Securities and Exchange Commission v. AIC, Inc. et al
Filing
159
MEMORANDUM, OPINION AND ORDER: SEC's Motion for Partial Summary Judgment 93 is GRANTED to the extent discussed herein. It is ORDERED that the SEC submit an appropriate form of judgment. This matter will proceed to trial on the SEC's remaining claims. Signed by Chief District Judge Thomas A Varlan on 9/12/13. (ABF)
UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF TENNESSEE
AT KNOXVILLE
SECURITES AND EXCHANGE COMMISSION, )
)
Plaintiff,
)
)
v.
)
)
AIC, INC., COMMUNITY BANKERS
)
SECURITIES, LLC, and
)
NICHOLAS D. SKALTSOUNIS,
)
)
Defendants,
)
)
and
)
)
ALLIED BEACON PARTNERS, INC.,
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(f/k/a Waterford Investment Services, Inc.),
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ADVENT SECURITIES, INC., and ALLIED
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BEACON WEALTH MANAGEMENT, LLC
)
(f/k/a CBS Advisors, LLC),
)
)
Relief Defendants.
)
No.: 3:11-CV-176
(VARLAN/GUYTON)
MEMORANDUM OPINION & ORDER
This matter is before the Court on plaintiff Securities and Exchange Commission’s
(“SEC”) Motion for Partial Summary Judgment [Doc. 93], in which the SEC moves the
Court to grant summary judgment against defendants AIC, Inc. (“AIC”), Community
Bankers Securities, LLC (“CB Securities”), and Nicholas D. Skaltsounis (“Skaltsounis”)
(collectively, “AIC defendants”) on the AIC defendants’ estoppel, waiver, unclean hands,
and advice of counsel defenses to the SEC’s claims, and also moves the Court to grant
summary judgment against the AIC defendants for violating §§ 5(a) and 5(c) of the
Securities Act of 1933, 15 U.S.C. §§ 77e(a) & (c). In addition, the SEC seeks summary
judgment against the relief defendants in this matter, Allied Beacon Partners, Inc.,
Advent Securities, Inc. (“Advent”), and Allied Beacon Wealth Management (“ABWM”)
(collectively, “relief defendants”), on its disgorgement claim, contingent upon a finding
of liability against the AIC defendants.
The AIC defendants and relief defendants
submitted a response [Doc. 98], to which the SEC submitted a reply [Doc. 101]. The
parties have also submitted various affidavits and exhibits in support of their respective
positions. Having considered the arguments of the parties, in light of the record in this
case and the prevailing case law, the SEC’s motion will be granted.
I.
Relevant Background
This dispute arises from the offering of promissory notes and stock in AIC, a
Virginia-based holding company for several registered broker-dealers (co-defendant CB
Securities and relief defendants Allied Beacon Partners, and Advent), and a stateregistered investment adviser (ABWM), by the AIC defendants from 2006 through 2009
[Doc. 65 ¶ 13]. CB Securities, a registered broker-dealer with the SEC until 2009,
employed independent brokers throughout the country, including an office located in
Maryville, Tennessee [Id. ¶ 14]. At all times relevant to this matter AIC owned an
eighty-eight percent interest in CB Securities [Id.]. Similarly, AIC owned a ninety
percent interest in ABWM (formerly known as CBS Advisors), Allied Beacon Partners
(formerly known as Waterford Investment Services, or “Waterford”), and Advent, all of
2
which were registered in Tennessee, among other states, to sell securities [Id. ¶¶ 18-20].1
Co-defendant Skaltsounis founded AIC in 2000, and during the period in question, served
as AIC’s president and CEO and held similar positions in CB Securities, Advent, and
CBS Advisors, in addition to serving as Chairman of the Board of Directors of Waterford
[Id. ¶ 15]. The SEC alleges that the AIC defendants orchestrated an offering fraud that
defrauded investors of millions of dollars in multiple states, with the proceeds distributed
amongst the AIC defendants and to the relief defendants.
As neither AIC nor its subsidiaries were profitable, AIC had a constant need for
capital in order to fund their operations, which AIC met by offering and issuing securities
in the form of promissory notes as well as common and preferred stock [Id. ¶¶ 23-25].
Through sales of both notes and stock, AIC raised over $7 million from at least seventyfour investors in fourteen states during the relevant time period [Doc. 65 ¶ 29]. The SEC
claims that in the process of offering and selling these securities, the AIC defendants
made material misrepresentations about AIC’s business and omitted disclosures
regarding the risks associated with investing [Doc. 94-1 at 5].2 As set forth in the SEC’s
brief in support of its motion for summary judgment, potential note holders would receive
the relevant promissory note, stockholders would receive a subscription agreement, and
occasionally, the AIC defendants would use other material to solicit investors, such as
1
The parties do not dispute that all four entities associated with AIC were operated as
subsidiaries of AIC.
2
These omissions include the fact that AIC had never been profitable, that AIC had no
revenue from business operations, and that AIC’s ability to pay returns to investors was
dependent upon attracting new investors [Doc. 94-1 at 5].
3
executive summaries, which also contained material misstatements and omissions [Id. at
6]. These investments were sold without a registration statement in effect as to AIC, as
required by the Securities Act of 1933. In order to maintain the fraud, the SEC claims,
the AIC defendants induced investors to reinvest or renew their AIC investments, making
further misstatements in the process. As a result, many of these investors did reinvest
their funds by rolling over their investments into new promissory notes. Of the funds
raised, $948,389 was distributed to Skaltsounis, approximately $2.8 million was
distributed to CB Securities, and approximately $1 million was distributed to the relief
defendants [Id. at 7]. In its First Amended Complaint, the SEC alleges that another $2.5
million of new investor funds were distributed back to investors, so that the fraud was
operated as a Ponzi scheme [Doc. 65 ¶ 32].
The SEC commenced this civil enforcement action in 2011, and in its First
Amended Complaint claims numerous violations of the federal securities laws, including:
(1) violations of § 5 of the Securities Act of 1933 for selling unregistered, non-exempt
securities without proper registration as to the AIC defendants; (2) violations of § 17 of
the Securities Act for offering and selling securities by fraudulent means as to the AIC
defendants; and (3) violations of § 10(b) of the Exchange Act of 1934, and Rule 10b-5
thereunder, for engaging in fraud in connection with the sale of AIC’s securities as to the
4
AIC defendants.3 The Commission seeks permanent injunctive relief against the AIC
defendants as well as disgorgement from both the AIC and relief defendants.
II.
Standard of Review
Summary judgment under Rule 56 of the Federal Rules of Civil Procedure is
proper “if the movant shows that there is no genuine dispute as to any material fact and
the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a). The
moving party bears the burden of establishing that no genuine issues of material fact
exist. Celotex Corp. v. Catrett, 477 U.S. 317, 330 n.2 (1986); Moore v. Phillip Morris
Cos., 8 F.3d 335, 339 (6th Cir. 1993). All facts and all inferences to be drawn therefrom
must be viewed in the light most favorable to the non-moving party. Matsushita Elec.
Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986); Burchett v. Kiefer, 301 F.3d
937, 942 (6th Cir. 2002). “Once the moving party presents evidence sufficient to support
a motion under Rule 56, the non-moving party is not entitled to a trial merely on the basis
of allegations.” Curtis Through Curtis v. Universal Match Corp., Inc., 778 F. Supp.
1421, 1423 (E.D. Tenn. 1991) (citing Catrett, 477 U.S. at 317). To establish a genuine
issue as to the existence of a particular element, the non-moving party must point to
evidence in the record upon which a reasonable finder of fact could find in its favor.
Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). The genuine issue must also
3
The SEC has settled all claims with defendants Graves and Guyette [Docs. 146, 156].
