SEC Charges Attorneys Who Implemented Fraud Scheme

by Dorsey & Whitney LLP
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Two attorneys, with fiduciary duties to their clients by virtue of their role as escrow agents, served not as the protector of client funds, but enablers of a fraudulent scheme. The plot was uncovered by OCIE during an inspection of a broker-dealer being used to trade the client investment money. SEC v. Rust, Civil Action No. 1:16-cv-03573 (S.D.N.Y. Filed May 13, 2016).

Defendants Jay Rust and Christopher Brenner are attorneys licensed to practice law in the State of Texas. Atlantic Rim Funding is the alter ego of Individual X, a person currently serving a 20 year term in a California prison for securities fraud unrelated to this action.

Attorney Rust was recruited by Individual X in November 2011to serve as an escrow agent for a commercial lending program with Atlantic. Previously, Mr. Rust had served as an escrow agent for Individual X, that person’s wife, and others on another matter. Individual X was sued in that matter by investors. Those investors claimed he failed to honor his commitments. Mr. Rust was aware of the suit.

The new program through Atlantic called for would-be borrowers to deposit cash amounting to ten percent of an anticipated loan. Those funds would then be leveraged to secure a loan ten times the amount of the deposit, according to the sale pitch.

The participation of Attorney Rust was important to investor confidence, Individual X explained. Indeed, part of Mr. Rust’s function was to assure investors that he would serve as the escrow agent on their behalf, protecting their deposits, the securities purchased with their cash and the loan proceeds. Investors were not told that Attorney Rust entered into an agreement with Individual X which entitled him to any interest from the deposit of their funds as well as 3% of Atlantic’s profits from all amounts in trade associated with any collateral or funds generated by his services. That amount would be a minimum of $15,000 per month up to a maximum of $100,000 per month.

Beginning in December 2010, and continuing for over the next year and one half, Mr. Rust solicited thirteen small business owners. They deposited about $8.5 million with Attorney Rust as their escrow agent. Each investor execute an agreement which assured them regarding the safety of the escrow, that there would only be nominal handling fees and that investments would be in government backed securities or instruments.

Those representations were materially misleading. In fact Mr. Rust opened a brokerage account, claiming that the source of funds would be “business/self-employment.” The investor funds were not put in government securities but others. Eventually Mr. Rust misappropriated portions of the funds and, when he could not repay investors as required, began using new investor funds to repay earlier ones.

In early August 2011 Individual X replaced Attorney Rust with Attorney Brenner. He had a prior experience with Atlantic – Mr. Brenner was representing an Atlantic client who had deposited $500,000 in July 2011 through Mr. Rust and had not received any loan funds.

Nevertheless, Mr. Brenner agreed to serve as escrow agent for the same lending program that Mr. Rust had touted. Mr. Brenner understood, according to the complaint, that his role was essentially the same as that of Mr. Rust – to induce investor participation with assurances of safety and security. From September 2011 through March 2012 he did just that, securing 15 new clients for the scheme who put up $3.4 million. The results for those clients were the same as for those recruited by Mr. Rust – the funds were not invested as represented, portions were misappropriated and eventually new investor funds repaid prior investors. The complaint alleges violations of Exchange Act Section 10(b). The case is pending.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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