Securities and Exchange Commission v. Schooler et al
Filing
1081
ORDER Granting in Part and Denying in Part #1015 the SEC's Motion for Partial Summary Judgment on its First and Second Caims for Relief: With regards to the Stead property fair market value representation in Western's brochure, the SEC's first and second causes of action are granted as to all elements; and With regards to all other alleged misrepresentations and omissions, the SEC's first and second causes of action are granted as to an offer or sale of a security, granted as to interstate commerce, denied as to materiality, and denied as to intent. Signed by Judge Gonzalo P. Curiel on 6/3/15. (dlg)
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UNITED STATES DISTRICT COURT
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SOUTHERN DISTRICT OF CALIFORNIA
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SECURITIES AND EXCHANGE
COMMISSION,
Plaintiff,
v.
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LOUIS V. SCHOOLER and FIRST
FINANCIAL PLANNING
CORPORATION, dba Western
Financial Planning Corporation,
CASE NO. 3:12-cv-2164-GPC-JMA
ORDER GRANTING IN PART AND
DENYING IN PART THE SEC’S
MOTION FOR PARTIAL
SUMMARY JUDGMENT ON ITS
FIRST AND SECOND CLAIMS
FOR RELIEF
[ECF No. 1015]
Defendants.
I. INTRODUCTION
Before the Court is Plaintiff Securities and Exchange Commission’s (the “SEC”)
Motion for Partial Summary Judgment on its First and Second Claims for Relief. (ECF
No. 1015.) Defendants Louis V. Schooler (“Schooler”) and First Financial Planning
Corporation d/b/a Western Financial Planning Corporation (“Western”) (collectively,
“Defendants”) oppose. (ECF No. 1063.)
The parties have fully briefed the motion. (ECF Nos. 1015, 1063, 1067.) A
hearing on the SEC’s motion was held on May 19, 2015. (ECF No. 1073.) Upon review
of the moving papers, admissible evidence, oral argument, and applicable law, the
Court GRANTS IN PART AND DENIES IN PART the SEC’s motion for partial
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1 summary judgment.
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II. BACKGROUND
This is an enforcement action brought by the SEC. (See ECF No. 1.) The SEC
4 alleges that Defendants defrauded investors in the sale of general partnership (“GP”)
5 units which were, as a matter of law, unregistered securities. (Id.) On September 4,
6 2012, the SEC filed its complaint. (Id.) On October 22, 2012, this case was transferred
7 to the undersigned judge. (ECF No. 52.) On July 15, 2013, Defendants filed an answer
8 to the SEC’s complaint. (ECF No. 255.) On March 28, 2014, the SEC filed a motion
9 for partial summary judgment with regards to whether the GP units were securities.
10 (ECF No. 563.) On April 25, 2014, the Court granted the SEC’s motion for partial
11 summary judgment and found that the GP units at issue in this case were securities as
12 a matter of law (the “Securities Order”). (ECF No. 583.) The facts of this case are set
13 forth in further detail in the Securities Order. (Id. at 1–11.)
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On March 13, 2015, the SEC filed the present motion for partial summary
15 judgment on its first and second claims for relief. (ECF No. 1015.) On April 24, 2015
16 Defendants filed an opposition to the SEC’s motion. (ECF No. 1063.) On May 8, 2015,
17 the SEC filed a response to Defendants’ opposition. (ECF Nos. 1067.) The SEC moves
18 for summary judgment on its first and second claims for relief: that Defendants violated
19 Section 17(a) of the Securities Act of 1933 (“Section 17(a)”), 15 U.S.C. § 77q(a),
20 Section 10(b) of the Exchange Act of 1934 (“Section 10(b)”), 15 U.S.C. § 78j(b), and
21 Rule 10b-5 promulgated under the Exchange Act of 1934 (“Rule 10b-5”), 17 C.F.R.
22 § 240.10b-5. (ECF No. 1 ¶¶ 67–74; ECF No. 1015.)
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III. LEGAL STANDARD
Federal Rule of Civil Procedure 56 empowers the Court to enter summary
25 judgment on factually unsupported claims or defenses, and thereby “secure the just,
26 speedy and inexpensive determination of every action.” Celotex Corp. v. Catrett, 477
27 U.S. 317, 325, 327 (1986); FED. R. CIV. P. 56. Summary judgment is appropriate if the
28 “pleadings, depositions, answers to interrogatories, and admissions on file, together
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1 with the affidavits, if any, show that there is no genuine issue as to any material fact
2 and that the moving party is entitled to judgment as a matter of law.” FED. R. CIV. P.
3 56(c). A fact is material when it affects the outcome of the case. Anderson v. Liberty
4 Lobby, Inc., 477 U.S. 242, 248 (1986).
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The moving party bears the initial burden of demonstrating the absence of any
6 genuine issues of material fact. Celotex, 477 U.S. at 323. The moving party can satisfy
7 this burden by demonstrating that the nonmoving party failed to make a showing
8 sufficient to establish an element of his or her claim on which that party will bear the
9 burden of proof at trial. Id. at 322–23. If the moving party fails to bear the initial
10 burden, summary judgment must be denied and the Court need not consider the
11 nonmoving party’s evidence. Adickes v. S.H. Kress & Co., 398 U.S. 144, 159–60
12 (1970).