The SEC has also brought additional claims against AIC, CB Securities, and Skaltsounis for their
specific roles in the alleged scheme [Doc. 65 ¶¶ 107-119].
5
be material; that is, it must involve facts that might affect the outcome of the suit under
the governing law. Id.
The Court’s function at the point of summary judgment is limited to determining
whether sufficient evidence has been presented to make the issue of fact a proper
question for the factfinder. Anderson, 477 U.S. at 250. The Court does not weigh the
evidence or determine the truth of the matter. Id. at 249. Nor does the Court search the
record “to establish that it is bereft of a genuine issue of material fact.” Street v. J.C.
Bradford & Co., 886 F.2d 1472, 1479–80 (6th Cir. 1989). Thus, “the inquiry performed
is the threshold inquiry of determining whether there is a need for a trial—whether, in
other words, there are any genuine factual issues that properly can be resolved only by a
finder of fact because they may reasonably be resolved in favor of either party.”
Anderson, 477 U.S. at 250.
III.
Analysis
A.
The AIC Defendants’ Affirmative Defenses
In their amended answer [Doc. 84], the AIC defendants assert several affirmative
defenses to some or all of the SEC’s claims. First, the AIC defendants claim that the
SEC’s claims “are barred, in whole or part, by the doctrines of unclean hands, waiver,
and estoppel” [Id. at 5]. Second, the AIC defendants claim that they relied upon the
advice of counsel during the offer and sale of all AIC investment products. In support of
their motion for summary judgment, the SEC claims that, in light of the evidence of
6
record, the AIC defendants cannot create a genuine issue of material fact as to the
availability of any of the asserted defenses.
1.
Equitable Defenses of Estoppel, Waiver, and Unclean Hands4
The AIC defendants base their defenses of estoppel, waiver, and unclean hands on
the SEC’s conduct and statements made while examining the relevant companies at issue
prior to the investigation in this case, as well as conduct and statements made during the
course of the investigation which led to the filing of this action. The AIC defendants
contend that the SEC knew that AIC was raising capital through the issuance of debt and
equity, and that the SEC, along with the Financial Industry Regulatory Authority
(“FINRA”), and its predecessor, the National Association of Securities Dealers
(“NASD”), approved these transactions. In doing so, the AIC defendants argue, the SEC
waived its ability to file suit based upon any shortcomings in the transactions. The AIC
defendants submit that their estoppel defense is similarly based on the fact that during the
course of a 2006 audit of CB Securities, the SEC represented that “everything was fine,”
and did so again in 2009 during the investigation of AIC that led to the present action
[Doc. 98 at 10]. The AIC defendants also rely upon the fact that during this time period,
the SEC did not take any action with regards to various reports and audited financial
statements received from AIC and its subsidiaries. AIC believed that the SEC’s lack of
pointing out deficiencies and other lack of action constituted approval of AIC’s stock and
note offerings [Doc. 96-10 at 7-12].
4
Given the overlap of both the factual bases and legal analysis for these defenses, the
Court will address them together.
7
Waiver has generally been defined as the “the voluntary relinquishment by a party
of a known right.” Chattem, Inc. v. Provident Life & Accidental Ins. Co., 676 S.W.2d.
953, 955 (Tenn. 1984) (citation omitted). To constitute a waiver of a benefit there must
be clear, unequivocal, and decisive acts of the party showing an intention not to have the
benefit/right conferred. Jenkins Subway, Inc., v. Jones, 990 S.W.2d 713, 722 (Tenn. Ct.
App. 1999). Waiver may be proved by any number of ways, including the following:
express declarations; acts and declarations manifesting an intent not to claim the benefit;
a course of acts and conduct; or “by so neglecting and failing to act, as to induce a belief
that it was the party’s intention and purpose to waive.” Id. (quotation omitted). While
waiver represents an intentional relinquishment of a known right, estoppel involves a
misrepresentation relied upon by another to his detriment. Id. at 723. The elements of
estoppel include: (1) words or actions that amount to a false or misleading representation
by the party against whom estoppel is asserted; (2) reasonable reliance on the
misrepresentation by the party asserting estoppel; and (3) a detriment or “deleterious
change” to the party asserting estoppel. Id.; see, e.g. Osborne v. Mountain Life Ins. Co.,
130 S.W.3d 769, 774 (Tenn. 2004); see also Kosakow v. New Rochelle Raidology
Assocs., P.C., 274 F.3d 706, 725 (2d Cir. 2001) (noting that the doctrine of equitable
estoppel applies when “the enforcement of the rights of one party would work an
injustice upon the other party due to the latter’s justifiable reliance upon the former’s
words or conduct”). The doctrine of unclean hands similarly may be used “‘to deny
injunctive relief where the party applying for such relief is guilty of conduct involving
8
fraud, deceit, unconscionability, or bad faith related to the matter at issue to the detriment
of the other party.’” Performance Unltd., Inc. v. Questar Publishers, Inc., 52 F.3d 1373,
1383 (6th Cir. 1995) (quoting Novus Franchising, Inc. v. Taylor, 795 F. Supp. 122, 126
(M.D. Pa.1992)). The party claiming an equitable defense has the burden of proving it by
a preponderance of the evidence. Jenkins Subway, 990 S.W.3d at 722, 723.
In general “equitable defenses against government agencies are strictly limited.”
SEC v. Elecs. Warehouse, Inc., 689 F. Supp. 53, 73 (D. Conn. 1988). With respect to the
estoppel defense in particular, although the SEC must treat those subject to its regulation
fairly, “‘the government may not be estopped on the same terms as any other litigant.’”
SEC v. Blavin, 760 F.2d 706, 712 (6th Cir. 1985) (quoting Heckler v. Cmty. Health
Servs., 467 U.S. 51, 60 (1984)). This principle stems from “the interest of the citizenry as
a whole in obedience to the rule of law.” Heckler, 467 U.S. at 60. “The doctrine of
equitable estoppel is not available against the government except in the most serious of
circumstances, and is applied with the utmost caution and restraint.” Rojas-Reyes v. INS,
235 F.3d 115, 126 (2d Cir. 2000). In Graham v. SEC, 222 F.3d 994 (2d Cir. 2000),
where the SEC had initially reviewed a company’s activities before later conducting an
investigation which led to the filing of a complaint, the Second Circuit noted that “the
SEC’s failure to prosecute at an earlier stage does not estop the agency from proceeding
once it finally accumulated sufficient evidence to do so,” id. at 1008. See, e.g. Investors
Research Corp. v. SEC, 628 F.2d 168, 174 (D.C. Cir. 1980) (noting that, when specific
facts of improper activity were not revealed until later, the fact that the SEC was aware of
9
transactions was insufficient basis for estoppel defense). Courts have applied these same
principles with respect to the waiver defense. See SEC v. KPMG, No. 03 Civ. 671, 2003
WL 21976733, at *3 (S.D.N.Y. 2003) (noting that conversations between SEC and
defendant were “insufficient as a matter of law to reflect an intentional relinquishment by
the SEC of its right and duty under the law to file charges when it finds that charges are
appropriate under the laws passed by the Congress”). Similarly, courts addressing the
availability of the unclean hand defense have limited its application, finding that in order
for a party to rely upon the defense “the SEC’s misconduct must be egregious, the
misconduct must occur before the SEC files the enforcement action, and the misconduct
must result in prejudice to the defense of the enforcement action that rises to a
constitutional level and is established through a direct nexus between the misconduct and
the constitutional injury.” SEC v. Cuban, 798 F. Supp. 2d 783, 794 (N.D. Tex. 2011)
(citing cases).
