For local investors in limbo over the past two years, money – at least some of it – flowed last week. The court-appointed receiver liquidating assets for Los Altos-based Small Business Capital Corp. mailed checks returning approximately 43 percent of each investor’s original contribution.
For residents desperate for access to their investments, that ends a two-year asset freeze but doesn’t answer the bigger question – how much, ultimately, will they recoup? In an interview with the Town Crier, Thomas Seaman, the receiver, said that more money should be on the way later in the year. He filed a motion last week to sell the loan portfolios for SB Capital’s two investment funds, as well as its lending license and other assets, for eventual distribution to investors. The unpaid principal in the investment portfolio had a value of approximately $15 million, and most loans are “good and performing.”
Seaman couldn’t name a total anticipated return to investors, but he said he expects “to make another very significant distribution once the assets are sold.”
Real investments, disputed returns
As of spring 2012, just before the Securities and Exchange Commission (SEC) shut it down, SB Capital had raised $42 million from more than 400 investors. It sold membership interest in two funds, both of which maintained portfolios of commercial mortgage loans. The portfolios generated returns. Some borrowers defaulted, but others steadily repaid with interest.
U.S. District Judge Edward J. Davila froze SB Capital’s accounts in 2012 at the SEC’s request and appointed a receiver to investigate and later dismantle the company. The SEC argued in court that as SB Capital’s principal, Los Altos resident Mark Feathers exaggerated his funds’ profits, misleading investors and luring them into keeping their money with the company, and that he masked liabilities and covered expenses by deceptively moving money among the funds and the company.
The documents investors received from SB Capital represented that monthly returns would be no less than 7.5 percent, a rate of return SB Capital continued to purport to earn even as the recession gripped California. The SEC characterized Feathers’ optimistic communication with investors and concurrent borrowing against investor funds as a “Ponzi-like scheme.”
Feathers, who defended himself in court, denied the allegations and claimed that the loans and funds transfers were a legitimate practice. But in August 2013, Davila entered a summary judgment in the case accepting the SEC’s claims, and in November 2013, he ordered Feathers to pay nearly $8 million to the court, representing the amount SB Capital was found to have improperly removed from the investment funds. The SEC also requested that a $300,000 penalty be assessed against Feathers, which Davila modified to $10,000 in his November ruling.
“The loans and money transfers between the funds and from the funds to (SBC) allowed Feathers to conceal or misrepresent the true net income, performance, and yield of the funds,” Davila wrote in his judgment. “The SEC has shown that Feathers was not using fund profits to pay out returns, but rather other member investments – contrary to the representations of the Funds’ offering documents – as ‘Ponzi-like payments.’”
Too good to be true?
Since long before Charles Ponzi launched his famous pyramid scheme in 1919, investors have bought into opportunities that promise more than they deliver. A fund would be Ponzi-like if it paid out fictitious interest, derived from sources other than genuine profit. Enticing investors with the promise of high returns and low risk is considered a hallmark of pyramid schemes, and bringing in new investors is essential for an enterprise that needs new money to pay out returns to those already in the fund.
When SB Capital counted more than $7 million as “receivables” rather than expenses, that had the effect of inflating the funds’ profits and generating false returns for investors, according to the SEC. The judge’s ruling agreed with that interpretation. Davila described the transfers as “significant conflicts of interest” that were not clearly communicated to investors. Not revealing those practices to new investors provided an unrealistically rosy picture of the funds’ profitability, he said.
“A reasonable investor would consider the true source of returns as important when making the decision to invest,” Davila wrote. “Information regarding a company’s financial condition is material to investment.”
Feathers has continued to appeal Davila’s judgment and has petitioned to dismiss the receiver. The receiver’s work and related attorney fees totaled nearly $2.2 million, or approximately 6 percent of the assets recovered during the investigation.