Securities and Exchange Commission v. Mapp, III et al
MEMORANDUM OPINION AND ORDER re 44 MOTION to Dismiss Under Federal Rules of Civil Procedure 12(b)(6) and 9(b) and Memorandum of Law in Support Thereof filed by Warren K Paxton, Jr.. Defendant Warren K. Paxton, Jr.s Motion to Dismiss (Dkt. #44) is hereby GRANTED and Plaintiffs claims against Defendant Warren K. Paxton, Jr. are DISMISSED with prejudice. Signed by Judge Amos L. Mazzant, III on 3/2/17. (cm, )
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United States District Court
EASTERN DISTRICT OF TEXAS
SECURITIES AND EXCHANGE
WILLIAM E. MAPP, III,
WARREN K. PAXTON, JR.,
CALEB J. WHITE, and
CIVIL ACTION NO. 4:16-CV-246
MEMORANDUM OPINION AND ORDER
Pending before the Court is Warren K. Paxton, Jr.’s Motion to Dismiss Under Federal
Rules of Civil Procedure 12(b)(6) and 9(b) (Dkt. #44). Having considered the relevant pleadings,
the Court finds that the motion should be granted.
This motion comes before the Court following the Court’s conditional dismissal of Warren
K. Paxton, Jr. (“Paxton”) from the underlying action (Dkt. #39). The Court granted the Securities
and Exchange Commission (the “Commission”) leave to allege additional facts that might support
a claim under the statutes alleged in its original complaint (the “Original Complaint”). The facts
alleged in the new complaint (the “Amended Complaint”), which the Court must accept as true,
are as follows:
Servergy, Inc. (“Servergy”) is a computer hardware company that develops secure, cloudbased data storage servers. From November 2009 to September 2013, Servergy raised
approximately $26 million in private securities offerings to develop what it claimed was a
revolutionary new server. William E. Mapp, III (“Mapp”), Servergy’s co-founder and then-CEO,
was responsible for the fundraising campaign and had signatory authority over Servergy’s bank
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accounts. As Servergy’s primary fundraiser, Mapp identified prospective investors through wordof-mouth referrals and offered compensation to individuals for introducing new investors to the
Paxton became involved in Servergy’s fundraising campaign in the summer of 2011.
Paxton currently serves as the Attorney General of Texas. Before serving as Texas’s Attorney
General, Paxton was a Texas state senator from January 2013 to December 2014 and a Texas state
representative from January 2003 to December 2012. Paxton was previously an investment adviser
representative of Mowery Capital Management (“MCM”). Paxton at times solicited clients on
MCM’s behalf and collected asset management fees. In 2011, Paxton reported legal services
income from MCM. Paxton was also registered as an investment adviser representative from July
2003 to December 2004 and from December 2013 to November 2014.
On July 12, 2011, Mapp met Paxton—then a member of the Texas House of
Representatives—at Paxton’s law office in McKinney, Texas, to discuss Servergy. During their
meeting, Mapp offered to pay Paxton a 10% commission for any investors Paxton recruited to
invest with Servergy. Following the meeting, Mapp emailed Paxton and reiterated his offer to pay
Paxton either with Servergy common stock or a combination of cash and stock. Paxton responded
to Mapp’s offer via email, stating, “I will get to work.”
Paxton actively recruited investors for Servergy between July 11, 2011, and July 31, 2011.
Throughout Paxton’s recruiting efforts, Paxton raised $840,000 for Servergy—32% of all
investment funds raised by Servergy in 2011—by promoting the company and soliciting investors
for an undisclosed transaction-based compensation in the form of 100,000 shares of Servergy
common stock. Paxton told prospective investors that he had met with Servergy’s management
and determined it was a great company and the investment presented an interesting opportunity.
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Paxton did not conduct any due diligence into Servergy or reveal to potential investors that he was
being compensated to promote Servergy’s stock.