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Once the moving party has satisfied this burden, the nonmoving party cannot rest
14 on the mere allegations or denials of his or hear pleading, but must “go beyond the
15 pleadings and by her own affidavits, or by the ‘depositions, answers to interrogatories,
16 and admissions on file’ designate ‘specific facts showing that there is a genuine issue
17 for trial.’” Celotex, 477 U.S. at 324 (citing FED. R. CIV. P. 56 (1963)). If the
18 non-moving party fails to make a sufficient showing of an element of its case, the
19 moving party is entitled to judgment as a matter of law. Id. at 325. “Where the record
20 taken as a whole could not lead a rational trier of fact to find for the nonmoving party,
21 there is no ‘genuine issue for trial.’” Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,
22 475 U.S. 574, 587 (1986) (citing FED. R. CIV. P. 56 (1963)). In making this
23 determination, the Court must “view [] the evidence in the light most favorable to the
24 nonmoving party.” Fontana v. Haskin, 262 F.3d 871, 876 (9th Cir. 2001). The Court
25 does not engage in credibility determinations, weighing of evidence, or drawing of
26 legitimate inferences from the facts; these functions are for the trier of fact. Anderson,
27 477 U.S. at 255.
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1
IV. DISCUSSION
2 A. Evidentiary Disputes
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1. Judicial Admissions
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First, the statements made by Defendants, (ECF No. 571-1 ¶¶ 9–10), are not, as
5 the SEC argues, “conclusively binding.” (See ECF No. 1067, at 2–3 (citation omitted).)
6 Federal Rule of Civil Procedure 7 generally allows for two types of filings by the
7 parties: (1) “pleadings,” and (2) “motions and other papers.” FED. R. CIV. P. 7. Rule 7
8 further specifies that there are exactly seven types of pleadings, primarily complaints,
9 answers to complaints, and replies to answers to complaints. Id. Ignoring this
10 distinction, the SEC misinterprets American Title Insurance Co. v. Lacelaw Corp., 861
11 F.2d 224 (9th Cir. 1988), and Ferguson v. Neighborhood Housing Services, 780 F.2d
12 549 (6th Cir. 1986). With regards to pleadings, those cases do hold that “stipulations
13 and admissions in the pleadings are generally binding on the parties and the Court.”
14 Am. Title, 861 F.2d at 224 (citation and quotation marks omitted); Ferguson, 780 F.2d
15 at 551. But Defendants’ statements at issue are not contained in the pleadings, they are
16 contained within a response to a statement of facts submitted in conjunction with an
17 opposition to a motion. (See ECF No. 571-1 ¶¶ 9–10.) This is, of course, not a
18 “pleading” but an “other paper[],” FED. R. CIV. P. 7, and thus not governed by
19 Ferguson. 780 F.2d at 550 (“The primary issue presented by this appeal is the
20 significance and effect of NHS’ admission in its answer . . . .”) (emphasis added).
21 Statements contained in non-pleadings, such as briefs, are governed by the Ninth
22 Circuit’s holding in American Title: “statements of fact contained in a brief may be
23 considered admissions of the party in the discretion of the district court.” 861 F.2d at
24 226–27 (emphasis in original). To the extent that Defendants now dispute a statement
25 contained in an earlier non-pleading filing, (compare ECF No. 1063-1 ¶¶ 8–9 with ECF
26 No. 571-1 ¶¶ 9–10 ), the Court exercises its discretion and does not consider the earlier
27 statement to be a judicial admission. (Cf. ECF No. 1029, at 11.)
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1
2. Schooler’s 2015 Deposition
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Second, Defendants argue that statements from Schooler’s 2015 deposition are
3 inadmissible because Schooler was unable to review the transcript pursuant to Federal
4 Rule of Civil Procedure 30(e). (ECF No. 1063-1 ¶ 13.) Though one of Schooler’s
5 attorneys, Philip Dyson, declares that Mr. Dyson was not “notified by the certified
6 court reporter that Mr. Schooler’s transcript was ready for review,” (ECF No. 1063-2
7 ¶ 13), the SEC has submitted a letter indicating that another of Schooler’s attorneys,
8 Eric Hougen, was notified that Schooler’s transcript was available for review, (ECF
9 No. 1067-2, Ex. 4). Ultimately, Rule 30(e) permits introduction of Schooler’s original
10 deposition testimony. See Podell v. Citicorp Diners Club, Inc., 112 F.3d 98, 103 (2d
11 Cir. 1997) (original answer admissible even when deponent amends deposition
12 transcript). Furthermore, to the extent that Schooler believed his deposition statements
13 were in error, he could have stated so in his declaration, which he did not directly do.
14 (See ECF No. 1063-3.) Though he alleges that he never obtained a copy from the court
15 reporter pursuant to Rule 30(e), (id. ¶ 17), his counsel was in possession of at least the
16 portions of the transcript that the SEC submitted in support of its present motion and
17 his counsel could have shared those portions with him. (See ECF Nos. 1015-5, 1015-6.)
18 Accordingly, the Court finds that the statements contained in Schooler’s 2015
19 deposition can be considered by the Court for purposes of the present motion.
