Administrative Law Judge Jason S. Patil backtracked on his previous refusal to toss the claims and, on reconsideration, handed a victory to Roni Dersovitz and his Cresskill-based hedge fund RD Legal Capital LLC in finding that the evidence the SEC’s Division of Enforcement relied upon was insufficient, and in some cases, undermined its theory that the valuations at issue were “unreasonable or improper.” The judge said the rest of the claims in the suit would be addressed in a subsequent decision.
Dersovitz and RD Legal purportedly told investors the funds would go toward discounted legal receivables, such as attorneys' fees, from law firms in settled proceedings, according to court records. The valuation claim in the SEC’s administrative suit alleged that the valuation method failed to account for so-called “litigation risk,” that would be posed, for example, if a plaintiff’s attorney doesn’t collect in a case and can’t pay RD Legal.
But the SEC failed to establish its valuation allegations in part because a third-party valuation expert “repeatedly” opined that the discount rate of the receivables reflected the risk of nonpayment, and said the rates were appropriate for those risks, the opinion said.
“As to the other evidence the division cites, there is nothing in the fund’s financial statements evidencing a failure to account for litigation risk or that counters [the valuation expert’s] testimony regarding such risk being appropriately captured through the discount rate,” the opinion said.
In fact, the financial statements repeatedly stress “the significant judgment and uncertainty” that comes with valuing Level 3 assets with “unobservable” inputs like the legal receivables at issue, Judge Satil continued.
“This belies the division’s implied premise that the valuation model should have explicitly distinguished between ‘something that’s valued at a dollar because there’s a 100 percent chance you’re going to get the dollar and something else that’s valued at a dollar because there’s a 50 percent chance you’re going to get $2,’” the opinion said.
The judge also found the division’s reliance on the testimony of investor witnesses “unpersuasive,” noting that their input and the SEC’s arguments were “less an objection to the valuations — the accuracy of which the division does not ultimately contest — and more to the terms of the funds that permitted respondents to withdraw gains monthly.” The SEC overlooked the disclosure in the offering documents to which every investor agreed, permitting withdrawals based on unrealized gains, the opinion said.
Witnesses provided by Dersovitz and RD Legal, including two other valuation experts and a partner for the funds’ outside auditor, also helped their case, according to the opinion.
Among their testimony were statements that RD Legal “acted appropriately and [in a manner] consistent with industry practices” and “conformed to valuation principles,” and that the valuations were “reasonable,” the opinion said.
"Having carefully scrutinized the division’s recitation of all evidence on this issue, I find that, as a matter of law, its allegations on valuation amount to nothing," Judge Patil wrote.
"We are happy with the decision and appreciate Judge Patil taking the step of issuing summary disposition while the post-hearing briefing is ongoing,” attorney Terence Healy of Hughes Hubbard & Reed LLP, representing Dersovitz and RD Legal, told Law360.
The SEC does not comment on pending litigation.
The SEC’s July 2016 lawsuit alleges Dersovitz and his hedge fund raised millions from investors by claiming their funds would be used to purchase discounted legal receivables, such as attorneys' fees, from law firms in settled proceedings, and collect returns of more than 13 percent a year once the settlements were paid. But the SEC said much of the money was used to buy unsettled cases' receivables whose collection still presented significant risks.
The hedge fund told investors the investments were safe because litigation had already ended in the cases and binding settlements had been reached that would be paid by "investment grade obligors" such as rated insurers, municipalities and corporations, the SEC said.
In particular, the SEC said Dersovitz invested as much as 60 percent of the cash in legal receivables tied to litigation against the Islamic Republic of Iran while concealing the risk associated with collecting on a judgment in that case — even while assuring investors that their funds were going toward settled cases. The SEC is seeking disgorgement and civil penalties.
Dersovitz and RD Legal fired back with their own complaint in New Jersey federal court, alleging the SEC’s claims were “cherry-picked from marketing materials and presentations” and never even alleged investors lost money. The suit was dismissed for lack of subject matter jurisdiction and Dersovitz appealed to the Third Circuit, but later dropped the case, court records show.
Dersovitz and RD Capital are represented by Terence Healy of Hughes Hubbard & Reed LLP.
The SEC is represented by Michael Birnbaum, Jorge Tenreiro and Victor Suthammanont.
The case is In the Matter of RD Legal Capital LLC et al., case number 3-17342, before the Securities and Exchange Commission.
--Editing by Pamela Wilkinson.