On July 22, 2011, Paxton organized and invited at least seven prospective investors to an
investment pitch at Servergy’s office. Paxton attended that meeting and also introduced Mapp to
at least five additional prospective investors by telephone and email the same day. Among the
people Paxton recruited were his friends, business associates, law firm clients, and members of an
investment group (the “Investment Group”) of which he belonged.
The Investment Group consisted of four members (“Investors 1, 2, 3, and 4”) not including
Paxton. Based on prior dealings in the Investment Group, members trusted each other to consider
the interest of the group as a whole and not exploit one another for a member’s personal benefit.
Typically, the member who recommended the investment would monitor the investment going
forward and represent the group’s interest. Paxton did not inform the Investment Group of his
compensation arrangement with Servergy.
Following the initial pitch to the Investment Group, Paxton followed up with one of its
members (“Investor 1”), a fellow state representative, to further encourage his investment in
Servergy. Investor 1 has been involved in the Investment Group for 25 years along with Investors
2, 3, and 4. These four investors have operated under the established policy and expectation that
members participating in an investment deal do so on what Investor 1 calls an “equal dollar-fordollar basis,” in which everyone takes the same risk and receives the same benefit. No one member
makes money or otherwise benefits from the investment of another member. There was an
expectation that if one member of the group was to benefit from a deal, he would disclose that
benefit. The group had a known and established pattern of conduct in which the member who
recommends an investment typically monitors the deal going forward and represents the interests
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of the members who have invested. The Amended Complaint alleges Paxton knowingly or
recklessly violated his duty to disclose his compensation based on his formal and informal
fiduciary relationship with the Investment Group members.
Investor 1 and Paxton have a personal and professional relationship dating back to 2003.
Paxton lived in Investor 1’s apartment while in Austin on House business. Paxton served as
Investor 1’s attorney, setting up entities for Investor 1’s family and certain business ventures.
Paxton began to participate in investments with the Investment Group before soliciting its
members to invest in Servergy in 2011. Investor 1 informed Paxton of the Investment Group’s
established purpose, policies, and practices. Paxton had previously brought other investment
opportunities to the Investment Group. To Investors 1, 2, 3, and 4’s knowledge, Paxton did not
receive any compensation for investments he brought to the Investment Group before Servergy.
Paxton agreed to provide legal services in exchange for shares of at least one investment made
through the Investment Group, which Paxton disclosed to the Investment Group members. Paxton
also performed legal services for members of the Investment Group and some of the entities in
which the Investment Group invested.
Investor 1 believed Paxton was investing in the Servergy Investment. Paxton told Mapp
that he intended to act as a point person for the Investment Group. Paxton testified that the other
three investors would likely invest if Investor 1 were to invest. All four of the Investment Group
members invested in Servergy. Investor 2 initially missed the investment deadline. Paxton placed
an unsolicited late night phone call to Investor 2 to change his mind, stating that the offering price
would double if he did not invest within the next week. Following the phone call, Investor 2
invested $150,000 with Servergy. Both Investor 1 and Investor 2 stated they would not have
invested in Servergy had they known Paxton was being paid to promote the company. Investor 3
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claims Paxton’s failure to disclose his compensation led him into believing that no such
compensation was in place. Had Investor 4 known of Paxton’s compensation, he would have been
skeptical of the investment opportunity.
Also present at the initial July 22, 2011 investment pitch were members of a separate
investment group of which Paxton was affiliated, the S3 Group. In 2011, Paxton performed legal
services for the S3 Group and served as a registered agent of an S3 Group entity, S3 Management
Group, LLC. Paxton is also a member of two S3 Group entities.
On July 23, 2011, Paxton forwarded one of Mapp’s solicitation emails directly to a
prospective investor and offered to answer any of the individual’s questions. By July 28, 2011,
five of the twelve prospective investors Paxton recruited had invested a total of $840,000 in
Servergy. On August 5, 2011, Servergy issued a stock certificate to Paxton for 100,000 shares as
payment for “services.” Servergy issued Paxton a Form-1099 in the amount of $100,000 for the
2011 tax year.