20 B. Fraud
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The SEC alleges that Defendants violated three antifraud provisions: (1) Section
22 17(a), (2) Section 10(b), and (3) Rule 10b-5. (ECF No. 1 ¶¶ 67–74.) There are four
23 elements to violations of all three provisions: “[1] a material misstatement or omission
24 [2] in connection with the offer or sale of security [3] by means of interstate commerce”
25 [4] made with the requisite intent. Sec. and Exch. Comm’n v. Phan, 500 F.3d 895,
26 907–08 (9th Cir. 2007) (citation omitted). For “[v]iolations of Section 17(a)(1), Section
27 10(b), and Rule 10b-5,” scienter is satisfied by a showing of recklessness. Sec. and
28 Exch. Comm’n v. Dain Rauscher, Inc., 254 F.3d 852, 856 (9th Cir. 2001) (emphasis
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1 and citation omitted). For “[v]iolations of Sections 17(a)(2) and (3),” intent is satisfied
2 by a showing of negligence. Id. (citation omitted).1
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As the Court previously found that the GP units at issue in this case are securities
4 and that Defendants advertised or sold the GP units through telephone and mail, (ECF
5 No. 583, at 3, 20; see also ECF No. 4-25), the Court finds that the SEC has satisfied
6 its burden with regards to the security and interstate commerce elements and thus
7 GRANTS the SEC summary judgment on these elements. See Sec. and Exch. Comm’n
8 v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) (“We have said that the ‘in
9 connection with’ requirement is met if the fraud alleged ‘somehow touches upon’ or
10 has ‘some nexus’ with ‘any securities transaction.’”) (quoting Sec. and Exch. Comm’n
11 v. Clark, 915 F.2d 439, 449 (9th Cir. 1990)). The Court now turns to whether the
12 statements or omissions were material and whether Defendants acted with the requisite
13 intent.
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1. Materiality
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Materiality is defined as “a substantial likelihood that the disclosure of the
16 omitted fact would have been viewed by the reasonable investor as having significantly
17 altered the ‘total mix’ of information made available.” TSC Indus., Inc. v. Northway,
18 Inc., 426 U.S. 438, 449 (1976). The Ninth Circuit has cautioned that “[d]etermining
19 materiality in securities fraud cases ‘should ordinarily be left to the trier of fact.’”
20 Phan, 500 F.3d at 908 (quoting In re Apple Computer Secs. Litig., 886 F.2d 1109, 1113
21 (9th Cir. 1989)). “[E]ven when there is no dispute as to the facts, it usually is for the
22 jury to decide whether the conduct in question meets the reasonable-person standard.”
23 Phan, 500 F.3d at 908 (citations and emphasis omitted). Thus a misstatement or
24 omission must be “so obviously important to an investor, that reasonable minds cannot
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The SEC notes that “[t]he Supreme Court has never addressed whether
negligence is necessary to prove a violation of Sections 17(a)(2) and (a)(3),” and
27 argues that negligence may not be required to prove a violation of Sections 17(a)(2) or
(3). (ECF No. 1015-1, at 12, 24–25.) However, the Ninth Circuit has unequivocally
28 stated that negligence is an element of Section 17(a)(2) and (a)(3) violations. Phan, 500
F.3d at 907; Dain Rauscher, 254 F.3d at 856.
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1 differ on the question of materiality,” for the Court to decide the issue of materiality
2 on summary judgment. TSC Indus., 426 U.S. at 450 (quoting Johns Hopkins Univ. v.
3 Hutton, 422 F.2d 1124, 1129 (4th Cir. 1970)).
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The SEC argues three bases for materiality: (1) failure to disclose the price that
5 Western’s initial purchase price on the properties it resold to the GPs at nearly 500%
6 that initial price, (2) the inclusion of purportedly comparable properties that were not
7 actually comparable, and (3) failure to disclose that the GPs’ properties were subject
8 to mortgages. (ECF No. 1015-1, at 14–22.)
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a. Land Value
It is undisputed that Defendants omitted Western’s purchase price for the GP
11 properties from the information disclosed to the investors. (ECF No. 4-1, 139:3–14,
12 177:20–178:5.) Defendants respond that this omission is immaterial for four reasons:
13 (1) Defendants disclosed their conflict of interest to the investors, (2) Defendants’ prior
14 GP investments had been successful, (3) Defendants disclosed the speculative nature
15 of the investments, and (4) Western’s purchase price was “readily and publicly
16 available.” (ECF No. 1063, at 6–11.) First, the partnership representations do state that
17 there is a conflict of interest between Defendants and the investors. (ECF No. 14-3 ¶
18 74.) Second, while some prior GP investments may have been successful, the Court is
19 not convinced that the evidence provided by Defendants undisputedly proves that
20 alleged success. (See ECF No. 1003, at 13 (discussing the weaknesses in Defendants’
21 evidence of alleged success).) Third, the partnership representations do state that the
22 GP units are speculative investments. (ECF No. 14-3 ¶ 6.) Fourth, while Schooler
23 declares that the price Defendants “paid for the land . . . [is] public information
24 available in county records and title reports,” Defendants previously stated that they
25 “have not been able to obtain the final closing statements for all of the properties
26 acquired before 2004.” (ECF No. 1063-3 ¶ 15; ECF No. 981, at 36 n.7.) Receiver
27 Thomas C. Hebrank, who acts as federal equity receiver in this case, has also indicated
28 that, even after title report searches, he was unable to find Western’s purchase price for
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1 land held by approximately 26 GPs. (ECF No. 852-1, Ex. A.)
2
As an initial matter, the case cited by the SEC for the proposition that
3 information relevant to fair market value can be material to a securities purchaser, SEC
4 v. Cochran, 214 F.3d 1261 (10th Cir. 2000), is inapposite. (ECF No. 1015-1, at 14.)
