Securities And Exchange Commission v. Torchia et al
Filing
66
OPINION AND ORDER granting 20 Motion for Preliminary Injunction and denying as moot 2 Motion for TRO . See pages 71-73 of this Order for specifics. IT IS FURTHER ORDERED that the assets of Defendants be, and hereby are, frozen. IT IS FURTHER O RDERED that a Receiver be appointed in this action to marshal and preserve the Assets. Mr. Al B. Hill of Taylor English Duma LLP in Atlanta, Georgia is determined by the Court to be uniquely qualified to serve as Receiver, and he is appointed the Re ceiver in this matter. IT IS FURTHER ORDERED that, while this injunction is in effect, the following written reports are required as outlined on pages 78-81 of this Order. See pages 82-85 for further requirements. IT IS FURTHER ORDERED that the Court shall hold, on Wednesday, May 11, 2016, at 10:00 am, a telephonic status conference with counsel for the parties and the Receiver. Counsel and the Receiver are required, before the status conference, to confer and submit to the Court their joint su mmary of any disputes or potential disputes regarding the scope or application of this Order, or any practical issues or considerations regarding the enforcement and execution of this Order. Signed by Judge William S. Duffey, Jr on 4/25/2016. (anc) Modified on 4/25/2016 in order to correct ruling info (anc).
(“AMC”), and Spaghetti Junction, LLC’s (“Spaghetti Junction”) (collectively,
“Defendants”) Motion to Dismiss [21].
I.
BACKGROUND AND FINDINGS OF FACT
A.
Introduction
This action involves alleged fraudulent schemes operated by Mr. Torchia
and the Defendant entities he controls. The alleged fraud involves two separate
investment schemes. In the first, CN Capital raises money to invest in sub-prime
auto loans and life insurance settlements. ([20.1] at 4). CN Capital raises the
funds by selling unregistered promissory notes to investors, who are told that they
will receive a 9% “fixed” return and that their promissory notes are “100% asset
backed.” (Compl. ¶ 2). CN Capital tells promissory note investors that it expects
to generate returns from its investments in excess of the 9% interest payable on the
notes. ([20.1] at 5). The second involves CN Acceptance, which sells unregistered
fractional interests in life settlement contracts (“LS Interests”) to investors.
(Compl. ¶ 4).
The SEC contends that Defendants’ own forensic accounting analysis
reveals that their financial situation is dire, CN Capital is insolvent and has been
for years, and that Defendants are attempting to obscure CN Capital’s financial
condition. The SEC argues that Defendants did not disclose CN Capital’s
2
insolvency to investors, in violation of federal securities laws. (See Compl.
¶¶ 10-12). The Complaint alleges that Defendants violated Sections 5(a), 5(c),
17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act of 1933, 15 U.S.C. §§ 77a, et
seq. (“Securities Act”), Section 10(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78a, et seq. (“Exchange Act”), and subsections (a), (b), and (c) of Rule
10b-5 under the Exchange Act, 17 C.F.R. § 240.10b-5 (“Rule 10b-5”). (Id.
¶¶ 10-12). The SEC asks the Court to “shut down this fraudulent scheme and
appoint a receiver to marshal and liquidate the assets to prevent investors from
losing any more money than they already have as a result of the Defendants[’]
fraud.” ([20.1] at 18-19).
Defendants argue that the SEC’s allegations are based on a
misunderstanding of Defendants’ business model and operations. ([61] at 6).
They argue that the SEC’s allegation that CN Capital is insolvent relies on a
“non-GAAP,[1] preliminary, cash flow analysis[.]” ([26] at 2). Defendants claim
that the fair market value of life settlements owned by Credit Nation exceeds $40
million, (Defs.’ Initial Disclosures [19] at 4), and that taking the fair market value
of these assets into account shows that CN Capital is solvent. Defendants seek
dismissal of this action and oppose an injunction, including because the life
1
Generally Accepted Accounting Principles.
3
insurance settlements it sells to investors are not securities, the SEC has not made a
prima facie case that Defendants violated registration requirements or the antifraud
provisions of the federal securities laws, and the SEC failed to provide evidence of
scienter or intent to defraud. (See, e.g., [26] at 4-13).
B.
Defendants’ Business
1.
Overview
Defendant James Torchia is the CEO of CN Capital, CN Acceptance, and
AMC (collectively, “Credit Nation”). ([21.1] at 2). Although the Credit Nation
entities are separate, they function as a unit. (Id. at 4). Mr. Torchia is also the
CEO of CN Auto, a used car dealership that is no longer in operation. (Id.).
Mr. Torchia owns Spaghetti Junction, through which he loaned Credit Nation
millions of dollars in start-up capital between 2008 and 2011. (Id. at 3). The
ownership structure of the various entities under Mr. Torchia’s control is depicted
in the following chart provided by the SEC:
4
([20.1] at 23).
Credit Nation raises money to invest in (i) sub-prime auto loans and (ii) life
insurance settlements. ([20.1] at 4; [21.1] at 3). Credit Nation raises the
investment capital by selling three- and five-year promissory notes to investors.
([21.1] at 3). Credit Nation tells promissory note investors that they will receive a
9% fixed return and that their promissory notes are “100% asset backed.” ([20.1]
at 4-5). Credit Nation tells promissory note investors that Credit Nation expects to
generate returns from its investments in excess of the 9% interest payable on the
5
notes. (Id. at 5). Credit Nation’s advertisements for its promissory notes included
the following newspaper advertisements:
([2.10] at CN-SEC-000550, -000553).2
2
Credit Nation also ran radio advertisements containing the following
language:
Hello, I’m Bob Guess with Credit Nation. You know, most
Americans are tired of bank returns, they’re afraid of the run-up in
Wall Street, and fed up with misleading claims of returns on annuities
and insurance companies. If you’re looking for sound investments
6
Defendants’ sub-prime auto loan and life insurance settlement operations are
represented in the following chart provided by the SEC:
and security of principal where your money works as hard as you do,
give Credit Nation a call. Because of the new JOBS Act passed by
Congress there is now a level playing field for investors. With Credit
Nation you can earn a nine percent return on your money backed by
hard assets dollar for dollar. If you prefer growth over income we
have an asset-backed product thats [sic] averaged double digits
historically. Don’t put all your eggs in one basket. Call Credit Nation
for a free consultation today. It’s never been harder to stay ahead of
inflation than it is today, so diversify your portfolio. That’s the
answer. Call us at 1-800-542-9513, that’s 1-800-542-9513. Don’t
gamble with your financial future. Call us today. 1-800-542-9513.
([2.9] at 2).
7
([20.1] at 24). These operations are explained in further detail below.
2.
Defendants’ Investments in Sub-Prime Auto Loans
Credit Nation provides automobile loans (the “Sub-Prime Auto Loans”) at
high interest rates to individuals with credit problems. (Id. at 5). The Sub-Prime
Auto Loans are secured by the automobiles purchased with the loan proceeds.
(Id.). Credit Nation’s offering materials and advertising circulars describe the
steps that it takes to ensure that its Sub-Prime Auto Loans are profitable, such as
requiring high down payments and attaching a GPS tracker to each vehicle. (See,
e.g., [2.13] at CN-SEC-000599-560). Credit Nation tells investors that, in its
discretion, it will keep the Sub-Prime Auto Loans and profit from the interest or
that it will resell the loans at a profit. ([20.1] at 5).
AMC, a subsidiary of CN Capital, makes the investments in Sub-Prime Auto
Loans. (Id.). AMC originates loans directly from automobile dealerships and also
purchases loans. (Id.). Many of the Sub-Prime Auto Loans that AMC purchased
were from the now-defunct CN Auto, a car dealership controlled by Mr. Torchia.
(Id. at 5-6).
The SEC contends that Credit Nation’s investments in Sub-Prime Auto
Loans “have never been profitable,” (id. at 6), and that it never disclosed its
millions of dollars in losses to promissory note investors, (id.).
8
3.
Defendants’ Investments in Life Insurance Settlements
Credit Nation also invests in life insurance settlements at a discount to their
maturity value—that is, the death benefit of the underlying policy. Credit Nation
buys life insurance policies, either from an insured or from a settlement company
that acts as a broker, hoping that the combination of the purchase price and the
premiums paid over time will be less than the death benefits that Credit Nation
ultimately receives upon the death of the insured. (Id. at 6-7).
Credit Nation told buyers of its promissory notes that it planned to focus on
buying policies with life expectancies in the three-to-four year range, ([2.13] at
CN-SEC-000561), and that it expects to receive a 15% return on its portfolio of life
insurance settlements, ([2.12] at CN-SEC-042943).
After it purchases a life insurance policy, CN Capital either holds the policy
or sells it, in whole or in part, at a markup. It sells LS Interests through its affiliate,
CN Acceptance. CN Acceptance tells LS Interest investors that it will pay
premiums for the life expectancy of the insured, plus two years if the insured lives
that long. (Compl. ¶ 4). In return, LS Interest investors receive a portion of the
death benefit when the insured dies. (Id.).
The SEC contends that Credit Nation’s investments in life insurance
settlements have not been profitable, and that Credit Nation has suffered
9
multi-million dollar operating losses. (Id. ¶¶ 72, 77). The SEC alleges that
Defendants are insolvent and have liabilities that greatly exceed their assets, and
that this financial situation has never been disclosed to investors. (Id. ¶ 77). The
SEC also alleges that Mr. Torchia has misappropriated and misused investor
money through “loans” and transfers between him and the Defendant entities. (Id.
¶¶ 88-112).
Defendants argue that the fair market value of life settlements owned by
Credit Nation exceeds $40 million, (Defs.’ Initial Disclosures [19] at 4), and that
their life settlement business is profitable. Their theory is that when an insurance
policy is purchased, its value is its face value minus the premiums it expects to pay
until the insured dies. Put another way, if a policy with a face value of $1 million
is purchased for $600,000, its value is $1 million minus estimated premiums
required to be paid to keep the policy in force. They reject that the value is what
they paid or what a willing purchaser would pay for the policy in an arm’s length
purchase.
C.
Procedural History
On November 10, 2015, the SEC filed its TRO Motion. On
November 13, 2015, the Court held a hearing on the motion. (Minute Entry [13]).
Counsel for both the SEC and Defendants participated in the hearing.
10
(Nov. 13, 2016, Hr’g Tr. [16]). At the hearing, the Court determined that it
required more information from the parties—and more time—to decide whether
injunctive relief and a receiver were required. The Court requested the parties to
negotiate a consent order that would preserve the status quo to allow the Court the
opportunity to analyze the parties’ positions in more depth. (See id. at 57:6-10;
57:22-58:1; 59:2-20; 64:12-65:5). The parties agreed to the Court’s request. (Id.
at 65:10-66:4).
On November 18, 2015, the parties submitted their proposed consent order
[15] (“Consent Order”). The Consent Order provided for, among other things:
(i) a preliminary injunction briefing schedule; (ii) a preliminary injunction
evidentiary hearing; (iii) expedited discovery; (iv) a freeze, pending the Court’s
determination of the SEC’s preliminary injunction motion, on advertising, offering,
or selling additional promissory notes and on Defendants’ transfers of assets or
funds. On November 20, 2015, the Court entered the Consent Order [17].3
On December 1, 2015, the SEC filed its Preliminary Injunction Motion. The
same day, Defendants filed their Motion to Dismiss. Defendants move, under
3
On January 13, 2016, the parties submitted to the Court a second Proposed
Consent Order [53], which extended the terms of their initial Consent Order until
the Court’s ruling on the SEC’s Preliminary Injunction Motion. On
January 14, 2016, the Court entered the parties’ second Proposed Consent Order as
an order of the Court [55].
11
Federal Rule of Civil Procedure 12(b)(1), to dismiss the SEC’s claims related to
the sale of LS Interests, arguing that the LS Interests are not securities. ([21.1] at
2, 8). Defendants move, under Federal Rule of Civil Procedure 12(b)(6), to
dismiss the SEC’s other claims. (Id. at 2).
On January 8 and 9, 2016, the Court held its hearing on the SEC’s
Preliminary Injunction Motion. (Minute Entries [51], [52]). The testimony
provided at the hearing is discussed in detail below. On February 1, 2016, the
parties filed their respective post-hearing briefs. ([60], [61]).
D.
Preliminary Injunction Hearing
On January 8 and 9, 2016, the Court held its hearing on the SEC’s
Preliminary Injunction Motion. The following individuals testified at the hearing:
Susan Hartman, an accountant hired by Credit Nation to conduct a forensic
accounting of its finances; M. Bryan Freeman, the SEC’s life settlement valuation
expert; Defendant James Torchia; Amberly Green, Mr. Torchia’s manager of his
personal financial matters and a policy underwriter at Credit Nation; and Jessica
Hardie, Credit Nation’s manager of operations. (Tr. of Prelim. Inj. Hr’g [56], [57]
(“Tr.”)).
12
1.
Susan Hartman’s Testimony and Financial Snapshots
Ms. Hartman was hired by Credit Nation in 2015 in response to the SEC’s
investigation into Credit Nation’s financial dealings. (See Tr. at 8:18-9:2). As part
of her responsibilities, she created financial snapshots (the “Financial Snapshots”)
of Credit Nation’s finances for 2014 and the first six months of 2015. (Id. at
8:19-23; Pl.’s Ex. 1; Pl.’s Ex. 2).
Ms. Hartman testified that the individuals responsible for accounting at
Credit Nation “were not trained accountants,” and that this was unusual for a
company the size of Credit Nation. (See Tr. at 13:19-22, 14:5-20). Partly for this
reason, the Financial Snapshots she created are not in accordance with GAAP.
(See id. at 13:7-12; 64:5-21).
Ms. Hartman created the Financial Snapshots using Credit Nation’s bank
statements and its internal accounting records. (Pl.’s Ex. 1 at 1; Pl.’s Ex. 2 at 3-4).
