California.-based investment advisor Paul Horton Smith Sr. allegedly ran a Ponzi scheme on elderly clients by raising millions of dollars selling fictitious securities in his company, promising "private annuity contracts" and using those earnings to pay returns to other investors, according to an SEC complaint filed in the U.S. District Court for the Central District of California on May 19.
Criminal charges soon followed; Smith was arrested by the FBI and charged with one count of wire fraud, according to the U.S. Attorney’s Office for the Central District of California. If convicted, Smith could face 20 years in prison.
According to the SEC complaint, Smith sold securities in his company, Northstar Communications, via his own state-registered RIA firm, eGate, and Planning Services, an insurance and estate planning company he ran, between January 2018 and when he was arrested. The SEC asserted that Smith was able to pull off the fraud by touting his bona fides as a “trusted fiduciary” with extensive experience in the industry.
In reality, Smith had been barred from selling securities in Idaho for 10 years in 2008, and was issued a notice in February of this year that the California Department of Business Oversight intended to bar him from the securities industry, according to the SEC. He was not registered with the SEC “in any capacity,” according to the SEC complaint.
“Through his promotion of advisory, tax, and financial planning services, Smith created a trusting relationship he then used to solicit investors to purchase securities issued by Northstar. As Smith told investors during a February 2020 workshop, ‘your pockets aren’t going to get picked, okay? . . . We are all fiduciaries,’” the complaint read. “In fact, and in breach of Smith’s fiduciary duty, clients’ pockets were getting picked clean through his Ponzi scheme.”
Smith did not return a request for comment, and an attorney with the public defender's office that represented him during criminal proceedings declined to comment.
According to the complaint, Smith would entice investors through free workshops and other events, allegedly touting annual interest payments between 3% and 10.5% if clients invested in Northstar’s “private annuity contracts.” However, those investments never made it into brokerage accounts, according to the complaint. There was about $5.6 million in Northstar’s bank account from investor deposits, with $5.3 million paid to investors as interest payments or return of the principal investments. Those funds were never put into investments or assets in Smith’s three companies, according to the SEC.
“Based upon the deposits and payments from Northstar’s bank accounts, deposits of investor funds were almost the exclusive source of payments made to investors in Northstar, in a classic Ponzi scheme fashion,” the complaint read.
Additionally, Smith used about $175,000 in investor funds to settle lawsuits against him; in February, one elderly client filed a lawsuit to get back his investment in Northstar. Smith settled and agreed to make an initial payment of $80,000, but Northstar didn’t have that in the bank at the time. A short time later, there was $191,000 in Northstar’s bank account from a new investor, and Smith made the settlement payment 18 days later with no significant additional deposits made during that period.
The spread of COVID-19 didn’t stop Smith, according to the complaint. Once the shelter-in-place orders began, he started soliciting investors by phone and in meetings at his office or investors’ homes. He also held workshops, free-meal seminars and even planned a “comedy night” at a local theater before the coronavirus crisis hit.
The SEC is seeking an injunction against Smith, along with the return of “ill-gotten gains” with interest and civil penalties. The court granted a temporary restraining order and asset freeze on May 20, with a hearing scheduled for June 3 regarding whether the asset freeze should be continued and if a preliminary injunction should be issued.
Michele Wein Layne, the director of the SEC’s Los Angeles Regional Office, said Smith had raised millions through guaranteeing investors would see a return.
“Investors should be wary of investments promising no risk and high returns, which are classic warning signs of investment fraud,” she said.