Case 1:16-cv-01752-LMM Document 23 Filed 01/11/17 Page 1 of 28

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION
SECURITIES AND EXCHANGE
COMMISSION,
Plaintiff,
v.
HOPE ADVISORS, LLC, and KAREN
BRUTON,
Defendants,
JUST HOPE FOUNDATION,
Relief Defendant.

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CIVIL ACTION NO.

1:16-CV-01752-LMM

ORDER
This case comes before the Court on Defendants Motion to Dismiss [18].
The Court held a hearing on the Motion on December 1, 2016. After due
consideration, the Court enters the following Order:
I.

BACKGROUND1
Plaintiff contends that this enforcement action arises out of an allegedly

fraudulent scheme to generate fees by Defendant Hope Advisors, a registered

investment adviser, and its principal, Defendant Karen Bruton. Dkt. No. [1] 1.

All facts are construed in a light most favorable to Plaintiff as the non-moving
party.
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Hope Advisors was founded on March 23, 2011, and is wholly owned by Bruton.
Id. 6.
Hope Advisors manages the accounts for two private investment funds,
Hope Investments, LLC (HI) and HDB Investments, LLC (HDB) (collectively
the Funds). Id. 1. HI was formed on February 16, 2011, while HDB was
formed in April of 2008. Id. 9-10. However, HDB no longer operates. Id. 10.
The Funds primarily traded in: (1) options; (2) options on futures; and (3)
futures. Id. 20. HI still trades in those options.
Hope Advisors only compensation for managing the Funds comes from an
incentive fee, calculated at 10% and 20% of the profits for HI and HBD,
respectively. Id. 1. The compensation scheme requires that, if the Funds suffer
losses, Hope Advisors will not receive a fee in subsequent months until the losses
have been offset by gains. Id. 31. In other words, the Funds have to make up all
prior losses before Hope Advisors can be paid. Id. 2.
This is known as a high water-mark fee structure. Id. In determining
whether the Funds make up all prior losses, the fee structure looks only to
realized gains and losses rather than to so-called unrealized gains and losses.2
The Complaint also alleges that HI paid an additional 10% incentive fee to
Just Hope Foundation (Hope Foundation), which in turn funded Just Hope
Unrealized gains and losses are those attributable to open trading positions at a
months end rather than closed trading positions. Because the trading position is
still open and subject to change, the Funds have not technically gained or lost any
investment and only gain or lose investment once the trading position is closed.

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International, a charity founded by Bruton. Id. 5. While Hope Foundation was

not involved in the alleged fraud, it did not provide any goods or services to HI in
exchange for the fees. Id. As such, Plaintiff claims it was unjustly enriched and
should act as the Relief Defendant. Id.
HIs Investment Structure
All investors in HI received a Private Placement Memorandum (PPM)
which disclosed the high water-mark fee structure. Id. 35. The PPM states, any
loss by the Fund in any month is made up dollar for dollar to investors before
the Incentive [fee] is paid again on New Trading Profits made on the Funds
trades. Id. 37.
Additionally, the PPM specifically states that this fee structure gives Hope
Advisors an incentive to defer realization of losses. Id. 38. According to the
Complaint, however, the PPM then immediately minimizes the risk that losses
could be deferred for any substantial period of time. Id. The PPM states, due to
the type of trading in which [Hope Advisors] engages, it is unlikely that [it] will
be able to defer realization of losses on positions for any extended period of time
since most trades into which [Hope Advisors] enters will only be open for 30 to
90 days at maximum. Id. 39.
The PPM also discloses that, when an investor redeems investment, his or
her unrealized gains or losses are excluded. Id. 40. It states, Withdrawing
Member receives only his or her pro rata portion of Net Realized Profits or Losses

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at the Withdrawal Date. Id. The Withdrawing Member will not participate in
Unrealized Gains or Losses. Id.
The PPM further discloses that, after a member withdraws from HI, all
other Members remaining . . . will receive the benefit of any gains realized
subsequent to the Withdrawal date. Id. However, those remaining members
also participate in any losses subsequently realized on positions that were
outstanding as of that Withdrawal [d]ate and closed after the Withdrawal [d]ate.
Id.
To invest in HI, an investor must invest at least $250,000. Id. 25. This is
known as the investors capital account. Id. According to HIs documents, only
realized gains and losses affect investors capital accounts and only realized gains
and losses affect the amount any investor may redeem from HI. Id. 26.
Originally, Hope Advisors only reported to investors their realized capital
account positions. Id. 27. That is, Hope Advisors would only tell investors about
realized gains and losses in their capital accounts. Id. However, after an audit by
the National Futures Association in August of 2013, Hope Advisors began
reporting to investors their share of HIs net asset value, which included
unrealized gains and losses. Id. Therefore, investors could see any accruing
unrealized losses.