The AIC defendants assert that the defenses of waiver and estoppel are available
in this case based upon the SEC’s 2006 audit of CB Securities, the SEC’s
investigation/examination of AIC in 2009 (which served as the genesis of the current
action), and various filings AIC and its subsidiaries made with the SEC and FINRA,
including Form D filings, FOCUS reports, and audited financial statements.5 Upon
5
The Court notes that to the extent the AIC defendants seek to rely upon their dealings
with FINRA or the NASD to act as a waiver or estoppel on the part of the SEC, such reliance is
meritless, as FINRA is a private, non-profit corporation which conducts its own investigatory
and disciplinary actions, and is independent from the SEC. See Graham, 222 F.3d at 1007 n.25
(noting the same in describing the NASD).
10
reviewing the material, and the relevant deposition testimony related to them, however,
the Court concludes that these cannot serve as the basis for a waiver or estoppel defense
in this case.
In June 2006, the SEC conducted a broker-dealer examination of CB Securities
and discovered several violations of the rules pertaining to the Exchange Act and rules of
the National Association of Securities Dealers (“NASD”), the predecessor to FINRA, as
noted in a letter from the SEC sent to Skaltsounis [Doc. 96-11]. The examination did not
involve CB Securities’ involvement in the sale of AIC stock and notes, and none of the
violations involve the sale of securities at issue in this case. One violation pertains to
continuing education for CB Securities’ representatives, while the other two addressed
various items used in calculating the firm’s net capital [Id. at 2]. The end of the report
includes several statements and disclaimers related to the investigation.
The first
indicates that the findings in the letter are “based on the staff’s examination, and are not
findings or conclusions of the Commission” [Id.]. The letter also warns to “not assume
that your firm’s activities not discussed in this letter are in full compliance with the
federal securities laws or other applicable obligations” [Id.]. Given the letter’s subject
matter, pertaining to the examination of an AIC subsidiary at the beginning of the
offerings in question, and the disclaimers contained therein, the Court concludes that
there is nothing from the 2006 examination indicating a voluntary relinquishment of the
SEC’s ability to bring suit for violations of various statutory provisions of the Securities
and Exchange Acts for the purposes of waiver. The AIC defendants have also not
11
presented any argument or evidence that this letter constitutes a misrepresentation
sufficient for estoppel, when the letter issued at the beginning of the relevant time period
does not reference the sale of securities or promissory notes in question and contains
express language that it is not a final decision does not pertain to activities not discussed
in the letter. Thus, the 2006 examination of CB Securities cannot serve as the basis for
the equitable defenses asserted by the AIC defendants.
In late 2009, the SEC visited AIC and conducted an investigation pertaining to the
offering of securities that culminated in the filing of the instant complaint. During the
visit, Skaltsounis testified that the analysts made several statements that the SEC “didn’t
find anything alarming or out of whack,” that AIC “was in good shape” [Doc. 96-10 at 8]
and similar comments.
AIC’s Executive Vice President at the time, Paula Collier,
similarly stated that the SEC’s analysts present claimed they “really [were] not finding
anything” [Doc. 96-12 at 4].
In addition, however, Collier testified that she never
received express approval of the securities offerings by the SEC, and that the analysts
informed her that they were not finished with their examination [Id.].
The facts of this case are analogous to the facts at issue in KPMG, a case involving
violations of the securities laws in connection with audits conducted by the defendant,
2003 WL 21976733 at *1. During the course of an SEC investigation, the SEC had
shown the defendant several documents pertaining to its client, the Xerox Corporation,
which prompted a meeting and several communications between the defendant and the
SEC. The SEC did not advise the defendant of any problems with Xerox’s accounting
12
methodology, and in response to an inquiry by the defendant of whether there were other
issues needed to be addressed, the SEC answered that the defendant had “hit them all.”
Id. When the defendant attempted to raise these conversations as a defense based on
waiver or estoppel, the court granted the SEC’s motion to strike, finding that the
statements did not indicate that the SEC would not bring a civil suit, or that the SEC was
waiving its right to bring such a suit. Id. at *3. The court noted that “the SEC must be
able to conduct reasonable investigations without the risk that oral communications such
as those alleged here will create a bar to the agency’s pursuit of claims.” Id. at *4.
The same reasoning applies in this case, in that the SEC’s informal statements
made during the course of investigation cannot serve to preclude an action when the SEC
later has sufficient evidence to file a complaint. Moreover, unlike the SEC’s statements
in KPMG, here the SEC did not affirm that AIC’s offerings were compliant, but merely
commented, during the course of their investigation, that they were not really finding
anything.
The AIC defendants also rely upon their filings, and the filings of the relief
defendants, as evidence that the SEC knew about the offerings in question and, by failing
to take action sooner, showed the agency’s approval of them. The Court disagrees. The
filings in question, such as the Form D filings for unregistered securities, as well as the
audited financial statements, were made by the AIC defendants themselves, and the
defendants have not presented any case law supporting their claim that the SEC’s
acceptance of documents indicating the occurrence of securities sales precludes the SEC
13
from filing an action when it subsequently learns that those sales violated the securities
laws. The AIC defendants have similarly not presented evidence that the SEC was made
aware of the facts underlying the present allegations and made a conscious decision not to
act. Thus, the Court concludes that the materials relied upon by the defendants do not
create a genuine issue of material fact as to the availability of the estoppel or waiver
defenses.
Although the AIC defendants do not address their unclean hands defense in
response to the SEC’s motion for summary judgment, in his deposition testimony,
Skaltsounis claims that the SEC engaged in numerous acts of misconduct, including
accusing AIC of running a Ponzi scheme, jumping to conclusions with regards to its
allegations, and bringing the present suit in Tennessee rather than Virginia, where AIC is
headquartered [Doc. 96-10 at 17-18]. Although the Court notes that the defendants have
not presented any evidence to substantiate these claims, more importantly, even taken as
true, defendants have not created a genuine issue of material fact that the SEC’s actions
leading up to the filing of this complaint were egregious, or resulted in prejudice rising to
a constitutional level.6 Accordingly, the Court finds that there is no genuine issue of
material fact as to the availability of the equitable defenses raised by defendants, and
summary judgment in favor of the SEC is appropriate.
6
With respect to the AIC defendants’ arguments concerning venue, the Court notes that
the AIC defendants have previously filed a motion based on improper venue, which was denied
in an Order by the magistrate judge in this case [Doc. 30].
14
2.
Advice of Counsel
The AIC defendants also assert their good faith reliance on the advice of counsel
as an affirmative defense, specifically related to the advice given by Tom Grant and the
law firm of Troutman Sanders. The SEC, in support of its motion, presented various
deposition testimony of office assistants, board members, Skaltsounis, and others, to
show that the defendants cannot point to any specific legal advice that was given in
relation to the disputed transactions. In response, the AIC defendants submitted an
interrogatory response in which they listed the scope of advice received by Grant and
Troutman Sanders and the manner in which Grant and Troutman Sanders advised AIC
with respect to various transactions. The AIC defendants also submitted a collection of
promissory notes and subscription agreements with issuance dates ranging from 2002
through 2006 bearing footnotes with the letters “TS,” which the AIC defendants claim
stands for Troutman Sanders [Doc. 98-6].
To establish good faith reliance on the advice of counsel, defendants must prove
that they “(1) made a complete disclosure to counsel; (2) requested counsel’s advice as to
the legality of the contemplated action; (3) received advice that it was legal; and (4)
relied in good faith on that advice.” SEC v. Goldfield Deep Mines Co., 758 F.2d 459, 467
(9th Cir. 1985) (citing SEC v. Savory Industries, Inc., 665 F.2d 1310, 1314 n.28 (D.C.
