Collin County Confidence: Securities Fraud Investigations

J. Mitchell LittleScheef & Stone, LLP

Collin County Bench Bar ConferenceMarch 2012

The DilemmaProsecutorial and Regulatory Resources vs. “The Sweet Spot”•If you steal $700, justice is swift.•If you steal $7 million, you can buy a lot of time.•It takes time for investors to realize they’ve been scammed; precious evidence wastes away.Investigative Resources vis-à-vis Non-Violent Crime•Do we want our police and investigators hunting child molesters or confidence men?•Can we afford for them to do both?•If an outsider were to look at how Collin County spends its money, what would they think was important to the county?

The Dilemma

7th-largest County in Texas by population.One of the fastest-growing counties in Texas.Judicial and legal spending are largely flat or down.Capital improvements (Facilities) spending has increased significantly from 2007 on, but so has the white-collar crime.So…How do you compete with the crooks?•Having a nicer building to take them to doesn’t help.•New investigative techniques.•Properly-funded special task force.•Collin County is already a leader in this field, so what is the incentive to get better?

The People

The RealityCollin County has a securities fraud problem.•Greg Rand; Aspen Exploration (Plano Ponzi Scheme; Pled Northern District)•James G. Temme; Stewardship Fund (Plano Ponzi Scheme; SEC Receivership)•John Arthur Apple; NAPC (Frisco resident/Pled Northern District)•Edward S. Digges, Jr.; Millennium Terminal Investment Program (99 years, Collin County DA)•William June Fletcher (25 years, Collin County DA)•Greenway Energy Partners (8 years, Collin County DA)•Titan Wealth Management; John J. Kim (10 years, Collin County) Thomas Lester Irby (24 years, Collin County DA)•Charles Scott Goist (46 years, Collin County DA)•Bill Seelye (99 years, Collin County DA )•Aransas Oil; Bill Durkee (25 years, Collin County DA)•Texas Securities Partners (Broker-Dealer Registration Revoked)•Quadwealth; Jeremy Louder (Pled – Eastern District)

The last four years.

Trends

North Texas: Promoter’s Paradise

Common Violations:1. Public Solicitation.2. Illicit Use of Investment Proceeds.3. Failing to Disclose Promotional Costs.4. Self-Interested Transactions.5. Movement of Money Between Offerings.

One East Texas Case To finance oil and gas operations,

one East Texas oil and gas promoter sold a three rounds of investment certificates, with each certificate entitling the holder to 4 of the promoter’s 320 mineral acres.

The promoter vastly oversold his leasehold rights, meaning only the first 80 certificates had value, with the remainder being worthless.

One particular lease was sold to eleven different people.

That promoter was C.M. “Dad” Joiner, and those leases constituted the discovery of what was then the largest oil field on planet Earth.

After the investors sought a receivership, H.L. Hunt bought Joiner out and settled the investors claims, one-by-one. Burrough, Bryan. The Big Rich. The Penguin Press, 2009.

Another East Texas Case

Actual Script From an Oil and Gas Boiler Room

“Crime doesn’t pay!” ... Yeah ... Right.

Section 4(A) of the TSA reads:The term "security" or "securities" shall include

any limited partner interest in a limited partnership, share, stock, treasury stock, stock certificate under a voting trust agreement, collateral trust certificate, equipment trust certificate, preorganization certificate or receipt, subscription or reorganization certificate, note, bond, debenture, mortgage certificate or other evidence of indebtedness, any form of commercial paper, certificate in or under a profit sharing or participation agreement, certificate or any instrument representing any interest in or under an oil, gas or mining lease, fee or title, or any certificate or instrument representing or secured by an interest in any or all of the capital, property, assets, profits or earnings of any company, investment contract, or any other instrument commonly known as a security, whether similar to those herein referred to or not. The term applies regardless of whether the "security" or "securities" are evidenced by a written instrument. Provided, however, that this definition shall not apply to any insurance policy, endowment policy, annuity contract, optional annuity contract, or any contract or agreement in relation to and in consequence of any such policy or contract, issued by an insurance company subject to the supervision or control of the Texas Department of Insurance when the form of such policy or contract has been duly filed with the Department as now or hereafter required by law.

