Sec. & Exch. Comm'n v. Criterion Wealth Mgmt. Servs., Inc.

• Decision Date: 25 April 2022
• Docket Number: Case No. 2:20-cv-01402-ODW (JEMx)
• Citation: 599 F.Supp.3d 932
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. CRITERION WEALTH MANAGEMENT SERVICES, INC., et al., Defendants.
• Court: U.S. District Court — Central District of California

599 F.Supp.3d 932

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,

v.CRITERION WEALTH MANAGEMENT SERVICES, INC., et al., Defendants.

Case No. 2:20-cv-01402-ODW (JEMx)

United States District Court, C.D. California.

Signed April 25, 2022

Charles E. Canter, DoHoang Thien Duong, John B. Bulgozdy, Michael Raymond Sew Hoy, US Securities and Exchange Commission, Los Angeles, CA, for Plaintiff.

Justin M. Penn, Hinshaw and Culbertson LLP, Chicaco, IL, Kenneth Edward Yeadon, Pro Hac Vice, Hinshaw & Culbertson LP, Chicago, IL, for Defendants Criterion Wealth Management Insurance Services, Inc., Robert Allen Gravette.

Jeffrey Robert Thomas, Thomas Law LLC, Denver, CO, for Defendant Mark Andrew MacArthur.

ORDER GRANTING IN PART AND DENYING IN PART PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT [41]; ORDER DENYING DEFENDANTS’ MOTIONS FOR SUMMARY JUDGMENT [50] [51]

OTIS D. WRIGHT, II, UNITED STATES DISTRICT JUDGE

I. INTRODUCTION

The Securities and Exchange Commission ("SEC") brought this enforcement action against Defendant Criterion Wealth Services and its co-owners, Defendants Robert A. Gravette and Mark A. MacArthur, for fraud and breach of fiduciary duty in violation of the Investment Advisers Act of 1940 ("Advisers Act"), 15 U.S.C. §§ 80b-1 to 80b-18c. Three summary judgment motions are pending. First, the SEC moves for summary judgment in its favor as to liability on its first, second, and fourth claims. (Notice SEC Mot., ECF No. 41.) Second, Criterion and Gravette move together for summary judgment in their favor on the SEC's first, second, and fifth claims. (Criterion Mot., ECF No. 51.) Finally, MacArthur moves for summary judgment in his favor on the SEC's first, second, and sixth claims. (MacArthur Mot., ECF No. 50.) After carefully considering the papers filed in connection with the Motion, the Court deemed the matter appropriate for decision without oral argument. Fed. R. Civ. P. 78 ; C.D. Cal. L.R. 7-15. For the reasons that follow, the Court GRANTS IN PART and DENIES IN PART the SEC's Motion, and the Court DENIES Defendants’ Motions.

II. FACTUAL BACKGROUND

Criterion is registered as an investment adviser with the SEC, and between 2014 and 2018, it managed $58 million to $190 million in investments.¹ (Pl.’s Statement of Uncontroverted Facts ("PSUF") 1, 3, ECF No. 41-2; see also Criterion Resp. PSUF, ECF No. 62-1; MacArthur Resp. PSUF, ECF No. 65-1.) Defendants Gravette and MacArthur are individual investment advisers who co-owned Criterion until 2016, at which time MacArthur converted to working for Criterion as an independent contractor. (PSUF 4–14.) In 2017, MacArthur left Criterion altogether. (PSUF 15.) Throughout most of this period, Gravette and MacArthur were the only investment adviser representatives at Criterion. (MacArthur Statement of Additional Uncontroverted Facts ("MacArthur SAUF") 262, ECF No. 65-1.)

Criterion, as a registered investment adviser, filed annual Form ADVs² from 2014 to 2020, with Gravette signing the Form ADVs for most of this period. (PSUF 16–17.) In describing its business, Criterion represented in Part 2 of its Form ADVs³ that it provided "advisory services," including "continuous advice to a client regarding the investment of client funds based on the individual needs of the client" and "portfolio management services ... using an asset allocation portfolio approach" based on "a personalized variation of a model asset allocation portfolio which is designed to meet a particular investment goal." (PSUF 18.) Criterion further represented that its "investment recommendations ... will generally include advice regarding the following securities," followed by a list of twenty-one types of assets Criterion might recommend. (PSUF 19.) One of these asset types was "Private Placement Offerings."⁴ (Id. )

The majority of Criterion's clients were individual investors. (PSUF 24.) Criterion formalized its advisory relationships by having new clients sign an Investment Advisory Agreement. (PSUF 25.) This Advisory Agreement provided that Criterion, in its capacity as a registered investment adviser, would provide either or both of the following types of investment services: (1) Discretionary Investment Management Services, which were based on "an evaluation of clients[’] goals, investment objectives, needs, financial and tax status, investment policies, guidelines, reasonable restrictions and risk tolerance among other factors;" and (2) Alternative Investment Consulting, which would "allow access to an alternative investment on a stand alone basis to accredited investors only." (PSUF 26–28.) Criterion charged fees for its advisory services in the form of a percentage of an investor's assets under management with Criterion. (PSUF 20.) Until 2016, Criterion had two different fee schedules. The first was a higher percentage-of-assets fee applied to services encompassing stocks, bonds, and cash. (PSUF 21.) The second was a lower percentage-of-assets fee, the "Alternative Investment Fee," applied to services encompassing hedge fund investments, private placement investments, and private equity investments.⁵ (PSUF 22.)

