Clients of John Lawton are suing to recover their hedge fund investments

Clients of former Wayzata investor John Lawton and his Paramount Partners hedge fund have sued to get their investments back even though his dwindling assets have been frozen by the Securities and Exchange Commission (SEC).

The 14 clients, all Minnesotans, are seeking to recoup $2.4 million they invested with Lawton from 2006 through 2008. They also are asking for punitive damages.

Lawton was put out of business, at least temporarily, in February when the SEC accused him of misleading clients about the nature and size of their investments and obtained a preliminary injunction to halt his dealings. Lawton has denied the allegations of securities fraud.

The attorney for the investors, Patrick Neaton, said the individuals suing Lawton were promised healthy returns on their investments and were given falsified statements that showed significant investment gains, on which they paid taxes.

Neaton said those gains were "phantom profits."

"It's like a double whammy," Neaton said of the investment losses and the taxes his clients paid on inflated income.

The lawsuit alleges that Lawton and his company sold unregistered securities, made material misrepresentations, violated consumer fraud protection laws, unjustly enriched themselves at the investors' expense, were negligent and breached their fiduciary duties to the investors.

Capital Solutions said it was disappointed to be included as a defendant in the lawsuit. "We were victims, too," general counsel Richard Dobson said Tuesday. He said the company is "cooperating fully" with regulators, and noted that three of its executives collectively lost between $500,000 and $1 million through investments with Lawton.

According to the suit, investors "were induced" to invest with Paramount through advertisements and personal solicitations. Paramount described itself as "an extremely successful hedge fund which had a history of obtaining significant profits."

Paramount told investors it had averaged an annual return of 27.95 percent a year since 2002, including a 64.97 percent return in 2007, according to the suit.

According to SEC documents, Lawton's investment advisory firm, Crossroads Capital Management, gave its clients financial statements that listed assets of $17 million as of Dec. 31, 2008, when in reality, there was just $5.3 million in those accounts. The asset balance stood at $1.3 million when the SEC stepped in.

Lawton, 34, moved his operation to the San Francisco area about a year ago.