Tex. Rev. Civ. Stat. Title 19, Art. 581-4.

What is a security?

An “investment contract” is:

1. An investment of money;2. In a common enterprise;3. With an expectation of

profits;4. To be derived solely from

the efforts of others.

Caldwell v. State, 95 S.W.3d 563 (Tex.App.---Houston [1st. Dist.], 2002).

SEC v. W.J. Howey & Co., 328 U.S. 293 (1946).

This is the securities “catch-all” in an increasingly complex financial universe.

What is an “investment contract?”

State Regulatory Challenges

From 2006-2010, the Texas State Securities Board issued twelve cease-and-desist orders to Texas issuers of oil and gas securities.

From 2006-2010, the Alabama Securities Commission issued ten cease-and-desist orders to Texas issuers of oil and gas securities.

Texas and Alabama only had one in common.

The Statutes We Care About

The Securities Act of 1933 (15 USC §77a, et seq.)

The Texas Securities Act (Tex. Rev. Civ. Stat. Title 19, Art. 581)

Texas State Securities Board Rules (Tex. Admin. Code, Title 7, Part 7)

1. Limited Partnerships2. Direct Participation3. General Partnerships/Joint

Ventures4. L.L.C. Member Units5. Stock6. Promissory Notes

Typical Structures/Syndication Methods

Joint Venturesa. Not securities. Russell v. French,

709 S.W.2d 312 (Tex.App.—Texarkana, 1986).b. Under Texas law, a joint venture

is a general partnership. c. Is there common control/profit

sharing?d. Can the joint venturers replace

the person or sponsor who has managerial power?

e. Is management delegated to someone else?

f. Do the joint venturers know who the others are?

g. Detailed factual analysis is necessary to stay out of the “investment contract” rubric.

SUBSTANCE OVER FORM

Typical Structures/Syndication Methods

Section 12(A) of the TSA:Except as provided in Section 5 of this Act,

no person, firm, corporation or dealer shall, directly or through agents, offer for sale, sell or make a sale of any securities in this state without first being registered as in this Act provided. No agent shall, in behalf of any dealer, sell, offer for sale, or make sale of any securities within the state unless registered as an agent for that particular registered dealer under the provisions of this Act.

Tex. Rev. Civ. Stat. Title 19, Art. 581-12(A)

If you want to issue, offer or sell securities, you must register them and be registered yourself.

Federal and state registration is a lengthy and expensive process.

The expense and complexity associated with registered offerings have spawned a massive unregistered securities sub-industry.

The General Rule

Section 5(I) of the TSA:Except as hereinafter in this Act specifically provided, the provisions of this Act shall not apply to the sale of any security when made in any of the following transactions and under any of the following conditions, and the company or person engaged therein shall not be deemed a dealer within the meaning of this Act; that is to say, the provisions of this Act shall not apply to any sale, offer for sale, solicitation, subscription, dealing in or delivery of any security under any of the following transactions or conditions: [ . . .]

I. Provided such sale is made without any public solicitation or advertisements:

(a) the sale of any security by the issuer thereof so long as the total number of security holders of the issuer thereof does not exceed thirty-five (35) persons after taking such sale into account;[ . . . . ]; or

(c) the sale by an issuer of its securities during the period of twelve (12) months ending with the date of the sale in question to not more than fifteen (15) persons (excluding, in determining such fifteen (15) persons, purchasers of securities in transactions exempt under other provisions of this Section 5, purchasers of securities exempt under Section 6 hereof and purchasers of securities which are part of an offering registered under Section 7 hereof), provided such persons purchased such securities for their own account and not for distribution.

Tex. Rev. Civ. Stat. Title 19, Art. 581-5I.

Exemptions from Registration

Section 5(T) of the TSA:T. Such other transactions or conditions as the Board by rule, regulation, or order may define or prescribe, conditionally or unconditionally.