Cir. 1981)); see also United States v. Kindo, 52 F.3d 1373, 1383-84 (6th Cir. 1995) (“The
elements of a reliance on counsel defense are (1) full disclosure of all pertinent facts to
counsel, and (2) good faith reliance on counsel’s advice.”). While good faith reliance on
15
advice of counsel by a criminal defendant may rebut evidence of criminal intent, in the
context of a securities action, reliance on counsel “is not a complete defense, but only one
factor for consideration.” Markowski v. SEC, 34 F.3d 99, 105 (2d Cir. 1994). “Good
faith reliance on the advice of counsel means more than simply supplying counsel with
information.” SEC v. Enters. Solutions, Inc., 142 F. Supp.2d 561, 576 (S.D.N.Y. 2001).
“‘Compliance with federal securities laws cannot be avoided by simply retaining outside
counsel to prepare required documents.’” Id. (quoting Savoy, 665 F.2d at 1315 n.28).
The burden is on the defendant to establish each element of a reliance on counsel defense.
SEC v. CMKM Diamonds, Inc., No. 2:08-cv-437, 2011 WL 30447476, at *3 (D. Nev. Jul.
25, 2011).
The Court finds that the promissory notes and subscriptions bearing the Troutman
Sanders initials do not create a genuine issue of material fact as to the AIC defendants’
good faith reliance on the advice of Grant or Troutman Sanders. There is no indication,
from reviewing the documents in question, that an actual attorney, be it Grant or another
attorney at Troutman Sanders, drafted the particular note, or whether an attorney rendered
advice or otherwise approved the underlying transactions. There is no evidence that the
AIC defendants specifically requested an attorney’s advice prior to entering into a
specific transaction or that an attorney stated that a specific transaction was legal. The
SEC, in contrast, has presented evidence contesting the claim that attorneys prepared
each of the documents in question. Della Tabar, who served as Skaltsounis’s executive
assistant during the relevant time period, testified that once Grant sent “the initial draft,”
16
prior to the issuance of the securities in question, Tabar would prepare a promissory note
or subscription agreement for a particular investor at Skaltsounis’s direction, filling in the
requisite form which was stored on her computer [Doc. 96-17 at 19-20]. With specific
regard to the footnotes, Tabar testified that she would change the footnotes to reflect the
date, and then would save the document on her computer with the relevant investor’s
name in the filename [Doc. 104 at 4-5].
Ultimately, however, whether Troutman
Sanders’s attorneys prepared each form is immaterial to the issue of whether AIC made a
full disclosure of its activities to the law firm’s attorneys for the specific reason of
verifying their legality, as the drafting of documents does not constitute rendering legal
advice on a specific transaction.
Tabar testified that, to her knowledge, neither Grant nor Troutman Sanders were
consulted prior to filling out each promissory note or subscription agreement, or before
the documents were sent to an investor [Doc. 96-17 at 24]. Tabar, in fact, did not recall
any time in which Mr. Skaltsounis sought specific advice from any attorney regarding the
preparation of the notes, subscription agreements, and reinvestment letters at issue in this
case [Id. at 18]. Similarly, Skaltsounis testified that, although Grant provided a draft
subscription agreement and draft promissory note in or before 2006, Grant was not
consulted before Skaltsounis signed each subscription agreement [Doc. 96-10 at 22], and
that he could not recall any conversations pertaining to a specific promissory note [Doc.
96-28 at 10]. Nor have the AIC defendants presented evidence on any advice rendered as
to what materials should be given to potential investors, or that AIC was selling securities
17
to purchasers without verifying their accredited status. Thus, the Court finds that, with
respect to the issuance of promissory notes and subscription agreements, the AIC
defendants cannot meet their burden of showing that they requested advice after fully
disclosing the pertinent facts to counsel and relied upon that advice in good faith.
The Court reaches the same conclusion with regard to the AIC defendants’ use of
reliance upon counsel as a defense to the SEC’s allegations that made AIC material
misstatements and omissions in the documents sent to investors. While AIC asserts that
it relied upon Grant and Troutman Sanders to ensure that “company materials,
confidential corporate information, executive summaries, financial statements, and other
information” complied with the securities laws [Doc. 98 at 12], AIC has not presented
evidence that it solicited an attorney’s advice with respect to the preparation of any of
these documents, or that an attorney prepared them. Skaltsounis, in contrast, testified that
he prepared drafts of executive summaries, pulling information from various departments
of AIC, and subsequently sent the documents to Grant and Troutman Sanders for review
[Doc. 96-29 at 50]. Skaltsounis also testified that the documents may have been further
revised after any such review, and could not recall any specific recommendations
provided by Grant or Troutman Sanders [Id.]. This does not indicate that AIC’s attorneys
were aware of the omissions alleged in the relevant documents, nor does it indicate that
an attorney concluded the specific activity was compliant with the securities laws.
Similarly, with regard to verbal disclosures which the SEC claims were misleading,
18
Skaltsounis testified that Grant never provided guidance on verbal disclosure, other than
stating what disclosures were required [Id. at 4].
The AIC defendants rely upon Grant’s status as a member of the board of directors
as evidence that he approved the offerings and sales in question, and the documents
associated with those sales. While the AIC defendants argue that they relied upon Grant,
as “the one Board member who held himself out as an expert in securities matters” [Doc.
98 at 13], the AIC defendants have failed to present evidence as to what advice Grant
gave the board, after being asked for specific advice and being fully informed of a given
issue. At least one board member, Douglas Mussler, who served during the time period
in question, testified that, although he assumed Grant and Skaltsounis had additional
conversations, Grant did not render specific legal advice during board meetings [Doc. 9615 at 6]. Mussler stated that any specific discussion related to required disclosures and
the specific sales of securities would not likely occur at a board meeting because that was
an “operational function” rather than a function of the board [Id. at 4].
In this case, the SEC has cited to deposition testimony from eight former
employees and executive officers of AIC and its subsidiaries indicating that none of the
eight could testify that Grant or Troutman Sanders gave specific legal advice with regard
to the offerings at issue in this case [Doc. 94-1 at 21-22]. Viewing the evidence provided
by the AIC defendants in response, and all evidence, in a light most favorable to the AIC
defendants, does not create a genuine issue of material fact as to the advice of counsel
defense. As “the party who raises an affirmative defense has the burden of proof as to
19
those defenses,” United States v. Baker, No. 3:08-CV-374, 2009 WL 1407018, at *2
(E.D. Tenn. May 19, 2009), and the AIC defendants have not presented evidence that
they can sustain that burden, the Court finds that summary judgment in favor of the SEC
as to this defense is appropriate. See SEC v. George, 426 F.3d 786, 798 (6th Cir. 2005)
(noting that to survive summary judgment in light of SEC’s evidence, the “defendants
needed to present affirmative evidence, not just affirmative assertions, demonstrating a
disputed issue of material fact”). Accordingly, the SEC’s motion on this defense will be
granted.
B.
Violation of Section 5 of the Securities Act
The SEC also seeks summary judgment on its claim that the AIC defendants
violated §§ 5(a) and 5(c) of the Securities Act for the unregistered sale of securities from
2006 through 2009. The AIC defendants do not dispute that securities were sold during
the relevant time period which were not registered; rather, the AIC defendants argue that
every sale of securities was made pursuant to one of the exemptions provided for by the
statute.
