The Securities and Exchange Commission ("SEC") filed a civil enforcement action against two individuals, accusing them of operating a $163 million Ponzi scheme by purporting to sell interests in two Dominican Republic timeshare resorts. James B. Catledge, of San Diego, California, and Derek F. C. Elliott, of Hillsburgh, Ontario, were charged in Nevada federal court with multiple violations of federal securities laws in connection with the scheme. The SEC is seeking injunctive relief, disgorgement of all ill-gotten gains, and civil monetary penalties.
According to the SEC, Elliott and his father purchased the Cofresi resort in the Dominican Republic in 2003 through their company EMI Sun Village, Inc. ("EMI Sun Village"), with the intent to finish construction and open the resort for business. However, after encountering financial difficulties, a friend urged them to get in touch with Catledge, whose company Net Worth Solutions ("Net Worth") could assist with marketing and fund-raising. After hiring Catledge, Elliott began selling securities related to the Cofresi resort through EMI Sun Village. This form of security, known as the "Residence", offered a prospective purchaser the right to either occupy a room at the Cofresi resort for a period of time proportional to his investment, or to decline the use of the room and instead allow the unit to be rented out in return for an annual non-use fee ("NUF"). The NUF ranged from 8% to 12%, and was paid out quarterly. After a five-year period, investors were given the option of either having their principal returned or rolling it over for another five years at a higher NUF. Investors were assured that their investment was guaranteed, and that they would share in the appreciation of the value of the timeshare itself over time.
While the Cofrisi resort was still in the process of being "constructed", Elliott and his father purchased another hotel in the Dominican Republic called the Sun Village Juan Dolio ("Sun Village"). While he initially sold interests based on the "Residence" interest marketed in the Cofrisi resort, Elliott began offering a new form of investment known as the "Passport" that promised investors a fractional ownership interest rather than a timeshare. Instead of a NUF, a prospective investor was promised a 5% annual return, paid quarterly, until the Sun Village was opened. After the hotel opened, the investor would then be entitled to split the net rental proceeds with the hotel. An investor purchasing a Passport interest would make half of their investment in cash and half by promissory note.
Net Worth had exclusive marketing rights to sell both the Passport and Residence interests. Prospective investors were shown elaborate visual presentations with titles such as "Real Estate Secrets of the Wealthy" to convince people to invest their savings in the Residence and Passport securities. These presentations were shown at road shows conducted throughout the western United States. Overall, nearly 1,200 investors purchased $72.6 million worht of investments in Cofresi and $91.2 million in Sun Village, for a total investment of nearly $164 million. However, investors were not told that the proceeds from these investments would be used for a variety of reasons, and only a small percentage would go towards construction. For example, out of the $91.2 million raised from Sun Village investors, only $8 million was spent on construction. The majority of the remainder, nearly $38 million, was used to pay "commissions" to existing investors. Similarly, over $21 million of the $72.6 million raised from Cofresi investors was used to fund the payment of commissions to investors. These commissions, totaling nearly $60 million, continued to be paid out despite the fact that both Cofresi and Sun Village experienced yearly operating losses that eventually culminated in the loss of both properties to foreclosure in 2009.
Elliott and Catledge made numerous misrepresentations and omissions to investors, according to the SEC's complaint. This included promises that the returns would be guaranteed, that both resorts were profitable, and that "100% of invested capital goes to work for the owner." Instead, Sun Village investor funds were used for a variety of non-construction expenses, including funding the purchase of a yacht, to pay expenses of the Cofresi resort, and to purchase an additional property. Sun Village funds were also used to pay NUFs to Cofresi investors - the hallmark of a Ponzi scheme. Additionally, by failing to register the Passport and Residence securities that were being solicited to prospective investors, the SEC contended that the offerings and resulting misappropriation of offering proceeds were in violation of federal securities laws.
After the Idaho Department of Finance began investigating the scheme in 2005, Catledge and Elliott entered into a consent decree in 2007 that included the promise that they would make a rescission offer to all Idaho purchasers. However, this rescission offer was never made, and in 2009, the state of Idaho attorney general filed charges against the pair, alleging that they had violated Idaho securities laws by engaging in the sale of unregistered securities.
According to the Globe and Mail, Mr. Elliott has since launched a new luxury vacation rental website called Preferred Escapes.
The SEC complaint is here.