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HDB Investments Structure

In the Complaint, Plaintiff focuses on one investors dealings with
Defendants through HDB: Investor A. Investor A was the largest and primary
investor in HDB. Id. 17. Eventually, Investor A was the sole investor in HDB. Id.
The terms of Investor As investment in HDB are governed by an operating
agreement. Id. 44. The agreement specifies that Hope Advisors is entitled to
20% of the Net Capital Appreciation of HDB. Id. 45. Net Capital Appreciation is
defined as the increase in a funds Net Asset Value over the course of an
accounting period, typically one year. Id. 46. Net Asset Value includes both
realized and unrealized gains and losses. Id. 47. In other words, according to
the operative document, unlike with HI, Defendants were never entitled to
calculate HDBs fee based on realized gains alone. Id. 48. Nonetheless,
Defendants allegedly charged HDB using the same structure implemented for HI.
Id. 49
The HDB operating agreement contains a similar high water-mark fee
structure described in HIs PPM. Id. 50. Each investor is given a Loss Recovery
Account and any decreases in HDBs Net Asset Value during an accounting
period are added to the account. Id. 51. Subsequent increases in HDBs Net
Asset Value are deducted from the Loss Recovery Account. Id. No incentive fee
may be paid until the Loss Recovery Account has a zero balance. Id. However, as
discussed above, Plaintiff alleges Defendants did not use this method to calculate
fees.
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The Complaint alleges that Investor A understood that Defendants were

taking 20% of monthly profits. Id. 52. However, he allegedly did not understand
the mechanics of how it was calculated. Id. According to the Complaint, Investor
A believed that HDB was charged a fee in accordance with the operating
agreement, not with HIs PPM which did not include unrealized losses. Id. 53.
He signed a letter to that effect in September of 2015 in response to concerns
raised during Plaintiffs examination of Defendants business. Id.
Defendants General Trading Practices
By 2014, the Funds were trading heavily in options on S&P 500 Index
Futures. Id. 54. Those futures are referred to as E-Minis. Id. As general
background, futures can be referred to as put options or call options. Id. 55. A
put option gives a trader the option to sell the underlying future at a particular
price, known as the strike price. Id. A call option gives a trader the option to
purchase the underlying future at a particular strike price. Id.
According to the Complaint, for most of the futures upon which
Defendants traded, the options to buy or sell could not be exercised prior to
maturity of the option. Id. 56. That is, the option to buy or sell the future could
not be exercised until a specific datethe maturity date. Instead, the options
were exercised automatically if the option was in the money at the maturity