“The Securities Act and the required filing of registration statements under Section
5 exist to protect investors by requiring they receive sufficient information to make
informed investment decisions.” SEC v. Sierra Brokerage Servs., Inc., 712 F.3d 321, 329
(6th Cir. 2013) (citing SEC v. Ralston Purina Co., 346 U.S. 119, 124 (1953)). Taken
together, §§ 5(a) and 5(c) require that securities be registered with the SEC before they
20
can be sold or offered for sale. 15 U.S.C. § 77e(a), (c).7 To establish a prima facie
violation of § 5, the SEC must prove the following: “(1) [that] no registration statement
was in effect for the securities; (2) that the defendant directly or indirectly sold or offered
to sell the securities; and (3) that means of interstate transportation or communication
were used in connection with the offer or sale.” Eur. & Overseas Commodity Traders,
S.A. v. Banque Paribas London, 147 F.3d 118, 124 n.4 (2d Cir 1998), abrogated on other
grounds by Morrison v. Nat’l Australia Bank Ltd., 130 S. Ct. 28269 (2010). Scienter is
not an element of a § 5 violation because that section imposes strict liability on sellers of
securities. SEC v. Sierra Brokerage Servs., 608 F. Supp. 2d 923, 939 (S.D. Ohio 2009)
(citing SEC v. Calvo, 378 F.3d 1211, 1215 (11th Cir. 2004)). Once the SEC establishes a
prima facie case, the defendant bears the burden of showing that the challenged securities
7
Section 5(a) states:
Unless a registration statement is in effect as to a security, it shall be unlawful for
any person directly or indirectly—
(1) to make use of any means or instruments of transportation or communication
in interstate commerce or the mails to sell such security through the use or
medium of any prospectus or otherwise; or
(2) to carry or cause to be carried through the mails or in interstate commerce, by
any means or instruments of transportation, any such security for the purpose of
sale or delivery after sale.
15 U.S.C. § 77e(a).
Section 5(c) states in relevant part:
It shall be unlawful for any person, directly or indirectly, to make use of any
means or instruments of transportation or communication in interstate commerce
or of the mails to offer to sell or offer to buy through the use or medium of any
prospectus or otherwise any security, unless a registration statement has been filed
as to such security . . . .
15 U.S.C. § 77e(c).
21
transactions fall within one of the enumerated exemptions from registration. Id. (citing
Ralston Purina, 346 U.S. at 126).
In this case, the SEC contends, and the AIC defendants do not dispute, that the
AIC defendants offered and sold securities without registering those securities with the
SEC. As to the element of registration, Skaltsounis testified during depositions that there
were not any registration statements in effect for the common stock, preferred stock, and
promissory notes sold during the relevant time period, so that this first element is met
[See Doc. 96-1 at 3-4]. Regarding the second element, the SEC submitted evidence of
stock certificates and subscription agreements, as well as promissory notes and rollover
letters on those notes, to prove that securities were in fact offered and sold by the AIC
defendants [See Doc. 96-2]. As it is undisputed that the AIC defendants sold securities to
investors in multiple states, including but not limited to Virginia, Tennessee, and
Colorado, the Court also concludes that the SEC has proven the interstate commerce
element. Thus, the SEC has brought forward sufficient evidence to establish a prima
facie case that the AIC defendants violated § 5. Where the parties disagree, however, is
on the issue of whether there is sufficient evidence so as to create a question of fact as to
the availability of one of the statutory exemptions of § 5’s strict liability provisions.
1.
Exempted Securities Under Section 3
The AIC defendants, in their amended answer [Doc. 84], claim that “[o]ne or more
classes of securities offered by AIC are exempted securities” pursuant to § 3(a)(3) of the
Securities Act, concerning notes and similar instruments with maturity dates of nine
22
months or less, and Section 3(a)(9), concerning securities exchanged with existing
security holders where no commission was paid.8 The SEC argues on summary judgment
that the AIC defendants cannot meet their burden of showing that the securities sold in
the relevant time period were exempt under either provision of § 3.
a.
Notes with Short Term Maturities
Section 3(a)(3) states, in relevant part, that the following securities are exempt
from the provisions of the Securities Act:
[a]ny note, draft, bill of exchange, or banker’s acceptance which arises out
of a current transaction or the proceeds of which have been or are to be
used for current transactions, and which has a maturity at the time of
issuance of not exceeding nine months, exclusive of days of grace, or any
renewal thereof the maturity of which is likewise limited[.]
15 U.S.C. § 77c(a)(3). Despite this language, several circuit courts have held that the
“‘mere fact that a note has a maturity of less than nine months does not take the case out
of the [Securities Acts], unless the note fits the general notion of commercial paper.’”9
SEC v. R.G. Reynolds Enters., 952 F.2d 1125, 1132 (9th Cir. 1991) (quoting Zeller v.
Bogue Elec. Mfg. Corp., 476 F.2d 795, 800 (2d Cir. 1973)) (alterations in original); see,
e.g,. SEC v. Cont’l Commodities Corp., 497 F.2d 516, 524-25 (5th Cir. 1974) (“[I]t is the
character of the note, not its maturity date, which determines coverage under both the
8
In its motion for summary judgment the SEC notes that neither of the claimed
exemptions under Section 3 were pled in response to the original complaint, and were only raised
in the AIC defendants’ amended answer [See Doc. 94-1 n.25]. The Court finds it appropriate to
discuss both exemptions, given that the parties have fully briefed these issues.
9
Commercial paper has been defined by the Supreme Court in this context as “shortterm, high quality instruments issued to fund current operations and sold only to highly
sophisticated investors.” Reves v. Ernst & Young, 494 U.S. 56, 72 (1990). The AIC defendants
have not alleged that the notes at issue fit this definition.
23
registration provisions of the Securities Act of 1933 and the Securities Exchange Act of
1934.”); see also Am. Bank & Trust Co. v. Wallace, 702 F.2d 93, 94-95 (6th Cir. 1983)
(noting that the “duration . . . of the promissory note does not per se remove it from the
purview of either the 1934 [Exchange] Act or 1933 [Securities] Act”).
Rather than focus on the maturity of the notes in question, courts have focused on
the methodology adopted by the Reves Court in determining whether a note falls within
the scope of the Securities Act’s provisions, beginning with the presumption that every
note is a security. Reves v. Ernst & Young, 494 U.S. 56, 65 (1990); see, e.g., SEC v. Tee
to Green Golf Parks, Inc., No. 00-CV-4788, 2011 WL 147862, at *6-7 (W.D.N.Y. Jan.
18, 2011). The presumption may be overcome by showing that the note in question bears
a “family resemblance” to those notes which have been judicially recognized as not
qualifying as securities,10 based upon the analysis of four factors: (1) the motivation
prompting the transaction; (2) the plan of distribution; (3) the reasonable expectation of
the investing public; and (4) whether some factor reduces the risk of the instrument,
rendering the federal securities laws unnecessary. Bass v. Janney Montgomery Scott,
Inc., 210 F.3d 577, 585 (6th Cir. 2000) (quotations and citations omitted). Under the first
10
The Reves Court provided the following list of notes which it held were not securities:
notes delivered in consumer financing, notes secured by a mortgage on a home,
notes secured by a lien on a small business or some of its assets, notes relating to
a “character” loan to a bank customer, short-term notes secured by an assignment
of accounts receivables, notes which formalize an open-account indebtedness
incurred in the ordinary course of business, and notes given in connection with
loans by a commercial bank to a business for current operations.
Bass v. Janney Montgomery Scott, Inc., 210 F.3d 577, 585 (6th Cir. 2000) (citing Reves, 494
U.S. at 65).
24
factor, “if the seller’s motivation is ‘to raise money for the general use of a business
enterprise . . . and the buyer is interested primarily in the profit the note is expected to
generate, the instrument is likely to be a security.’” Id. (quoting Reves, 494 U.S. at 66).
As noted by the Sixth Circuit in Bass, the fourth factor not only includes comprehensive
regulatory schemes but also the presence of collateral or insurance as evidence of reduced
risk. Id.