Tex. Rev. Civ. Stat. Title 19, Art. 581-5T.

(k) Uniform limited offering exemption.

In addition to sales made under the Texas Securities Act, §5.I, the State Securities Board, pursuant to the Act, §5.T, exempts from the registration requirements of the Act, §7, any offer or sale of securities offered or sold in compliance with the Securities Act of 1933, Regulation D, Rules 230.505 and/or 230.506 [ . . .]

Vastly simplified:(1)Accredited investors;(2)No commissions to unlicensed brokers;(3)No public solicitation;(4)File SEC Form D correctly.

Exemptions from Registration

Two Competing Notions:1. Any cold call is a public

solicitation. (SEC, Texas SSB)Tumbleweed Bowling Corp. v. P.T. Matise, 388 S.W.2d 479 (Tex.Civ.App. Beaumont 1965, reh. denied).In Tumbleweed Bowling, the controlling facts in leading the Court to hold that the defendant engaged in public solicitation in selling stock were:

(1) he did not know the purchasers before he contacted them; and

(2) that he would have continued talking to people until he sold all $150,000 of the stock in question.

What is public solicitation?

Two Competing Notions:2. There needs to be a closer review of the

solicitation. (Issuers)Sibley v. Horn Adveritising, Inc., 505 S.W.2d 417 (Tex. Civ. App. 1974, reh. denied). In Sibley, the Court found that the offering was exempt from registration because:

(1) “An offering to those shown to be able to fend for themselves is a transaction ‘not involving any public offering.’”

(2) The investor was able to fend for himself because he was an experienced investor and had personal experience with the issuer in previous offerings.

What is public solicitation?

Is it a security under Section 4?

Is it registered under Section 12?

Is it exempt under Section 5?

A Simple Flow Chart

Yes.

No.

No.

Minimum 2 years.

Criminal ChangesHouse Bill 2342, effective 9/1/11ftp://ftp.legis.state.tx.us/bills/82R/analysis/html/house_bills/HB02300_HB02399/HB02342E.HTM

Increased fines from $5,000 to $10,000 to accompany 3rd Degree Felonies.Adopts felony degree language from the Texas Penal Code.Adopts the 12.42 enhancement, “stacking degrees.”

Criminal ChangesSec. 29. Penal Provisions. Any person who shall:A. Sell, offer for sale or delivery, solicit subscriptions or orders for, dispose of, invite offers for, or who shall deal in any other manner in any security or securities without being a registered dealer or agent as in this Act provided shall be deemed guilty of a felony of the third degree.B. Sell, offer for sale or delivery, solicit subscriptions to and orders for, dispose of, invite orders for, or who shall deal in any other manner in any security or securities issued after September 6, 1955, unless said security or securities have been registered or granted a permit as provided in Section 7 of this Act, shall be deemed guilty of a felony of the third degree.C. In connection with the sale, offering for sale or delivery of, the purchase, offer to purchase, invitation of offers to purchase, invitations of offers to sell, or dealing in any other manner in any security or securities, whether or not the transaction or security is exempt under Section 5 or 6 of this Act, or in connection with the rendering of services as an investment adviser or an investment adviser representative, directly or indirectly:(1) engage in any fraud or fraudulent practice;(2) employ any device, scheme, or artifice to defraud;(3) knowingly make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading; or(4) engage in any act, practice or course of business which operates or will operate as a fraud or deceit upon any person, is:(a) guilty of a felony of the third degree, if the amount involved in the offense is less than $10,000;(b) guilty of a felony of the second degree, if the amount involved in the offense is $10,000 or more but less than $100,000; or(c) guilty of a felony of the first degree, if the amount involved is $100,000 or more.D. Knowingly violate a cease and desist order issued by the commissioner under the authority of Section 23A, 23B, or 23-2 of this Act shall be deemed guilty of a felony of the third degree.E. Knowingly make or cause to be made, in any document filed with the commissioner or in any proceeding under this Act, whether or not such document or proceeding relates to a transaction or security exempt under the provisions of Sections 5 or 6 of this Act, any statement which is, at the time and in the light of the circumstances under which it is made, false or misleading in any material respect shall be deemed guilty of a felony of the third degree.F. Knowingly make any false statement or representation concerning any registration made or exemption claimed under the provisions of this Act shall be deemed guilty of a state jail felony.G. Make an offer of any security within this State that is not in compliance with the requirements governing offers set forth in Section 22 of this Act shall be deemed guilty of a state jail felony.H. Knowingly make an offer of any security within this State prohibited by a cease publication order issued by the Commissioner under Section 23C of this Act shall be deemed guilty of a state jail felony.I. Render services as an investment adviser or an investment adviser representative without being registered as required by this Act shall be deemed guilty of a felony of the third degree.J. A conviction of an offense under this section may be enhanced as provided by Section 12.42, Penal Code.Sec. 29-1. Limitation. An indictment for an offense under Subsection C of Section 29 may be brought only before the fifth anniversary of the day on which the offense is committed.Sec. 29-2. Aggregation of Amounts Involved in Securities Fraud. When amounts are obtained in violation of this Act under one scheme or continuing course of conduct, whether from the same or several sources, the conduct may be considered as one offense and the amounts aggregated in determining the grade of the offense.