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date.3 Id. If the options matured out of the money, the option would simply
expire. Id.
Fraudulent Trading Scheme
According to the Complaint, in October and December of 2014, the Funds
experienced significant trading losses due to volatility in the financial markets.
Id. 58. In response to these losses, Plaintiff contends that in November 2014
Defendants began fraudulently trading options to continue receiving their
incentive fees. Id. 2.
In particular, the Complaint alleges that Defendants exploited the HI fee
structures use of realized gains and losses over unrealized gains and losses. Id.
For instance, the Complaint alleges that, at the end of each month, Hope Advisors
caused the Funds to make certain Scheme Trades that had the purpose and
effect of realizing a large gain in the current month while effectively guaranteeing
a large loss would be realized early the following month. Id. 3. The trades would
be executed again the following month to make up for the large loss created as a
result of the trades made the prior month. Id.
In essence, these trades continuously converted any realized losses (which
would prevent Defendants from receiving their incentive fee if not made up the
following month) into realized gains in the current month and realized losses in
In the money refers to an option contract that, if it were exercised today,
would be worth more than $0. For example, suppose stock A trades at $300 per
share. Stock A call options with a strike price of $200 would be in the money
because the option holder could buy stock A at $200 and turn around and sell it
for $300. The value of the call option is $100.
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the next month. Id. However, according to the Complaint, Defendants never
allowed the rolled over realized losses to materialize. Id. Instead, Defendants
merely rolled those losses to the next month indefinitely, to ensure continued
incentive fees.
According to the Complaint, Hope Advisors employees maintained a
spreadsheet that tracked, month to date, the realized losses of the Funds. Id.
Allegedly, as the end of each month approached, Bruton picked the amount of
profit she wished the Funds to show (and de facto, the fees she wished to
generate), and her traders would size the Scheme Trades accordingly. Id.
Essentially, the Complaint alleges that Bruton would manufacture some sort of
profit in the Funds such that investors would believe the Funds were making
money and Bruton could collect her incentive fees. Plaintiff characterizes this
alleged scheme as accounting fiction.
The Complaint explains that the Scheme Trades often involved the selling
and buying of paired options. That is, Defendants would sell options that were
set to expire at the end of the current month (first leg options) and
simultaneously buy the same amount of options at the same strike price that
would expire early the next month (second leg options). Id. 67.
Without delving too far into details not necessary in this Order, the result
of this alleged scheme is that, for about a week or two at the end of the month and
beginning of the next month, the Funds would convert realized loss to a
combination of realized gain and unrealized loss. Because they showed realized
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gains at the end of the month, when the Funds calculated Defendants fees,
Defendants always got their incentive fee. A week later, however, the unrealized
loss and realized gains would convert back to realized loss.
The Complaint contends that these trades had almost no exposure to
market movements. Id. 78. In other words, the Funds stood almost no chance
of losing or making money on the paired Scheme Trades regardless of which
direction the market moved. Id. As a result, Plaintiff alleges they were not done to
benefit the Funds or the Investors, and were done simply to ensure Defendants
continued fee at the Funds expense.
Additionally, the Complaint contends that, without these Scheme Trades,
Defendants would receive almost no incentive fees from at least October 2014
through the present. Id. 4. However, through the Scheme Trades, Defendants
have allegedly extracted millions of dollars in incentive fees while, in recent
months, the Funds have avoided realizing more than $50 million in losses. Id.
For example, as of February 29, 2016, HI is worth approximately $136
million. Id. 22. As of the same date, Plaintiff alleges HI has an unrealized loss of
approximately $57 million. Id. 23. According to the Complaint, HI had
unrealized losses at the end of every month for at least two years, with the
amount fluctuating between $3 million and $62 million. Id. 24.
Plaintiff also alleges that Defendants did not abide by the HBD operating
agreement while calculating fees. Regardless of the Scheme Trading, Plaintiff
argues that between October 2014 and June 2015, HBD carried significant
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unrealized losses which should have been, but were not, calculated into
Defendants fees for HDB. Id. 93 The Complaint contends that, if the unrealized
losses had been factored in, Defendants would not have received any fees from
HBD. Id. 94. Instead, Defendants allegedly collected over $1 million worth of
fees during that period. Id. 95.
Plaintiff alleges that Defendants never told investors about the Scheme
Trades. Id. 99. Additionally, Plaintiff alleges that Defendants never told
investors that Bruton could and would pick the amount of realized gains every
month to ensure whatever fee she wanted. Id. 101. Plaintiff alleges that
Defendants may have informed investors that there was an incentive for Hope
Advisors to defer losses, but they did not inform investors that Bruton could
essentially neutralize the high water-mark structure by endlessly rolling over
losses. Id. 102.
Redemption Practices
Plaintiff next contends that Defendants redemption practices were
fraudulent. Specifically, Plaintiff takes issue with the fact that investors who
withdraw from the Funds do so without taking on unrealized losses. Id. 105.
That is, investors get the full value of their realized gains without having their
investment reduced by unrealized losses. Id. According to Plaintiff, the
redeeming investors receive a windfall while the pro rata share of unrealized
losses for each remaining investor increases. Id. 106.

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For new investors, Plaintiff argues that this poses a serious issue. New
investors who place money in the Funds could immediately be subject to large
realized losses if Defendants choose to suddenly cease Scheme Trading. Id. 107.
According to Plaintiff, if the unrealized losses continue or there is a significant
exodus, the last investors to redeem will get no money while the earlier investors
would have only realized gains. Id. 108. Plaintiff alleges that this serious risk is
not disclosed to investors. Id.
Plaintiff asserts eight counts against Defendants and Hope Foundation as
relief Defendant. Count I asserts fraud in violation of section 17(a)(1) of the
Securities Act against Defendants; Count II asserts fraud in violation of section
17(a)(2)-(3) of the Securities Act against Defendants; Count III asserts fraud in
violation of section 10(b) and Rule 10b-5 of the Exchange Act against Defendants;
Count IV asserts fraud in violation of section 206(1) of the Advisers Act against
Defendants; Count V asserts fraud in violation of section 206(2) of the Advisers
Act against Defendants; Count VI asserts fraud in violation of section 206(4) and
Rule 206(4)-8 of the Advisers Act against Defendants; Count VII asserts a claim
for aiding and abetting fraud in violation of the above provisions against
Defendant Bruton; and Count VIII asserts a claim for unjust enrichment against
relief Defendant Hope Foundation.
II.

