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Smerling admits to $140m sub line fraud, agrees to ‘debrief’ SEC lawyers

JES Capital fraud last year shook the sub line credit world.

The founder of a private equity adviser has pleaded guilty to charges that he ginned up phony subscription credit documents to obtain $140 million in credit lines from two of the industry’s most important banks.

Elliot Smerling admitted that he “forged subscription agreements from limited partners, forged audit letters attesting to his private equity firm’s finances, and falsified bank account statements” to obtain loans from Silicon Valley Bank and Sumitomo Mitsui Banking Corporation. He pleaded guilty to one count each of securities and bank fraud in US Judge Denise L Cote’s courtroom in the Southern District of New York February 8.

The court entered a money judgement against Smerling of $133.96 million.

Smerling’s indictment last year shook the subscription credit line world. It also exposed a potentially major flaw in the market’s due diligence system. Banks such as Silicon Valley – sometimes called “the bank of private equity” – often rely on fund advisers’ words when underwriting loans, though it is fund investors who are ultimately on the hook to cover a default by a fellow investor. Banks have since added extra safeguards to their due diligence processes.

But the issue is not likely lost on SEC Chairman Gary Gensler. He’s worried aloud and often that the private funds industry is rife with conflicts that he says now threaten the entire economy. Prosecutors haven’t filed a plea agreement with Smerling, but court documents show that he agreed to “debrief” Commission lawyers about the scam.

In July, Citizens Bank’s own private suit against Smerling – accusing him of defrauding it for $56 million in loans – was consolidated with SVB’s.

‘Investigative agencies’

At the time of his indictment, prosecutors alleged that Smerling had turned to Silicon Valley for $95 million to refinance a previous loan from Sumitomo. The loans were supposed to back his adviser, JES Global Capital III GP ($500 million in AUM).

He forged commitment documents from a private university based in Manhattan and the investment management division of a New York-based “banking and financial services institution.” He also invented a letter from an audit firm that he hadn’t hired, prosecutors claimed.

At the time, authorities claimed that $80 million was missing. Smerling is working with the court-appointed receiver and “investigative agencies” to help recover the money, court documents show.

He’s scheduled to appear for sentencing in Cote’s courtroom May 13.