Securities and Exchange Commission v. Shields et al

Filing 46

ORDER granting 28 Motion to Dismiss. Plaintiff's claims in this lawsuit are DISMISSED WITHOUT PREJUDICE. Judgment SHALL ENTER on behalf of defendants and relief defendants and against plaintiff, Securities and Exchange Commission, on all claims for relief and causes of action; provided, that the judgment as to these claims shall be without prejudice. By Judge Robert E. Blackburn on 9/6/12.(mjgsl, )

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLORADO
Judge Robert E. Blackburn
Civil Action No. 11-cv-02121-REB
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff,
v.
JEFFORY D. SHIELDS (a/k/a Jeffrey D. Shields) and
GEODYNAMICS, INC. (f/k/a or d/b/a Geodynamics Exploration, Inc.),
Defendants,
and
GEODYNAMICS, INC. JOHNSTON’S CORNER #1 and #2 JOINT VENTURE,
GEODYNAMICS, INC. HUSKIE #1 JOINT VENTURE,
GEODYNAMICS, EXPLORATION, INC. TRUMPETER #1 and #2 JOINT VENTURE,
GEODYNAMICS, INC. EVDA #1 JOINT VENTURE,
FLORIBAMA OIL CORPORATION,
CARBOTEC, INC.,
TRITON ENERGY ASSET MANAGEMENT, INC. (d/b/a Triton Energy Asset
Management, LLC),
GEODYNAMICS PROPERTY MANAGEMENT, LLC,
T.E.A.M. PROPERTY MANAGEMENT, LLC (d/b/a T.E.A.M. Property Management),
S&P ENERGY, LLC,
AURUM ENERGY ASSOCIATES, LLC, and
UNUM, LLC,
Relief Defendants.

ORDER GRANTING MOTION TO DISMISS
Blackburn, J.
The matter before me is Defendant GeoDynamics, Inc.’s Motion To Dismiss

Pursuant to Fed. R. Civ. P. 12(b)(6) [#28],1 filed September 27, 2011. I grant the
motion.
I. JURISDICTION
I have subject matter jurisdiction pursuant to 28 U.S.C. § 1331 (federal question).
II. STANDARD OF REVIEW
When ruling on a motion to dismiss pursuant to Fed. R. Civ. P. 12(b)(6), I must
determine whether the allegations of the complaint are sufficient to state a claim within
the meaning of Fed. R. Civ. P. 8(a). For many years, “courts followed the axiom that
dismissal is only appropriate where ‘it appears beyond doubt that the plaintiff can prove
no set of facts in support of his claim which would entitle him to relief.’” Kansas Penn
Gaming, LLC v. Collins, 656 F.3d 1210, 1214 (10th Cir. 2011) (quoting Conley v.
Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957)). Noting that this
standard “has been questioned, criticized, and explained away long enough,” the
Supreme Court supplanted it in Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 562,
127 S.Ct. 1955, 1969, 167 L.Ed.2d 929 (2007). Pursuant to the dictates of Twombly, I
now review the complaint to determine whether it “‘contains enough facts to state a
claim to relief that is plausible on its face.’” Ridge at Red Hawk, L.L.C. v. Schneider,
493 F.3d 1174, 1177 (10th Cir. 2007) (quoting Twombly, 127 S.Ct. at 1974). “This
pleading requirement serves two purposes: to ensure that a defendant is placed on
notice of his or her alleged misconduct sufficient to prepare an appropriate defense, and

1

“[#28]” is an example of the convention I use to identify the docket number assigned to a
specific paper by the court’s electronic case filing and management system (CM/ECF). I use this
convention throughout this order.

2

to avoid ginning up the costly machinery associated with our civil discovery regime on
the basis of a largely groundless claim.” Kansas Penn Gaming, 656 F.3d at 1215
(citation and internal quotation marks omitted).
As previously, I must accept all well-pleaded factual allegations of the complaint
as true. McDonald v. Kinder-Morgan, Inc., 287 F.3d 992, 997 (10th Cir. 2002).
Contrastingly, mere “labels and conclusions or a formulaic recitation of the elements of
a cause of action” will not be sufficient to defeat a motion to dismiss. Ashcroft v. Iqbal,
556 U.S. 662, 678, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) (citations and internal
quotation marks omitted). See also Robbins v. Oklahoma, 519 F.3d 1242, 1247-48
(10th Cir. 2008) (“Without some factual allegation in the complaint, it is hard to see how
a claimant could satisfy the requirement of providing not only ‘fair notice’ of the nature of
the claim, but also ‘grounds' on which the claim rests.”) (quoting Twombly, 127 S.Ct. at
1974) (internal citations and footnote omitted). Moreover, to meet the plausibility
standard, the complaint must suggest “more than a sheer possibility that a defendant
has acted unlawfully.” Iqbal, 129 S.Ct. at 1949. See also Ridge at Red Hawk, 493
F.3d at 1177 (“[T]he mere metaphysical possibility that some plaintiff could prove some
set of facts in support of the pleaded claims is insufficient; the complaint must give the
court reason to believe that this plaintiff has a reasonable likelihood of mustering factual
support for these claims.") (emphases in original). For this reason, the complaint must
allege facts sufficient to “raise a right to relief above the speculative level.” Kansas
Penn Gaming, 656 F.3d at 1214 (quoting Twombly, 127 S.Ct. at 1965). The standard
will not be met where the allegations of the complaint are “so general that they