LEGAL STANDARD
Federal Rule of Civil Procedure 8(a)(2) requires that a pleading contain a

short and plain statement of the claim showing that the pleader is entitled to
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relief. While this pleading standard does not require detailed factual
allegations, labels and conclusions or a formulaic recitation of the elements of
a cause of action will not do. Ashcroft v. Iqbal, 556 U.S.662, 678 (2009) (quoting
Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007)). A complaint or
counterclaim is viewed in the light most favorable to the [or defendant], and all of
the [defendants] well-pleaded facts are accepted as true. Although a complaint or
counterclaim need not contain detailed factual allegations, it must include
enough facts to state a plausible claim for relief. United States v. Jallali, 478 F.
App'x 578, 579 (11th Cir. 2012) (internal citation omitted) (quoting Iqbal, 556
U.S. at 679). A complaint is plausible on its face when it provides the factual
content necessary for the court to draw the reasonable inference that the
defendants are liable for the conduct alleged. Id. at 678.
To survive a motion to dismiss, a claim of fraud must also satisfy the
heightened pleading requirements of Federal Rule of Civil Procedure 9(b), which
provides that [i]n alleging fraud or mistake, a party must state with particularity
the circumstances constituting fraud or mistake. However, [m]alice, intent,
knowledge, and other condition of a persons mind may be alleged generally.
FED. R. CIV. P. 9(b). Rule 9(b) may be satisfied if the pleading sets forth: (1) the
precise statements, documents, misrepresentations, or omissions made; (2) the
time, place, and person responsible for the statement or omission; (3) the content
and manner in which these statements misled the plaintiff; and (4) what the

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defendant gained by the alleged fraud. Brooks v. Blue Cross & Blue Shield of Fla.,
Inc., 116 F.3d 1364, 1371 (11th Cir. 1997).
III.

DISCUSSION

As discussed above, Plaintiff brings seven counts against Defendants and

one count against the relief Defendant. Defendants make three arguments as to
why Plaintiffs claims should be dismissed. The Court will discuss each.
a. Were the Investors Fully Informed?
Defendants first contend that their investors were fully informed of
Defendants operations and any attendant risks. Related to that argument,
Defendants contend that Plaintiff has not shown any fraudulent omissions, that
any alleged omissions were made in connection with an offer, sale, or purchase of
securities, or that Defendants had scienter where required. Therefore, according
to Defendants, there can be no claims under any provision of 10(b) of the
Securities Exchange Act, 17(a) of the Securities Act, or 206 of the Investment
Advisers Act.
As way of background, 10(b) makes it unlawful for any person, in
connection with the purchase or sale of any security, to directly or indirectly
employ any manipulative or deceptive device or means prohibited by such rules
and regulations as the SEC may prescribe. 15 U.S.C. 78j(b). Rule 10b-5,
promulgated by the SEC, dictates that it shall be unlawful for any person, directly
or indirectly, to, in connection with the purchase or sale of any security: (1)
employ any device, scheme, or artifice to defraud; (2) make any untrue statement
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of a material fact or to omit to state a material fact necessary, in light of the

circumstances, to make the statement not misleading; and (3) to engage in any
act, practice, or course of business which operates or would operate as a fraud or
deceit upon any person. 17 C.F.R. 240.10b-5.
To properly allege a violation of 10(b) and Rule 10b-5, a claimant must
allege: (1) a material misrepresentation or materially misleading omission; (2)
that the material misrepresentation or omission was made in connection with the
purchase or sale of securities; and (3) that the offender had scienter. S.E.C. v.
Torchia, 1:15-CV-3904-WSD, 2016 WL 1650779, at *12 (N.D. Ga. April 25, 2016).
Under the Securities Act, Plaintiff claims Defendants committed fraud in
violation of 17(a)(1), (2), and (3). Subsection (a)(1) makes it unlawful for any
person to employ any device, scheme, or artifice to defraud another in the offer or
sale of any securities. 15 U.S.C. 77q(a)(1). Subsection (a)(2) makes it unlawful to
obtain money or property in the offer or sale of any securities by means of any
untrue statement of a material fact or any omission of a material fact that would
be necessary, in light of the circumstances, to make the statement not misleading.
15 U.S.C. 77q(a)(2). Subsection (a)(3) makes it unlawful to engage in any
transaction, practice, or course of business which operates or would operate as a
fraud or deceit upon the purchaser in the offer or sale of any securities. 15 U.S.C.
77q(a)(3).
Proof of a violation of 17(a)(1) through (3) requires essentially the same
elements as 10(b) and Rule 10b-5. However, proof of scienter is not required
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for subsections (2) and (3). Id. (quoting S.E.C. v. Monarch Funding Corp., 192
F.3d 295, 308 (2d Cir. 1999).
Under the Investment Advisers Act, Plaintiff claims Defendants have
violated 206(1), (2), (4) and Rule 206(4)-8. Subsection (1) makes it unlawful
for any investment adviser to employ any device, scheme, or artifice to defraud
any client or prospective client, either directly or indirectly. 15 U.S.C. 80b-6(1).
Subsection (2) makes it unlawful for any investment adviser to engage in any
transaction, practice, or course of conduct which operates as a fraud or deceit
upon any client or prospective client. 15 U.S.C. 80b-6(2). Subsection (4) makes
it unlawful for any investment adviser to engage in any act, practice, or course of
conduct which is fraudulent, deceptive, or manipulative. 15 U.S.C. 80b-6(4).
Subsection (4) also dictates that the SEC shall define what it means for an
investment adviser to engage in fraudulent, deceptive, or manipulative acts. Id.
Rule 206(4)-8(a) dictates that it shall constitute a fraudulent, deceptive, or
manipulate act under 206(4) for any investment adviser in a pooled investment
vehicle4 to: (1) make any untrue statement of material fact or omit a statement of
material fact to any investor or prospective investor in the pooled investment
vehicle; or (2) otherwise 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. 17 C.F.R. 206(4)-8(a).
A pooled investment vehicle is an investment fund that collects funds from a
number of individual investors. The funds are then combined into a single
investment fund.

