RIA Compliance Blog
Earlier this month, the Securities and Exchange Commission (“SEC”) instituted an administrative proceeding against Blue Ocean Portfolios, LLC (“Blue Ocean”), an SEC-registered investment advisor with approximately $106 million in regulatory assets under management, and its Principal, CEO and Chief Compliance Officer, James A. Winkelmann, Sr. According to the allegations, Blue Ocean and Winkelmann began raising capital from clients of Blue Ocean in order to generate business proceeds for Blue Ocean in April, 2011. The adviser raised the funds by issuing a number of what it called “Royalty Units,” which were in fact interests that paid a minimum return to the investors with the prospect of a higher return if Blue Ocean’s advertising investment yielded successful new customers with annually recurring revenue.
The SEC’s Order Instituting Proceedings alleged that these offerings were fraudulent because they contained material misrepresentations regarding the historical efficiency of advertising dollars spent by Blue Ocean. For example, in the first offering memorandum, Blue Ocean misrepresented its “advertising conversion rate,” a measure of how many dollars Blue Ocean spent compared to the annually recurring revenue generated by the advertising, by more than 100 percent, according to the SEC. In a second offering memorandum, according to the SEC, Blue Ocean misrepresented its advertising conversion rate by more than 75 percent. Blue Ocean continued by misrepresenting the advertising conversion rate in the third and fourth offerings by 50 percent and 15 percent, respectively.
The SEC also alleged it was a fraudulent practice for Blue Ocean and Winkelmann to misrepresent the existence and the nature of the conflict of interest that was created by the fact that the adviser was offering its own securities to its clients. According to the offering material, Winkelmann represented that the interest of Blue Ocean and of Winkelmann himself were “aligned” with those of the investors. This was alleged to be a misrepresentation, since, as a result of the capital raised and the resulting increase in Blue Ocean business, Winkelmann paid himself additional compensation between April, 2011 and August, 2014 while during the same time period, Blue Ocean only paid the minimum amount required under the terms of the offering memoranda to the Royalty Unit investors.
Finally, the SEC alleged that Blue Ocean violated Rule 206(4)-2, the “Custody Rule.” As Blue Ocean accrued payments due to its investors for their investment in the Royalty Units, it maintained those funds in a commingled account with the advisers’ own general funds. By failing to segregate the clients’ assets, by failing to notify the clients that Blue Ocean was holding their cash, and by failing to follow the safekeeping requirements of the Custody Rule, Blue Ocean allegedly violated the rule. The SEC’s order concluded by charging Blue Ocean and Winkelmann with willful violations of numerous provisions of the Securities Act, the Exchange Act, the Advisers Act, and various rules promulgated under those Acts.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.