The Amended Complaint alleges Paxton continually concealed his Servergy payments.
Paxton falsely characterized, omitted key information, or refused to disclose information about his
Servergy commissions to the Investment Group in his tax filings, in his mandated political
disclosures, and in testimony before the Commission. Servergy issued a Form-1099 to Paxton,
classifying the 100,000 shares in Servergy stock as non-employment compensation, which Paxton
reported as income related to legal services on his 2011 Form 1040. On August 23, 2011, Paxton
signed a subscription agreement in which he claimed he had paid $100,000 in exchange for the
shares he received in Servergy. On October 28, 2011, Mapp sent Paxton a revised subscription
agreement indicating that Paxton was receiving his shares as a Servergy service provider rather
than for cash consideration, but Paxton never executed the corrected agreement. Paxton disclosed
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his ownership of Servergy stock in his mandated political disclosures in the “stock” section but
not the “sources of occupational income” or “gift” sections.
On September 12, 2011, Paxton asked Mapp which of his potential investors had in fact
invested in Servergy. On September 24, 2011, Mapp sent Paxton a list of Paxton’s contacts that
had not yet invested in Servergy. The next day, Paxton emailed a potential investor, inviting him
to a Servergy webinar. On October 4, 2011, Mapp renewed his offer via email to pay Paxton to
In early 2013, Mapp, Paxton, and Investor 1 had a meeting about the status of the
investment. Mapp falsely told Investor 1 that Servergy was flush with purchase orders. On
February 4, 2013, Mapp sent Paxton an update email, to which Paxton responded, “hopefully this
will keep them calm.” Paxton forwarded this email to Investor 1 and informed him that he would
check back to see how his fundraising was going. On February 10, 2013, Paxton informed Mapp
that Investor 1 seemed satisfied with the report and said he could “check in once a month on
progress that will help you and them.” On March 28, 2013, Mapp asked Paxton to check up on
Investor 1 because Paxton was “running point” for the Investment Group. Upon being informed
by Servergy management that Paxton had entered into an agreement to solicit investors, the
Investment Group members retained an attorney who sent Paxton a certified mail letter requesting
that he disclose his compensation arrangement with Servergy. Paxton never responded.
On April 11, 2016, the Securities and Exchange Commission filed its Original Complaint
(Dkt. #1) in this Court against Mapp, Paxton, Servergy, and an additional promoter, Caleb J. White,
asserting various violations of federal securities laws. The Commission specifically claims that
Paxton violated Sections 17(a) and 17(b) of the Securities Act and Sections 10(b) and 15(a) of the
Exchange Act. On June 9, 2016, Paxton filed a Motion to Dismiss Under Federal Rules of Civil
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Procedure 12(b)(6) and 9(b) (Dkt. #16). On July 5, 2016, the Commission filed its Response in
Opposition (Dkt. #25). On July 15, 2016, Paxton filed a Reply (Dkt. #26). On September 2, 2016,
the Court held oral argument at the request of the parties. On October 7, 2016, the Court issued a
Memorandum Opinion and Order (the “Opinion”) (Dkt. #39), conditionally granting Paxton’s
motion to dismiss. The Court granted the Commission leave to amend its allegations against
Paxton to submit additional facts that might support a claim under the statutes alleged in the
Original Complaint. On October 21, 2016, the Commission filed its Amended Complaint (Dkt.
#40). On November 4, 2016, Paxton filed his Motion to Dismiss Under Federal Rules of Civil
Procedure 12(b)(6) and 9(b) (Dkt. #44). On November 18, 2016, the Commission filed its
Response (Dkt. #45). On November 28, 2016, Paxton filed his Reply (Dkt. #46). On December 5,
2016, the Commission filed its Sur-Reply (Dkt. #47).
II. LEGAL STANDARD
Paxton moves for dismissal under Rule 12(b)(6) of the Federal Rules of Civil Procedure,
which authorizes certain defenses to be presented via pretrial motions. A Rule 12(b)(6) motion to
dismiss argues that, irrespective of jurisdiction, the complaint fails to assert facts that give rise to
legal liability of the defendant. The Federal Rules of Civil Procedure require that each claim in a
complaint include “a short and plain statement . . . showing that the pleader is entitled to relief.”