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encompass a wide swath of conduct, much of it innocent.” Robbins, 519 F.3d at 1248.
Instead “[t]he allegations must be enough that, if assumed to be true, the plaintiff
plausibly (not just speculatively) has a claim for relief.” Id.
The nature and specificity of the allegations required to state a plausible claim
will vary based on context and will “require[] the reviewing court to draw on its judicial
experience and common sense.” Iqbal, 129 S.Ct. at 1950; see also Kansas Penn
Gaming, 656 F.3d at 1215. Nevertheless, the standard remains a liberal one, and “a
well-pleaded complaint may proceed even if it strikes a savvy judge that actual proof of
those facts is improbable, and that a recovery is very remote and unlikely.“ Dias v. City
and County of Denver, 567 F.3d 1169, 1178 (10th Cir. 2009) (quoting Twombly, 127
S.Ct. at 1965) (internal quotation marks omitted).
III. ANALYSIS
This action involves alleged securities fraud in the operation of four oil and gas
exploration and drilling ventures. Each of the four joint ventures is governed by a
separate but comparable Joint Venture Agreement (“JVA”) (see Def. Motion App., Exh.
A), as well as a Confidential Information Memorandum (“CIM”) (see id., Exh. B).2 The
SEC maintains that, despite their ostensible organization as joint ventures, the
investments in these ventures are in fact “investment contracts,” and therefore come
within the definition of “securities” as that term is defined by the Securities Act of 1933,
48 Stat. 74, and the Securities Exchange Act of 1934, 48 Stat. 881. See 15 U.S.C. §§

2

These documents are referenced in the SEC’s complaint (see Compl. ¶ 36-37 at 11-12 [#1],
filed August 15, 2011) and central to its claims in this lawsuit. I therefore may and do consider these
documents in resolving the instant motion. Prager v. LaFaver, 180 F.3d 1185, 1189 (10th Cir.), cert.
denied, 120 S.Ct. 405 (1999).

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77b(1) & 78c(a)(10). See also Tcherepnin v. Knight, 389 U.S. 332, 342, 88 S.Ct. 548,
556, 19 L.Ed.2d 564 (1967) (noting that definitions of “security” under Securities Act and
Exchange Act are functionally equivalent). Because I find to the contrary, I grant
defendants’ motion to dismiss for failure to state a claim.
An investment contract is “a contract, transaction, or scheme whereby a person
invests his money in a common enterprise and is led to expect profits solely from the
efforts of the promoter or a third party.” SEC v. W.J. Howey Co., 328 U.S. 293, 29899, 66 S.Ct. 1100, 1102-03, 90 L.Ed. 1244 (1946). The operative definition is
purposefully broad and intended to reach “[n]ovel, uncommon, or irregular devices,
whatever they appear to be.” SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351,
64 S.Ct. 120, 124, 88 L.Ed. 88 (1941). The analysis is guided by “a flexible rather than
a static, principle, one that is capable of adaptation to meet the countless and variable
schemes devised by those who seek the use of the money of others on the promise of
profits.” Howey, 66 S.Ct. at 1103. Accordingly, the court must focus on the “economic
realities of the underlying transaction and not on the name it carries.” United Housing
Foundation, Inc. v. Forman, 421 U.S. 837, 849, 95 S.Ct. 2051, 2059, 44 L.Ed.2d 621
(1975).
As in most cases in which this issue becomes central, the only point of
contention here is whether investors were led to expect profits “solely from the efforts of
others.” See Kline Hotel Partners v. Aircoa Equity Interests, Inc., 725 F.Supp. 479,
481 (D. Colo. 1989). As interpreted by later precedents, this requirement has been