Applying the foregoing to the promissory notes offered and issued by the AIC
defendants, the Court concludes that the promissory notes, regardless of their maturities,
represent securities subject to the provisions of § 5. Initially, the Court notes that the AIC
defendants do not dispute that none of the judicially created exceptions set forth in Revis
apply in this case [See Doc. 96-1 at 9-23]. Turning to the first Revis factor, it appears that
AIC’s purpose in selling the notes was to raise money for “the general use of AIC and its
subsidiaries” [Id. at 24], and from AIC’s perspective, those who received notes from AIC
did so because of the prospect of interest [Id. at 27].11 See Reves, 494 U.S. at 68 (noting
that investors hoped to earn profit in the form of interest in finding note to be security).
As to the second factor, Skaltsounis testified that both current customers of CB Securities
and new customers received promissory notes, and that approximately 40 notes were sold
to customers in several states, so that the plan of distribution also indicates the notes were
securities. Cf. Tee to Green, 2011 WL 147862 at *7 (noting that sale of promissory notes
in at least six different states indicated that the notes in question were securities). The
11
That purchasers of the notes did so for reasons of profit is further evidenced by the
notes themselves, at least some of which offered an interest rate of 12.5% [See Doc. 96-34 at 4].
25
AIC defendants have not argued or presented evidence that the expectation of the note
holders was anything other than to receive a return on their investment in the form of
interest over the maturity period of their respective notes, under the third factor. Finally,
the AIC defendants have not shown that there was any independent regulatory scheme to
protect note holders, nor does it appear that there was any collateral or insurance involved
related to the promissory notes. Accordingly, the Court concludes that the notes in
question were “securities” for purposes of the Securities Act and thus are not exempt
from the requirements of § 5 under § 3(a)(3).
b.
Securities Sold to Existing Security Holders
The AIC defendants also claim that at least some of the securities sold were
exempt under § 3(a)(9), which exempts “any security exchanged by the issuer with its
existing securities holders exclusively where no commission or other remuneration is
paid or given directly or indirectly for soliciting such exchange.” 15 U.S.C. § 77c(a)(9).
In response to the SEC’s motion for summary judgment, however, the AIC defendants
have not submitted evidence of transactions involving existing exclusively AIC securities
investors, nor submitted any evidence or affidavits on whether those who sold AIC
securities received a commission.12 The SEC, in support of its motion, submitted the
interrogatory responses of AIC and Skaltsounis noting the investors with whom
Skaltsounis communicated during the relevant time period, many of whom appear to be
12
In fact, the AIC defendants, in response to the SEC’s motion for summary judgment,
only state that there is “no evidence that there was a commission or remuneration paid” in regard
to a transaction for the rollover of a promissory note [Doc. 98 at 16].
26
first-time investors referred by CB Securities brokers or members of the AIC board to
invest in the company [Doc. 96-25 at 14-17]. In light of this evidence, and given that the
AIC defendants have not presented any evidence indicating that the sole recipients of
securities in this time period were current investors, which is their ultimate burden to
prove in asserting a statutory exemption, the Court finds that the AIC defendants have not
created a genuine issue of material fact as to whether the securities in question were
exempt pursuant to §3(a)(9).
2.
Exempt Transactions Under Regulation D
The AIC defendants also contend that the securities offerings and sales occurring
between 2006 and 2009 did not involve public offerings so that the transactions
themselves are exempt under § 4 of the Securities Act and the regulations promulgated
thereunder, commonly referred to as the “Regulation D exemption,” 17 C.F.R. § 230.501
et seq. The AIC defendants specifically rely upon Rule 506 under Regulation D, based
upon the nature of the offering and the status of their investors.
Under § 4(a)(2), the registration requirements of the Securities Act do not apply to
“transactions by an issuer not involving any public offering.” 15 U.S.C. § 77d(a)(2). A
non-public offering has been defined by the Supreme Court as “‘[a]n offering to those
who are shown to be able to fend for themselves.’” Mark v. FSC Securities Corp., 870
F.2d 331, 333 (6th Cir. 1989) (alteration in original) (quoting Ralston Purina, 346 U.S. at
125. Regulation D, and Rule 506 in particular, codify this principle, and set forth specific
27
conditions that must be met in order to fall within the safe harbor. 17 C.F.R. § 230.506.13
Under Rule 506 the offers and sales must first satisfy all of the terms and conditions set
forth in Rules 501 and 502, as well as meet the following specific conditions:
(i)
Limitation on number of purchasers. There are no more than or the
issuer reasonably believes that there are no more than 35 purchasers of
securities from the issuer in any offering under this section.
....
(ii)
Nature of purchasers. Each purchaser who is not an accredited
investor either alone or with his purchaser representative(s) has such
knowledge and experience in financial and business matters that he is
capable of evaluating the merits and risks of the prospective investment, or
the issuer reasonable believes immediately prior to making any sale that
such purchaser comes within this description.
Id.
Rule 501 notes that in calculating the total number of purchasers, relatives of other
purchasers with the same primary residence are excluded, as are “accredited investors.”
An accredited investor is defined as any person who comes within one of eight
enumerated categories, “or who the issuer reasonably believes” comes within one of the
categories, which include the following: banks; business development companies; nonprofit organizations with a certain amount of assets; directors, executive officers, and
general partners of the issuer (or of a general partner of the issuer); natural persons with
individual or joint net worth exceeding $1 million; and any natural person with individual
income of $200,000 (or joint income of $300,000) in each of the two most recent years
and has a reasonable expectation of reaching the same income level in the current year.
13
In Mark, the Sixth Circuit noted that it was the company seeking the application of the
safe harbor’s burden to prove that the conditions of Rule 506 have been met. 870 F.2d at 334.
28
17 C.F.R. § 230.501(a). “In order to come within the Rule 506 safe harbor, [the issuer] is
required to offer evidence of the issuer’s reasonable belief as to the nature of each
purchaser.” Mark, 870 F.2d at 335; see also SEC v. Credit First Fund, LP, No. CV058741 DSF, 2006 WL 4729240, at *12 (C.D. Cal. Feb. 13, 2006) (“The party claiming the
exemption must show that it is met not only with respect to each purchaser, but also with
respect to each offeree.”) (quoting SEC v. Murphy, 626 F.2d 633, 644-45 (9th Cir.
1980)).
Rule 502 sets forth conditions for the type of financial and other information that
must be provided to any non-accredited investors for offers and sales under Regulation D,
and requires that such information be provided within a reasonable period of time prior to
sale. Rule 502 also sets forth limitations on the manner of the offering and types of
solicitations that are permitted, as well as limits on resale of any securities sold under
Regulation D.
In this case, the SEC argues that the safe harbor afforded by Rule 506 is
unavailable to the AIC defendants because securities were sold to individuals who did not
qualify as unaccredited investors or were otherwise sophisticated so as to understand the
merits and risks of the prospective investment and who did not receive the requisite
financial information. Although the SEC claims that numerous investors of AIC stock
and notes during the relevant time period were not accredited, the SEC submitted
evidence on several such investors, which the AIC defendants addressed in their response
and which the Court will analyze to determine the availability of Rule 506.
29
The first investor that the SEC argues is unaccredited is Jovena Daniels, who filled
out a “Direct Account Form” with CB Securities on September 12, 2009, and who was
procured by defendant Graves [Doc. 96-33].
Ms. Daniels, a resident of Stafford,
Virginia, indicated that her income was between $0 and $29,000, and noted that she was
unemployed at the time.
Although she estimated her financial net worth as being
between $100,000 and $149,000, she wrote that her total net worth was “$300,000” [Id.].
