SEC Charges Recidivist In Offering Fraud That Targeted IAs

In many offering frauds the underlying business is largely worthless. Retail investors who know or trust those conducting the offering purchase interests with values that match those of the underlying interests with the cash going to the person operating the scheme. The Commission’s latest offering fraud action is different. Run by a securities law recidivist, the underlying business had value. Two large groups of investors were represented by investment advisers. Nevertheless, the scheme essentially collapsed on itself because the recidivist running it grossly oversold the underlying business and the resulting obligations could not be serviced – particularly since he was looting the operation. SEC v. Iannelli, Civil Action No. 2:18-cv-05009 (C.D. Cal. Filed June 5, 2018).

Defendant Ralph Iannelli is a securities law recidivist. He was enjoined by the Commission in a fraud action in 1975 and later permanently barred from the securities business. He has also been held in contempt for violating the injunction. Defendant Essex Capital Corporation was founded by Mr. Iannalli in 1993. The firm operates an equipment leasing business. Essentially, the firm claims to lease specialized business equipment to start-ups.

Mr. Iannelli raised capital for the firm initially by soliciting friends and members of the community to purchase promissory notes, typically with an interest rate of about 8.5%. One of the marketing materials claimed that 100% of investor funds would be used toward the purchase of equipment. Investors would be repaid over 36 months. Essex claimed that its business model could be structured to create this result.

Over time Essex started to raise more money than it needed to purchase equipment. In 2014, for example, the firm raised over $20 million from its promissory note and limited partnership investors. Essex also borrowed an additional $6 million from banks. Yet the firm only spent $2.3 million — less than 9% of its incoming funds — to purchase equipment. In contrast $25 million of the incoming funds was spent paying back investors and banks. Overall the firm had a net operating loss of over $2 million. This trend continued in 2015 and 2016.

Mr. Iannelli and Essex continued raising capital. Investment Adviser A, for example, had been recommending Essex to clients since about 2002. Between February 2015 and March 2017 more than 20 clients of Advisor A invested about $8.1 million in Essex. Those investment decisions were based on materially false financial statements furnished by Mr. Iannelli.

Similarly, Mr. Iannelli induced Investment Adviser B and its clients to invest substantial sums based on false representations. Under the arrangements with Adviser B its clients would invest through convertible promissory notes. Mr. Iannelli represented that Essex would match each investment by a client of Adviser B on a 1 to 1 basis. The clients invested over $23 million. Essex did not invest anything. Mr. Iannelli also represented that he would personally guarantee the investments of Adviser A and Adviser B clients. In total, Mr. Iannelli personally guaranteed over $60 million in promissory notes and debt between 2014 and 2017, nearly 5 times his personal assets at the time.

Mr. Iannelli did personally benefit from the scheme. During the 2014 to 2017 period he siphoned millions of dollars out of the company in the form of discretionary bonuses and interest-free personal loans to himself.

Over time the ability of Essex to service its obligations depended almost entirely on its ability to obtain loans from banks or raise additional funds from investors. By March 2017 the firm was on the verge of collapse. When the Commission’s investigation began Mr. Iannelli furnished the correct financial information to the outside auditors who then restated the financial statements of Essex. The firm was insolvent. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 2418 (June 6, 2018).