5 Because Cochran was an appeal from a grant of summary judgment in favor of the
6 defendant, the Tenth Circuit viewed the facts in the light most favorable to the SEC in
7 that case. 214 F.3d at 1262–63 (citation omitted). Thus, while Cochran stands for the
8 proposition that information relevant to fair market value can be material in certain
9 situations, it says nothing about whether an omission of such information is sufficiently
10 obvious to make its materiality appropriately resolved on summary judgment. See TSC
11 Indus., 426 U.S. at 450. The SEC’s reliance on SEC v. Fehn, 97 F.3d 1276 (9th Cir.
12 1996), is misplaced for similar reasons. (See ECF No.1015-1, at 15.) Fehn was an
13 appeal of a final judgment after a bench trial. 97 F.3d at 1282. Thus, the issue of
14 materiality was submitted to the finder of fact in Fehn, which the SEC argues against
15 in this case. Just as in Cochran, Fehn does not say whether an omission is sufficiently
16 obvious where a disclosure of the omitted fact could remedy an otherwise misleading
17 statement. See id. at 1290 n.12. However, the Ninth Circuit has stated that “the
18 materiality of information relating to financial condition, solvency and profitability is
19 not subject to serious challenge.” Sec. and Exch. Comm’n v. Murphy, 626 F.2d 633,
20 653 (9th Cir. 1980).
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The Court notes that this is an extremely close call. The pertinent facts— that
22 Western marked up the GP properties by upwards of 500% and that Western did
23 disclose to at least some investors that it would make a “very substantial profit”—are
24 not in dispute. Other courts have found that failures to disclose far smaller markups
25 were material omissions even when accompanied by disclosures that there was some
26 sort of markup. See, e.g., Sec. and Exch. Comm’n v. Alliance Leasing Corp., No. 3:9827 cv-1810-J-CGA, 2000 WL 35612001 (S.D. Cal. Mar. 20, 2000), aff’d 28 F. App’x 648
28 (9th Cir. 2002). For example, in Alliance Leasing, the defendants made a general
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1 disclosure that they would receive “commissions,” but failed to disclose that those
2 commissions amounted to 30%. 2000 WL 35612001, *10. On summary judgment, the
3 district court found that “[r]easonable minds could not differ that a general disclosure
4 of ‘commissions’ is not the equivalent of a disclosure of 30% commissions.” Id. The
5 district court thus granted summary judgment for the SEC, finding that “large
6 commissions amounting to 30 cents on every dollar invested are patently material”
7 because “large commissions impact the profitability of an investment and as such are
8 material to an investor’s informed decision.” Id. While the reasoning of Alliance
9 Leasing is quite persuasive, the Court finds that the materiality of the land value
10 omissions should be submitted to the finder of fact.
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On one hand, Western’s initial purchase price may have been material to an
12 investor because it affected the likelihood that the investor would realize a return on
13 his or her investment, and, if so, how much that return could be. On the other hand,
14 Defendants did represent that they would make a “very substantial profit” by selling
15 the property to the investors, (ECF No. 14-3 ¶ 74), and thus the specific amount paid
16 by Western may have been immaterial because the investors were already informed that
17 that amount was substantially less than what the investors paid for the property. That
18 said, this disclosure was buried on the tenth page of an eleven page document in the
19 middle of a series of disclaimers. (See id.) While it is a close call, based on the
20 disclosure of what Defendants stood to gain, the Court cannot say that Western’s
21 purchase price is “so obviously important, that reasonable minds cannot differ on the
22 question of materiality.” TSC Indus., 426 U.S. at 450 (citation omitted); see also Sec.
23 and Exch. Comm’n v. Meltzer, 440 F. Supp. 2d 179, 194 (E.D.N.Y. 2006) (“[T]he
24 difference in compensation may or may not be material to a reasonable investor; it may
25 be that simply being alerted to the fact that some significant amount was paid is
26 significant, but that the actual amount is immaterial.”). Accordingly, the Court finds
27 that the materiality of Defendants’ alleged omission of the price Western paid for the
28 properties is a question to be decided by the finder of fact.
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1
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b. Comparable Properties
The SEC cites three alleged misrepresentations regarding allegedly comparable
3 properties (“comps”): (1) comps provided to Western’s sales representatives to help
4 market the Pyramid Highway property to investors, (ECF No. 4-24); (2) a brochure
5 provided to investors regarding the Stead property, (ECF No. 7-1, Ex. 1); and (3) the
6 use of land purchased by Wal-Mart as a comp for the Stead property in an email sent
7 by Western employee John Naviaux, (ECF No. 4-25, Ex. 25; ECF No. 7 ¶ 9). (ECF No.
8 1015-1, at 4–5, 8–10, 19–20.)
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In response, Defendants argue that: (1) the investors represented that they did not
10 rely on Defendants’ representations, (ECF No. 14-3 ¶ 19);2 and (2) the comps “were
11 merely puffery, and not actionable misrepresentations or omissions of material fact.”
12 (ECF No. 1063, at 12.) As an initial matter, whether the investors actually relied on the
13 representations is irrelevant to the SEC’s fraud causes of action. See Sec. and Exch.
14 Comm’n v. True N. Fin. Corp., 909 F. Supp. 2d 1073, 1097 (D. Minn. 2012)
15 (explaining that reliance is not an element of Section 17(a), Section 10(b), or
16 Rule10b-5 causes of action brought by the SEC); see also Sec. and Exch. Comm’n v.
17 Rana Research, Inc., 8 F.3d 1358, 1364 (9th Cir. 1993) (“The SEC need not prove
18 reliance in its action . . . on the basis of violations of section 10(b) and Rule 10b-5.”);
19 Sec. and Exch. Comm’n v. Credit Bancorp, Ltd., 195 F. Supp. 2d 475, 490–91
20 (S.D.N.Y. 2002) (“The SEC does not need to prove investor reliance, loss causation,
21 or damages in an action under Section 10(b) of the Exchange Act, Rule 10b–5, or
22 Section 17(a) of the Securities Act.”) (citations omitted). The Court now turns to the
23 alleged misrepresentations cited by the SEC.