Ms. Daniels signed the form indicating that she was aware of the nature of what was
being offered (i.e. investment products by a non-bank) and that she had received a copy
of the customer agreement (which is not included with the account form itself in the
record). In the notes for use by CB Securities, its representative took Ms. Daniels’s
driver’s license information. The form also indicates that a CB Securities principal
reviewed the form on September 16, 2009 [Id.]. It does not indicate whether Ms. Daniels
was deemed an accredited investor, whether Ms. Daniels herself was required to attest to
her status as an accredited investor, or whether Ms. Daniels was informed that the
promissory note was being issued without registration. A promissory note in the amount
of $50,000, along with $2,500 in interest, was issued by AIC on September 28, 2009
[Doc. 98-8]. The Court notes that the promissory note itself similarly does not indicate
that Ms. Daniels has been qualified as an accredited investor, or that the note’s validity is
dependent upon her status as such, or that the note was issued without registration.
From this, none of the documents in the record indicate that Ms. Daniels was an
accredited investor, nor explain how AIC’s agents formed a “reasonable belief” as to Ms.
30
Daniels’s status prior to issuing the note, particularly given that Ms. Daniels was a new
customer of CB Securities. At his deposition, Skaltsounis testified that he had not seen
the form before and could not authenticate it. As AIC has not presented any evidence
that Ms. Daniels was an accredited investor, and the SEC has presented evidence that she
was not, the Court finds that Ms. Daniels was not an accredited investor, so that the AIC
defendants were required to meet the conditions set forth in Rules 502 and 506. As to
Rule 502’s requirements, the AIC defendants have not presented evidence that Ms.
Daniels received any financial information, which the defendants had an obligation to
provide, or that Ms. Daniels was advised on the limitations of resale of the note. In
addition, the AIC defendants have not presented evidence which led them to reasonably
believe that Ms. Daniels, assuming she received the requisite information, had “such
knowledge and experience in financial and business matters” so that she was capable of
evaluating the merits and risks of the prospective investment.
17 C.F.R. §
230.506(b)(2)(ii). Thus, the Court concludes that the safe harbor provisions of Rule 506
were not available to the AIC defendants in their offering and sale of the promissory note
to Ms. Daniels.14
14
The AIC defendants argue that regardless of her status as an accredited investor, the
note issued to Ms. Daniels is exempt because it has a maturity of six months. The maturity of
the note, however, is immaterial to the issue of whether the safe harbor provisions of Rule 506
were available to the AIC defendants, and as discussed, under the Reves analysis all of the notes
in question were subject to the Securities Act’s requirements.
31
The Court reaches a similar conclusion with respect to several promissory notes
issued to Clarice Newman, a resident of Maryville, Tennessee.15 Ms. Newman filled out
several account forms on March 3, 2008 with CB Securities, procured by CB Securities
representative Carol LaRue [Doc. 96-33 at 12-14]. Ms. Newman indicated that she had
35 years of investment experience, was retired, with an income between $30,000 and
$59,000, and a net worth of $350,000 [Id.]. Similarly to Ms. Daniels, there is no other
information on the form indicating and AIC has otherwise presented evidence that Ms.
Daniels was an accredited investor. Although the form indicates that Ms. Newman was
an existing customer of CB Securities, this alone cannot create a genuine issue of
material fact as to accredited status, particularly in light of AIC’s admission that Ms.
Newman was potentially unaccredited and that it did not know what documents were
given to her prior to her investment [Doc. 98 at 20]. Without any evidence that the AIC
defendants had a reasonable belief as to either Ms. Newman’s status as an accredited
investor or to their compliance with the conditions of Rules 502 and 506, the Court finds
that the sale of promissory notes to Ms. Newman were not covered under Regulation D.16
15
Although there is no promissory note issued to Ms. Newman in the record, the AIC
defendants admit in their response to the SEC’s motion for partial summary judgment that Ms.
Newman received two promissory notes in 2008 and rolled her investment into a new promissory
note in July 2009 [Doc. 98 at 20 n.11].
16
The Court notes that the SEC submitted additional account forms for individuals for
whom there do not appear to be promissory notes or subscription agreements in the record. Two
of these individuals, Elizabeth Green (income of less than $59,000, net worth of less than
$800,000) and Robert Stuart (income of less than $130,000, net worth of “$500,000+”) on the
face of the forms, do not appear to meet any of the definitions of “accredited investor status,” nor
have the AIC defendants presented any other evidence as to these investors’ status or receipt of
the requisite financial information [Doc. 96-33].
32
In response, the AIC defendants first reference an answer to one of the SEC’s
interrogatories, in which AIC stated that it relied upon four categories of information in
justifying that it had a reasonable belief as to the status and nature of each investor: 1) the
advice of Troutman Sanders and Tom Grant; 2) due diligence by AIC and its authorized
agents; 3) “existing and established familial, personal and business relationships,
including information supplied by Investors on account opening forms, in client
agreements, and relating to other private placements” [Doc. 98 at 19]; and 4) investor
representations in promissory notes, subscription agreements, and other documents
relating to investments.
As to the first category, AIC notes that it was informed by its attorneys that the
Form D’s, offering materials, and instruments used in connection with the AIC
investments were compliant. As previously discussed, the AIC defendants have not
presented any evidence that its counsel examined any of the actual investors who
received these unregistered securities to determine whether they were accredited, or that
its attorneys were aware of any such specific transactions. Although the AIC defendants
submitted a compilation of every Form D filed on their behalf as an exhibit to their
response [Doc. 98-7], as required under Regulation D, the form itself does not inform the
SEC (or the attorney preparing the form) anything about the nature of the investor. The
forms discuss the transactions, rather than the investors themselves and the information
provided to them, the focal point of Rule 506.
33
The AIC defendants have similarly not directed the Court to any evidence
describing the process by which AIC’s agents/brokers exercised due diligence prior to
selling securities to investors, nor have they presented any financial information that was
given to investors prior to their investment. During deposition testimony, Skaltsounis
stated that he did not know what information was provided to potential preferred
stockholders or potential promissory noteholders [Doc. 96-1 at 37]. Although the AIC
defendants submitted, and the record contains, several subscription agreements and
questionnaires completed by investors where they are specifically asked to attest to their
accredited status [Doc. 98-9 (subscription agreement and questionnaire for George and
Patricia Gilbert)], the AIC defendants have not presented similar agreements and
questionnaires for the other new customers whose investments were solicited during the
relevant time period.
See Mark, 870 F.2d at 337 (noting that blank subscription
documents and questionnaires did not amount to probative evidence of compliance with
Rule 506 when it was the “answers and information received from purchasers” that was
determinative).
Moreover, while the account forms contain blank spaces related to
accredited status as discussed, supra, there is no indication that the account forms or
promissory notes given to noteholders contain any places where potential investors were
to affirm their accredited status, unlike the subscription agreements. This makes the AIC
defendants’ reliance upon the investors’ agreement to invest in a promissory note as a
basis for compliance with Rule 506 unreasonable, particularly when several account
forms, on their face, indicate unaccredited status. Because the Court finds that the AIC
34
defendants have not presented any evidence creating a genuine issue of material fact as to
their having met the conditions of Rule 506 for each investor, and the SEC has presented
affirmative evidence showing the unavailability of the safe harbor, the Court concludes
that the sales of AIC securities were not exempt under Regulation D.
3.
Exemption Under Section 4(a)(1)
In their response to the SEC’s motion for summary judgment, the AIC defendants
claim that the provisions of § 5 do not apply as “[t]here is no genuine dispute that CBS
and Skaltsounis are not issuers, underwriters or dealers in AIC securities” [Doc. 98 at
16]. The SEC argues that the defense is baseless given the fact that both CB Securities
and Skaltsounis are dealers, and that, even if they were not dealers, their participation in
the transaction is enough to impose liability under §§ 5(a) and 5(c).
