John Hughes, the co-founder, president and chief compliance officer of Prophecy Asset Management, yesterday pleaded guilty to defrauding dozens of clients out of $294 million, said the U.S. Attorney’s Office for the District of New Jersey.
According to the statement, Hughes, a 56-year-old resident of Mahwah, N.J., and his co-founding partner—identified in the firm’s latest Form ADV filing as Jeffrey R. Spotts—operated investment funds that held more than $360 million.
From January 2015 to March 2020, Hughes and Spotts told their clients that the firm used a “first-loss” trading strategy in which the firm would allocate funds to a diverse pool of subadvisors who had to provide cash collateral in order to backstop potential losses, the statement said, adding that because of this and related false claims, the firm’s clients believed their money was invested in low-risk, transparent and diversified funds.
“In reality, over time, Hughes and his co-founder allocated most of the funds’ capital to a single, primary subadvisor without requiring him to provide cash collateral to back potential losses. They also failed to suspend his allocations or trading, even though he sustained approximately $290 million in losses that far exceeded his cash collateral,” the statement said. “Hughes, his co-founder, and the subadvisor also actively covered up these spiraling losses and collateral deficiencies by using, among other things, bogus transactions and forged documents.”
Hughes pleaded guilty in district court to one count of conspiracy to commit securities fraud, the statement said, and at his sentencing in March 2024 faces a maximum penalty of five years in prison and a fine of $250,000.
Yesterday the Securities and Exchange Commission also charged Hughes in the same matter, although the SEC’s estimate of funds lost was $350 million, the agency said.
According to the SEC complaint, from 2014 to March 2020, Hughes and Spotts mislead investors about activities at Prophecy, making false statements about the funds’ diversity, liquidity, stability and returns. The agency’s charges included violations of the Securities Act, Exchange Act and Advisers Act.
“Hughes deceived the investment funds’ investors, prospective investors, auditors and administrator about nearly every aspect of the investment funds, including their structure and operation, risk-management practices, investments and performance,” the SEC complaint stated.
Instead of operating in the way they were advertising, Hughes and Spotts moved most of the investment fund’s assets to a single subadvisor, referred to as Individual 2, who “sustained massive losses,” the complaint said.
During the relevant period, Hughes, Spotts and Prophecy collected more than $15 million in management and incentive fees. By March 2020, the funds, which held $500 million at their peak, lost more than $350 million. The losses prompted the auditor’s withdrawal of its 2018 audit opinion and resignation, at which point Hughes, Spotts and Prophecy indefinitely suspended redemptions by investors, the complaint said.
“Hughes, [Spotts and Prophecy] never disclosed to investors that Individual 2 had sustained massive losses or that they were permitting Individual 2 to continue trading without providing sufficient collateral,” the SEC said.
The SEC complaint seeks disgorgement of all ill-gotten gains and civil penalties.