Yorkville, executives charged with fraud relating to its investments

SEC alleges firm exaggerated its returns to hide losses, increase fees

By Devika Patel

Knoxville, Tenn., Oct. 17 - Yorkville Advisors, LLC has been charged by the Securities and Exchange Commission with scheming to overvalue managed assets and exaggerate the reported returns of hedge funds it managed in order to hide losses and increase the fees collected from investors since 2008.

In a Wednesday complaint, the SEC alleged that the Jersey City-based investment advisor and its founder and president Mark Angelo and chief financial officer Edward Schinik enticed more than $280 million in investments from funds by falsely portraying Yorkville as a firm that managed a highly collateralized investment portfolio and employed a robust valuation procedure. They misrepresented the safety and liquidity of the investments made by the hedge funds and charged at least $10 million in excessive unearned fees to the funds based on the fraudulently inflated values of the managed investments.

The investments include convertible debentures, convertible preferred stock and promissory note investments held by the hedge funds managed by Yorkville.

According to the SEC's complaint, Yorkville, Angelo and Schinik defrauded investors in the YA Global Investments (U.S.) LP and YA Offshore Global Investments Ltd hedge funds by failing to adhere to Yorkville's stated valuation policies. The complaint said the Yorkville, Angelo and Schinik ignored negative information about certain investments and withheld adverse information about investments from Yorkville's auditor, which enabled Yorkville to carry some of its largest investments at inflated values. The complaint also claims that Yorkville, Angelo and Schinik misled investors about the liquidity of the funds, collateral underlying the investments and Yorkville's use of a third-party valuation firm.

The companies in which Yorkville invested were typically either start-up companies or distressed public companies whose stock was not traded on a national securities exchange, the complaint said.

For many years, the complaint reported, Yorkville was able to trade out of the shares it received in connection with its financing transactions. Prior to the credit crunch and ensuing financial crisis of 2007 to 2008, a significant portion of Yorkville's income resulted from selling converted shares into the open market. However, by the fall of 2008, and as market conditions deteriorated, there was little volume in these securities, and Yorkville found itself unable to generate cash by selling the converted shares. Consequently, the complaint states, the funds' returns in 2008 and 2009 consisted primarily of unrealized gains from marked-up investments and accrued (and unpaid) interest payments on the loans issued by the funds, instead of trading profits. These interest payments were accrued because a large number of the portfolio companies were in poor financial condition and could no longer make their required interest payments to Yorkville. In many cases, the portfolio companies had defaulted on their obligations to the funds.

Examples of the portfolio companies in which Yorkville invested include FutureMedia plc and Smartire Systems, Inc.

In documents prepared in connection with the 2008 year-end audit, Yorkville stated that its funds expected to realize their full investment through the sale of FutureMedia and projected a sales price of 6.5 to 8 times FutureMedia's earnings, which Yorkville estimated at £1 million, or roughly $1.46 million. The documentation supported a value of only $9.5 million to $11.6 million for FutureMedia. Yet Yorkville valued the convertible at its full face value, plus accrued interest, when it had no basis to recover that amount.

For Smartire, the complaint alleges, Yorkville contended that the Smartire investment should remain at its full value, because the funds were going to receive all of the proceeds from Smartire's asset sale to another company. In reality, Yorkville had sold at least half of its interest to another entity and therefore was not entitled to the full amount of the proceeds. Also, Yorkville did not discount its estimate of future proceeds to their net present value as required. Consequently, rather than the full face value of the convertible, the convertible positions should have been marked down. Yorkville also did not report that Smartire had defaulted on all convertibles it had issued to the firm.

The complaint seeks a final judgment which, among other things, would require Yorkville, Angelo and Schinik to pay civil penalties.

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