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relaxed somewhat, see Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir. 2003),3 and has
come to focus on whether the investors retain control over significant decisions of the
enterprise. “The question is whether an investor, as a result of the investment
agreement itself or the factual circumstances that surround it, is left unable to exercise
meaningful control over his investment.” Id. See also Rivanna Trawlers Unlimited v.
Thompson Trawlers, Inc., 840 F.2d 236, 240 (4th Cir. 1988).
Given these standards, “[a] general partnership interest is presumed not to be an
investment contract because a general partner typically takes an active part in
managing the business and therefore does not rely solely on the efforts of others.” SEC
v. Merchant Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007). Nevertheless, the Tenth
Circuit has cautioned that the focus of the inquiry is not solely on “whose efforts actually
affected the success or failure of the enterprise,” Maritan v. Birmingham Properties,
875 F.2d 1451, 1457 (10th Cir. 1989), but that instead, “[c]onsideration must be given to
control over the factors essential to the success of the enterprise,”Crowley v.
Montgomery Ward & Co., 570 F.2d 877, 880 (10th Cir. 1978). In particular, because
“[t]he principal purpose of the securities acts is to protect investors by promoting full
disclosure of information necessary to informed investment decisions[,] . . . access to
information about the investment, and not managerial control, is the most significant
factor.” Maritan, 875 F.2d at 1457 (citation and internal citations and quotation marks
omitted). “The strong presumption that an interest in a general partnership is not a

3

“Since Howey,. . . the Supreme Court has endorsed relaxation of the requirement that an
investor rely only on others' efforts, by omitting the word ‘solely’ from its restatements of the Howey test.
And neither our court nor our sister circuits have required that an investor . . . expect profits ‘solely’ from
the efforts of others.” Robinson, 349 F.3d at 170 (internal citations omitted).

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security can only be overcome by evidence that the general partners were rendered
passive investors because they were somehow precluded from exercising their powers
of control and supervision.” Banghart v. Hollywood General Partnership, 902 F.2d
805, 808 (10th Cir. 1990).
In determining whether sufficient allegations have been made to overcome this
presumption, the proper focus is on the rights provided in the contract itself:
[R]egardless of the control actually exercised, if a
partnership agreement retains real power in the general
partners, then an investment in the general partnership is not
a security. Thus, our determination of whether a general
partnership interest can be characterized as a security turns
on the partnership agreement.
When a partnership agreement allocates powers to general
partners that are specific and unambiguous and those
powers provide the general partners with access to
information and the ability to protect their investment, then
the presumption is that the general partnership is not a
security. As the court in Rivanna stated, “[e]ven when
general partners do not individually have decisive control
over major decisions, they do have the sort of influence
which generally provides them with access to important
information and protection against a dependence on others.”
Id. 808 (internal citations omitted). See also Maritan, 875 F.2d at 1458 (noting that “the
contract between the parties [is] the proper focal point, rather than actual participation”).
Investors’ expectations of control are analyzed as of the time the interest is sold,
although evidence regarding the actual operation of the venture may shed light on the
question of how control was allocated at the outset. See Merchant Capital, 483 F.3d at
756.

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The SEC does not contend that the JVAs did not afford the joint venturers a
significant degree of control over the operations of the joint venture. Instead, the thrust
of its argument is that these powers were rendered insubstantial or illusory as a result of
defendants’ alleged fraud. Initially, it points out that many of the investors in the joint
ventures are inexperienced in the oil and gas industry and thus allegedly entirely reliant
on GeoDynamics and Shields. (Compl. ¶¶ 87-93 at 25-27.) Yet this fact, standing
alone, is relevant only when “the partners are so dependant on a particular manager that
they cannot replace him or otherwise exercise ultimate control.” Williamson v. Tucker,
645 F.2d 404, 424 (5th Cir.), cert. denied, 102 S.Ct. 396 (1981). See also Rivanna
Trawlers Unlimited, 840 F.2d at 242 n.10 (“In a word, a general partner is not
dependent only on the degree of his own business sophistication in order to exercise
intelligently his partnership powers.”).4 More importantly, such dependence must have
been part of the original expectations at the inception of the transaction “and not some
subsequent decision to delegate partnership duties.” Williamson, 645 F.2d at 424 n.14
(citation and internal quotation marks omitted). Here, the JVAs retained to the joint
venturers the ability to control the joint ventures through the exercise of their substantial
voting rights.5 See Gordon v. Terry, 684 F.2d 736, 741 (11th Cir. 1982) (“An investor

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Nor is there any allegation that joint venturers were prevented from seeking outside assistance
to better understand the industry or any particular management decision if they felt it beyond their ken.
Robinson, 349 F.3d at 171. See also Maritan, 875 F.2d at 1459 (noting that although general partner
“was not told about the mortgage on the property, [] he surely was not prevented from finding out”);
Rivanna Trawlers Unlimited, 840 F.2d at 242 n.10 (“To the extent a partner needs advice or assistance
in the exercise of his powers, he is of course free to consult with more knowledgeable partners or third
persons, or to employ accountants and lawyers.”)
5

For example, GeoDynamics, as Managing Venturer, may be removed or substituted without
cause by a simple majority vote. (Def. Motion App., Exh. A ¶ 5.7 at 51.) Also by a simple majority, the
joint venturers may develop rules and procedures to provide for meetings at which a vote is sought or