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i. The Pyramid Highway Property
The evidence shows that the comps provided to Western’s sales representatives
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At oral argument, the vast majority of Defendants’ argument with regards to the
comps was that the investors stated that they did not rely on Western’s representations.
28 (See ECF No. 1073.) As the Court notes below, reliance is not an element of the
antifraud provisions in an SEC enforcement action.
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1 regarding the Pyramid Highway property were not comparable at the time of
2 investment. (Compare ECF No. 182-1, Ex. 13, at 97 (Pyramid Highway property
3 purchased by Schooler for approximately $3,000 per acre, sold to Western for
4 approximately $5,700 per acre, and then sold to investors for approximately $15,000
5 per acre) with ECF No. 4-24 (comps for the Pyramid Highway property valued between
6 approximately $130,000 per acre and $700,000 per acre).) Indeed, Schooler himself has
7 admitted as much. (ECF No. 4-1, Ex. 1, at 164:1–25; ECF No. 4-2, Ex. 2, at
8 311:4–315:25.) However, the SEC does not cite what representations were made to
9 investors regarding the Pyramid Highway property. Though these “comps” were
10 provided to Western’s sales representatives, that does not show what those sales
11 representatives actually said to investors. Even if these comps were advertised to
12 investors, the investors may have viewed them as what the property “could become”
13 rather than what it was currently worth. (ECF No. 4-2, Ex. 2, at 314:19.) This is
14 consistent with an investor’s declaration that Western provided both “true comps,” i.e.,
15 properties that allegedly were comparable at the time of the investment, and “future
16 comps,” i.e. properties that allegedly showed what the property could be valued at in
17 the future, (ECF No. 563-4 ¶ 5), and the SEC’s evidence does not indicate whether the
18 Pyramid Highway comps it cites as alleged misrepresentations were advertised as “true
19 comps” or “future comps.” Accordingly, the SEC has failed to carry its burden to show
20 that a the Pyramid Highway comps were material.
ii. The Stead Property3
21
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The SEC makes two arguments with regards to the Stead property: (1) that the
23 comps given in Western’s brochure and in an email sent by Western employee John
24 Naviaux “were not, in fact, comparable” to the Stead property, (ECF No. 1015-1, at
25 19); and (2) the fair market value representation of the Stead property in Western’s
26 brochure was “less than 1/25th” of the actual fair market value, (ECF No. 1015-1, at
27
3
The Stead property is comprised of two primary parcels: (1) the North Stead
28 property containing approximately 39.8 acres, and (2) the South Stead property
contained approximately 76 acres. (See ECF No. 7-1, Ex. 1, at 5.)
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1 10). The parties do not dispute that Western’s brochure on the Stead property,
2 displayed to potential investors (see ECF No. 1015-7, Ex. 4, at 39:9–41:7), stated that
3 the South Stead property “would, under current market conditions, be evaluated at
4 approximately $2.50 per sq foot” and that, “[i]n the past, similar commercial property
5 in the Reno area has been valued between $6.00 and $15.00 per sq foot, with some
6 small commercial pads approaching a price of $20.00 per square foot.” (ECF No. 7-1,
7 Ex. 1, at 5–6.) Similarly, the parties do not dispute that Mr. Naviaux sent an email to
8 an investor stating that “[w]e paid $2.50 a Sq. Ft.” for the Stead property and that Wal9 Mart paid “$8.78 per sq. ft.” “for their new site in Stead, NV.” (ECF No. 4-25, Ex. 25.)4
10
First, the Court finds that the alleged comps to the Stead property—$6.00 to
11 $15.00 per square foot in Western’s brochure and $8.78 per square foot in Mr.
12 Naviaux’s email—may have been “future comps” and thus not necessarily material
13 misrepresentations. This is consistent with the fact that Western’s brochure stated that
14 the $6.00 to $15.00 per square foot comps were from “the past” and that “[t]here is no
15 way to predict whether higher values would return.” (ECF No. 7-1, Ex. 1, at 5.) As with
16 the Pyramid Highway comps, a hypothetical reasonable investor could arguably have
17 viewed these comps as what the marketed property “could become,” (ECF No. 4-2, Ex.
18 2, at 314:19), and not considered the misrepresentation to be material. Accordingly, the
19 Court finds that the materiality of Defendants’ alleged misrepresentation regarding the
20 purportedly comparable properties is a question to be decided by the finder of fact. See
21 TSC Indus., 426 U.S. at 450.
22
Second, the Court finds that the statement by Western—that, “under current
23 market conditions,” the South Stead property would “be evaluated at approximately
24 $2.50 per sq foot,” (ECF No. 7-1, Ex. 1, at 5)—was a material misrepresentation. The
25 appraisal obtained by the SEC which states that the fair market value of the Stead
26
4
The Court notes that this email appears to have been sent after the sale of GP
27 units in that instance because it states “[w]e paid” and thus would not necessarily be
a representation made in connection with the offer or sale of a security. (ECF No. 4-25,
28 Ex. 25 (emphasis added).) Though not entirely clear, “[w]e” appears to refer the
investor herself. (See ECF No. 1015-7, Ex. 4, at 42:3–22.)