The Financial Snapshots include, for 2014 and 2015: CN Capital Sources and
Uses, AMC Sources and Uses, Consolidated Sources and Uses (CN Capital and
AMC), CN Auto Sales Sources and Uses, CN Capital Profit and Loss,4 AMC
Profit and Loss, Consolidated Profit and Loss (CN Capital and AMC), CN Capital
4
Ms. Hartman testified that the CN Auto Sales Sources and Uses analysis was
not included in the CN Capital and AMC Consolidated Sources and Uses because
CN Auto Sales is not a fully owned subsidiary of CN Capital. (Tr. at 63:4-8).
13
Assets and Liabilities, AMC Assets and Liabilities, Consolidated Assets and
Liabilities (CN Capital and AMC), and Consolidated Related Party Assets and
Liabilities (CN Capital and AMC). (Pl.’s Ex. 1; Pl.’s Ex. 2).
Ms. Hartman testified that, as of December 31, 2014, the face value of all
the life insurance settlements that Credit Nation owned, or in which it had an
interest—$12,541,372—was less than Credit Nation’s total liability on investor
notes payable—$29,387,719. (Tr. at 79:25-80:10; see also Pl.’s Ex. 2 at 31).
Thus, if all of those life insurance settlement policies matured as of
December 31, 2014—well before many of them were expected to mature—Credit
Nation still would not have sufficient funds to satisfy its obligations to promissory
note holders. (See Tr. at 80:11-17; Pl.’s Ex. 2 at 31).
Ms. Hartman testified that, based on her forensic analysis, the consolidated
liabilities of CN Capital and AMC for 2014 were $32,478,510 and its assets were
$8,897,858. (Tr. at 79:13-21). The companies had, based on her cash flow
analysis, a net loss of $6,164,051 in 2014. (Pl.’s Ex. 2 at 28). Ms. Hartman
testified that, for the period January 1, 2015, through June 30, 2015, CN Capital
and AMC, on a cash flow basis, had a consolidated net loss of $4,230,251. (Tr. at
94:10-25; see also Pl.’s Ex. 1 at 11). Assuming losses would accumulate at the
same rate as they did in the first six months of 2015, CN Capital and AMC would
14
have had, on an annualized basis, a net loss in 2015 of over $8 million—about $2
million more than its losses in 2014. As of June 30, 2015, CN Capital and AMC
had total liabilities of $41,902,589 and assets of only $14,996,245. (Tr. at 98:1-22;
Pl.’s Ex. 1 at 15). The Financial Snapshots show that, as of June 30, 2015, CN
Capital and AMC had a negative total cash flow, and net income. (Pl.’s Ex. 1 at
1-11).
Ms. Hartman testified that one significant difference between the 2015
analysis and the 2014 analysis is that the maturity value of life settlements
increased after December 31, 2014. (See Tr. at 96:4-13). This increase was due to
Credit Nation’s purchase of additional life insurance policies. (Id. at 96:14-15).
Ms. Hartman testified that, based on the analysis she conducted, Credit
Nation was operating at a loss in 2014 and 2015, (id. at 125:21-25), that it was not
profitable, (id. at 126:6), and that, based on her analysis of Credit Nation’s profits
and losses from 2014 to 2015, its losses were accelerating, (id. at 126:8-15).
Ms. Hartman noted that, while her Financial Snapshots were not GAAP
compliant, a GAAP compliant balance sheet would record “unearned revenue” for
policies that Credit Nation sold to investors in the past. (Id. at 67:4-23, 75:10-25,
95:14-25). On a GAAP compliant balance sheet, unearned revenue is a liability.
(Id. at 95:19-21).
15
Ms. Hartman’s Financial Snapshots also contain information regarding
transfers between Mr. Torchia and the Defendant entities, or other entities he or his
relatives control. For instance, Mr. Torchia directed the transfer of hundreds of
thousands of dollars to CN Auto, Spaghetti Junction, National Viatical,
RiverGreen, Willie West, Jason’s Automotive, and Sixes Tavern.5 (Pl.’s Ex. 1 at
5-6; Pl.’s Ex. 2 at 17-19). Ms. Hartman testified that these kinds of transfers are
“not a best practice” and that generally transfers of this sort are done “out of
convenience” and because of “cash flow issues.” (Tr. at 31:17-33:2).
Further examples of transfers between Mr. Torchia and Torchia-related
entities include CN Capital and AMC’s 2014 transfers of approximately $1.1
million to CN Auto, Mr. Torchia’s now-defunct dealership. (Pl.’s Ex. 2 at 21). At
the time of this transfer, CN Auto owed Credit Nation more than $5 million, (Id. at
39 (non-collectable loan to CN Auto of $6.4 million at the end of 2014)), and, as of
June 30, 2015, CN Auto owed CN Capital $6,405,593 in loans categorized as
“non-collectible.” (Pl.’s Ex. 1 at 17). Ms. Hartman testified that, for part of 2014,
CN Auto paid the payroll of both CN Auto and AMC. (Tr. 40:14-16). Money also
flowed back and forth between Credit Nation and RiverGreen, and Mr. Torchia’s
5
National Viatical, RiverGreen, Sixes Tavern, and Willie West are all
Torchia-related entities. (See Tr. at 15:11-13; 23:1-7; 55:20-23; 221:12-15;
224:19-22).
16
untrained employees “kept track of who owes who for what on [a] spreadsheet.”
(See id. at 54:9-15). Ms. Hartman also testified that Credit Nation purchased a life
settlement policy from Mr. Torchia and then sold the policy to a third party. (Id. at
61:20-25).
2.
M. Bryan Freeman’s Testimony
Mr. Freeman testified as the SEC’s life settlement6 valuation expert.7 He
performed an analysis of the ten policies that make up the majority of the death
benefits owned by Credit Nation ($67.5 million out of a total $75.1 million) to
determine the fair market value of the policies. (Pl.’s Ex. 20; see also Tr. at
159-65). Mr. Freeman testified and provided an analysis showing that the total fair
market value of these policies is between $1.5 million and $2.2 million. (Tr. at
164:12-22; Pl.’s Ex. 20). He testified that this analysis does not include overhead
costs to manage the policies. (Tr. at 192:6-11). Mr. Freeman also suggested that
Credit Nation may not have the ability to pay the premiums on the life insurance
policies it owned. (See id. at 188:11-18).
6
Mr. Freeman explained that life settlements technically differ from “viatical
settlements,” but that, under Georgia law and in common parlance, the two terms
are used interchangeably. (See Tr. at 135:13-136:1).
7
On January 7, 2016—the day before the preliminary injunction hearing—
Defendants filed their motion to disqualify Mr. Freeman as an expert. ([50]). At
the hearing, the Court denied the motion, allowing Defendants to address, on
cross-examination, the matters set forth in their motion. (Tr. at 4:8-16).
17
3.
James Torchia’s Testimony
When asked whether he had reviewed Ms. Hartman’s Financial Snapshots,
Mr. Torchia stated that he is “not an accountant.” (Id. at 270:13-14). He also
deferred to his “CPAs” when asked whether AMC, which operates the Sub-Prime
Auto Loan portion of Credit Nation’s business, was profitable. (See id. at
270:10-17).8
Mr. Torchia believes that he and his company are “the best in the world” at
valuing insurance policies. (Id. at 211:20-22). When asked how he determined the
purchase price for life insurance policies, Mr. Torchia struggled to provide a
coherent explanation of his process, and his answers were often evasive and not
responsive. (See id. at 210:13-211:19; 233:22-239:23). He stated he buys certain
policies “[b]ecause we feel that the life expectancies in certain areas are off,” and
that he is “looking for homeruns and . . . for potential.” (Id. at 214:3-20). He
ultimately explained that his methodology involves applying a factor of 10% to the
policy to determine the cost of insurance. (See id. at 239:2-23). He testified that
8
Mr. Torchia was called by Defendants as a witness in Defendant’s case-inchief. The evidence presented by the SEC was sufficient to show that Defendants
did not have a viable motion to dismiss at the end of the SEC’s case-in-chief and
Defendants thus were allowed to present evidence on their behalf for the Court’s
consideration.
18
Credit Nation has its “own doctors . . . who are better than the life expectancy
doctors.” (Id. at 214:8-14).
Mr. Torchia was questioned regarding three specific life insurance policies
in which he sold or pledged LS Interests to investors, and he was questioned
regarding Mr. Freeman’s valuation analysis on those three policies. For the first
policy, Mr. Torchia sold approximately 70% of the death benefit from a policy
issued to an insured named Kahan. The revenue generated by the sale of the LS
Interests in the Kahan policy was $977,475.37. (Id. at 246:4-8; Pl.’s Ex. 31).
Mr. Freeman calculated that Credit Nation would be required to pay premiums of
$1,860,837 on the Kahan policy to keep it in force until the life expectancy
estimated by Credit Nation. (Tr. at 250:17-22). Mr. Torchia was asked to multiply
the percentage of the death benefit sold by the total premiums required to be paid,
and the result was approximately $1,302,000. (Id. at 251:3-18). Mr. Torchia was
then asked to subtract $977,475.37—the revenue generated by the sale of
approximately 70% of Kahan’s death benefit—from the premiums required to be
paid on those sold death benefits, and the result was a loss for Credit Nation of
approximately $325,000, assuming Kahan lived to the life expectancy Credit
Nation estimated. (See id. at 251:3-23). Put another way, assuming Kahan lived
to life expectancy, Credit Nation would lose, through paying the required
19
premiums, $325,000 on its sale of approximately 70% of Kahan’s death benefit.
Mr. Torchia attempted to dispute this figure by claiming that Credit Nation
“inherited along with that [Kahan] portfolio . . . 14 million dollars’ worth of death
benefit on top of it for free on people that were older.” (Id. at 251:24-252:2).
Mr. Torchia, however, could not explain the source of these purported profits, and
he could not identify any policy he claimed was a part of the $14 million fourpolicy deal that included the Kahan portfolio. (Id. at 252:3-254:2).
Next, Mr. Torchia sold 41% of the death benefit on a policy issued to an
insured named Sneider. The total revenue generated by the sale of LS Interests in
the Sneider policy was $2,050,000. (Id. at 255:2-6; Pl.’s Ex. 43). Mr. Freeman’s
calculations showed that the anticipated premiums on the Sneider policy totaled
$6,699,648. (Tr. at 255:19-24). Mr. Torchia performed the same calculations as
above, and the result showed that, if Sneider lived to the life expectancy Credit
Nation calculated, Credit Nation would lose approximately $700,000 on the sale of
those LS Interests. (Id. at 258:9-21). Mr. Torchia again struggled to explain this
loss estimate, claiming, confusingly, that “we inherited 24 million dollars in death
benefit for free. Just pay the premiums.” (Id. at 258:24-259:3). Mr. Torchia
conceded that, in numerous cases, life expectancies for policies Credit Nation
20
owned exceeded Credit Nation’s estimated life expectancies for those policies.
(See id. at 265:24-267:7).
Mr. Torchia testified that Mr. Freeman’s valuation of the value of Credit
Nation’s life settlements is incorrect, noting that Mr. Freeman’s expertise is in a
different life settlement market than the one in which Credit Nation operates. (Id.
at 219:3-13). Mr. Torchia claimed that he could sell Credit Nation’s life settlement
policies “in under three months for at least [$]35 million.” (Id. at 219:10-13). He
did not provide any criteria, process, or methodology by which he reached this
valuation.
On cross examination, Mr. Torchia testified that there is an outstanding
$5 million judgment against an entity called National Viatical, for which judgment
Mr. Torchia is jointly liable. (Id. at 272:12-14). When asked how he would satisfy
the judgment, Mr. Torchia stated he would not take money from Credit Nation to
pay the judgment, and that he “intend[s] to fight it to the death.” (Id. at
272:21-273:10). Mr. Torchia also offered testimony to the effect that he maintains
discretion to decide how Credit Nation operates financially, including by loaning
money to related entities and engaging in a variety of transactions Mr. Torchia
decides are appropriate. (See id. at 216:17-217:2; 221:16-25; 222:9-23; 272:1-16).
21
When questioned about Credit Nation’s representations to investors that life
settlements and Sub-Prime Auto Loans would generate sufficient revenue to pay
9% interest on the promissory notes, Mr. Torchia stated “we didn’t represent
that. . . . We represented that we are going to enter into the auto loans and
policies . . . [b]ut we also have other revenue streams.” (Id. at 275:25-276:6). He
stated that “[w]e will get there. We have generated [a] lot in buying and selling
loans. We just, you know, we haven’t—we haven’t had as much money to do the
auto loans as we would like to. But we are just about there right now.” (Id. at
276:7-10).
Mr. Torchia testified that Credit Nation reported losses in 2011, 2012, and
2013. (Id. at 271:2-8). He testified that Defendants “told [investors] we could run
at a loss. And I don’t think it’s my duty to tell [investors] that we are running at a
loss.” (Id. at 277:23-278:3).
When questioned whether he sometimes used the company credit card to pay
for Sixes Tavern’s expenses, he stated that, “if it’s used by the Sixes Tavern, it gets
paid back by Sixes Tavern, or it gets reduced off of my deficit, but it gets paid
back.” (Id. at 221:16-23). When asked whether these transactions were accounted
for, he answered “[y]eah, I believe so.” (Id. at 221:24-25). When asked a similar
question regarding whether “Credit Nation accounts for monies flowing back and
22
forth from Credit nation to RiverGreen,” he stated that his “bookkeepers do that,
bookkeepers and the people that handle the account.” (Id. at 223:20-23). He
reiterated that he is “just not a very good accountant. We have outside CPAs that
were brought in to set up the systems that were in place . . . . Accounting is not my
strong suit.” (Id. 223:25-224:6). He did not testify that trained or certified
accountants are usually employed by Credit Nation.9
4.
Amberly Green’s Testimony
Ms. Green, Mr. Torchia’s manager of his personal financial matters and a
policy underwriter at Credit Nation, testified that, based on her understanding of
Mr. Torchia’s bank accounts and finances, a $5 million judgment against
Mr. Torchia would “significantly impact his ability to loan money” to Credit
Nation. (Id. at 317:8-22).