The Advisory Agreement referred to Criterion's Form ADV and required clients to sign with their initials to indicate receipt of the Form ADV. (PSUF 36.) Gravette and MacArthur each signed the Advisory Agreements as a "Financial Advisor." (PSUF 37.)

In addition to their positions with Criterion, Gravette and MacArthur were also registered representatives of Ausdal Financial Partners, Inc. (PSUF 48, 51.) Ausdal is a registered broker-dealer. (PSUF 49.) Gravette and MacArthur operated Ausdal in concert with their operation of Criterion; specifically, when investors entered into a relationship with Criterion, those investors opened a brokerage account with Ausdal to invest in private securities. (Criterion's Statement of Uncontested Facts ("Criterion SUF") 12, ECF No. 51-1.) Ausdal, acting through Gravette and MacArthur, would then broker the transactions in the private placement investments for Criterion's clients. (PSUF 56.) This practice began as early as June 2014, with Ausdal brokering the private placement investments for Criterion's clients. (PSUF 61.) The majority of Ausdal's broker-dealer clients were also Criterion's advisory clients. (PSUF 55.)

Each investor who was to invest in private placements would complete and sign an Ausdal New Account Form. (Criterion SUF 10.) Moreover, before an investor made a particular investment in a private placement, the investor completed and signed an Ausdal Private Placement Information Form. (Criterion SUF 11.) The investor would also receive copies of the fund's offering documents, including the private placement memorandum. (Criterion SUF 12.)

With respect to these investments, Gravette and MacArthur would conduct due diligence, employ the above-mentioned "asset allocation portfolio approach," and perform continuing due diligence after the investments were made. (PSUF 41–44.) At regular intervals, Criterion offered its clients broader portfolio reports that integrated information about all of a given client's assets under management—including stocks, bonds, private placement offerings, and all other holdings—into a single digest. (PSUF 45.)

Defendants do not dispute this basic business structure; instead, they dispute in which capacity—investment adviser or broker-dealer—Gravette and MacArthur acted when recommending private placements, executing the transactions, and monitoring the investments on behalf of their dual Criterion/Ausdal clients. (See PSUF 61.)

A. T2's Funds: SREI and AOFIV

Four private placement offerings are at issue in this case. Two were offered by T2 Holdings, LLC, a company with whose two principals MacArthur had a pre-existing personal and professional relationship. (PSUF 92.) The first T2 fund is the Strategic Real Estate Income Fund ("SREI Fund"). (PSUF 88.) Initially, T2 made investments in the SREI Fund available to investors solely through Class A units. (PSUF 89.) Returns on Class A units came in three phases. First, Class A unit holders in the SREI Fund would receive all returns until profits achieved a 6% annualized return threshold (i.e., a 6% "hurdle"). Then, T2 was entitled to a performance allocation of 100% of all new investment income until its profit participation had caught up such that 80% of all profits to date had been allocated to Class A investors, and 20% had been allocated to T2. Third and finally, for any investment returns after that, Class A investors and T2 shared in investment income at 80% and 20%, respectively. (PSUF 90; Compl. ¶ 38, ECF No. 1.) In short, this was "an 80/20 profit split in favor of investors with a 6% hurdle." (Compl. ¶ 39.)

Ausdal entered into a placement agreement with T2 under which Ausdal would broker investor transactions in the SREI Fund, and in exchange, T2 would pay Ausdal 50% of the performance allocation that T2 received for as long as the investors Ausdal referred remained invested in the SREI Fund. (PSUF 95.) As part of this placement agreement, T2 created special Class C units for the SREI Fund, available only to Criterion clients. Class C units were identical to Class A units, except that after the investment cleared the hurdle, Class A investors and T2 would share income at 60% and 40%, respectively (rather than at 80% and 20%). In short, Class C units provided a 60/40 profit split in favor of investors with a 6% hurdle. (PSUF 103; see Compl. ¶ 42.) Criterion's clients who invested in the SREI Fund purchased only Class C units. (PSUF 106.) All other investors in the SREI Fund, who were referred to it by at least twenty other investment advisers, invested in Class A units. (PSUF 105, 107.)

T2 had a separate fund called the T2 Opportunity Fund IV (Master), L.P. ("Master Fund"), which it launched in 2014 with a single feeder fund. (PSUF 123.) The shares offered by that feeder provided an 80/20 profit split in favor of investors with an 8% hurdle. (PSUF 127.) To accommodate Criterion and...