Business

U.S. SEC Sues Cannabis-Related Investment Entities for Fraud

By Hilary Corrigan Jul 31, 2020
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The U.S. Securities and Exchange Commission sued several individuals and their cannabis-related companies in California federal court this week, alleging they defrauded investors while raising more than $25M.

According to the July 28 civil lawsuit, nine entities and their principals raised more than $25M from more than 400 investors in multiple states between September 2017 to February 2019, “ostensibly to finance two marijuana related businesses.” (Read the complaint here.)

Five of those entities—Smart Initiatives, LLC, Valley View Enterprises LLC, Target Equity LLC, Zabala Farms Group, LLC, and Green Growth Ventures, LLC—raised about $12.3M from about 226 investors to invest in a newly established and licensed marijuana farm in Salinas, Calif. The other four entities—C Quadrant LLC, GPA Enterprises LLC, RJ Holdings Group, LLC, and Extraction Capital Tier 1, LLC—raised about $13.2M from about 211 investors to develop C-Quadrant, a startup CBD extraction facility in Salinas.

In soliciting investor funds, five of the entities’ principals “misled and deceived actual and prospective investors about the profits they could expect to realize on their investments,” the suit states. Those five defendants are Richard Portillo, Charles Lloyd, Mark Heckele and brothers Todd and Jeremy Johnson. The suit, filed in U.S. District Court in California’s Central District, alleges they claimed the investments would generate annual returns of 100% or more.

The suit further alleges that the Johnsons deceived investors on how their money would be used, misrepresented their compensation and misappropriated at least $2.7M of investor money. It says the Johnsons and another defendant, Michael Gregory, another principal at C-Quadrant, “also misled and deceived investors about a purported ‘business loan’” to develop the CBD facility. Gregory used that money to pay off different investors in an unrelated entity, the suit says.

Attorneys for the defendants did not return requests for comment in time for publication. All of the entities and individuals operate in California or Arizona, according to the complaint.

‘Misled and deceived’

The lawsuit alleges the Johnsons, Gregory and Portillo misrepresented their financial and business backgrounds to investors. It says Gregory and Portillo claimed they made large personal capital contributions to their entities when they hadn’t. The Johnsons and Gregory also falsely claimed C-Quadrant had a business and research relationship with a prominent California university, according to the suit.

The suit also says that the Johnsons, Portillo, Lloyd, Heckele and three marketing entities acted as unregistered broker-dealers for the offerings. They used general solicitation, including cold calls, Craigslist, Facebook and other websites and social media, the suit says. But they weren’t registered with the commission, as the U.S. Exchange Act requires.

The offerings sold securities as investment contracts—offering membership units in the entities in exchange for an investment of money, with expected profits dependent on the entities and the farm or CBD extraction facility. For instance, the Johnsons controlled four entities to raise investor funds for the marijuana farm. Through those entities, they raised about $12.2M from about 210 investors in multiple states, the suit says.

But the suit says none of the securities offerings were registered with the commission, as the Securities Act requires, so investors did not get the information a registration statement must provide to protect them. 

The brothers ran another entity to raise investor funds for the CBD extraction facility, the suit says. Through it, they raised more than $6.5M from about 83 investors in multiple states. And along with Gregory, they controlled another entity to raise investor funds for the CBD extraction facility. Through it, they raised nearly $1M from 15 investors in multiple states.

“Unaccredited and unsophisticated”

The offerings involved soliciting investors through calls by an in-house sales team and online, through GBI Marketing and social media, the suit says. For prospective investors, the Johnsons led tours of the farm and CBD facility, and Gregory led tours of the CBD facility. 

The Johnsons misled investors by saying they would get annual returns of 100%-200%, according to the suit. But their expected return-on-investment projections for the marijuana farm depended on that farm making about $30M in 2018 and each year after—despite it having “virtually no operating history, much less a history of making anywhere close” to $30M a year, the suit says.

The suit also notes that many of the investors in the offerings were “unaccredited and unsophisticated.”

Undisclosed information?

The suit further alleges Jeremy Johnson did not disclose his 2012 bankruptcy filing to investors. Additionally, the Johnsons and Gregory did not disclose that Gregory had used a C-Quadrant business loan to pay investors in an unrelated entity, using the extraction facility property as collateral for the loan.

Meanwhile, the lawsuit called a positive summary of Portillo’s background in RJ Holdings’ private placement memorandum “materially misleading in light of Portillo’s extensive criminal record.” That record includes domestic violence and witness intimidation convictions, as well as convictions for felony assault with a deadly weapon, felony taking of a vehicle and felony possession of marijuana for sale, according to the suit.

Portillo had formed RJ Holdings as a fundraising vehicle for C-Quadrant. Portillo, RJ Holdings and CIS Marketing falsely stated to prospective investors that they were guaranteed a 100% annual return and that existing investors already received such returns, the suit says. Through his entity, Portillo raised about $2.8M from about 52 investors in multiple states, it says.

“Deceived investors”

Defendants Lloyd and Heckele conducted at least two unregistered securities offerings, the suit says. One of their entities raised nearly $3M from 61 investors in multiple states to invest in C-Quadrant. Their other entity raised about $755,000 from about 16 investors in multiple states to invest in one of the Johnsons’ entities and, in turn, the marijuana farm.

But Heckele, Lloyd and their two entities “deceived investors” over the expected returns on investments, the suit says. They suggested investors were guaranteed a return of 100% or more each year, but existing investors weren’t making “anywhere close to that amount,” the suit says.

The SEC seeks permanent injunctions, disgorgement of the gains plus interest, and civil penalties.

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