Regarding Mr. Torchia’s loans to Credit Nation and other entities,
Ms. Green testified that there were no loan agreements in place. (Id. at
304:24-305:5). Ms. Green testified that Mr. Torchia loaned $2,964,000 to CN
Auto between 2007 and 2013 “in order for it to operate.” (Id. at 315:18-316:9).
9
Despite Credit Nation’s mass media advertisements to the public,
Mr. Torchia claims he allows only “high-net-worth individuals” to invest in life
settlements. (Tr. at 219:10-13). The evidence is undisputed that life settlements
are part of the two investments intended to fund notes owned by investors.
23
When asked to clarify the purpose of the $2,964,000 loan, she testified that she did
not know the exact purpose of Mr. Torchia’s loans to CN Auto. (Id. at
316:16-20).10, 11
II.
DEFENDANTS’ MOTION TO DISMISS
The SEC’s Complaint alleges that Defendants violated Sections 5(a), 5(c),
17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act, Section 10(b) of the
Exchange Act, and SEC Rule 10b-5. Defendants move, under Federal Rule of
Civil Procedure 12(b)(1), to dismiss the SEC’s claims related to the sale of
LS Interests, arguing that the LS Interests are not securities. ([21.1] at 2, 8).
Defendants move under Federal Rule of Civil Procedure 12(b)(6) to dismiss the
SEC’s other claims. (Id. at 2).
A.
Legal Standards
1.
Federal Rule of Civil Procedure 12(b)(1)
“Attacks on subject matter jurisdiction under Fed. R. Civ. P. 12(b)(1) come
in two forms. ‘Facial attacks’ on the complaint require[ ] the court merely to look
and see if [the] plaintiff has sufficiently alleged a basis of subject matter
10
The testimony of Ms. Hardie, Credit Nation’s manager of operations, had
limited probative value. The parties do not rely on her testimony in their
post-hearing briefs, and the Court does not rely on it in this Opinion and Order.
11
The Court sets out additional facts and allegations below.
24
jurisdiction, and the allegations in [the] complaint are taken as true for the
purposes of the motion.’” Menchaca v. Chrysler Credit Corp., 613 F.2d 507, 511
(5th Cir.1980),12 cert. denied, 449 U.S. 953 (1980) (citing Mortensen v. First Fed.
Sav. & Loan Ass’n, 549 F.2d 884, 891 (3d Cir. 1977)). “Factual attacks” are
challenges to the “existence of subject matter jurisdiction in fact . . . and matters
outside the pleadings . . . are considered.” Id.
The Court, having reviewed the arguments presented by both parties,
determines that Defendants’ Rule 12(b)(1) Motion to Dismiss is a facial attack.
The Court thus considers the allegations in the Complaint as true for the purposes
of the motion. Menchaca, 613 F.2d at 511.
2.
Federal Rule of Civil Procedure 12(b)(6)
On a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of
Civil Procedure, the Court must “assume that the factual allegations in the
complaint are true and give the plaintiff[] the benefit of reasonable factual
inferences.” Wooten v. Quicken Loans, Inc., 626 F.3d 1187, 1196 (11th Cir.
2010). Although reasonable inferences are made in the plaintiff’s favor,
“‘unwarranted deductions of fact’ are not admitted as true.” Aldana v. Del Monte
12
In Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir. 1981) (en banc), the
Eleventh Circuit adopted as binding precedent all of the decisions of the former
Fifth Circuit handed down prior to the close of business on September 30, 1981.
25
Fresh Produce, N.A., 416 F.3d 1242, 1248 (11th Cir. 2005) (quoting S. Fla. Water
Mgmt. Dist. v. Montalvo, 84 F.3d 402, 408 n.10 (11th Cir. 1996)). Similarly, the
Court is not required to accept conclusory allegations and legal conclusions as true.
See Am. Dental Ass’n v. Cigna Corp., 605 F.3d 1283, 1290 (11th Cir. 2010)
(construing Ashcroft v. Iqbal, 556 U.S. 662 (2009); Bell Atl. Corp. v. Twombly,
550 U.S. 544 (2007)).
“To survive a motion to dismiss, a complaint must contain sufficient factual
matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’”
Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 570). Mere “labels and
conclusions” are insufficient. Twombly, 550 U.S. at 555. “A claim has facial
plausibility when the plaintiff pleads factual content that allows the court to draw
the reasonable inference that the defendant is liable for the misconduct alleged.”
Iqbal, 556 U.S. at 678 (citing Twombly, 550 U.S. at 556). This requires more than
the “mere possibility of misconduct.” Am. Dental, 605 F.3d at 1290 (quoting
Iqbal, 556 U.S. at 679). The well-pled allegations must “nudge[] their claims
across the line from conceivable to plausible.” Id. at 1289 (quoting Twombly, 550
U.S. at 570).
26
B.
Analysis
1.
The LS Interests are Securities
As a threshold matter, the parties disagree whether the LS Interests sold by
Credit Nation qualify as securities under Section 2(a)(1) of the Securities Act and
Section 3(a)(10) of the Exchange Act.13
The Eleventh Circuit Court of Appeals addressed this issue in
SEC v. Mutual Benefits Corp., 408 F.3d 737 (11th Cir. 2005). In Mutual Benefits,
the Eleventh Circuit upheld the district court’s denial of defendant’s motion to
dismiss for lack of subject matter jurisdiction, holding that life settlement contracts
are “investment contracts” under the test set forth by the United States Supreme
Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). 408 F.3d at 745. The
Howey test provides that an investment contract for purposes of the federal
securities laws means “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 . . . .” 328 U.S. at 298-99.
Applying the Howey test, the Mutual Benefits court found that there was no
genuine dispute that the life settlement contracts at issue involved “(1) an
13
In response to the SEC’s first set of requests for admission, Defendants
admitted that the promissory notes offered by CN Capital are securities. ([48.1] at
3).
27
investment of money, (2) in a common enterprise, (3) involving the expectation of
profits.” 408 F.3d at 742-43. Turning to the remaining element, “whether the
investor’s expectation of profits is based ‘solely on the efforts of the promoter or a
third party[,]’” the Eleventh Circuit noted that “investment schemes may often
involve a combination of both pre- and post-purchase managerial activities, both of
which should be taken into consideration in determining whether Howey’s test is
satisfied.” Id. at 743-44. The Eleventh Circuit also noted that many courts “have
found investment contracts where significant efforts included the pre-purchase
exercise of expertise by promoters in selecting or negotiating the price of an asset
in which investors would acquire an interest.” Id. at 744 (citing cases). The
Eleventh Circuit concluded:
The investors here relied on [the defendant] to identify terminally ill
insureds, negotiate purchase prices, pay premiums, and perform life
expectancy evaluations critical to the success of the venture. The
flexible test we are instructed to apply by Howey . . . covers these
activities, qualifying [the defendant]’s viatical settlement contracts as
‘investment contracts’ under the Securities Acts of 1933 and 1934.
Id. at 745.
Defendants’ attempts to distinguish the SEC’s allegations here from those at
issue in Mutual Benefits are unconvincing. Defendants first argue that the SEC’s
allegations do not satisfy the “common enterprise” prong of the Howey test.
([21.1] at 8). Relying on SEC v. Unique Fin. Concepts, Inc., 196 F.3d 1195 (11th
28
Cir. 1999), Defendants argue that whether the “common enterprise” prong is met
depends on whether the “fortunes of the investor are interwoven with and
dependent on the efforts and success of those seeking the investment or of third
parties.” ([21.1] at 8). They argue here, the SEC alleges investors purchase
policies from Credit Nation inventory, and that policies are identified and acquired
before an investor ever places an investment with Credit Nation. (Id. at 9 (citing
Compl. ¶¶ 4, 51)). Defendants contend their “investors’ fortunes are tied directly
to market forces (e.g., when a policy matures), not interwoven with the efforts and
success of Credit Nation.” (Id.).
This argument is meritless. First, that some of Defendants’ activities
occurred pre-purchase is irrelevant, because “investment schemes may often
involve a combination of both pre- and post-purchase managerial activities, both of
which should be taken into consideration in determining whether Howey’s test is
satisfied.” Mutual Benefits, 408 F.3d at 743-44. Second, in finding a common
enterprise, the Eleventh Circuit in Mutual Benefits noted only that “[t]he
investment scheme here involved both horizontal commonality, in that investor
money was typically pooled to invest in a viatical settlement and investors shared
both the promise of profits and the risk of loss, and vertical commonality in that
any profits were tied to the efforts of the promoters.” 408 F.3d at 743 n.4. The
29
Eleventh Circuit did not set forth a temporal requirement that the “efforts of the
promoters” must be undertaken after the investor makes the investment.14
Here, the Complaint alleges that, as part of the LS Interest scheme:
“investors receive a pro rata distribution from the policy proceeds when the insured
dies”; “CN Acceptance is required to pay the policy premiums for up to two years
beyond the insured’s projected life expectancy”; “CN Acceptance establishes a
projected life expectancy for the insured”; if the insured lives more than two years
beyond the projected life expectancy, CN Acceptance may “require LS Interest
investors to make the future premium payments”; CN Acceptance will “monitor
when premium payments are due”; and CN Acceptance provides LS Interest
investors with “a list of services that CN Acceptance provides.” (Compl. ¶¶ 4, 53,
55, 57). These allegations show investors shared the promise of profits and the
risk of loss, and that investors’ profits were tied to CN Acceptance’s life
expectancy projections, their ongoing efforts of monitoring, making premium
payments, and facilitating collection of the benefit upon maturity. The “common
enterprise” prong is satisfied.
14
The Eleventh Circuit found “frivolous” the defendant’s contention that the
“common enterprise” prong was not met, and the Eleventh Circuit relegated to a
footnote its analysis of this prong. Mutual Benefits, 408 F.3d at 743 n.4.
30
Defendants next argue the allegations in the Complaint do not satisfy the
final Howey prong, which requires that the investor’s expectation of profits be
based solely on the efforts of the promoter or a third party. Defendants argue that
the Complaint does not allege facts analogous to those alleged by the SEC in
Mutual Benefits. ([21.1] at 9-11). Defendants note specifically that, in Mutual
Benefits, the defendant, among other activities, “required investors to place money
in escrow before it purchased any interest or engaged in any activities on
[investors’] behalf”; “never asked investors pay additional premiums” “after
policies were purchased”; “recruited doctors to evaluate the health of an insured”;
and “monitored the health of the insureds[.]” (Id. at 9-10). Defendants also argue
that the “SEC does not allege that Credit Nation selects interests specifically for LS
Interest purchasers.” (Id. at 10).
The Mutual Benefits decision does not require a complaint to allege these
specific facts. The Howey test was met in Mutual Benefits because “investors’
expectations of profits . . . relied heavily on the pre- and post-payment efforts of
the promoters in making investments in viatical settlement contracts profitable.”
408 F.3d at 744. In reaching this conclusion, the court did not identify any
individual factor as dispositive. Instead, the Court simply listed several factors that
supported its conclusion that the final prong was met, including: “[t]he investors
31
here relied on [the defendant] to identify terminally ill insureds, negotiate purchase
prices, pay premiums, and perform life expectancy evaluations critical to the
success of the venture.” Id. at 745. The Complaint here alleges that Defendants
bought life insurance policies from insureds, paid premiums, performed life
expectancy evaluations, and monitored premium payments, among other “services
that CN Acceptance provides.” (See Compl. ¶¶ 4, 51-57). The Complaint’s
allegations here track those listed by the court in Mutual Benefits.
The crux of Defendants’ argument is that the “the LS Interest purchasers’
fortunes relied more on market forces (i.e., insured’s health and longevity) than
Credit Nation’s efforts and success.” ([21.1] at 11). This characterization ignores
the reality of the investment Defendants offered—an investment that required
investors to rely on Defendants to evaluate and purchase insurance policies based
on Defendants’ analysis of and recommendations regarding “market forces,”
specifically, insureds’ health and longevity. In a real way, Defendants’ argument
discredits their effort to distinguish this case from Mutual Benefits. Their
argument ignores that LS Interest purchasers necessarily relied on Defendants’
pre-purchase selection of the insurance policies, and that the Complaint alleges this
selection involved, at the very least, life expectancy evaluations. (See Compl. ¶¶ 4,
51-57). As the Eleventh Circuit noted, “investment schemes may often involve a
32
combination of both pre- and post-purchase managerial activities, both of which
should be taken into consideration in determining whether Howey’s test is
satisfied.” Mutual Benefits, 408 F.3d at 743-44. The Mutual Benefits Court also
noted:
[w]hen profits depend upon market forces, public information is
available to investors by which they can independently evaluate the
possible success of the investment. In the case before us, investors
were far more dependent on the efforts and information provided by
[defendant] than an investor relying on the open market to produce a
profit.
408 F.3d at 744 n.5. Here, the Court finds that the allegations in the Complaint
show that LS Interest investors were dependent on the efforts and information
provided by Credit Nation and did not rely on the open market to produce a
profit.15 The LS Interest contracts are “investment contracts” subject to the
Securities Act and the Exchange Act.
2.
Violation of Section 5 of the Securities Act
The SEC alleges that Defendants violated Sections 5(a) and 5(c) of the
Securities Act. “Under Section 5 of the Securities Act, securities offered for sale
15
Defendants rely on SEC v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996)
to show that other courts have found that “ministerial efforts” such as those alleged
by the SEC do not convert Life Settlements into investment contracts subject to
SEC regulation. ([21.1] at 11). Defendants’ reliance is misplaced, because the
Eleventh Circuit in Mutual Benefits expressly “decline[d] to adopt the test
established by the Life Partners court.” 408 F.3d 737.