Fed. R. Civ. P. 8(a)(2). The claim must include enough factual allegations “to raise a right to relief
above the speculative level.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). Thus, “[t]o
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.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)
(quoting Twombly, 550 U.S. at 570).
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Rule 12(b)(6) provides that a party may move for dismissal of an action for failure to state
a claim upon which relief can be granted. Fed. R. Civ. P. 12(b)(6). The court must accept as true
all well-pleaded facts contained in the plaintiff’s complaint and view them in the light most
favorable to the plaintiff. Baker v. Putnal, 75 F.3d 190, 196 (5th Cir. 1996). In deciding a Rule
12(b)(6) motion, “[f]actual allegations must be enough to raise a right to relief above the
speculative level.” Twombly, 550 U.S. at 555; Gonzalez v. Kay, 577 F.3d 600, 603 (5th Cir. 2009).
“The Supreme Court recently expounded upon the Twombly standard, explaining that ‘[t]o 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.’” Gonzalez, 577 F.3d at 603 (quoting Iqbal, 556 U.S. at
678 (2009)). “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.”
Id. “It follows, that ‘where the well-pleaded facts do not permit the court to infer more than a mere
possibility of misconduct, the complaint has alleged—but it has not ‘shown’—‘that the pleader is
entitled to relief.’” Id.
In Iqbal, the Supreme Court established a two-step approach for assessing the sufficiency
of a complaint in the context of a Rule 12(b)(6) motion. First, the court should identify and
disregard conclusory allegations, for they are “not entitled to the assumption of truth.” Iqbal,
556 U.S. at 664. Second, the Court “consider[s] the factual allegations in [the complaint] to
determine if they plausibly suggest an entitlement to relief.” Id. “This standard ‘simply calls for
enough facts to raise a reasonable expectation that discovery will reveal evidence of the necessary
claims or elements.” Morgan v. Hubert, 335 F. App’x 466, 470 (5th Cir. 2009). This evaluation
will “be a context-specific task that requires the reviewing court to draw on its judicial experience
and common sense.” Iqbal, 556 U.S. at 679.
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In determining whether to grant a motion to dismiss, a district court may generally not “go
outside the complaint.” Scanlan v. Tex. A&M Univ., 343 F.3d 533, 536 (5th Cir. 2003). However,
a district court may consider documents attached to a motion to dismiss if they are referred to in
the plaintiff’s complaint and are central to the plaintiff’s claim. Id.
Paxton also moves to dismiss the Commission’s claims under Federal Rule of Civil
Procedure 9(b). Rule 9(b) “prevents nuisance suits and the filing of baseless claims as a pretext to
gain access to a ‘fishing expedition.’” United States ex rel. Grubbs v. Kanneganti, 565 F.3d 180,
191 (5th Cir. 2009). Rule 9(b) states, “In alleging fraud or mistake, a party must state with
particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other
conditions of a person’s mind may be alleged generally.” Fed. R. Civ. P. 9(b).
Rule 9(b)’s particularity requirement generally means that the pleader must set forth the
“who, what, when, where, and how” of the fraud alleged. United States ex rel. Williams v. Bell
Helicopter Textron, Inc., 417 F.3d 450, 453 (5th Cir. 2005). A plaintiff pleading fraud must
“specify the statements contended to be fraudulent, identify the speaker, state when and where the
statements were made, and explain why the statements were fraudulent.” Herrmann Holdings Ltd.