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1 property was $0.077 per square foot as of August 2010 and $0.053 per square foot as
2 of July 2012. (ECF No. 5-1, Ex. 1, at 4.)5Citing the “Expert-Opinion Rebuttal Report
3 of Louis V. Schooler,” Defendants dispute the appraised values, arguing that the SEC’s
4 appraiser “used properties that are completely dissimilar.” (ECF No. 1063-1, at 26
5 (quoting ECF No. 862-9, Ex. 8, at 12–14).) However, the cited report by Schooler does
6 not attempt to rebut the Stead appraisal, but rather attempts to rebut the appraisals of
7 the Dayton IV and Washoe 5 properties. (See ECF No. 862-9, Ex. 8, at 4–5.) Thus,
8 Defendants cite no evidence that in any way disputes the Stead appraisal as nothing in
9 Schooler’s report indicates an issue with the SEC’s appraisals other than for the Dayton
10 IV and Washoe 5 properties.
11
However, the Court does note that Western’s brochure assumed that the Stead
12 property’s surface water rights were worth “$40,000 per acre foot,” (ECF No. 7-1, Ex.
13 1, at 5), but the SEC’s appraiser does not appear to have valued the water rights in his
14 appraisals because he stated that the water rights were either limited, potentially
15 inadequate for development, or potentially lost due to non-use. (See ECF No. 5-2, Ex.
16 1, at 69–70). Viewing the evidence in the light most favorable to Defendants, the Court
17 finds it appropriate to add the water rights valuation assumed by Western to appraised
18 value obtained by the SEC.
19
The Stead property was purchased with approximately 104.895 acre feet of water
20 rights, (ECF No. 5-1, Ex. 1, at 28; ECF No. 5-2, Ex. 1, at 69), which comes out to
21 approximately $4,195,800 based on the $40,000 per acre foot assumption in Western’s
22 brochure. Divided by the approximately 4,596,407.64 square feet in the Stead property,
23 this would increase the SEC’s appraised values by $0.913 per square foot had
24 Western’s assumption been used. This results in values of $0.99 per square foot for
25 August 2010 and $0.966 per square for July 2012.
26
5
The Stead property is approximately 105.519 acres, which is approximately
27 4,596,407.64 square feet. (See ECF No. 5-1, Ex. 1, at 3–4.) The appraiser valued the
property at $355,000 as of August 2010 and $244,500 as of July 2012. (Id.) This results
28 in approximately $0.077 per square foot and $0.053 per square foot appraisals,
respectively.
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1
As discussed above, the undisputed evidence indicates that the fair market value
2 of the Stead property was, using Western’s assumptions regarding water rights,
3 approximately one dollar per square foot in August 2010 and July 2012. By
4 representing that the fair market value of the South Stead property was $2.50 per
5 square foot, Western’s representation was 150% greater than the actual market value.
6 In the mind of a hypothetical reasonable investor, this misrepresentation would have
7 significantly changed the “total mix” of information, TSC Indus., Inc. v. Northway,
8 Inc., 426 U.S. at 449, because he or she was led to believe that the property was worth
9 more than double what the true fair market value was. Cf. Johnston v. Bumba, 764 F.
10 Supp. 1263 (N.D. Ill. 1991), aff’d 983 F.2d 1072 (7th Cir. 1992) (“We find this
11 disclosure [of ‘substantial profit’] too vague to satisfy the requirements of disclosure,
12 particularly where the fair market value of the systems was misrepresented.”). Due to
13 the magnitude of difference between the actual fair market value and Western’s
14 statements, summary judgment on the misrepresentation of the South Stead property’s
15 fair market value is appropriate because it is “so obviously important, that reasonable
16 minds cannot differ on the question of materiality.” TSC Indus., 426 U.S. at 450
17 (citation omitted). Accordingly, the Court finds that the fair market value
18 representation in Western’s brochure on the Stead property was material.
19
20
c. Mortgages
There is no evidence that Defendants directly told the investors that the GP
21 properties were encumbered by mortgages owed by Western. (See ECF No. 4-2, Ex.
22 2, at 289:14–15, 330:9– 25; ECF No. 4-5, Ex. 5, at 53:13–54:18.) Defendants respond
23 that the investors had notice of the mortgages because: (1) the partnership
24 representations specifically authorized the execution of deeds of trust, (ECF No. 14-3
25 ¶ 23); (2) the all inclusive trust deeds (“AITDs”) executed by the GPs in relation to
26 each property specifically mentioned the mortgages (see, e.g., ECF No. 1063-2, Exs.
27 6–8); and (3) the underlying mortgages were publicly “available in county records and
28 title reports,” (ECF No. 1063-3 ¶ 15). (ECF No. 1063, at 12–14.)
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1
As an initial matter, the AITDs appear to have been executed after the investors
2 made the decision to hand over their money to Western and thus, at the time the
3 investors purchased the security, the AITDs would not have informed the investors of
4 the underlying mortgages. (Compare ECF No. 182-1, Ex. 13, at 102 (escrow close date
5 for Pyramid Highway 177 Partners was May 6, 2010) with ECF No. 1063-2, Ex. 6
6 (AITD for Pyramid Highway 177, LLC executed on May 6, 2010).) However, as
7 Western, not the GPs or the investors, owed the mortgages, the mortgages were
8 essentially a “contingent liability” that Western might fail to pay the mortgages,
9 causing either the GP to pay the mortgage or the property to be foreclosed upon. Fehn,
10 97 F.3d at 1291. The materiality of a contingent liability depends “upon a balancing of
11 both the indicated probability that the event will occur and the anticipated magnitude
12 of the event in light of the totality of the company activity.” Basic Inc. v. Levinson, 485
13 U.S. 224, 238 (1988) (quoting Sec. and Exch. Comm’n v. Tex. Gulf Sulphur Co., 401
14 F.2d 833, 849 (2d Cir. 1968)). While the magnitude of the event is significant—either
15 foreclosure and loss of the investment property or the payment of potentially over a
16 million dollars, (see, e.g., ECF No. 182, at 5 (Dayton Valley II property secured by $1.5
17 million mortgage))—there is no evidence of the probability that Western would fail to
18 pay the mortgages. The SEC merely argues that “the magnitude of the event . . .
