disclosed these facts to the Fixed Fund's investors. In January 2002, NFSI wrote off the worthless assets, another fact that NFSI and Herwick never disclosed to Fixed Fund investors. The value of the Fixed Fund's assets has fallen to approximately 50% of the amount owed to Fixed Fund investors as principal and purported accrued dividends. As of March 31, 2003, the value of the Fixed Fund's assets totaled no more than $7.4 million while the amounts it owed investors in principal and purported accrued returns totaled at least $14.1 million. NFSI never disclosed this fact to Fund investors either.
Instead, the complaint alleges, NFSI continued to promote the Fixed Fund as an investment vehicle that purportedly seeks preservation and protection of capital while providing regular monthly cash distributions. Moreover, NFSI has provided Fixed Fund investors with quarterly account statements that purport to credit those investors with their contracted-for rates of return -- returns which have not been generated by the Fund's underlying assets and which neither the Fund nor NFSI can possibly repay. In addition, NFSI defrauded the Fixed Fund and its investors by charging the Fixed Fund an undisclosed management fee, which for 2002 constituted more than 10% of the value of the Fixed Fund's assets. In 2002, NFSI took over $700,000 in management fees, while in 2001 it took over $520,000 in fees, none of which was disclosed to investors.
The SEC's complaint alleges that NFSI and Herwick's conduct violated the antifraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1) and (2) of the Investment Advisers Act of 1940. The SEC's complaint asks the Court to permanently enjoin NFSI and Herwick from future violations of the foregoing provisions; to order NFSI and Herwick to disgorge, with prejudgment interest, all ill-gotten gains from their illegal conduct; and to pay civil penalties.
Acting on the SEC's lawsuit, on September 29, 2003, the Honorable Steven V. Wilson, United States District Judge for the Central District of California, issued an order prohibiting NFSI and Herwick from distributing funds or selling assets without notification to and permission from the SEC. The order further required NFSI and Herwick to provide the SEC with an accounting of sources and distribution of funds since June 2003. The Court denied the SEC's request for a temporary restraining order against further violations of the antifraud provisions of the federal securities laws and the SEC's request for the appointment of a temporary receiver over NFSI. The Court scheduled a trial on a preliminary injunction to begin on October 21, 2003.