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Defendants argue that all of these claims should be dismissed because

Plaintiff has not shown a fraudulent omission, that the omissions were made in
connection with an offer, sale or purchase of a security, or that Defendants had
scienter, where required.
i. Omissions
Plaintiff alleges that, while Defendants disclosed some of their investment
strategies, they did not disclose all relevant and necessary information.
Specifically, Plaintiff alleges that Defendants failed to disclose: (1) the allegedly
fraudulent trading practices which affected Defendants incentive fee; (2) the
affect of the fraudulent practices on the redemption practices; and (3) that
Defendants would calculate the HDB fee based only on realized gains and losses,
contrary to the terms of the operating agreement.
It is well recognized that [b]y voluntarily revealing one fact about its
operations, a duty arises for the corporation to disclose such other facts, if any, as
are necessary to ensure that what was revealed is not so incomplete as to
mislead. Findwhat Investor Grp. v. Findwhat.com, 658 F.3d 1282, 1305 (11th
Cir. 2011) (quoting Backman v. Polaroid Corp., 910 F.2d 10, 16 (1st Cir. 1990)). A
statement is misleading if in the light of the facts existing at the time of the
[statement] . . . [a] reasonable investor, in exercise of due care, would have been
misled by it. Id. (citing S.E.C. v. Tex. Gulf Sulphur Co., 401 F.2d 833, 863 (2d
Cir. 1968)).

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In determining whether a defendant has misrepresented or omitted

material facts, courts must decide whether the statements given, read in their
totality, would accurately inform the investors of the defendants conduct. See
Slate v. Mitzner, No. 1:94-CV-0684-CC, 1995 WL 351305, at *3 (N.D. Ga. 1995)
(citing In re Convergent Techs. Sec. Lit., 948 F.2d 507 (9th Cir. 1991)). For
instance, [s]ome statements, although literally accurate, can become, through
their context and manner of presentation, devices which mislead investors. Id.
Therefore, the disclosure required by the securities laws is measured not by
literal truth, but by the ability of the material to accurately inform rather than
mislead prospective buyers. Id.
Defendants contend that the Funds offering materials provided a
thorough, accurate, and complete description of the salient terms of the
investments, the risks, the incentive fee, how the incentive fee is calculated, and
how redemption practices work. For instance, Defendants contend that the
Complaint itself admits the offering materials set forth how profits, losses, and
the incentive fees are calculated. Additionally, Defendants argue that the
Complaint admits the offering materials disclose Brutons incentive to roll over
unrealized losses, the very crux of this case. Lastly, the Complaint admits that the
Funds unrealized losses are disclosed in capital statements such that investors
can see their realized gains but also see the large unrealized losses. According to
Defendants, all of these disclosures negate any argument that Defendants acted