19 represents such a significant financial loss, that the mortgage information was clearly
20 material.” (ECF No. 1015-1, at 21.)
21
While the possibility of such an event could be material to a hypothetical
22 reasonable investor, if the event’s likelihood was low then the mortgage information
23 may not have been material. Because the SEC has not presented evidence that Western
24 ever failed to meet its obligations on these mortgages, let alone that such an event had
25 a more than marginal chance of occurring, the Court cannot say that the disclosure of
26 underlying mortgages is “so obviously important, that reasonable minds cannot differ
27 on the question of materiality.” TSC Indus., 426 U.S. at 450 (citation omitted).
28 Accordingly, the Court finds that the materiality of Defendants’ alleged omission of the
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1 underlying mortgages is a question to be decided by the finder of fact.
2
As the Court has found that only one of the SEC’s alleged bases for materiality
3 is properly decided on summary judgment, the Court GRANTS IN PART AND
4 DENIES N PART the SEC’s motion for summary judgment as to materiality. The SEC
5 requests “that the Court grant summary judgment as to the elements of its claims that
6 [the Court] deems have been established.” (ECF No. 1015-1, at 25.) Accordingly, the
7 Court turns to whether Defendants acted with scienter or negligence.
8
2. Intent
9
Generally, intent in securities fraud cases “should not be resolved by summary
10 judgment.” Provenz v. Miller, 102 F.3d 1478, 1489 (9th Cir. 1996) (emphasis in
11 original). Because of this, “the moving party bears a heavier burden of showing that
12 there exists no genuine issue of material fact.” Sec. and Exch. Comm’n v. Seaboard
13 Corp., 677 F.2d 1289, 1295 (9th Cir. 1982). Section 17(a)(1), Section 10(b), and Rule
14 10b-5 require a showing of recklessness; Sections 17(a)(2) and (a)(3) require a showing
15 of negligence. Dain Rauscher, 254 F.3d at 856. Reckless conduct is “defined as a
16 highly unreasonable omission, involving not merely simple, or even inexcusable
17 negligence, but an extreme departure from the standards of ordinary care, and which
18 presents a danger of misleading buyers or sellers that is either known to the defendant
19 or is so obvious that the actor must have been aware of it.” See Hollinger v. Titan Cap.
20 Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (quoting Sundstrand Corp. v. Sun Chem.
21 Corp., 553 F.2d 1033, 1045 (7th Cir.) cert. denied, 434 U.S. 875 (1977)). Negligent
22 conduct is defined as a “fail[ure] to use the degree of care and skill that a reasonable
23 person of ordinary prudence and intelligence would be expected to exercise in the
24 situation.” True N. Fin., 909 F. Supp. 2d at 1122 (citations omitted). Defendants
25 respond to the SEC’s allegations by arguing that: (1) they relied on the advice of
26 counsel, and (2) intent should be decided by the finder of fact. (ECF No. 1063, at
27 14–16.)
28 / /
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1
2
a. Reliance on Counsel
There are four elements that Defendants must prove to show reliance on the
3 advice of counsel: they “(1) made a complete disclosure to counsel; (2) requested
4 counsel’s advice as to the legality of the contemplated action; (3) received advice that
5 it was legal; and (4) relied in good faith on that advice.” Sec. and Exch. Comm’n v.
6 Goldfield Deep Mines Co. of Nev., 785 F.2d 459, 467 (9th Cir. 1985) (citing Sec. and
7 Exch. Comm’n v. Savoy Indus., Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir. 1981).
8 However, “such reliance does not operate as an automatic defense, but is only one
9 factor to be considered.” Id. (citation omitted). Though the SEC argues that “Schooler
10 never sought legal advice regarding his disclosures” prior to 2010, (ECF No. 1067, at
11 9), the Court is not so convinced. Schooler specifically asked his counsel whether the
12 GP units were securities, to which the response was, essentially, “probably not.” (See
13 ECF No. 1063-3, Exs. 1–4.) Because the antifraud provisions operate only in
14 connection with the offer or sale of a security, Phan, 500 F.3d 895 at 907–08, by
15 asking whether the GP units were securities and being advised that they were not,
16 Schooler was also asking whether he was in compliance with the antifraud provisions.
17
However, with regards to the Stead property brochure, the Court finds that
18 Defendants have not shown that they “made a complete disclosure to counsel” and thus
19 have failed to carry their burden. Goldfield, 785 F.2d at 467. Specifically, Defendants
20 never told counsel that they represented a property’s alleged fair market value to
21 investors, instead merely disclosing that they would use “sales videos, aerial
22 photographs, and the basic property description to sell the partnership interest.” (ECF
23 No. 1063-3, Ex. 2.) With regards to all other alleged misrepresentations and omissions,
24 the Court does not reach Defendants’ reliance on counsel argument because, as
25 discussed below, the Court finds that the SEC has failed to carry its burden on the
26 element of intent.