33
must be registered by filing a registration statement with the SEC, unless a
statutory exemption to the registration requirement applies.” SEC v. Bronson,
14 F. Supp. 3d 402, 407 (S.D.N.Y. 2014) (citing 15 U.S.C. § 77e). “In order to
establish a prima facie case for a violation of § 5 of the Securities Act, the SEC
must demonstrate that (1) the defendant directly or indirectly sold or offered to sell
securities; (2) through the use of interstate transportation or communication and the
mails; (3) when no registration statement was in effect.” SEC v. Big Apple
Consulting USA, Inc., 783 F.3d 786, 806-807 (11th Cir. 2015) (quoting
SEC v. Calvo, 378 F.3d 1211, 1214 (11th Cir. 2004)). “Once participation in an
unregistered sale has been shown, the [sellers] have the burden of proving an
exemption to the registration requirements.” Id. at 807 (quoting Zacharias v. SEC,
569 F.3d 458, 464 (D.C. Cir. 2009)).
Defendants acknowledge their promissory notes are securities. ([21.1] at 12;
see also [48.1]16 at 3).17 They argue, however, that the SEC’s Section 5 claims
should be dismissed because Credit Nation “was permitted to offer its notes to
16
The SEC introduced this document into evidence at the preliminary
injunction hearing as Plaintiff’s Exhibit 100.
17
Defendants admit that CN Capital “used instrumentalities of interstate
commerce in connection with the offer and sale of promissory notes.” ([48.1] at
4). Defendants also admit that “[n]o registration statement was in effect with the
Commission as to the promissory notes sold by Credit Nation Capital.” (Id.).
34
unaccredited investors” under Rule 506(c), 17 C.F.R. § 230.506(c), ([21.1] at 13),
essentially contending that the promissory notes are exempt from the registration
requirements.
Defendants have the burden to prove an exemption applies. Big Apple,
783 F.3d at 807. “A court may dismiss a claim on the basis of an affirmative
defense raised in the motion to dismiss, only if the facts supporting the defense
appear on the face of the complaint, and it appears beyond doubt that the plaintiff
can prove no set of facts in support of his claim that would entitle him to relief.”
Bronson, 14 F. Supp. 3d at 407 (citing United States v. Space Hunters, Inc.,
429 F.3d 416, 426 (2d Cir. 2005)); see also Twin City Fire Ins. Co. v. Hartman,
Simons & Wood, LLP, 609 F. App’x 972, 976 (11th Cir. 2015) (“A complaint may
be dismissed . . . when the existence of an affirmative defense ‘clearly appears on
the face of the complaint.’” (quoting Quiller v. Barclays Am./Credit, Inc., 727 F.2d
1067, 1069 (11th Cir. 1984))).
Here, Defendants do not argue that the allegations in the Complaint
conclusively show the promissory notes are exempt from registration. They argue,
instead, that the SEC does not allege sufficient facts to show that the promissory
notes are not exempt from registration. (See [21.1] at 12-14 (“The SEC also does
not specify when Investor A invested with Credit Nation . . . . Without more
35
specific information, the . . . Defendants are unable to answer the SEC’s
allegations”; “the SEC fails to allege who met with Investor A and secured his
investment . . . third-party verification is not the only way to satisfy the
requirement in Rule 506(c) . . .”; “A sizeable minimum investment may also
indicate accredited status depending on other information available to a promoter.”
(emphasis added))). The SEC, however, does not have the burden to prove that the
promissory notes are not exempt from registration. It is Defendants’ burden to
show the promissory notes are, in fact, exempt. Big Apple, 783 F.3d at 807.
Defendants fail to identify any Complaint allegations clearly showing the
promissory notes are exempt from registration. Defendants’ Motion to Dismiss the
SEC’s Section 5 claims is denied. See Twin City, 609 F. App’x at 976.
3.
Violation of the Anti-Fraud Provisions
Defendants next move to dismiss the SEC’s claims that Defendants violated
Sections 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act, Section 10(b) of the
Exchange Act, and SEC Rule 10b-5 (collectively, the “Anti-Fraud Provisions”).
To establish a violation of Section 10(b) and Rule 10b-5, the SEC must prove by a
preponderance of the evidence that Defendants made “(1) material
misrepresentations or materially misleading omissions, (2) in connection with the
purchase or sale of securities,” and that they “(3) made [them] with scienter.”
36
SEC v. Merchant Capital, LLC, 483 F.3d 747, 766 & n.17 (11th Cir. 2007) (citing
Aaron v. SEC, 446 U.S. 680, 695 (1980); SEC v. Zandford, 535 U.S. 813, 816 n.1
(2002)).
A complaint alleging claims under Section 10(b) and Rule 10b-5 must
satisfy the heightened pleading requirements established under Rule 9(b) of the
Federal Rules of Civil Procedure. SEC v. Strebinger, 114 F. Supp. 3d 1321, 1329
(N.D. Ga. 2015) (citing Kammona v. Onteco Corp., 587 F. App’x 575, 581 (11th
Cir. 2014)). To do so, a plaintiff “must state with particularity the circumstances
constituting fraud or mistake.” Fed. R. Civ. P. 9(b).
Proof of a violation of Section 17(a)(1) through (3) requires “[e]ssentially
the same elements” in connection with the offer or sale of a security, except that
proof of scienter is not required for the SEC to seek an injunction under Section
17(a)(2) or (3). SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999)
(citing SEC v. First Jersey Secs., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996));
see also Merchant Capital, 483 F.3d at 766 (citing Aaron v. SEC, 446 U.S. 680,
697, 702 (1980)).18
18
All of these violations also require proof of an interstate commerce or mails
element. See 15 U.S.C. § 78j(b); 15 U.S.C. § 77q(a). The Complaint alleges,
(Compl. ¶ 15), and Defendants admit, ([48.1] at 4-5), that CN Capital and CN
Acceptance used instrumentalities of interstate commerce in connection with the
37
The SEC alleges that Defendants19 misled investors about the safety and
profitability of Credit Nation. (See, e.g., Compl. ¶¶ 1, 83). It also accuses
Mr. Torchia of misappropriating investor funds, using new investor money to
disguise the venture’s operating losses, extensively commingling funds among
entities under his control, and using the Defendant entities’ assets to prop one
another up. (See, e.g., id. ¶ 89).
The misleading statements or material omissions alleged in the Complaint
include:
The promissory notes were “100% asset backed” or “backed by
hard assets dollar for dollar.” (Id. ¶¶ 46, 48, 49).
CN Capital “expect[ed]” to generate interest income and long-term
capital gains from its investments in automobile loans and Life
Settlements in excess of the interest payable on the notes. (Id.
¶ 43).
CN Capital “ancitipat[ed]” that less than one month’s collection of
automobile loan payments was sufficient to meet one year of
premiums on Life Settlements Credit Nation held. (Id. ¶ 45).
offer and sale of promissory notes and LS Interests. The Court determines the
Complaint sufficiently alleges the interstate commerce element.
19
The SEC alleges the “Offering Defendants” made misrepresentations and
omissions. The Offering Defendants are Mr. Torchia, CN Capital, and CN
Acceptance. For the sake of simplicity, the Court refers to the Offering Defendants
simply as “Defendants” or “Credit Nation.”
38
CN Capital “expect[ed]” that its Life Settlements would generally
yield about 15% per annum. (Id. ¶ 44).
Credit Nation’s investments are fully secured by assets, and Credit
Nation is profitable. (Id. ¶¶ 71-73, 76, 83).
Credit Nation failed to disclose its “multi-million dollar per year
operating losses” and “massive insolvency.” (Id. ¶¶ 3, 77-81).
Neither CN Capital nor the promissory notes it offers are disclosed
to those who purchase LS Interests through CN Acceptance. (Id.
¶ 56).
Credit Nation failed to disclose its obligation to repay startup loans
from Torchia and related entities. (Id. ¶ 112).
Defendants argue that the SEC’s claims fail to identify when, where, and to whom
the alleged misstatements or omissions were made, and thus fail to meet the
heightened pleading requirements of Rule 9(b). ([21.1] at 17).
The Eleventh Circuit has stated:
Rule 9(b) is satisfied if the complaint sets forth (1) precisely what
statements were made in what documents or oral representations or
what omissions were made, and (2) the time and place of each such
statement and the person responsible for making (or, in the case of
omissions, not making) same, and (3) the content of such statements
and the manner in which they misled the plaintiff, and (4) what the
defendants obtained as a consequence of the fraud.
Dixon v. Allergan USA, Inc., ––– F. App’x –––, –––, 2016 WL 946553, at *2
(11th Cir. Mar. 14, 2015) (quoting Tello v. Dean Witter Reynolds, Inc., 494 F.3d
956, 972 (11th Cir. 2007)).
39
Defendants’ suggestion that the SEC failed to identify when, where, and to
whom the alleged misstatements or omissions were made is, at least, disingenuous.
In addition to the allegations listed above, the Complaint also alleges a variety of
fact-specific allegations of fraud:
CN Capital’s “2013 offering memorandum, which was used from September
2013 through November 2014,” (Compl. ¶ 40), “expects the pool of Life
Settlements will generally yield about 15% per annum,” (id. ¶ 44).
“The November 2014 Offering Memorandum, which is still in use, contains
similar statements[.]” (Id. ¶ 41).
“Credit Nation’s newspaper advertisements, which have appeared in
Georgia, South Carolina, Texas and California, generally state, among other
things, that the investment: (i) generates a 9% fixed return with interest paid
quarterly; (ii) is 100% asset backed . . . .” (Id. ¶ 46).
Radio advertisements have been broadcast in Texas, Georgia, and South
Carolina, (id. ¶ 47), the specific text of which advertised a 9% return on
investment and that assets are backed dollar for dollar, (id. ¶¶ 48-49).
A 78 year old retiree and resident of South Carolina (“Investor A”) invested
$50,000 in promissory notes and $50,000 in LS Interests after seeing a
Credit Nation advertisement in his local newspaper in late 2013. (Id.
¶¶ 66-67).
In early September 2015, Credit Nation produced to the SEC non-GAAP
financial reports which “confirm that the representations made by the
company regarding the safety of the investments and the profitability of its
investment strategy are false.” (Id. ¶¶ 74-76). The report showed the notes
are not “100% asset backed” or “backed by hard assets dollar for dollar”
because “the company’s liabilities dwarf its assets and the company has
sustained multi-million dollar per year operating losses.” (Id. ¶ 77).
40
These allegations are merely a subset of the detailed allegations in the
Complaint.20 The Court finds that the SEC’s factual allegations, with respect to its
fraud claims under Section 10(b) and Rule 10b-5, satisfy the particularity pleading
requirements of Rule 9(b).
Defendants next argue that, in alleging that Defendants’ representations and
omissions were misleading, “the SEC misconstrues the financial information
[Defendants] provided in connection with the SEC’s two-year investigation.”
([21.1] at 17). They contend that the SEC inappropriately relies on a cost basis
analysis of Credit Nation’s finances to allege that Credit Nation’s liabilities exceed
its assets, that Credit nation does not use cost basis to value its Life Settlements,
that the SEC ignores GAAP accounting principles, and that the SEC ignores key
disclosures in the offering memoranda. (Id. at 17-19).
On a motion to dismiss pursuant to Rule 12(b)(6), the Court must “assume
that the factual allegations in the complaint are true and give the plaintiff[] the
benefit of reasonable factual inferences.” Wooten, 626 F.3d at 1196. The
Complaint plausibly alleges that Credit Nation’s assets are substantially
outweighed by its liabilities, (see, e.g., Compl. ¶¶ 3, 76-83), and the Court must
20
The SEC points out that the offering memoranda and LS Interest sales
packets were produced by Credit Nation to the SEC and given to each investor, and
Credit Nation thus had ample “fair notice” of the SEC’s claims. ([25] at 21).
41
assume these allegations are true.21 Defendants also urge the Court to consider
their argument that the Financial Packets referenced in the Complaint do not show
that Credit Nation is insolvent. That the Court conducted a TRO hearing and a
two-day preliminary injunction hearing addressing, in large part, whether the
Financial Packets show Credit Nation is insolvent undermines Defendants’
litigation position that the Complaint and Financial Packets, on their face, do not
show that Credit Nation is insolvent. Defendants’ arguments that the Complaint
relies on “misconstrue[d]” evidence are appropriate arguments in opposition to the
SEC’s Preliminary Injunction Motion, and their arguments are addressed below in
the Court’s consideration of that motion. These arguments are not, however, a
21
In their Motion to Dismiss, Defendants point to disclosures in their offering
memoranda warning investors of the possibility of Credit Nation operating at a loss
and its liabilities exceeding its assets. ([21.1] at 19). Taking as true the
Complaint’s allegations that the offering memoranda were distributed while Credit
Nation actually operated at a loss and while its liabilities exceeded its assets, the
offering documents’ generic cautionary language was affirmatively deceptive,
because the language implied that the risks cautioned against had not occurred,
when they had. See Merchant Capital, 483 F.3d at 769 (“[T]o warn that the
untoward may occur when the event is contingent is prudent, to caution that it is
only possible for the unfavorable events to happen when they have already
occurred is deceit.”).
42
basis for the Court to dismiss the SEC’s claims.22 Defendants’ Motion to Dismiss
is denied.
III.
THE SEC’S PRELIMINARY INJUNCTION MOTION
The Court now addresses the SEC’s motion for injunctive relief. In its
Preliminary Injunction Motion, the SEC seeks a preliminary injunction, a freeze of
Defendants’ assets, and the appointment of a receiver. The Court first addresses
whether the SEC has met its burden to support the preliminary injunction sought.
22
Defendants also argue that Mr. Torchia and Credit Nation did not
commingle funds or misappropriate investor money, and that Credit Nation is not a
Ponzi scheme. It is not clear which elements of a violation of Section 17, Section
10(b), or Rule 10b-5 Defendants seek to undermine with these arguments. The
SEC is not required to allege that Credit Nation meets some specific definition of a
Ponzi scheme for it adequately to allege securities violations. The allegations in
the Complaint regarding Mr. Torchia’s misappropriation of investor money
support the SEC’s fraud claims, and, as a result, the SEC alleges sufficient facts to
sustain claims of fraud under the Securities Act and the Exchange Act. The Court
finds that the SEC’s allegations that Mr. Torchia and Credit Nation
misappropriated investor money are sufficiently well-pled. A sample of the SEC’s
specific allegations of misappropriation includes: Mr. Torchia gave undocumented
“loans” to Credit Nation, for which transfers to himself and his other business are
purportedly repayment; these purported loans were not disclosed to investors;
Spaghetti Junction and CN Capital transferred hundreds of thousands of dollars to
Sixes Tavern; and Mr. Torchia transferred $195,842 of CN Capital funds to
Willie’s West, LLC, which used the funds to purchase a residential home in
Canton, Georgia in which Mr. Torchia lives. (Compl. ¶¶ 100, 104, 110, 112).