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fraudulently in violation of the various securities acts as all the allegedly

fraudulent activity was disclosed in the investors materials.
After arguing more generally that all pertinent information was disclosed
to investors, Defendants turn to the individual alleged omissions more closely.
First, Defendants argue that, contrary to the Complaint, Defendants fully
disclosed their trading practices and incentive fee in HIs offering materials.
According to Defendants, the PPM specifically told investors that the
incentive fee would be paid only on net realized profits. In fact, Defendants
argue, this incentive structure was repeated several times throughout the PPM.
Additionally, Defendants argue that the PPM made it clear that net realized
profits would not include any open (unrealized) positions. Lastly, the pro rata
share of the incentive allocation was disclosed on the investors capital
statements, such that they always knew how much they were paying to
Defendants.
However, Defendants misunderstand exactly what Plaintiff has alleged in
its Complaint. The SEC does not allege that Defendants failed to disclose that
incentive fees were based on realized gains over unrealized lossesor even that
Defendants did not repeat this policy enough times in the offering materials.
Instead, the Complaint focuses on the fact that Defendants did not disclose to
investors that Bruton and her team could and would essentially create whatever
profits they wanted the Funds to reflect through the Scheme Trades to ensure
they received their incentive fees at the Funds expense. In essence, Plaintiff
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contends that Defendants misled investors into thinking the high water-mark
structure would prevent incentive fees when the funds carried realized losses,
when in reality, Defendants could completely negate the high water-mark
structure altogether.5
Defendants go on to argue that, even if the offering materials did not
disclose everything, Bruton sent several letters to investors that did fully disclose
her activities. For instance, Bruton sent a letter to investors in March of 2013
describing how she kept certain positions open at the end of the month to ensure
the Funds did not experience a loss. By keeping the positions open, the letter
asserts that the Funds actually realized a net gain of 1.51%. According to the
letter, this is a typical trading strategy that occurs on a monthly basis. There are
usually positions in play for future months. Dkt. No. [18-8] (March 2013 Letter)
(emphasis added).
In December 2014, Bruton sent a second letter describing how, [w]hen
[the Funds] experience such radical moves in the market, [Defendants] need time
to manage through events. [Defendants] accomplish this by moving positions
into future months in order to provide that time. That is what we have been doing
for the last 3 months and have now moved the unrealized positions into 2015.

While the PPM did disclose that Bruton had an incentive to roll over unrealized
losses, Plaintiff contends Defendants instantly trivialized that possibility by
claiming that, based on the nature of the trades, unrealized losses would not carry
for long. Therefore, while Defendants did imply that Bruton could essentially
avoid the high water-mark for a limited time, it did not disclose that Defendants
could basically eliminate it altogether, as Plaintiff alleges they did.
5

