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SECURITIES AND EXCHANGE COMMISSION v. WEALTHMANAGEMENT LLC

December 1, 2010

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF-APPELLEE,
v.
WEALTHMANAGEMENT LLC, ET AL., DEFENDANTS-APPELLEES.



Appeal from the United States District Court for the Eastern District of Wisconsin. No. 1:09-cv-00506-WCG-William C. Griesbach, Judge.

The opinion of the court was delivered by: Sykes, Circuit Judge.

APPEAL OF: JAMES P. AND SANDRA J. VERHOEVEN EDWIN WILSON M.D. IRA and the REVOCABLE TRUST

ARGUED MAY 26, 2010

Before RIPPLE, KANNE, and SYKES, Circuit Judges.

This is an appeal from a collateral order issued in an enforcement action brought by the Securities and Exchange Commission ("SEC") against a Wisconsin-based investment firm and its principals. For more than twenty years, Wealth Management LLC handled client accounts for hundreds of investors. Many were retirees, so Wealth Management usually stuck to traditional safe, low-risk investments. That changed in 2003 when Wealth Management set up six unregistered investment vehicles-similar to hedge funds-and began investing heavily in unconventional and illiquid assets. The six funds failed, and the SEC filed an enforcement action against Wealth Management and two of its principal officers alleging a host of securities-law violations. At the SEC's request, the district court froze Wealth Management's assets and appointed a receiver to perform an accounting and fashion a plan to distribute whatever assets could be recovered.

The receiver faced a daunting task. Of the approximately $131 million Wealth Management had under management, only about $6.3 million was recoverable. The receiver proposed to distribute the diminished assets to investors on a pro rata basis and also imposed a cutoff date after which any redemption distributions would be offset against the investor's total distribution. Certain investors filed objections to the proposed plan. The district court overruled the objections and approved the plan, and two objecting investors have appealed.

After filing their notice of appeal, the objectors asked the district court to stay the receiver's distribution until the resolution of the appeal. The district court denied this request. The objectors brought the stay motion to this court, and again it was denied. Then, after briefing was completed but prior to oral argument, the receiver went forward with a distribution of about $4 million of the recovered assets. On the heels of this distribution, the receiver moved to dismiss the appeal or summarily affirm because unwinding the distribution would be inequitable to the non-objecting investors and create administrative difficulties. We said we would take the motion with the merits.

We now affirm. The district court's decision to approve the plan was fair and reasonable and withstands scrutiny under the deferential standard-of-review applicable to decisions of this kind. Where a receivership trust lacks sufficient assets to fully repay investors and the investors' funds are commingled, a distribution plan may properly be guided by the notion that "equality is equity," and pro rata distribution is appropriate. Cunningham v. Brown, 265 U.S. 1, 13 (1924). In approving the receiver's proposed plan for distribution, the district court properly considered and rejected the objectors' contrary arguments-in particular, their argument that they were really creditors and not equity holders and therefore entitled to preferential treatment.

I. Background

A. Wealth Management and its Investors

Wealth Management LLC was a financial-planning firm located in Appleton, Wisconsin. As of May 2009, it managed 447 client accounts and had approximately $131 million under management. Many of its clients were retirees seeking safe, low-risk investments, so from 1985 until 2003, client assets were held in segregated accounts, separately managed, and typically invested in common instruments such as stocks, bonds, and highly liquid stock and bond funds. In 2003, however, Wealth Management altered this model by establishing six unregistered investment pools that were similar to hedge funds. These six funds, which are relief defendants in the underlying SEC action, are: WML Gryphon Fund LLC ("Gryphon"); WML Watch Stone Partners, L.P. ("Watch Stone"); WML Pantera Partners, L.P. ("Pantera"); WML Palisade Partners, L.P. ("Palisade"); WML L3 LLC ("L3"); and WML Quetzal Partners, L.P. ("Quetzal"). Gryphon was established as a Wisconsin limited-liability company; L3 was a Delaware limited-liability company, and the other four were Delaware limited partnerships. Wealth Management served as general partner or managing member for each of the six funds. Complete authority to select and manage the investments in these funds resided in two Wealth Management officers: James Putman, the firm's founder, Chief Executive Officer, and Chairman; and Simone Fevola, its President and Chief Investment Officer. Of the roughly $131 million under management in 2009, about $102 million was invested in these six funds-the lion's share, approximately $88 million, in Gryphon and Watch Stone.

The offering documents for Gryphon and Watch Stone represented that these funds would invest primarily in "investment grade" debt securities. This made sense given Wealth Management's client base-retirees who depended on their Wealth Management assets as a primary source of income and therefore required safe, low-risk investments. But this representation was far from the truth. Although Putman and Fevola told clients that the funds were safe and profitable, they were actually investing client assets in risky and illiquid investments-primarily subfunds and other alternative investments such as life-insurance-premium financing funds, real-estate financing funds, and a water park.

Yet Wealth Management's investors thought all was well. Not only did the firm communicate to its clients that their investments were stable and conservative, but it also issued monthly reports suggesting that the new Wealth Management funds were high-performing instruments that were exceeding industry benchmarks. The illusion ended in February 2008 when Wealth Management sent a letter to Gryphon investors saying that there was not enough money to pay redemptions in full and that redemptions would be limited to two percent per quarter of the value of each individual's investment.*fn1

At this point things began to unravel. In June 2008 Putman and Fevola informed Wealth Management's board that they had received kickbacks for steering assets to a life-insurance financing fund, and investors learned that the SEC was investigating Wealth Manage-ment's investment practices. These revelations led to a rash of employee resignations, and in December 2008 Wealth Management provided written notification to investors of its decision to completely suspend redemptions and liquidate the Wealth Management funds.

Two investors in Gryphon are the objectors in this appeal-Dr. Edwin Wilson and James and Sandra Verhoeven. After receiving the February 2008 letter *fn2 limiting redemptions to two percent of an investor's equity, Wilson notified Gryphon of his intent to redeem his entire investment; it appears that Wilson received a two-percent redemption in the spring of 2008. Similarly, on May 1, 2008, the Verhoevens asked to fully redeem their equity. Wealth ...


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