43
A.
Preliminary Injunction
The Securities Act provides:
Whenever it shall appear to the Commission that any person is
engaged or about to engage in any acts or practices that constitute or
will constitute a violation of the provisions of this subchapter, or of
any rule or regulation prescribed under authority thereof, the
Commission may, in its discretion, bring an action in any district court
of the United States, . . . to enjoin such acts or practices, and upon a
proper showing, a permanent or temporary injunction or restraining
order shall be granted without bond . . . .
15 U.S.C. § 77t(b). The Exchange Act contains a similar provision authorizing
injunctive relief. See 15 U.S.C. § 78u(d)(1).
In this Circuit, the “SEC is entitled to a preliminary injunction when it
establishes . . . (1) a prima facie case of previous violations of federal securities
laws, and (2) a reasonable likelihood that the wrong will be repeated.” Unique Fin.
Concepts, 196 F.3d at 1199 n.2; see also Calvo, 378 F.3d at 1216 (applying same
standard on review of a permanent injunction). In determining the probability that
a party will again engage in violations of the securities laws, a court should
consider the “egregiousness of the defendant’s actions, the isolated or recurrent
nature of the infraction, the degree of scienter involved, the sincerity of the
defendant’s assurances against future violations, the defendant’s recognition of the
wrongful nature of the conduct, and the likelihood that the defendant’s occupation
44
will present opportunities for future violations.” Id. (quoting SEC v. Carriba,
681 F.2d 1318, 1322 (11th Cir. 1982)).
In considering the SEC’s Preliminary Injunction Motion, the Court
understands that the federal securities laws are to be interpreted broadly and
liberally to effectuate Congress’s intent to protect investors and to reach the
various schemes devised by those persons who would use the money of others on
the promise of profits. See Carriba, 681 F.2d at 1324.
In this case, Defendants admit that the promissory notes sold by CN Capital
are securities, ([48.1] at 3), and the Court has found that the LS Interests also are
securities. The evidence in the record and the testimony and evidence presented
during the preliminary injunction hearing further support the Court’s conclusion
that the LS interests are securities.23 The Court next considers whether the SEC
established a prima facie case that Defendants violated the securities laws.
23
For instance, the record shows that CN Acceptance performed services for
investors such as monitoring the insured’s status, obtaining annual statements from
insurance companies, and applying for death benefits. ([2.15] at CN-SEC-000569,
-576). Mr. Torchia testified that Credit Nation hired doctors to analyze life
expectancy. (Tr. at 214:8-14).
45
1.
Prima Facie Case of Securities Violations
The SEC alleges that Defendants violated Sections 5(a) and 5(c) of the
Securities Act and the Anti-Fraud Provisions of the Securities Act and the
Exchange Act.
a)
Section 5 of the Securities Act
“In order to establish a prima facie case for a violation of § 5 of the
Securities Act, the SEC must demonstrate that (1) the defendant directly or
indirectly sold or offered to sell securities; (2) through the use of interstate
transportation or communication and the mails; (3) when no registration statement
was in effect.” Big Apple, 783 F.3d at 806-807. “Once participation in an
unregistered sale has been shown, the [sellers] have the burden of proving an
exemption to the registration requirements.” Id. at 807.
Defendants admit that (1) the promissory notes sold by CN Capital are
securities; (2) they were sold using the instrumentalities of interstate commerce;
and (3) no registration statement was in effect with the SEC as to those promissory
notes. ([48.1] at 3-4). It is thus Defendants’ burden to prove an exemption to the
registration requirements.
Defendants argue that the SEC “fails to show that Credit Nation did not take
reasonable steps to verify investors’ accredited statuses.” ([26] at 5). Defendants
46
also reiterate the argument they made in support of their Motion to Dismiss that
“an investor’s ability to satisfy a sizeable minimum investment can be an
indication of accredited status.” (Id. (emphasis added)). While interesting
observations, they ignore that the burden is on Defendants to prove an exemption
to the registration requirements.24 They also side step Defendants’ failure to offer
any evidence, or argument, to support that their sales of promissory notes were
exempt from the registration requirements. That they have raised the possibility
that the promissory notes were exempt is not enough. There is an absence of
evidence to support even an inference that a registration exemption applies. There
is nothing in the record to show that Defendants made any effort to determine if
investors were accredited or otherwise have the financial acumen or resources to
evaluate and understand the value or risk of the investments Defendants were
touting as providing 9% annual returns. Because the SEC has demonstrated that
Defendants sold securities through the use of interstate communication when no
registration statement was in effect, and because Defendants have not met their
burden to prove an exemption to the registration requirements, the Court
24
Defendants’ citations to SEC regulations that might provide exemptions
from the registration requirements, (see [26] at 5), is not enough to meet their
burden of proof. Defendants do not offer any evidence in support of their
argument that the regulations cited apply to the promissory notes.
47
necessarily finds that the SEC has established a prima facie case that Defendants
violated Section 5 of the Securities Act.25 See Big Apple, 783 F.3d at 806-807.
b)
The Anti-Fraud Provisions
The SEC also alleges that Defendants violated Sections 17(a)(1), 17(a)(2),
and 17(a)(3) of the Securities Act, Section 10(b) of the Exchange Act, and SEC
Rule 10b-5—known as the Anti-Fraud Provisions. To establish prima facie
violations of Section 17(a)(1), Section 10(b), and Rule 10b-5, the SEC must
demonstrate that Defendants made “(1) material misrepresentations or materially
misleading omissions, (2) in connection with the purchase or sale of securities,”
and that they “(3) made [them] with scienter.” See Merchant Capital, 483 F.3d at
766 & n.17. To establish that Defendants violated Sections 17(a)(2) and 17(a)(3),
“the SEC need only show (1) material misrepresentations or materially misleading
omissions, (2) in the offer or sale of securities, (3) made with negligence.”26 Id.
25
Based on the evidence presented, it is questionable whether Defendants will
be able to prove that an exemption applies.
26
All of these violations also require proof of an interstate commerce or mails
element. See 15 U.S.C. § 78j(b); 15 U.S.C. § 77q(a). Defendants admit, ([48.1] at
4-5), that CN Capital and CN Acceptance used instrumentalities of interstate
commerce in connection with the offer and sale of promissory notes and LS
Interests. The SEC thus has proved this element for purposes of its prima facie
case.
48
“[I]n SEC civil enforcement actions for preliminary injunctive relief under
the antifraud provisions of the federal securities laws . . . the proper standard of
proof is the preponderance of the evidence.” SEC v. First Fin. Grp. of Tex.,
645 F.2d 429, 434 (5th Cir. Unit A May 1981) (citations omitted).
Having determined that the promissory notes and LS Interests sold by
Defendants are securities, the Court determines that the second element of each test
is met. The Court now considers whether (1) Defendants made material
misrepresentations or materially misleading omissions (2) with scienter.
(1)
Material Misrepresentations or Omissions
“The test for materiality in the securities fraud context is ‘whether a
reasonable man would attach importance to the fact misrepresented or omitted in
determining his course of action.’” Merchant Capital, 483 F.3d at 765 (citing
Carriba, 681 F.2d at 1323). The SEC shows that Defendants advertised to
investors that promissory notes offered to them for sale would yield a “9% fixed
return APR” and were “100% asset backed” or “backed by hard assets.” (See, e.g.,
[2.9], [2.10]). Defendants admit that: (1) CN Capital has reported losses to the
IRS for each year since at least 2011; (2) CN Capital’s investments in sub-prime
automobile loans were not profitable in 2014 or in the first six months of 2015; and
(3) CN Capital told investors that “the expenses of operating the Company and
49
investment losses could exceed the Company’s income[,]” ([48.1] (emphasis
added)), but did not disclose that they already had.
At the hearing, Ms. Hartman, the forensic accountant hired by Defendants to
respond to the SEC’s investigation, testified at length regarding her analysis of
Credit Nation’s finances. Ms. Hartman was eminently qualified to perform the
forensic analysis about which she testified, and was well-qualified to explain the
opinions and conclusions she offered. Her testimony was articulate, supported by
uncontested facts, direct, and helpful. She was a compelling, credible witness.
Ms. Hartman testified that Credit Nation was operating at a loss in 2014 and
2015. (Tr. at 125:21-25). The company was not profitable. (Id. at 126:6). Based
on her analysis of Credit Nation’s profits and losses from 2014 to 2015, the losses
were accelerating. (Id. at 126:8-15). She testified that her analysis showed that
Credit Nation’s liabilities greatly exceeded its assets. (See id. at 79:13-21,
94:10-25, 98:1-22; Pl.’s Ex. 1 at 15).
Defendants admit they cannot identify any inaccuracies in Ms. Hartman’s
analysis of Credit Nation’s financial condition in 2014 and the first six months of
2015. ([48.1] at 5-6). They argue, however, that the SEC fails to show Defendants
made material misrepresentations or omissions because (1) the SEC incorrectly
values Credit Nation’s life insurance policies; (2) Ms. Hartman’s Financial
50
Snapshots are not GAAP compliant and thus understate its assets; and (3) Credit
Nation fully disclosed the possibility of operating losses to investors and explained
that its liabilities could exceed its assets. ([26] at 6-11).
Defendants argue that the SEC incorrectly values Defendants’ life insurance
policies. At the end of 2014, Defendants owned policies with a maturity value of
approximately $13 million. (Pl.’s Ex. 2 at 31). After December 31, 2014,
Defendants spent approximately $6 million to purchase new policies, (Pl.’s Ex. 1 at
1 (purchases of policies from third parties for $5,074,500 and purchase of a policy
from an affiliate for $1,196,549)), which have a maturity value of $75 million, (id.
at 13). Defendants thus claim that the total market value of their life settlements
“is at least $40 million,” (see, e.g., [19] at 4), which shows that Defendants are
solvent.
In support of this claim, Defendants rely solely on Mr. Torchia’s testimony
that he could sell Credit Nation’s settlement policies “in under three months for at
least [$]35 million.” (Tr. at 219:3-13). Mr. Torchia’s testimony was not credible.
The “opinions” he offered were not supported by facts and were based on broad,
speculative generalizations. His conclusory statements were not persuasive and the
Court believed many of them to be untrue. Mr. Torchia struggled to provide a
coherent explanation of his process to determine the purchase price for life
51
insurance policies, and his testimony was evasive. When confronted with
Mr. Freeman’s analysis of the total premiums Credit Nation was required to pay on
the Kahan policy and that the premiums exceeded the death benefits Credit Nation
expected, he testified, without any factual or logical support, that he “inherited
along with that [Kahan] portfolio . . . 14 million dollars’ worth of death benefits on
top of it for free on people that were older.” (Tr. at 251:24-252:2). Mr. Torchia
did not explain the source of the purportedly “free” $14 million in additional death
benefits, and the Court discredits the assertions as untrue. (Id. at 252:3-254:2).
Defendants do not identify, and the Court is unable to find, any support in the
record for Mr. Torchia’s far-fetched assertions. Confronted with a projected loss
on the Sneider policy, he claimed, equally unconvincingly, that “we inherited 24
million dollars in death benefits for free. Just pay the premiums.” 27 (Id. at
27
In their post-hearing reply brief [63], Defendants attempt to show that their
Sneider policy transactions were profitable. Defendants provide a declaration by
Ms. Hardie [63.1] which purports to show that, after taking into account the
purchase price, estimated premiums, sale revenue, maturity value, and maturity
owed to third parties, the net profit to Credit Nation is approximately $11.4
million. (See [63] at 2). Ms. Hardie did not offer testimony about the Sneider
transaction at the preliminary injunction hearing to explain Mr. Torchia’s
testimony about the “free” death benefits included in the transaction. In her
attempt to explain the transaction weeks later, and without being subject to
cross-examination, Ms. Hardie still does not provide specific information to
explain the “free” value about which Mr. Torchia testified and appears only to
52
258:24-259:3). The Court found wholly unpersuasive Mr. Torchia’s effort to prop
up Credit Nation’s finances.
The Court finds Defendants’ valuations of their life insurance policies are, at
best, unsubstantiated, and, at worst, deliberately misleading. Mr. Freeman, the
SEC’s life settlement valuation expert,28 testified that the ten policies that make up
the majority of the death benefits owned by Credit Nation have a total fair market
value between $1.5 million and $2.2 million. (Tr. at 164:12-22; Pl.’s Ex. 20).
Ms. Hartman’s analysis of Credit Nation’s own accounting records shows that the
total value, on a cost basis, of life settlements owned by Credit Nation was
approximately $9 million. ([2.5] at 15). These figures are credible both because
Mr. Freeman and Ms. Hartman provided detailed, thorough analyses, and because
the values are reasonably related to the price Credit Nation paid for the policies it
purchased in 2015—$6 million—and to the face value of the policies owned at the
end of 2014—$13 million.
Defendants, on the other hand, did not offer any evidence to support their
unsubstantiated claim that they could, today, sell for $40 million the policies they
provide information about the financial results they hope to achieve. Defendants
do not attempt at all to show that their Kahan policy transactions were profitable.
28
The Court found Mr. Freeman to be well-qualified to offer the testimony he
gave. His opinions were well-supported and reliable.
53
purchased a year ago for $6 million and policies they purchased previously—
policies that, in the aggregate, had only $13 million in maturity value at the end of
2014.29 According to Defendants, a company that has liabilities exceeding its
assets can purchase life insurance policies for a few million dollars that would,
practically overnight, inflate its assets by tens of millions of dollars because the
policies at some point would realize their face value when the insured died.