Section 33A(1) of the TSA: A person who offers or sells a security in violation of Section 7, 9 (or a requirement of the Commissioner thereunder), 12, 23C, or an order under 23A or 23-2 of this Act is liable to the person buying the security from him, who may sue either at law or in equity for rescission or for damages if the buyer no longer owns the security.

Rescission

Section 33A(2) of the TSA: A person who offers or sells a security (whether or not the security or transaction is exempt under Section 5 or 6 of this Act) by means of an untrue statement of a material fact or an omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, is liable to the person buying the security from him, who may sue either at law or in equity for rescission, or for damages if the buyer no longer owns the security. However, a person is not liable if he sustains the burden of proof that either (a) the buyer knew of the untruth or omission or (b) he (the offeror or seller) did not know, and in the exercise of reasonable care could not have known, of the untruth or omission. The issuer of the security (other than a government issuer identified in Section 5M) is not entitled to the defense in clause (b) with respect to an untruth or omission (i) in a prospectus required in connection with a registration statement under Section 7A, 7B, or 7C, or (ii) in a writing prepared and delivered by the issuer in the sale of a security.

Rescission

Section 33(D)(1),(6), and (7) of the TSA: (1) On rescission, a buyer shall recover

(a) the consideration he paid for the security plus interest thereon at the legal rate from the date of payment by him, less

(b) the amount of any income he received on the security, upon tender of the security (or a security of the same class and series).[ . . . ](6) On rescission or as a part of damages, a buyer or a seller shall also recover costs.(7) On rescission or as a part of damages, a buyer or a seller may also recover reasonable attorney's fees if the court finds that the recovery would be equitable in the circumstances.

Calculating a Rescission

Section 33(F)(1) of the Texas Securities Act:A person who directly or indirectly controls a seller, buyer, or issuer of a security is liable under Section 33A, 33B, or 33C jointly and severally with the seller, buyer, or issuer, and to the same extent as if he were the seller, buyer, or issuer, unless the controlling person sustains the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist.

Now It Gets Ugly...

Section 33(F)(2) of the Texas Securities Act:(2) A person who directly or indirectly with intent to deceive or defraud or with reckless disregard for the truth or the law materially aids a seller, buyer, or issuer of a security is liable under Section 33A, 33B, or 33C jointly and severally with the seller, buyer, or issuer, and to the same extent as if he were the seller, buyer, or issuer.

Now It Gets Much Uglier...

But . . . Sterling Trust Co.v. Adderly, 168 S.W.3d 835 (Tex. 2005).

An aider is subject to liability "only if it rendered assistance to the seller in the face of a perceived risk that its assistance would facilitate untruthful or illegal activity by the primary violator." The aider "must be subjectively aware of the primary violator's improper activity."