When the Securities and Exchange Commission brings charges against a real estate company, it catches my eye. The SEC accused Joshua Schuster and Schuster Enterprises LLC (d/b/a Silverback) of misleading investors and misappropriating some of that invested capital. Of course, this is just the SEC’s side of the case and Mr. Schuster has not had a chance to counter with his defense in this case. Or in the case brought by the Department Justice with criminal charges on the same activity.
With the SEC embrace of non-securities crypto, the SEC complaint takes the time to explain how Silverback was selling securities.
38. Based on discussions with Schuster during his solicitation of their investments, Investor A and Investor B expected to rely solely on Defendants’ expertise to develop the Second Avenue Project to manage and develop the project into a profitable investment.
39. These expectations were memorialized in the JVEM Gramercy LLC Agreement, which provided that Investor A and Investor B were non-managing members of JVEM Gramercy.
40. Specifically, Investor A and Investor B had no rights to participate in the day-to-day management of JVEM Gramercy or the Second Avenue Project, and no rights to replace the manager of JVEM Gramercy except in the event of the manager’s death or incapacity.
Clearly hitting up the “derived from the efforts of others” prong of the Howey test.
The complaint and indictment both detail an outflow of the invested cash to Mr. Schuster and other uses beyond the target investment. The SEC claims that Silverback misappropriated over $2 million of the funds to make payments for Mr. Schuster’s personal benefit, to cover Silverback’s general corporate and payroll expenses, and to fund other Silverback real estate projects. The Department of Justice puts the misappropriated funds at $10 million.
The question I have is: Were these payments affiliate fees owed to Silverback? It’s common for development projects to pay substantial fees to the sponsor for the overseeing the construction. At a minimum, it was poor record keeping and commingling of funds having invested capital be paid directly for personal items rather than having the payments going to Silverback then to the outside payments. At worse, the DOJ is correct and the funds were stolen.
However, there are some damning text messages with Mr. Schuster. “Josh. Need to figure out Cash. For [two investors in other project] and we have [payroll] Thurs. & we have no $ for bonuses.”
On the disclosure side, the SEC claims that Silverback failed to tell investors that the capital would be put to other uses outside the project. Worse, the SEC claims that Silverback failed to disclose some loan obligations, including one that was in default.
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