A financial advisor with no prior regulatory disclosures in his 20-year career settled an SEC case that highlights the importance of closely scrutinizing alternative investments.
Scott P. Trease of Matthews, North Carolina-based registered investment advisory firm Sapere Wealth Management recommended that three clients deploy a combined $7.3 million toward risky bets on a coal mining and natural resources company and on overseas trades involving a secondary form of collateral, the Securities and Exchange Commission
The RIA managed to recover $5 million of the total investments, and two affiliated business entities sued Aaron Cain McKnight,
Trease's case offers a cautionary tale for advisors about
"This is not what I'd call a small operation," Straney said of Sapere, an independent RIA whose
"It wasn't as though they were just overwhelmed," Straney said. "They were not inexperienced. … The key to this thing is due diligence in a formal, no-nonsense approach to something that is being brought to you by a third party and to document the due diligence that you perform. That's critical. You've got to do it and you've got to document it."
Trease and Sapere are "pleased to resolve the matter," said their attorney, Brian Whisler of Baker & McKenzie. "They look forward to continuing to serve their clients going forward."
Efforts to reach McKnight, who the SEC said is based in Dallas and — unbeknownst to Trease — had received a prison sentence of more than eight years after pleading guilty to criminal drug charges in 2007, were not successful. No lawyer is listed as representing him in his SEC case.
The unidentified person who introduced McKnight to Trease met the advisor at a July 4th party in 2017, and the two of them "developed a friendship over regular Bible study," according to investigators. The man described himself as a financier who had connections with groups of traders working in complex financial instruments. Trease was unaware that the unidentified person had received a prison sentence of nearly three years after being convicted of fraud charges in 2008 related to an advance-fee scheme, according to the SEC.
In 2018 and the following year, this man began identifying potential alternative investments that "were different from any type of transaction Trease and other Sapere personnel had ever been involved with before," investigators said.
Around April 2019, a representative for McKnight contacted the unidentified individual.
The unidentified man and Trease formed limited liability companies that would eventually make the investments that McKnight was pitching into an insurance policy that facilitated the mining company's bond offering and traded in a London-based collateral market of firms engaging in a financing process called
That's a method in which lenders who receive the rights to collateral through a loan re-use that same collateral to back additional transactions. Brokerages clearing trades for hedge funds often use the method.
McKnight promised big returns on the investments and assured Trease that he had 12,500 kilograms of gold valued at more than $800 million in a vault in Australia as his own collateral, the SEC said. McKnight told Trease and one of the RIA's clients that the insurance premium of $2.3 million would yield $1 million in profits within 60 days from the mining company's bond issuance of $450 million in notes, investigators said. The same client and two others expected 100% profits in 60 days from their bets in the London rehypothecation market totaling $5 million. The LLCs would earn part of the profits, as well.
The gold didn't exist, and the clients never saw big gains on the investments, according to investigators. Four months later, Trease and the RIA secured the return of their $5 million, which had found its way into "an account controlled by a person who had been indicted for a prime-bank conspiracy in 2007 and who had been a fugitive," the SEC said. The LLCs are seeking the remaining $2.3 million in losses in a pending lawsuit, according to the settlement.
"McKnight misappropriated most of the money within days of receiving it," the complaint in his case stated. Only $900,000 went to the insurance company for the premium, with $500,000 to an entity affiliated with the coal company and $100,000 to the unidentified man. At least $36,000 went to a jazz club where McKnight was the part owner, $25,000 repaid a pawn shop for a loan and $3,000 flowed to McKnight's mother, according to investigators.
In the settlement, which is subject to approval in the federal court of Charlotte, North Carolina, Trease and Sapere consented to a permanent injunction against future violations of their fiduciary duty and an undertaking to distribute the SEC's complaint and final judgment to their clients in addition to the fine and due diligence consulting for five years.
The regulator took the advisor and his firm to task for failing in their duty to conduct a full review of the investments and the people pitching them. The firm ignored its routine of tapping outside consultants to examine the complex instruments, and neither of the investments had any written agreements or term sheets that put how McKnight or any traders would use the clients' money into writing or required them to repay it after a certain timeframe, according to the SEC. Trease "also did not understand the London rehypothecation market," investigators said.
"Trease and Sapere did not reasonably understand these May 2019 investments and thus lacked a reasonable basis to recommend them to their clients," the SEC said. "By recommending investments to clients without a reasonable understanding of them, and in the face of red flags suggesting the investment might not be suitable, Sapere and Trease breached their fiduciary duties of care."