27
28
b. Stead Property Brochure
With regards to the material misrepresentation regarding the fair market value
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1 of the South Stead property in Western’s brochure noted above, the Court finds that
2 Defendants acted with scienter. It is undisputed that Defendants purchased the Stead
3 property for approximately $1.85 million, or approximately $0.40 per square foot, on
4 April 1, 2010. (ECF No. 5-1, Ex. 1, at 28–29; ECF No. 1063-1, at 26.) Because
5 Defendants’ purchase of the Stead property was an arm’s length transaction,
6 Defendants must have been aware that their purchase price represented, at most,
7 approximately the fair market value of the land. (See ECF No. 5-1, Ex. 1, at 28–29.)
8 Yet in spite of the knowledge of their own purchase price, Defendants represented to
9 investors that the fair market value of the South Stead property was $2.50 per square
10 foot, (ECF No. 7-1, Ex. 1, at 5), which was over six times greater than what they paid
11 for it. This affirmative misrepresentation was an “extreme departure from the standards
12 of ordinary care” that Defendants knew, or should have known, presented a danger of
13 misleading investors. Hollinger, 914 F.2d at 1569 (citation omitted). On this specific
14 misrepresentation, the Court finds the SEC has carried its burden with regard to intent,
15 and thus with regards to all elements. Accordingly, the Court GRANTS the SEC’s
16 motion for summary judgment with regards to this misrepresentation.
17
18
c. Other Alleged Misrepresentations and Omissions
With regards to the other misrepresentations and omissions , the SEC argues that
19 three things show scienter: (1) Defendants’ “fail[ure] to disclose Western’s purchase
20 price or an appraisal to investors,” (2) Defendants “provid[ing] ‘comps’ to the sales
21 force that were not truly comparable to the properties Western was offering,” and (3)
22 Defendants’ “fail[ure] to disclose that significant third-party mortgages encumbered
23 the properties being offered to investors.” (ECF No. 1015-1, at 22–23.)
24
Summary judgment on intent is “inappropriate . . . unless all reasonable
25 inferences that could be drawn from the evidence defeat the plaintiff’s claims.” Vaughn
26 v. Teledyne, Inc., 628 F.2d 1214, 1220 (9th Cir. 1980) (citation omitted); Provenz, 102
27 F.3d at 1489–90 (“Thus, summary judgment on the scienter issue is appropriate only
28 where ‘there is no rational basis in the record for concluding that any of the challenged
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1 statements was made with requisite scienter.’”) (emphasis in original) (quoting In re
2 Software Toolworks, 38 F.3d 1078, 1088 (9th Cir. 1994)). A reasonable inference that
3 Defendants’ actions were consistent with the ordinary standard of care can be drawn
4 with regards to all three of the alleged misrepresentations and omissions cited by the
5 SEC above. First, a reasonable person in Defendants’ position may have omitted
6 Western’s purchase because Defendants did disclose that they stood to make a “very
7 substantial profit.” (ECF No. 14-3 ¶ 74.) Second, a reasonable person in Defendants’
8 position may have represented the purportedly comparable properties as comparable
9 because Defendants could have believed that investors would view these comps as
10 what the property “could become” and not what it was worth at the time of investment.
11 (ECF No. 4-2, Ex. 2, at 314:19.) Third, a reasonable person in Defendants’ position
12 may have omitted the existence of the underlying mortgages because Defendants could
13 have believed that there was an extremely high likelihood that Western would meet its
14 payment obligations under the mortgage. See Basic, 485 U.S. at 238. Accordingly, the
15 Court finds that the SEC has not carried its burden with regards to the intent element
16 of the antifraud provisions and thus DENIES the SEC’s motion for summary judgment
17 with regards to intent on all other alleged misrepresentations and omissions.6
18
19
V. CONCLUSION AND ORDER
For the reasons stated above, IT IS HEREBY ORDERED that the SEC’s
20 Motion for Partial Summary Judgment on its First and Second Claims for Relief, (ECF
21 No. 1015), is GRANTED IN PART AND DENIED IN PART:
22
6
At oral argument, the SEC argued that “one misrepresentation to one investor
23 is sufficient to find a violation.” (ECF No. 1079.) While the SEC is technically correct,
the Court does note that, in determining the appropriate civil penalties in SEC
24 enforcement actions, each separate violation is relevant. See Sec. and Exch. Comm’n
v. Tourre, 4 F. Supp. 3d 579, 583 (S.D.N.Y. 2014) (“Courts assess civil penalties on
25 a per-violation basis.”). As the SEC has indicated that it may seek civil penalties in this
case, (ECF No. 685-1, at 14–15), the Court believes it appropriate to submit the
26 materiality and intent of the other alleged misrepresentations and omissions to the
finder of fact to determine whether Defendants did, in fact, commit any other
27 violations. Were the SEC to abandon its first and second causes of action based on the
other alleged misrepresentations and omissions and decide not to seek penalties based
28 on those alleged misrepresentations and omissions, the issue would not need to be
resolved by the finder of fact.
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1
1.
With regards to the Stead property fair market value representation in
2
Western’s brochure, the SEC’s first and second causes of action are
3
GRANTED as to all elements; and
4
2.
With regards to all other alleged misrepresentations and omissions, the
5
SEC’s first and second causes of action are GRANTED as to an offer or
6
sale of a security, GRANTED as to interstate commerce, DENIED as to
7
materiality, and DENIED as to intent.
8 DATED: June 3, 2015
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HON. GONZALO P. CURIEL
United States District Judge
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