Section 4(a)(1) of the Securities Act states that the provisions of § 5 do not apply
to “transactions by any person other than an issue, underwriter, or dealer.” 15 U.S.C. §
77d(a)(1). The Securities Act defines an underwriter, in part, as any person who “offers
or sells for an issuer in connection with, the distribution of any security, or participates or
has a direct or indirect participation in any such undertaking, or participates or has a
participation in the direct or indirect underwriting of any such undertaking . . . .” 15
U.S.C. § 77b(11). Similarly, a “dealer” is defined as “any person who engages either for
all or part of his time, directly or indirectly, as agent, broker, or principal, in the business
of offering, buying, selling, or otherwise dealing or trading in securities issued by another
person.” 15 U.S.C. § 77b(12).
35
The Courts finds defendants’ asserted defense to be meritless based upon the
language of the statute. Skaltsounis testified during his deposition that he procured many
of the AIC investments directly, was responsible for signing off on numerous
subscription agreements and promissory notes, and met with numerous investors
regarding the sale of AIC securities [Doc. 96-25 at 14-16]. CB Securities, a registered
broker-dealer with the NASD and FINRA during the relevant time period, and its
registered representatives, including Skaltsounis, Guyette and Graves, all engaged in the
sale of AIC stock and notes during the relevant time period. The defendants have
presented no evidence to contradict the record, which shows that the AIC defendants
directly participated in the distribution of AIC’s securities, so that the transactions are not
exempt under § 4(a)(1).
For the reasons previously discussed, the Court finds that the AIC defendants’
claimed exemptions and defenses to § 5 liability are not well-taken, and there is no
genuine issue of material fact as to whether the AIC defendants violated §§ 5(a) and 5(c)
through the unregistered sale of securities.17
Accordingly, the SEC’s motion for
summary judgment will be granted and judgment will be entered against the AIC
defendants and in favor of the SEC as to this claim.
17
The Court notes that the AIC defendants re-assert their advice of counsel defense to
this claim, but, as scienter is not an element of a § 5 violation, Sierra Brokerage, 608 F. Supp. 2d
at 939, the Court need not consider this defense as it relates to this specific claim.
36
C.
Liability of Relief Defendants
The SEC also seeks what it terms “contingent summary judgment” as to its claims
of disgorgement against the relief defendants, who received funds from AIC that
represented the proceeds of its alleged fraudulent and prohibited transactions at issue.
Specifically, the SEC claims that there is no genuine issue of material fact as to the relief
defendants’ receipt of funds, and to there being no legitimate claim to those funds, so that
the relief defendants are liable so long as the SEC proves the underlying violations
against the AIC defendants. The relief defendants argue that the relief defendants have a
legitimate claim to the funds at issue because they performed legitimate services, namely,
enhancing shareholder value by growing revenues, which, given their position as
subsidiaries of AIC, provided value to AIC’s shareholders [Doc. 98 at 22].
“‘Federal courts may order equitable relief against [such] a person who is not
accused of wrongdoing in a securities enforcement action where that person: (1) has
received ill-gotten funds; and (2) does not have a legitimate claim to those funds.’” SEC
v. George, 426 F.3d 786, 798 (6th Cir. 2005) (quoting SEC v. Cavanagh, 155 F.3d 129,
136 (2d Cir. 1998)). Courts have noted that the receipt of property as a gift, without the
payment of consideration, is insufficient to create a “legitimate claim” immunizing
property from disgorgement. CFTC v. Walsh, 618 F.3d 218, 226 (2d Cir. 2010) (citing
cases). Although not addressed by the Sixth Circuit, other courts have held that “relief
defendants who have provided some form of valuable consideration in good faith in
return for proceeds of fraud are beyond the reach of the district court’s disgorgement
37
remedy.” Id. (citing Janvey v. Adams, 588 F.3d 831, 834-35 (5th Cir. 2009) (purchaser of
certificates of deposit from bank had “ownership interest”)); CFTC v. Kimberlynn Creek
Ranch, Inc., 276 F.3d 187, 191-92 (4th Cir. 2002)); see also FTC v. Bronson Parnters,
LLC, 674 F. Supp. 2d 373, 392 (D. Conn. 2009) (“A relief defendant can show a
legitimate claim to the funds received by showing that some services were performed in
consideration for the monies.”).
The parties do not dispute that AIC gave capital contributions to each of the relief
defendants. The SEC provided the report of an expert witness, Professor Ray Stephens,
who determined the following amounts of capital contributions made to the relief
defendants during the relevant time period: (1) AIC to Waterford, $541,000; (2) AIC to
Advent, $516,150; and (3) AIC to CBS Advisors, $58,686.75 [Doc. 96-8 at 15]. The
defendants do not dispute these amounts in their response. Thus, the Court concludes
that these are the amounts that the relief defendants received from AIC.
The relief defendants dispute whether they have a legitimate claim to the
distributed funds. Specifically, the relief defendants argue that they provided services
back to AIC after receipt of the funds by growing their business, increasing their revenue,
and thus increasing shareholder value to AIC. The relief defendants point to audited
financial statements as proof of the value they provided to AIC. Professor Stephens,
however, stated in his report that “AIC’s ownership of each of its subsidiaries did not
change due to the cash capital contributions made to CB Securities, Waterford, Advent,
or CBS Advisors. AIC received nothing of value in exchange for the cash capital
38
contributions to CB Securities, Waterford, Advent, and CBS Advisors” [Doc. 96-8 at 11].
The SEC also submitted deposition testimony indicating that neither Advent [Doc. 96-35
at 5], Waterford [Doc. 96-37 at 3], nor CBS Advisors [Doc. 96-39 at 5] provided specific
services that were tied to the capital contributions.
The Court concludes that the relief defendants do not have a legitimate claim to
the contributions made by AIC. The relief defendants argue that the growth of their
business was “consideration” for the contributions received by AIC; however, the
contributions were a result of AIC’s existing ownership interest in the relief defendants,
which did not change in this time period [See Doc. 96-8 at 11-12]. Similarly, the benefit
AIC received from the relief defendants’ growth of their businesses was a direct result of
AIC’s ownership interest, rather than as consideration for the funds received. As the
relief defendants were subsidiaries of AIC, the Court finds it would be inappropriate to
allow those who violate the securities laws to retain the benefit of their fraudulent acts by
transferring the funds to a subsidiary or subsidiaries, which in turn generate revenue for
the parent through legitimate means. Moreover, unlike relief defendants who purchased
ill-gotten proceeds for value or who earned such proceeds as a result of their employment
relationship, the relief defendants have not presented any evidence that the contributions
received here involved the exchange of benefits and detriments which serves as
consideration to create an independent ownership interest in the received funds.
Accordingly, the Court finds that the contributions made by AIC were gratuitous and are
39
subject to disgorgement.18 The SEC’s motion in this regard is granted to the extent that
the relief defendants will be subject to disgorgement pending a finding of liability against
the AIC defendants on the SEC’s claims.
IV.
Conclusion
For the reasons previously stated, the Court finds that the SEC has shown there is
no genuine issue of material fact as to the claims and defenses presented in their Motion
for Partial Summary Judgment [Doc. 93], and the defendants have not presented any
evidence to rebut this showing. Accordingly, the SEC’s Motion for Partial Summary
Judgment [Doc. 93] is hereby GRANTED to the extent discussed herein.
It is
ORDERED that the SEC submit an appropriate form of judgment. This matter will
proceed to trial on the SEC’s remaining claims.
IT IS SO ORDERED.
s/ Thomas A. Varlan
CHIEF UNITED STATES DISTRICT JUDGE
18
Although the relief defendants assert the same affirmative defenses as the AIC
defendants to preclude the availability of disgorgement, the Court finds that these defenses fail
for the same reasons as previously discussed by the Court.
40
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