SEC Fines Adviser Who Obtained Misleading Morningstar Rating

On February 26, 2018, the Securities and Exchange Commission issued an Order Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order against EquityStar Capital Management, LLC, an unregistered investment adviser, and its owner, Steven Zoernack.  According to the SEC’s Order, EquityStar and Zoernack offered and sold investment interests in two unregistered investment funds from about May 2010 to about March 2014.  The SEC’s Order alleges that in the course of making these offers and sales, EquityStar and Zoernack “made material misrepresentations and omissions and engaged in a fraudulent scheme involving this and other deceptive conduct.”

Zoernack was tasked with writing and publishing marketing materials for the funds that EquityStar managed.  In these marketing materials, Zoernack allegedly claimed that the funds’ manager, whose name was not disclosed, had “an impeccable and unblemished past record with the SEC.”  According to the SEC, however, Zoernack was in fact the manager, and he had “two criminal fraud convictions, had previously filed for bankruptcy, and had numerous money judgments and liens against him.”  The Order also claims that Zoernack made various efforts to hide his criminal record and negative financial history, including paying a search-engine manipulator to make positive information about him appear before negative information in search engine results.

The SEC’s Order also alleges that Zoernack provided Morningstar with untrue information to obtain a five-star rating, Morningstar’s most prestigious rating, for one of the funds EquityStar managed.  Zoernack allegedly claimed that the fund had a performance history starting in 2009, that it possessed returns in the top 20% of all funds, and it possessed more than $120 million in assets under management.  In reality, however, the fund came into existence in 2012, which would have rendered the fund ineligible for listing on Morningstar’s website.  The funds’ returns displayed on Morningstar’s website were also allegedly hypothetical or products of “back-testing.”  Finally, the fund supposedly never possessed more than $3 million in assets.  Moreover, the biography that Zoernack provided to Morningstar allegedly did not contain any details regarding his criminal record and negative financial history.

Zoernack and EquityStar also allegedly made material misrepresentations regarding the funds’ investment returns in marketing materials and emails.  Most of these communications did not inform investors that the returns were not actual returns but rather back-tested returns.  Other communications featured a misleading footnote regarding the fact that the returns were back-tested.

The SEC’s Order also alleges that Zoernack mishandled investors’ funds by withdrawing about $1 million that he was not authorized to withdraw.  He then allegedly placed that money in EquityStar’s accounts, and eventually transferred it into his personal bank account or other bank accounts he controlled.  Zoernack also allegedly represented that the withdrawals were loans when in fact he did not reimburse the funds or pay any interest.

In light of the SEC’s findings, Zoernack and EquityStar each submitted offers of settlement, by which they agreed to refrain from further violations of the Investment Advisers Act of 1940, and to be barred from the securities industry, and Zoernack and EquityStar agreed to be restrained from becoming affiliates of any investment adviser.  Zoernack and EquityStar also agreed to pay $2,890,518.54 in disgorgement.

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