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who has the ability to control the profitability of his investment, either by his own efforts
or by majority vote in group ventures, is not dependent upon the managerial skills of
others.”), cert. denied, 103 S.Ct. 1188 (1983).
The SEC alleges, however, that the joint venturers cannot exercise these voting
rights meaningfully as a result of defendants’ fraud. Defendants allegedly control the
information presented on conference calls and the presentation of voting proposals in
such a way that investors have no ready alternative to voting against its proposals.
Moreover, defendants allegedly have concealed their pervasive misappropriation of
investor funds, misrepresented the status and feasibility of proposed projects and
concealed the actual intended use of investor funds, and restricted and/or denied
investors access to financial statements and other information necessary for them to
exercise their powers of control and supervision. (Compl. ¶¶ 94-98 at 28-30.)
The SEC’s allegations are certainly significant and troubling, and assuming them
to be true, as I must for purposes of this motion, they set forth a pervasive fraud on the
joint venturers. Nevertheless, they do not allege facts sufficient to make out a plausible
claim that the investments at issue here are securities. The SEC’s allegations all revolve
around post-investment developments. Such allegations are relevant only to the extent
they shed light on the powers the joint venturers reserved to themselves at the time they
entered into the JVAs. See Merchant Capital, 483 F.3d at 756.

required, and those holding 10% or more of the units may call meetings. (Id., Exh. A ¶ 4.11 at 50 & ¶ 5.6
at 51.) GeoDynamics cannot sell, transfer, or assign its interest in the joint venture without the consent of
51% of the venturers. (Id., Exh. A ¶ 6.1 at 52.) In addition, each joint venturer has all rights and
obligations of a General Partner under the Texas law. (Id., Exh. A ¶ 5.2 at 51.) See TEX. BUS. ORG.
CODE §§ 152.201 - 152.214. See also Rivanna Trawlers Unlimited, 840 F.2d at 242 n.8 (noting that
terms of partnership agreement were supplemented by provisions of Virginia partnership law).

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That is not the nature of the SEC’s theory, however.6 Instead, the SEC has
flipped the relevant inquiry on its head, reasoning backwards from the alleged fraud itself
to prove that the investors lacked control, and thus concluding that the investments are
securities. Yet if the SEC could back its way into a claim of securities fraud in this
manner, it is unlikely that any fraudulent scheme could be excluded from the ambit of the
federal securities laws. The securities laws, however, do not provide a broad federal
remedy for all common law frauds, no matter how egregious. See Marine Bank v.
Weaver, 455 U.S. 551, 556, 102 S.Ct. 1220, 1223, 71 L.Ed.2d 409 (1982). As pleaded
here, any relief from defendants’ alleged fraud lies under state, not federal, law.
Based on the foregoing considerations, I find and conclude that the SEC’s
allegations here are insufficient to state a plausible claim that the joint venture interests
at issue in this case are securities. Defendants’ motion to dismiss therefore will be
granted.
IV. ORDERS
THEREFORE, IT IS ORDERED as follows:
1. That Defendant GeoDynamics, Inc.’s Motion To Dismiss Pursuant to Fed.
R. Civ. P. 12(b)(6) [#28], filed September 27, 2011, is GRANTED;
2. That plaintiff’s claims in this lawsuit are DISMISSED WITHOUT PREJUDICE;
3. That judgment SHALL ENTER on behalf of defendants, Jeffory D. Shields
(a/k/a Jeffrey D. Shields) and GeoDynamics, Inc. (f/k/a or d/b/a Geodynamics

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Although the Merchant Capital court did examine post-investment events in finding that the
general partnership interests at issue there were in fact securities, it did so only as a way of highlighting
the lack of real control reserved to the non-managing partners in the investment contract itself. See
Merchant Capital, 483 F.3d at 757-60.

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Exploration, Inc.), and relief defendants GeoDynamics, Inc. Johnston’s Corner #1 and #2
Joint Venture; GeoDynamics, Inc. Huskie #1 Joint Venture; GeoDynamics Exploration,
Inc. Trumpeter #1 and #2 Joint Venture; GeoDynamics, Inc. EVDA #1 Joint Venture,
Floribama Oil Corporation; Carbotec, Inc.; Triton Energy Asset Management, LLC;
T.E.A.M. Property Management, LLC (d/b/a T.E.A.M. Property Management); S&P
Energy, LLC; Aurum Energy Associates, LLC; and Unum, LLC, and against plaintiff,
Securities and Exchange Commission, on all claims for relief and causes of action;
provided, that the judgment as to these claims shall be without prejudice.
Dated September 6, 2012, at Denver, Colorado.
BY THE COURT:

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