Extraordinary “wishing it were so” claims like these require evidence to support
them, which is not in the record here. Their theory appears to be that the moment
an insurance policy is purchased, its value is its face value minus the premiums it
expects to pay until the insured dies. Put another way, if a policy with a face value
of $1 million is purchased for $600,000, its value is $1 million minus estimated
premiums required to be paid to keep the policy in force. They reject that the value
is what they paid for the policy or what a willing purchaser would pay for the
policy in an arm’s length purchase.30 This valuation assumption is illogical and
29
Defendants’ policy face value valuation claim is illogical and inconsistent
with the evaluations performed by Ms. Hartman and Mr. Freeman. The value of an
asset is the fair market value, not what it may produce at some uncertain future
date after the continuous payment of premiums. Defendants’ valuation method
may be persuasive when advertised to investors. It is not persuasive to the Court.
30
Defendants do not appear to account for an insured living longer than the life
expectancy they estimate, the failure of the insurer, the company’s overhead, the
54
inconsistent with commercial reality.31, 32
Defendants also point to the following language in CN Capital’s offering
memoranda to support the claimed truthfulness of its representations to investors:
[T]he Company will determine the value of each Life Settlement
in its sole discretion, based on accepted industry standards . . . . For
purposes of valuing the Life Settlements, the Company may rely in
whole or in part upon, among other things, verbal or written
statements produced by generally accepted industry valuation
techniques, industry experts or unaffiliated third parties, and/or its
own estimates.
general uncertainty in the market, fraud in the application for the insurance policy,
or other factors. Mr. Torchia’s view is that it will all work out over time.
31
For these same reasons, the Court does not credit Defendants’ argument
that the “dramatic[]” increase in the maturity value of Credit Nation’s assets since
the end of 2014 is “an indication that [Credit Nation]’s financial picture is
continuing to improve and that [Credit Nation] is not ‘failing.’” ([61] at 5). If
Defendants’ valuation method was sound there would have been no need to
purchase additional policies to prop up the value of Defendants’ assets by simply
increasing the aggregate face value of policies held.
32
The Court notes that the total maturity value of the policies owned by Credit
Nation at the end of 2014 was approximately $13 million, and that Credit Nation’s
liabilities were approximately $30 million. That the maturity value and fair market
value of policies owned by Credit Nation may have increased in 2015 does not
bear on the securities sold during 2014. Even if, for every life insurance policy
owned by Credit Nation at the end of 2014, every insured had died on
January 1, 2015, Credit Nation would have received $13.3 million in death
benefits—not nearly enough to repay the $29 million it owed to investors, even if
Credit Nation’s other assets were included. (See Tr. at 80:11-17; Pl.’s Ex. 1; Pl.’s
Ex. 2). This evidence alone is sufficient to show that, in 2014, the offering
memoranda and advertisements contained material misstatements and omissions.
55
(2013 Offering Memorandum at 23; 2014 Offering Memorandum at 23 (emphasis
added)). Ms. Hartman, Defendants’ forensic accounting analyst, valued the Life
Settlements at their investment basis and determined that the policies are worth
approximately $9 million, which, together with Credit Nation’s $6 million in other
assets, is disturbingly short of the amount required to cover Credit Nation’s
approximately $42 million in liabilities. ([2.5] at 15).33 Defendants do not offer
any accepted industry standards they ever used to conduct valuations, and do not
offer any evidence of statements produced by generally accepted industry
valuation techniques, experts or other credible industry parties or methods upon
which they relied in valuing their life settlements. Defendants do not even offer
credible estimates they made, choosing to rely on Mr. Torchia’s back-of-thenapkin “valuation” decisions. There certainly is no evidence that Mr. Torchia’s
valuations were accepted within his industry. Simply stated, the only evidence
33
The Court also does not credit Defendants’ characterization of their business
as one that is “in the early years” and as one that is analogous to “a medical device
research and development company.” ([26] at 8). Defendants also argue that
“Credit Nation considers [losses] part of the[ir business] model.” ([61] at 5).
Credit Nation has been raising money since 2009, and Defendants do not appear to
contest that their investment strategy has never been profitable. Moreover,
Defendants did not disclose or market their investments as speculative—instead,
they told investors that their investments would be backed by hard assets dollar for
dollar.
56
offered by Defendants was Mr. Torchia’s unsubstantiated testimony that he could
sell the policies for at least $35 million.
To try to shore up their financial status, Defendants next argue that their own
forensic accountant’s analysis of Credit Nation’s finances is wrong. Defendants
contend that Ms. Hartman’s Financial Snapshots are “preliminary, subject to
revision, and based on a review of cash flow . . . .” ([26] at 9). They argue that the
Financial Snapshots are non-GAAP, which understates the value of Defendants’
assets. (Id. at 9-10).
Defendants ignore that Ms. Hartman’s analysis is not GAAP compliant
largely because Defendants’ records were kept by untrained, uncertified employees
and thus the records were not even capable of allowing a GAAP analysis. (See Tr.
at 13:19-22, 14:5-20). Defendants nevertheless argue—without factual or legal
support—that, under GAAP, premiums paid on the Credit Nation’s life settlements
would not be booked as an expense. Defendants also ignore Ms. Hartman’s
testimony that her non-GAAP accounting operated in Defendants’ favor, and not
its detriment. Ms. Hartman testified that a GAAP compliant balance sheet would
record “unearned revenue” for policies that Credit Nation sold to investors in the
past. (Id. at 67:4-23, 75:10-25, 95:14-25). Unearned revenue is a liability that
accounts for the fact that Credit Nation promised to pay premiums on behalf of
57
investors to whom it sold policies. (See id. at 67:6-23). The conclusion the Court
reaches here, considering all of the evidence available to it, including that
presented at the evidentiary hearing, is that Ms. Hartman’s analysis properly
presents sufficient evidence of Defendants’ finances based on Defendants’ own
bank statements and internal accounting records. Ms. Hartman’s Financial
Snapshots are a credible, accurate presentation of Defendants’ finances, and are
reliable.
Based on Ms. Hartman’s testimony and her Financial Snapshots,
Mr. Freeman’s testimony, and the entirety of the evidence in the record, the Court
finds that, during the period alleged by the SEC, Defendants’ liabilities exceeded
its assets by a material amount. Without disclosing these important financial facts,
Defendants made material misstatements when they told investors that the
promissory notes were “100% asset backed” and “backed by hard assets dollar for
dollar.” Defendants made material omissions when they failed to disclose their
losses and true financial circumstances to investors.
The Court also finds Credit Nation’s generic risk disclosures are insufficient
to make these misstatements and omissions immaterial. Defendants claim the
following language in their offering memoranda is sufficient to make its
disclosures not misleading:
58
Operating Deficits. The expenses of operating the Company and
investment losses could exceed the Company’s income, which could
result in the Company’s aggregate liability under the Notes
exceeding the value of its assets. If that occurs, the Company has the
right to repay Noteholders less than the principal amount of their
Notes.
(2013 Offering Memorandum [21.4] at 19 (ECF Pagination); 2014 Offering
Memorandum [21.5] at 19 (ECF Pagination) (emphasis added)).
Defendants necessarily admit that, when these disclosures were made,
CN Capital had reported losses to the IRS each year since at least 2011. (See
[48.1]). Ms. Hartman’s largely uncontroverted testimony further supports that
Credit Nation has been unprofitable for years and that its liabilities exceeded its
assets. Defendants’ generic disclosures that the company “could” experience
losses or that its liabilities may exceed its assets did not save Defendants’
misrepresentations, and they otherwise were affirmatively, materially misleading.
As the Eleventh Circuit stated in Merchant Capital, “[t]o warn that the untoward
may occur when the event is contingent is prudent, to caution that it is only
possible for the unfavorable events to happen when they have already occurred is
deceit.” 483 F.3d at 747. Here, the SEC presents ample evidence that the
unfavorable events—losses and liabilities that exceed assets—had already occurred
when Defendants made their disclosures, which made those disclosures materially
misleading. Further, these misstatements and omissions were material because “a
59
reasonable man would attach importance” to them. See id. at 765. Reasonable
investors, aware of the truth of the information represented to them and the status
of Defendants’ financial health withheld from them, would have been hesitant to
make the investment offered.
The SEC has met its burden to satisfy the first two elements required to
establish a prima facie case of a violation of the Anti-Fraud Provisions of the
securities laws. The Court now addresses the final element of scienter.34
(2)
Scienter
As the Eleventh Circuit explains:
Scienter may be established by a showing of knowing misconduct or
severe recklessness. Proof of recklessness requires a showing that the
defendant’s conduct was an extreme departure of the standards of
ordinary care, which presents a danger of misleading buyers or sellers
that is either known to the defendant or is so obvious that the actor
must have been aware of it.
SEC v. Monterosso, 756 F.3d 1326, 1335 (11th Cir. 2014) (alterations omitted)
(quoting Carriba, 681 F.2d at 1324). Scienter can be established through
circumstantial or direct evidence. Id. (citing SEC v. Ginsburg, 362 F.3d 1292,
1298 (11th Cir. 2004)).
34
To show that Defendants violated Sections 17(a)(2) and 17(a)(3), the SEC
need only show negligence, rather than scienter. Merchant Capital, 483 F.3d at
766.
60
The evidence here shows that Defendants were, at the very least, severely
reckless in offering the promissory notes for sale to investors. Defendants admit
CN Capital had reported losses to the IRS each year since at least 2011, ([48.1]),
but failed to inform investors of their poor financial health, choosing to instead
state that Credit Nation could incur losses rather than had actually incurred
significant losses by the time the representations were made to investors.
Mr. Torchia testified that Credit Nation reported losses in 2011, 2012, and 2013.
(Tr. at 271:2-8). He testified that Defendants “told [investors] we could run at a
loss. And I don’t think it’s my duty to tell [investors] that we are running at a
loss.” (Id. at 277:23-278:3 (emphasis added)). This evidence alone is sufficient to
support a finding of scienter.35 It certainly is evidence of Mr. Torchia’s and
Defendants’ belief they were not obligated to be truthful about their financial status.
Beyond operating losses, at the end of 2014, Credit Nation had
approximately $32 million in liabilities and assets consisting only of about $2.8
million in outstanding principal on auto loans, life settlements with a maturity
value of approximately $13.3 million, and about $1 million in cash. It is incredible
35
Ms. Hartman testified that the individuals responsible for accounting at
Credit Nation “were not trained accountants,” and that this was unusual for a
company the size of Credit Nation, (see Tr. at 13:19-22, 14:5-20), supporting that
Defendants’ practices at least deviated from the standards of ordinary care.
61
that a company faced with such a financial condition—even if the details were
unclear—was oblivious to it. The Court finds that Credit Nation’s financial
situation was “so obvious that [Mr. Torchia and Defendants] must have been aware
of it.” Monterosso, 756 F.3d at 1335. Indeed, the Court finds that Mr. Torchia
knew of Defendants’ precarious financial status, that it was trending worse, and
chose not to disclose it.
Credit Nation’s 2015 purchase of $6 million in life insurance policies further
supports that Mr. Torchia acted with scienter. Faced with an SEC investigation,
Credit Nation purchased $6 million in life insurance policies, and Mr. Torchia and
Defendants now claim—despite all evidence to the contrary—that the market value
of those policies is $35 to $40 million, rendering Credit Nation solvent. This sort
of arbitrary valuation sleight of hand, offered by a CEO whose testimony was not
credible, shows an “extreme departure from the standards of ordinary care” that
presented so obvious a danger of misleading buyers that Mr. Torchia “must have
been aware” of the risk. See SEC v. Imperiali, Inc., 594 F. App’x 957, 961 (11th
Cir. 2014) (quoting Ziemba v. Cascade Int’l, Inc., 256 F.3d 1194, 1202 (11th Cir.
2001)). Further, the circumstances surrounding Credit Nation’s purchase of the
policies, and their arbitrarily-inflated valuation of them, supports the reasonable
inference that Credit Nation purchased the policies to inflate artificially its assets
62
on its balance sheet. This inference further supports the Court’s determination that
Mr. Torchia acted with scienter.36 Because Mr. Torchia controls the other
Defendants, his scienter is imputed to them. SEC v. Manor Nursing Ctrs., Inc.,
458 F.2d 1082, 1089 n.3, 1096 n.16 (2d Cir. 1972).
The Court finds that the SEC has shown, by a preponderance of the
evidence, that Defendants violated the Anti-Fraud Provisions.
2.
Likelihood the Wrong Will Be Repeated
Having established their prima facie case of securities violations, the SEC
must establish a reasonable likelihood that the wrong will be repeated. Indicia that
a wrong will be repeated include: (1) the egregious nature of Defendants’ actions;
(2) the isolated or recurrent nature of the violations; (3) the degree of scienter
involved; (4) the sincerity of Defendants’ assurances; (5) Defendants’ recognition
of the wrongful nature of their conduct; and (6) the likelihood that Defendants’
present occupations will present opportunities for future violations. Salvo,
378 F.3d at 1216 (quoting Carriba, 681 F.2d at 1322).
36
Even if the Court had not found Defendants acted with scienter, the SEC met
its lesser burden to show, for purposes of Sections 17(a)(2) and 17(a)(3), that
Defendants acted with “negligence.” See Merchant Capital, 483 F.3d at 766.
Violations of Sections 17(a)(2) and 17(a)(3) also support the issuance of the
injunction the Court orders in this case.
63
Defendants argue that a preliminary injunction should not be issued,
including because they “already agreed to discontinue the sale of 9% promissory
notes pending resolution of the SEC’s” Preliminary Injunction Motion, they are
currently “revising [their] offering documents,” and they “asked [their] forensic
accountant to provide recommendations for improving [their] accounting
processes . . . .” ([26] at 15-16). This is too little, too late.
The Court finds the SEC has shown a reasonable likelihood of future
violations. Defendants’ conduct, in light of their financial situation, is egregious:
Defendants have repeatedly sold and solicited “100% asset backed” promissory
notes with a “9% fixed return” knowing—or at least recklessly disregarding—that
Credit Nation was unprofitable and that its financial situation was deteriorating.
