Adviser Sanctioned for False Statements to Prospective Investors

By: Joshua H. Watson
January 11, 2018

The Securities and Exchange Commission sanctioned a private equity fund adviser and its chief executive officer for making false statements about the other investors that had committed to invest in one of the adviser’s private equity funds. As part of a settlement with the SEC, the adviser agreed to cease acting as an investment adviser and its chief executive officer was barred from the investment management industry and ordered to pay almost $375,000.1

Gray Financial Group, Inc. is an Atlanta-based company that was formerly registered as an investment adviser with the SEC. The company primarily provided consulting services to pension and profit sharing plans, endowments, and other entities. The company expanded its business in 2011 to include originating, managing, and advising private equity funds of funds.

As the company was raising capital for one of its private equity fund of funds, the company’s chief executive officer, Laurence Gray, attended a meeting of the board of trustees of the City of Atlanta General Employees’ Pension Fund. The pension plan was an advisory client of Gray Financial at the time and was also considering making a $28 million investment in Gray Financial’s fund of funds. The SEC alleged that Gray made two misleading statements at that meeting.

First, Gray told the board that the pension plan’s then-proposed investment in the fund of funds was consistent with Georgia law. When asked by a pension plan trustee if the proposed investment was “consistent with the law,” Gray responded that it “absolutely” was and that “the only reason” the plan was permitted to make the investment was because of a recent change in state law.

Gray’s statement was false. Georgia state law permitted public pension plans to invest in private equity funds only when specific conditions were satisfied. Those conditions were not satisfied in the case of the plan’s proposed investment in Gray Financial’s fund. Gray “knew or was reckless in not knowing that his claim was false,” according to the SEC.

Second, Gray falsely stated that other public pension plans had already invested in the fund of funds. During the board meeting, a pension plan trustee asked Gray who else had invested in the fund. In response, Gray stated that an investment by the MARTA/ATU Local 732 Employees Retirement Plan “is already done” and that “Michigan, New York, Chicago, those plans are already executed, as well.”

Both of Gray’s statements were false. MARTA/ATU’s investment could not have been “done” because its board did not vote to approve the investment until three weeks later. Plans from Michigan, New York and Chicago could not have been “executed” because no plans from these states ever invested in Gray Financial’s fund.

The SEC found that Gray and Gray Financial willfully violated Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. Section 206(1) of the Advisers Act prohibits any investment adviser from employing any device, scheme, or artifice to defraud any client or prospective client. Section 206(2) of the Advisers Act prohibits any investment adviser from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.

The SEC’s sanctions against Gray Financial and its chief financial officer were severe. Gray Financial was censured and, as part of its settlement with the SEC, agreed to refrain from acting as an investment adviser in the future. Laurence Gray was barred from the investment management industry for a minimum of two years, ordered to disgorge approximately $225,000, and ordered to pay a $150,000 civil penalty.

The severity of these sanctions was based partly upon other conduct not described above that harmed three other public pension plans, including Gray Financial’s recommendations that the plans make investments that violated state law. The severity also appears to have been based partly upon the fact that Gray and Gray Financial’s conduct was directed at Gray Financial’s own advisory clients.

Gray’s false statements to the City of Atlanta General Employees’ Pension Fund likely would have violated the Advisers Act even if the pension plan had merely been a prospective investor, and not a current advisory client of Gray Financial. Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder make it unlawful for any investment adviser to a pooled investment vehicle to “[m]ake any untrue statement of a material fact … to any investor or prospective investor in the pooled investment vehicle” or “engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle.”

Investment advisers should be aware of their fiduciary duties when raising capital along with their obligations under Rule 206(4)-1 of the Advisers Act, which is commonly referred to as the “advertising rule.” While violations of the Advisers Act during the fundraising process tend to arise from misleading statements about the advisers’ investment performance, qualifications, or capabilities, the SEC’s settlement with Gray Financial demonstrates that misleading statements about a fund’s other investors may also be the basis for Advisers Act violations.

For more information, please contact Josh Watson.


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