On October 25, 2010, the SEC charged Southridge Capital Management LLC and Southridge Advisors LLC, each unregistered hedge fund advisers, and their principal, Stephen Hicks, for defrauding investors. First, the SEC alleged that Mr. Hicks overvalued the largest position held by certain funds by fraudulently misstating the acquisition price of the assets, thereby causing the funds to pay or accrue more than $1.8 million of management fees since 2004. According to the SEC's complaint, in early 2004, Mr. Hicks arranged the sale of a company acquired by the funds as a result of a defaulted note to Fonix Corporation in exchange for securities with a stated value of $33 million. The complaint alleged that neither the company sold nor the Fonix securities obtained in the transaction were accurately valued and that Fonix securities were thereafter wrongfully valued at acquisition cost.
Second, the SEC alleged that beginning in late 2003, Mr. Hicks fraudulently solicited investors to put money in new funds that were supposed to have a majority of their investments in unrestricted, free-trading liquid shares, cash or near cash. According to the SEC’s complaint, Mr. Hicks raised $80 million for the new funds and at year-end 2006 more than half of the assets in one new fund (and more than one-third of the assets in another new fund) were invested in relatively illiquid assets. The SEC alleged that by 2007 investors had submitted nearly $7 million in redemption requests that were unable to be satisfied.
Finally, the SEC alleged that between 2005 and 2008, the Southridge advisers and Mr. Hicks caused certain of the funds that had available cash to pay approximately $5 million of legal and administrative expenses of older funds that were illiquid and had no available cash. The SEC's complaint alleged that investors in the funds from which money was taken were not told about this misappropriation of fund assets while it was taking place. Instead, in February 2009, Mr. Hicks sent a letter to investors admitting that certain legal and administrative expenses had been improperly allocated between the funds, but rather than repaying the money to the funds, the Southridge advisers and Mr. Hicks transferred certain illiquid securities.