Despite their assurances that they are revising their offering documents,
Defendants have not presented any assurances that they will not continue to violate
federal securities laws now or in the future. Defendants also have not recognized
the wrongful nature of their acts, maintaining that their finances and their business
model are sound. Defendants’ present occupations—selling Sub-Prime Auto
Loans and LS Interests—clearly present opportunities for future violations. Credit
Nation continues to seek to sell promissory notes and LS interests, claiming that its
financial management is responsible and its financial condition enviable, and that
64
the SEC simply misunderstands its business model. The core facts are, however,
that Credit Nation has operated at a loss for years, its liabilities substantially
exceed its assets, and its financial situation is deteriorating. Defendants’
continuing financial and management issues support a reasonable likelihood of
future securities violations. To the extent Mr. Torchia claims he is seeking to
reform his companies’ operations to comply with SEC requirements, the Court
does not believe him. Rather his “fight it to the death” approach to business and
court obligations, (Tr. at 273:9-10), supports that reform is not reasonable to
expect.
The SEC has established a prima facie case of previous violations of federal
securities laws, as well as a reasonable likelihood that the wrong will be repeated.
The SEC has thus satisfied both requirements for a preliminary injunction pending
the outcome of this litigation.37 See Unique Fin. Concepts, 196 F.3d at 1199 n.2.
Having determined that the SEC has met its burden to show that a preliminary
injunction is warranted, the Court addresses whether an asset freeze should be
imposed and a receiver appointed.
37
The Court notes, however, that additional discovery will be taken in this
matter and that neither party should infer from this preliminary decision that the
Court’s findings and rulings will be unaffected by a full trial on the merits of this
action. SEC v. Shiner, 268 F. Supp. 2d 1333, 1343 (S.D. Fla. 2003).
65
B.
Receiver
In First Fin. Grp., the former Fifth Circuit Court of Appeals, in a case that is
binding precedent here, set out the considerations for the appointment of a receiver
in SEC enforcement actions:
The appointment of a receiver is a well-established equitable
remedy available to the SEC in its civil enforcement proceedings for
injunctive relief. The district court’s exercise of its equity power in
this respect is particularly necessary in instances in which the
corporate defendant, through its management, has defrauded members
of the investing public; in such cases, it is likely that, in the absence of
the appointment of a receiver to maintain the status quo, the corporate
assets will be subject to diversion and waste to the detriment of those
who were induced to invest in the corporate scheme and for whose
benefit, in some measure, the SEC injunctive action was brought. As
the Seventh Circuit stated in Securities and Exchange Commission
v. Keller Corporation, 323 F.2d 397, 403 (7th Cir. 1963):
The prima facie showing of fraud and mismanagement,
absent insolvency, is enough to call into play the
equitable powers of the court. It is hardly conceivable
that the trial court should have permitted those who were
enjoined from fraudulent misconduct to continue in
control of (the corporate defendant’s) affairs for the
benefit of those shown to have been defrauded. In such
cases the appointment of a trustee-receiver becomes a
necessary implementation of injunctive relief.
Thus, the appointment of a temporary receiver is often a
necessary ancillary form of relief in a SEC civil enforcement action
for injunctive relief. And it was for this purpose to insure complete
enforcement of the federal securities laws that the appointment of a
temporary receiver was requested by the SEC and granted by the
district court in the instant case.
66
645 F.2d at 438 (citations omitted).38
The Court determines that the evidence presented to it proves that Credit
Nation’s management, and financial position, are not sound. The Court is
unconvinced Credit Nation will act responsibly between now and trial. The
evidence also shows that Credit Nation reported losses every year since at least
2011, and that, based on Ms. Hartman’s analysis of Credit Nation’s profits and
losses from 2014 to 2015, its losses are accelerating, (Tr. at 126:8-15; see also Pl.’s
Ex. 1; Pl.’s Ex. 2). Under these circumstances, “the appointment of a []receiver
[is] a necessary implementation of injunctive relief.” First Fin. Grp., 645 F.2d at
438 (citing Keller Corp., 323 F.2d at 403).39
That Mr. Torchia and Credit Nation’s employees appear to be, at the very
38
District courts have recently applied the standard articulated in First Fin.
Grp. See, e.g., SEC v. Evolution Capital Advisors, LLC, 866 F. Supp. 2d 661, 668
(S.D. Tex. 2011) (“[U]pon a showing of fraud and mismanagement, appointment
of a receiver becomes a necessary implementation of injunctive relief” (internal
quotation marks omitted)); SEC v. AmeriFirst Funding, Inc., Civil Action No.
3:07-cv-1188-D, 2007 WL 2192632, at *3 (N.D. Tex. July 31, 2007).
39
Defendants argue that, in deciding whether a receiver should be appointed,
the Court should consider the availability of less severe equitable remedies and the
probability that a receiver may do more harm than good. ([26] at 14-15).
Defendants do not provide any authority that, in the context of an SEC civil
enforcement action, the Court should take these factors into consideration. The
Court finds that, in any event, given Defendants’ deteriorating financial situation, a
receiver is required, less severe equitable remedies would not suffice, and a
receiver would not do more harm than good.
67
least, severely reckless in their handling of their finances and the running of their
business, further supports that a receiver is required. Mr. Torchia testified that he
and his company are “the best in the world” at buying and selling insurance
policies, but he showed little grasp of the process by which a life insurance policy
is valued, or was unwilling to disclose it to the Court. His answers were evasive
and general. For instance, he stated he buys certain policies “[b]ecause we feel
that the life expectancies in certain areas are off,” and that he is “looking for
homeruns and . . . for potential.” (Tr. at 214:3-20). He stated that he is “just not a
very good accountant. We have outside CPAs that were brought in to set up the
systems that were in place . . . . Accounting is not my strong suit.” (Id.
223:25-224:6). Yet Ms. Hartman testified that the individuals responsible for
accounting at Credit Nation “were not trained accountants,” and that this was
unusual for a company the size of Credit Nation. (See id. at 13:19-22, 14:5-20).
Ms. Green, Mr. Torchia’s own financial manager, could not explain the purpose of
Mr. Torchia’s nearly $3 million in loans to CN Auto from 2007 to 2013. (Id. at
315:18-316:20). The testimony presented at the preliminary injunction hearing and
the evidence in the record shows numerous undocumented, unverified, or
unexplained transactions between Mr. Torchia and other entities, supporting that
Mr. Torchia and his staff are unable or unwilling to manage their finances. (See,
68
e.g., id. at 40:14-16 (CN Auto paid the payroll of both CN Auto and AMC); id. at
54:9-15 (money flow between Credit Nation and RiverGreen tracked on
spreadsheet by Mr. Torchia’s employees); Pl.’s Ex. 2 at 39 (non-collectable loan to
CN Auto of $6.4 million at the end of 2014); Pl.’s Ex. 1 at 5-6 and Pl.’s Ex. 2 at
17-19 (Mr. Torchia directed the transfer of hundreds of thousands of dollars to CN
Auto, Spaghetti Junction, National Viatical, RiverGreen, Willie West, Jason’s
Automotive, and Sixes Tavern); Tr. at 328:2-20 (no documentation memorializing
loans from Mr. Torchia or Credit Nation to Spaghetti Junction); id. at 304:24-305:5
(no loan agreements in place memorializing Mr. Torchia’s loans to Credit Nation
and other entities)). These findings further support that a receiver is required in
this case.
C.
Asset Freeze
A district court may exercise its full range of equitable powers, including an
asset freeze, to preserve sufficient funds for the payment of a disgorgement award.
FTC v. U.S. Oil & Gas Corp., 748 F.2d 1431, 1433-34 (11th Cir. 1984); see also
Levi Strauss & Co. v. Sunrise Int’l Trading Co., 51 F.3d 982, 987 (11th Cir. 1995).
Freezing assets is a well accepted equitable remedy employed to “preserve the
status quo” and is proper in actions arising under the Securities Act. SEC v. ETS
Payphones, Inc., 408 F.3d 727, 734-35 (11th Cir. 2005) (citing United States
69
v. Oncology Assocs., 198 F.3d 489, 494-99 (4th Cir. 1999)); see also Levi Strauss,
51 F.3d at 987 (a request for equitable relief invokes the district court’s inherent
equitable powers to order preliminary relief, including an asset freeze).
In light of Credit Nation’s precarious financial situation and inability or
unwillingness to manage its finances, the Court concludes an asset freeze is
justified and appropriate to preserve the status quo and to preserve sufficient funds
for the payment of any disgorgement award.40 The Court notes that there already
are in place certain restrictions on Defendants’ business and use of assets pursuant
to the November 20, 2015, and January 13, 2016, Consent Orders.
IV.
CONCLUSION
For the foregoing reasons,
IT IS HEREBY ORDERED that Defendants’ Motion to Dismiss [21] is
DENIED.
IT IS FURTHER ORDERED that the SEC’s TRO Motion [2] is DENIED
AS MOOT.
IT IS FURTHER ORDERED that the SEC’s Preliminary Injunction
Motion [20] is GRANTED. The specific terms of the injunction are as follows:
40
The SEC’s TRO Motion seeks the same relief as its Preliminary Injunction
Motion. Because the Court grants the SEC’s Preliminary Injunction Motion, it
denies as moot the SEC’s TRO Motion.
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PRELIMINARY INJUNCTION ORDER
I.
ENJOINING VIOLATIONS
IT IS HEREBY ORDERED that Defendants and their agents, servants,
employees, attorneys, and all persons in active concert or participation with them
are enjoined from violating, directly or indirectly:
A.
Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5(a),
(b) and (c) promulgated thereunder [17 C.F.R. § 240.10b-5(a), (b) and (c)],
by using any means or instrumentality of interstate commerce, or of the
mails, or of any facility of any national securities exchange, in connection
with the purchase or sale of any security:
1.
2.
B.
to employ any device, scheme, or artifice to defraud, to make
any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in
light of the circumstances under which they were made, not
misleading, or
to engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person,
by providing false or misleading information or omitting to
provide material information to actual or prospective investors
concerning the performance, return, existence, use or
disposition of investor funds.
Section 17(a)(1), (2) and (3) of the Securities Act [15 U.S.C. § 77q(a)(1), (2)
and (3)] in the offer or sale of any security by the use of any means or
instruments of transportation or communication in interstate commerce or by
71
use of the mails, directly or indirectly:
1.
2.
to obtain money or property by means of any untrue statement
of a material fact or any omission to state a material fact
necessary to make the statements made, in light of the
circumstances under which they were made, not misleading, or
3.
C.
to employ any device, scheme, or artifice to defraud;
to engage in any transaction, practice, or course of business
which operates or would operate as a fraud or deceit upon the
purchaser; by providing false or misleading information or
omitting to provide material information to actual or
prospective investors concerning the performance, return,
existence, use or disposition of investor funds.
Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. § 77e(a), (c)] in the
offer or sale of any security by the use of any means or instruments of
transportation or communication in interstate commerce or by use of the
mails, directly or indirectly to offer to sell securities, through the use or
medium of any advertisement, placement memoranda or otherwise, without
a registration statement having been filed with the SEC as to such securities.
D.
Defendants are specifically enjoined from making the representations and
omissions identified in this Order or representations and omissions regarding
rates of return and Defendants’ financial status in connection with the sale of
securities based on sub-prime auto loans, life insurance settlements, or the
sale of fractional interests in life settlement contracts.
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II.
PRESERVING RECORDS
IT IS FURTHER ORDERED that Defendants and their officers, directors,
agents, employees, servants, managers, general and limited partners, trustees,
employees, attorneys and accountants, any bank or financial institution holding any
assets of Defendants and all persons or entities in active concert or participation
with them, and each of them, are restrained and enjoined from destroying,
transferring or otherwise rendering illegible all books, records, papers, ledgers,
accounts, statements and other documents employed in any of such Defendants’
business, which reflect the business activities of Defendants, including those
described in the Complaint in this action.
III.
FREEZING OF ASSETS
IT IS FURTHER ORDERED that the assets of Defendants be, and hereby
are, frozen. The “Assets” are defined as any money, investment, property of any
kind, or any other thing of value, tangible or intangible, including those in which
one or more of Defendants has a beneficial interest that, in whole or in part, was
derived from, was acquired using, was used in connection with or otherwise related
to, or the result of, the conduct alleged in the Complaint in this action. The freeze
shall include, but not be limited to, those funds in any bank accounts, brokerage
accounts, mutual funds, hedge funds and any other accounts or property of any
73
Defendant. Defendants and their officers, directors, agents, employees, servants,
managers, general and limited partners, trustees, employees, attorneys and
accountants, and all persons in active concert or participation with them, except the
Receiver appointed by this Court, hereby are restrained from, directly and
indirectly, transferring, setting off, receiving, changing, selling, pledging,
encumbering, assigning, liquidating or otherwise disposing of or withdrawing the
Assets.
Any bank, brokerage firm, mutual or other fund, other financial firm and
institution, or any other person, partnership, corporation or other entity maintaining
or having custody or control of any of the Assets shall:
1.
freeze such Assets;
2.
within five (5) business days of receipt of such notice, file with
the Court and serve on counsel for the SEC and for Defendants,
a statement setting forth, with respect to such Assets, or account
in which Assets are maintained, the balance in the account or
the description of the Assets as of the close of business on the
date of the receipt of the notice; and
3.
promptly cooperate with the Receiver and the SEC to determine
whether and to what extent any accounts, funds or other assets
are actually assets or proceeds of assets of any of the
Defendants.
74
IV.
APPOINTMENT OF RECEIVER: GENERAL PROVISIONS
IT IS FURTHER ORDERED that a Receiver be appointed in this action to
marshal and preserve the Assets. Mr. Al B. Hill of Taylor English Duma LLP in
Atlanta, Georgia is determined by the Court to be uniquely qualified to serve as
Receiver, and he is appointed the Receiver in this matter.41 Mr. Hill has immediate
exclusive jurisdiction and possession of the Assets, and the property, real and
personal, including cash, securities, receivables and accounts, of Defendants.
If the Receiver seeks to resign his appointment as Receiver, the Receiver
shall first give written notice to counsel of record in this case, and the Court, of the
Receiver’s request to resign. The resignation must be approved by the Court under
any terms or conditions set by the Court.