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Dkt. No. [18-9] (December 2014 Letter). In June 2015, Defendants sent a third
letter telling investors that their strategy had reduced unrealized losses by 46%.
Dkt. No. [18-10] (June 2015 Letter).
Plaintiff counters that each of these statements suggests the trading
benefitted the Funds. However, Plaintiff argues that, in reality, and as the
Complaint alleges, the trading was set up in such a way that it only benefitted
Defendants to the Funds detriment. Dkt. No. [1] 87, 89-90. For instance,
Plaintiff alleges that the Scheme Trades essentially guaranteed that the Funds
would continue to realize a large loss in the ensuing months, thus perpetuating
the need for more Scheme Trades.
The Court agrees that, as alleged by Plaintiff, both the offering materials
and the letters sent by Bruton failed to disclose the nature of Brutons alleged
trading activity. First, the offering materials told investors that Defendants would
only be paid if there were realized gains. It did not inform investors that Bruton
could allegedly ignore this limit entirely. Second, the letters to investor do
characterize the trades as beneficial to the Funds. However, if Plaintiffs alleged
facts are to be taken as true, this characterization was inaccurate and deceptive.
As such, the Court finds that Plaintiff has properly alleged that Defendants failed
to fully disclose their trading practices.
Next, Defendants focus on their redemption practices. According to
Defendants, the offering materials fully disclose withdrawing members
redemption calculation. That is, the offering materials explain to investors that, if
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they withdraw, their redemption will reflect their pro rata share of realized gains
and losses. It will not include unrealized gains and losses. It goes on to explain
that the remaining investors will share in any unrealized gains and losses that are
subsequently realized.
Plaintiff counters that the issue is not that Defendants failed to tell
investors what happens when they exit the fund. Instead, Plaintiff argues that the
issue is that Defendants failed to tell investors what could happen when they
enter the fund. Specifically, Plaintiff alleges that Defendants should have told
investors that their new investments were subject to immediate reduction in
value if the unrealized losses were converted to realized losses.
The Court agrees. While Defendants disclosed the way in which the Funds
calculated redemptions, the Court finds that, given the allegedly fraudulent
Scheme Trades that created greater and greater losses, Plaintiff has properly
alleged that Defendants should have disclosed the risk to investors that, should
multiple investors leave, their investments could be greatly reduced when
Defendants finally realize the Funds losses. While savvy investors could certainly
understand the concept that, if multiple investors leave while there is large
unrealized loss, their investments would be greatly reduced, it is plausible, given
the disclosure in the PPM asserting that the fund could not carry unrealized
losses for long, that they believed this was an unlikely possibility.
Next, Defendants contend that their alleged failure to comply with the
HDB operating agreement is not an omission. Instead, Defendants contend that
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their failure to comply with the agreement amounts only to breach of contract;
the difference being that, to constitute fraud as required under securities law,
Defendants had to have the intent to defraud HDBs investors at the time the
contract was executed. According to Defendants, there are no allegations in the
Complaint that Defendants intended to defraud HDB from the very beginning.
Plaintiff counters that the Complaint alleges Defendants never complied
with the terms of the operating agreement. Thus, Plaintiff argues, the Court can
reasonably infer that if they never complied, they never intended to comply.
The Court agrees. Several other circuits have inferred fraudulent intent
when a contracting party either never complied with the terms of the contract or
only complied for a very short interval. See Halls Reclamation, Inc. v. Apac
Carolina, Inc., 103 F.3d 117, 1996 WL 726857, at *3 (4th Cir. 1996) (finding a jury
could infer fraud when the breaching party failed to perform the contract from
the contracts inception); U.S. v. Shah, 44 F.3d 285, 293 (5th Cir. 1995) (allowing
an inference of fraud where only a short time elapses between the making of the
promise and the refusal to perform it, and there is no change in the
circumstances.).
In addition, U.S. ex rel ODonnell v. Countrywide, 822 F.3d 650, 654 (2d
Cir. 2016), relied on by Defendants, is distinguishable because, in that case, the
Second Circuit found there was no evidence that the defendants never intended
to perform on the contract. At this stage in the litigation, however, the Court
cannot say there is no evidence of Defendants fraudulent intent. Instead, the
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Court must take Plaintiffs allegation that Defendants never performed on the
contract as true. The Court finds, therefore, that Plaintiff has alleged sufficient
facts to demonstrate omissions as required under 10b, 17(a), and 206
regarding the incentive fee/trading scheme, the redemption practices, and HDBs
incentive fee calculations.
ii. Scienter
Next, Defendants argue that Plaintiff has not alleged sufficient facts to
demonstrate that Defendants acted with the requisite scienter. To allege scienter,
there must be factual allegations that show: (1) the defendant acted with a
mental state embracing intent to deceive, manipulate, or defraud; (2) the
defendant acted with severe recklessness, which represents an extreme
departure from the standards of ordinary care, and involves the danger of
misleading investors which is either known to the defendant or is so obvious
that the defendant must have been aware of it; SEC v. Manion, 789 F. Supp. 2d
1321, 1334 (N.D. Ga. 2011), or (3) that the defendant engaged in a kind of willful
negligence and failed to use the degree of care and skill that a reasonable person
of ordinary prudence and intelligence would be expected to exercise in the
situation. SEC v. True N. Fin. Corp., 909 F. Supp. 2d 1073, 1122 (D. Minn. 2012).
Defendants argue that Plaintiffs allegation asserting that Defendants
intentionally adjusted the Funds trading strategy to avoid realized losses and
keep generating a fee is not enough to allege an inference of scienter. According
to Defendants, because they disclosed all of the requisite information to
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investors, their alleged trading strategy cannot demonstrate willful, reckless, or

negligently fraudulent conduct.
However, the Court has held that, based on the facts alleged, Defendants
should have disclosed additional facts. As such, Defendants argument that there
can be no scienter because they disclosed all they needed to disclose is not
persuasive.6
b. Were the Statements Made in Connection with the
Purchase, Sale, or Offer of Sale of a Security?
Defendants next argue that Counts I-III should be dismissed because the
Complaint fails to allege that the omissions or statements were made in
connection with the purchase, offer, or sale of a security as required by 10(b)
and 17(a). Specifically, Defendants contend that all of the allegedly fraudulent
trading occurred after investors chose to invest in the Funds. Additionally,
Defendants argue that the allegations involving the HDB fund are insufficient
because the Complaint merely avers that Defendants transferred Investor As
investments from HDB to HI in 2016. Defendants contend that the transfer is not
a sale because securities law defines sale as only including those dispositions of
a security for value. See 15 U.S.C. 77b(a)(3); 15 U.S.C. 78c(a)(14). Therefore,

Defendants argue in their reply brief that Plaintiff conceded this argument
because they do not respond to it. However, because Defendants argument is
essentially that they should not have had to disclose more than they did, all of
Plaintiffs arguments to the contrary adequately respond to this argument.
Therefore, the Court finds that Plaintiff has not conceded this point.