This Court shall retain jurisdiction over any action filed against the Receiver
and any persons retained to assist the Receiver to perform the duties required by
the Receiver.
41
Mr. Hill advises that he intends to engage lawyers at his firm to assist him to
fulfill his duties as Receiver. He has represented the hourly rates for the levels of
the attorneys he expects to request to work on this engagement. The Court finds
the hourly rates for Mr. Hill and the attorneys he intends to engage to assist him are
reasonable in the Atlanta market for legal services. The Court will, at a later date,
approve the engagement of his firm to provide legal services to him in connection
with the Receivership.
75
V.
AUTHORITY OF THE RECEIVER
IT IS FURTHER ORDERED that the Receiver shall have all the powers,
authorities, rights and privileges as those that would be exercised by the officers,
directors, managers and general and limited partners of the Defendants under state
and federal law, by the Defendants’ governing charters, by-laws, articles or
agreements, in addition to all powers and authority of a receiver at equity, and
those powers conferred on a receiver under 28 U.S.C. §§ 754, 959 and 1692, and
Fed. R. Civ. P. 66.
The officers, directors, trustees, managers, general and limited partners,
employees, investment advisors, attorneys, accountants, and other employees or
agents of the Defendants (collectively, the “Managers”) may be dismissed by the
Receiver, in the Receiver’s discretion. The powers and authorities of officers,
general partners, directors, managers and agents of the Defendants are suspended
upon entry of this Order. The Managers shall not have any power or authority with
respect to the Defendants’ operations or assets, until such time as power or
authority may be expressly granted by the Receiver.
The Receiver shall assume and control the operation of Defendants. No
person other than the Receiver and those authorized by the Receiver to act on the
Receiver’s behalf shall possess any authority to act by or on behalf of any of the
76
Defendants while this injunction is in effect.
The Receiver shall have the following general powers and duties:
1.
to use reasonable efforts to determine the nature, location and
value of all Assets;
2.
to take custody, control and possession of all Assets and records
relating to them; to sue for and collect, recover, receive and
take into possession any Assets in the custody, possession or
control of third parties. All persons and entities having control,
custody or possession of any Assets or documents relating to
them are hereby directed to turn such property over to the
Receiver;
3.
to manage, control, operate and maintain the Assets;
4.
to use the Assets solely for the benefit of Defendants’
businesses that are the subject of the Complaint, making
payments and disbursements and incurring expenses as may be
necessary or advisable in the ordinary course of business in
discharging the duties of Receiver;
5.
to engage and employ persons who, in the Receiver’s
discretion, will assist in carrying out the Receiver’s duties and
responsibilities, including, but not limited to, accountants,
attorneys, securities traders, registered representatives, financial
or business advisers, liquidating agents, real estate agents,
forensic experts, brokers, traders or auctioneers;
6.
to take necessary and appropriate action to preserve the Assets
or to prevent the dissipation or concealment of Assets;
7.
to issue subpoenas for documents and testimony consistent with
the Federal Rules of Civil Procedure;
8.
to bring appropriate legal actions allowed in state, federal, or
foreign court as the Receiver deems necessary or appropriate to
77
discharge his duties as Receiver;
9.
to pursue and defend all suits, actions, claims and demands
which may now be pending or which may be brought by or
asserted against the Defendants arising out of their businesses;
and
10.
to take such other action as may be approved by this Court.
VI.
REPORTS REQUIRED
IT IS FURTHER ORDERED that, while this injunction is in effect, the
following written reports are required:
A.
Within fourteen (14) calendar days of the entry of this Order, Defendants
shall file with the Court and serve upon the Receiver and counsel for the
parties a sworn statement, listing: (a) the identity, location and estimated
value of all Assets; (b) all employees (and job titles thereof), other
personnel, attorneys, accountants and any other agents or contractors of
Defendants; and, (c) the names, addresses and amounts of claims of all
known creditors and investors of the Defendants.
B.
Within thirty (30) days of the entry of this Order, Defendants shall file with
the Court and serve upon the Receiver and counsel for the parties a sworn
statement and accounting, with complete documentation, covering the period
from January 1, 2012, to the present, and providing the following
information:
78
1.
2.
every account at every bank, brokerage or other financial
institution: (a) over which Defendants have signatory
authority; and (b) opened by, in the name of, or for the benefit
of, or used by, Defendants;
3.
all credit, bank, charge, debit or other deferred payment card
issued to or used by each Defendant and their officers,
directors, employees and other agents, including but not limited
to the issuing institution, the card or account number(s), all
persons or entities to which a card was issued and with
authority to use a card, the balance of each account and card as
of the most recent billing statement, and all statements for the
last twelve months;
4.
all Assets received by any of them from any person or entity,
including the value, location, and disposition of any assets so
received; and
5.
all funds received by Defendants, and each of them, in any way
related, directly or indirectly, to the conduct alleged in the
Complaint. The submission must clearly identify, among other
things, all investors, the securities they purchased, the date and
amount of their investments, and the current location of such
funds; and
6.
C.
all Assets, wherever located, held by or in the name of
Defendants, or in which any of them, directly or indirectly, has
or had any beneficial interest, or over which any of them
maintained or maintains or exercised or exercises control;
all expenditures and transfers exceeding $1,000 made by any of
them, including those made on their behalf by any person or
entity.
Within thirty (30) calendar days of the entry of this Order, Defendants shall
provide to the Receiver and counsel for the parties copies of Defendants’
79
federal income tax returns for 2012 through the present with all relevant and
necessary underlying documentation.
D.
The Receiver is authorized, empowered and directed to develop a plan for
the fair, reasonable, and efficient recovery and management of all remaining,
recovered, and recoverable, Assets (the “Asset Plan”). Within ninety (90)
days of the entry date of this Order, the Receiver shall file the Asset Plan in
this action, with service copies to counsel of record.
E.
Within thirty (30) days after the end of each calendar quarter, the Receiver
shall file and serve a full report and accounting of the Assets (the “Quarterly
Status Report”), reflecting (to the best of the Receiver’s knowledge as of the
period covered by the report) the existence, value, and location of all Assets,
and of the extent of liabilities, both those claimed to exist by others and
those the Receiver believes to be legal obligations of Defendants. The
Quarterly Status Report shall contain the following:
1.
a summary of the operations of the Receiver;
2.
the amount of cash on hand, the amount and nature of accrued
administrative expenses, and the amount of unencumbered
funds in the estate;
3.
a schedule of all the Receiver’s receipts and disbursements
(attached as Exhibit A to the Quarterly Status Report), with one
column for the quarterly period covered and a second column
for the period from the inception of the receivership;
80
4.
5.
a description of liquidated and unliquidated claims of
Defendants, including the need for forensic and/or investigatory
resources; approximate valuations of claims; and anticipated or
proposed methods of enforcing such claims (including
likelihood of success in: (i) reducing the claims to judgment;
and, (ii) collecting such judgments);
6.
a list of all known creditors and investors with their addresses
and the amounts of their claims;
7.
the status of creditor and investor claims proceedings, after such
proceedings have been commenced; and
8.
F.
a description of all known Assets, including approximate or
actual valuations, anticipated or proposed dispositions, and
reasons for retaining assets where no disposition is intended;
the Receiver’s recommendations for continuation or
discontinuation of the receivership, and the reasons for the
recommendations.
Within ten (10) days after the entry of this Order, Defendants shall file with
the Court and serve upon the Receiver and counsel for the parties a list of
each proceeding of any kind, including, but not limited to, administrative,
civil, or criminal, in which one or more of the Defendants or their officers,
directors, employees or agents is a party. The list shall provide a detailed
summary of each proceeding.
81
VII. DEFENDANTS’ REQUIREMENTS
IT IS FURTHER ORDERED that, in addition to the other requirements set
out in this Order:
A.
Defendants and the past and present officers, directors, agents, managers,
general and limited partners, trustees, attorneys, accountants and employees
of the entity Defendants, as well as those acting in their place, are hereby
ordered and directed to:
1.
2.
assist the Receiver in fulfilling the Receiver’s duties and obligations.
They must respond promptly and truthfully to all requests for
information and documents from the Receiver; and
3.
B.
preserve and deliver to the Receiver, within ten (10) calendar days of
the entry of this Order, all paper and electronic information relating to
Defendants and all Assets; such information shall include but not be
limited to books, records, documents, accounts and all other
instruments and papers;
answer, including under oath if required by the Receiver, all
questions which the Receiver may ask and produce all documents
required by the Receiver regarding the business of Defendants, or any
other matter relevant to the operation or administration of the
receivership or the collection of funds due to Defendants. The
questions may be asked in writing or by any means allowed by the
Federal Rules of Civil Procedure.
Any persons acting for or on behalf of Defendants, and any persons
receiving notice of this Order by personal service, facsimile transmission or
otherwise, having possession of the property, business, books, records,
82
accounts or assets of the Defendants are hereby directed to promptly contact
the Receiver to discuss delivery of such records to the Receiver.
VIII. FINANCIAL INSTITUTION REQUIREMENTS
IT IS FURTHER ORDERED that all banks, brokerage firms, financial
institutions, and other persons, corporations, partnerships or entities which have
possession, custody or control of any Assets in the name or for the benefit, directly
or indirectly, of Defendants that receive actual notice of this Order by personal
service, or any other means shall:
1.
not liquidate, transfer, sell, convey or otherwise transfer any
assets, securities, funds, or accounts in the name of or for the
benefit of Defendants except upon instructions from the
Receiver;
2.
not exercise without the permission of the Court, any form of
set-off, alleged set-off, lien, or any form of self-help
whatsoever, or refuse to transfer any funds or assets to the
Receiver’s control;
3.
within seven (7) calendar days of receipt of that notice, file with
the Court and serve on the Receiver and counsel for the parties
a statement setting forth, with respect to each such account or
other asset not identified pursuant to Section III above, the
balance in the account or description of the assets as of the
close of business on the date of receipt of the notice; and
4.
cooperate immediately to provide information and to transfer
funds, assets and accounts to the Receiver or at the direction of
the Receiver.
83
IX.
INTERFERING WITH RECEIVER
IT IS FURTHER ORDERED that Defendants and all persons receiving
notice of this Order by personal service, or any other means, are hereby restrained
and enjoined from directly or indirectly taking any action, or causing any action to
be taken, without the express written agreement of the Receiver, which would:
1.
interfere with the Receiver’s actions to take control, possession,
or management of any Assets; such prohibited actions include
but are not limited to, using self-help or executing or issuing or
causing the execution or issuance of any court attachment,
subpoena, replevin, execution, or other process for the purpose
of impounding or taking possession of or interfering with or
creating or enforcing a lien upon any Assets;
2.
hinder, obstruct or otherwise interfere with the Receiver in the
performance of his duties; such prohibited actions include, but
are not limited to, concealing, destroying or altering records or
information;
3.
dissipate or otherwise diminish the value of any Assets; such
prohibited actions include but are not limited to, releasing
claims or disposing, transferring, exchanging, assigning,
encumbering, or in any way conveying any Assets, enforcing
judgments, assessments or claims against any Assets or any
Defendant, attempting to modify, cancel, terminate, call,
extinguish, revoke or accelerate (the due date), of any lease,
loan, mortgage, indebtedness, security agreement or other
agreement executed by any Defendant or which otherwise
affects any Assets; or
4.
interfere with or harass the Receiver, or interfere in any manner
with the exclusive jurisdiction of this Court over the Assets.
The Receiver shall promptly notify the Court and counsel of record of any
84
failure or apparent failure of any person or entity to comply in any way with the
terms of this Order.
X.
RECEIVER COMPENSATION
IT IS FURTHER ORDERED that the Receiver is entitled to reasonable
compensation and expense reimbursement from the Assets. Compensation payable
to the Receiver shall be reasonable and appropriate as determined by the Court.
A.
The Receiver shall apply, on or before the first day of each month, to
the Court for compensation and expense reimbursement from the
Receivership Estates (the “Monthly Fee Applications”). Each
Monthly Fee Application shall:
1.
2.
B.
comply with the terms of compensation agreed to by the
Receiver; and,
contain representations that: (i) the fees and expenses
included therein were incurred in the best interests of
Defendants; and, (ii) with the exception of the agreement
entered into with the Court, the Receiver has not entered
into any agreement, written or oral, express or implied,
with any person or entity concerning the amount of
compensation paid or to be paid from the Receivership
Estate, or any sharing thereof.
Monthly Fee Applications will be interim. At the conclusion of the
Receiver’s duties, as determined by the Court, the Receiver will file a
final fee application (the “Final Fee Application”).
85
C.
Monthly Fee Applications may be subject to a holdback up to 20% of
the fees and expenses approved by the Court upon the submission of
each Monthly Fee Application. The amounts held back during the
course of the receivership will be considered for payment by the Court
as part of the Final Fee Application.
At the termination of the Receiver’s duties, as determined by the Court, the
Receiver shall submit a Final Accounting, in a format to be approved by the Court.
XI.
TERM OF THE PRELIMINARY INJUNCTION
The purpose of this Preliminary Injunction is to maintain the status quo
while the Court considers whether to enter a permanent injunction in this matter.
As a result, this Preliminary Injunction will be in effect at least until a judgment is
entered in this case.
Counsel for the parties shall immediately send a copy of this Order and
Injunction to each person that they know, or reasonably should know, has
possession, custody and control of any of the Assets, including, but not limited to
banks, brokerage firms, mutual or other funds, and other financial institutions and
firms.
86
XII. STATUS CONFERENCE
IT IS FURTHER ORDERED that the Court shall hold, on Wednesday,
May 11, 2016, at 10:00 am, a telephonic status conference with counsel for the
parties and the Receiver. Counsel and the Receiver are required, before the status
conference, to confer and submit to the Court their joint summary of any disputes
or potential disputes regarding the scope or application of this Order, or any
practical issues or considerations regarding the enforcement and execution of this
Order.
SO ORDERED this 25th day of April, 2016.
_______________________________
WILLIAM S. DUFFEY, JR.
UNITED STATES DISTRICT JUDGE
87
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