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because Investor As funds were merely transferred without any actual sale of a
security, it cannot satisfy the last element of counts I-III.
Plaintiff counters that the Complaint sufficiently alleges that the omissions
and statements were made in connection with the purchase, offer, or sale of
securities because: (1) it alleges the above referenced transfer of Investor As
funds from HDB to HI during the relevant time period; and (2) it alleges that
Defendants offered investments in HI throughout the relevant time period.
According to Plaintiff, this is sufficient to demonstrate that Defendants were
making fraudulent omissions in connection with the purchase, offer, or sale of
securities.
The Court agrees with Plaintiff that the second allegation demonstrates
that Defendants made omissions in connection with the offer of securities. That
is, the allegation specifically says that Defendants offered investments
throughout the relevant time period.
However, an offer of sale is only sufficient with regard to 17(a) claims.
Specifically, 17(a) dictates that, It shall be unlawful for any person in the offer
or sale of any securities to engage in deceptive conduct. 15 U.S.C. 77q(a)
(emphasis added). Yet, a 10(b) claim requires that the defendant actually
purchase or sell a security, not merely offer to sell a security. See 15 U.S.C. 78j
(b) (. . . in connection with the purchase or sale of any security . . .).
Therefore, the Court agrees with Defendants that Plaintiff has failed to
state a claim under 10(b). Nonetheless, Plaintiff argues that it has additional
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evidence that new investments were made during the relevant period and that
existing investors re-invested into the Funds during the relevant time. It has
asked the Court to allow it to amend the Complaint to include these allegations,
which the Court will allow.7
c. Has Plaintiff Stated a Claim under Section 206(1) and (2)
of the Investment Advisers Act?
Defendants next argue that Plaintiff has not stated a claim under 206(1)
and (2) of the Investment Advisers Act such that counts IV and V should be
dismissed. Specifically, Defendants argue that the individual investors are not
Defendants clients. Instead, the Funds themselves are Defendants clients.
As discussed above, 206(1) and (2) of the Investment Advisers Act
prohibit investment advisers, like Defendants, from defrauding any client or
prospective client. 15 U.S.C. 80b-6(1)-(2). The Eleventh Circuit has
acknowledged that, in most cases, an investment adviser that manages and
advises a funds day-to-day activities works for the fund, not the individual
investors. See SEC v. Lauer, 478 F. Appx 550, 557 (11th Cir. 2012). However,

In allowing Plaintiff to amend, the Court will deny Defendants Motion as to

Count III as moot. However, Defendants will have the right to refile their Motion
as to Count III assuming Plaintiff does actually amend its Complaint. If Plaintiff
does not file an Amended Complaint within the requisite period of time,
Defendants may re-file their Motion as to Count III on this issue and the Court
will grant it. If Plaintiff does file an amended complaint and alleges that new
investors invested in the Funds during the relevant time period or that existing
investors re-invested, the Court is unlikely to grant a renewed motion on this
issue. However, Defendants will be permitted to file a renewed motion.

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individual investors may be a fund advisers client if the fund adviser also gives
personal advice to those individual investors. Id.
Plaintiff does not deny that the individual investors were not Defendants
clients. Instead, Plaintiff argues that the allegations state Defendants defrauded
their clients, the Funds, by engaging in fraudulent trading schemes at the Funds
expense.
Defendants counter that this argument should be rejected because the
Complaint oscillates between alleging fraud upon the individual investors and
fraud upon the Funds. However, Defendants argument is self-defeating as they
admit that Plaintiff has alleged fraud upon the Funds. While perhaps some of
Plaintiffs allegations focus only on individual investors, the Court will not
dismiss Plaintiffs Investment Adviser Act claims based on those few allegations
when Plaintiff has also sufficiently alleged fraud upon the Funds.8
IV.

CONCLUSION

In accordance with the foregoing, the Court DENIES with prejudice

Defendants Motion to Dismiss [18] as to Counts I, II, IV, V, VI, VII, and VIII. The
Court DENIES without prejudice Defendants Motion to Dismiss as to Count

At the end of their brief in support of their Motion to Dismiss, Defendants argue
that the claims must be dismissed because Plaintiff has failed to state a claim in
accordance with Rule 8. As support, Defendants argue that Plaintiff has not
provided any well-pled allegations that Defendants failed to disclose important
information.
However, this argument is merely a recitation of the arguments discussed
above. Because the Court has already analyzed those issues, it will not do so a
second time.

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III. Plaintiff has 14 days from the date of this Order to amend its Complaint as
directed by the Court. After Plaintiff has amended its Complaint, or if Plaintiff
fails to amend its Complaint, Defendants may re-file their Motion to Dismiss as
to Count III and only as to the issues discussed in this Order within 21 days of the
date Plaintiff files or fails to file an amended complaint.
IT IS SO ORDERED this 11th day of January, 2017

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