v. Lucent Techs. Inc., 302 F.3d 552, 564–65 (5th Cir. 2002). The goals of Rule 9(b) are to
“provide defendants with fair notice of the plaintiffs’ claims, protect defendants from harm to
their reputation and goodwill, reduce the number of strike suits, and prevent plaintiffs from
filing baseless claims.” Grubbs, 565 F.3d at 190 (citing Melder v. Morris, 27 F.3d 1097, 1100
(5th Cir. 1994)). Courts are to read Rule 9(b)’s heightened pleading requirement in conjunction
with Rule 8(a)’s insistence on simple, concise, and direct allegations. Williams v. WMX Techs.,
Inc., 112 F.3d 175, 178 (5th Cir. 1997). However, this requirement “does not ‘reflect a subscription
to fact pleading.’” Grubbs, 565 F.3d at 186. “Claims alleging violations of the Texas Insurance
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Code and the DTPA and those asserting fraud, fraudulent inducement, fraudulent concealment,
and negligent misrepresentation are subject to the requirements of Rule 9(b).” Frith v. Guardian
Life Ins. Co. of Am., 9 F. Supp. 2d 734, 742 (S.D. Tex. 1998); see Berry v. Indianapolis Life Ins.
Co., No. 3:08-CV-0248-B, 2010 WL 3422873, at *14 (N.D. Tex. Aug. 26, 2010) (“‘[W]hen the
parties have not urged a separate focus on the negligent misrepresentation claims,’ the Fifth Circuit
has found negligent misrepresentation claims subject to Rule 9(b) in the same manner as fraud
claims.”). Failure to comply with Rule 9(b)’s requirements authorizes the Court to dismiss the
pleadings as it would for failure to state a claim under Rule 12(b)(6). United States ex rel. Williams
v. McKesson Corp., No. 3:12-CV-0371-B, 2014 WL 3353247, at *3 (N.D. Tex. July 9, 2014)
(citing Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1017 (5th Cir. 1996)).
III. DISCUSSION AND ANALYSIS
The Commission alleges that Paxton engaged in fraudulent conduct by promoting
Servergy’s stock without disclosing to potential investors that he was being paid to do so. The
central issue in this case—as it was in the first motion to dismiss—is whether Paxton had a duty
to disclose his compensation under federal securities laws. 1 The Court must determine whether the
Commission pleaded sufficient facts to support a plausible claim against Paxton under federal
A. Fraud Under Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act
The Commission alleges that Paxton engaged in fraud in violation of Section 10(b) of the
Securities Act and Rule 10b-5 thereunder because he did not disclose to potential investors that he
This opinion will necessarily mirror much of the Court’s previous Opinion because the law has not changed and the
primary allegations have not changed. The Court has, however, fully considered the Commission’s Amended
Complaint, including any repeated factual allegations and sources of law. The primary factual addition to the Amended
Complaint is the Investment Group had an “established policy and expectation that members participating in an
investment deal do so on what Investor 1 calls an ‘equal dollar-for-dollar basis.’”
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was being paid to promote Servergy stock. To survive a motion to dismiss a securities fraud claim
under Rule 10b-5 of the Exchange Act, the Commission must allege facts that, if true, establish
(1) a misstatement or omission (2) of material fact (3) in connection with the purchase of a sale or
security (4) made with scienter. SEC v. Gann, 565 F.3d 932, 936 (5th Cir. 2009). Scienter is defined
as “a mental state embracing intent to deceive, manipulate, or defraud.” Id. The elements required
to establish a claim under Section 17(a) of the Securities Act are essentially the same except
scienter is not required. See SEC v. Evolution Capital, 866 F. Supp. 2d 661, 667 (S.D. Tex. 2011).
Since the Commission must essentially prove the same elements for Section 17(a) and Rule 10b5 violations, the Court will consider these allegations together. See SEC v. Arcturus Corp.,
No. 3:13-cv-4861-k, 2016 WL 1109255, at *14 (N.D. Tex. Mar. 21, 2016).
1. Liability Based upon a Misstatement
A defendant may be liable under Rule 10b-5 and Section 17(a) for either a misstatement or
an omission. The Commission first alleges that Paxton made actionable representations. Paxton
argues, and the Court agrees, that this is purely an omissions case. But the Court will nonetheless
address the Commission’s position. One of these alleged material misstatements includes Paxton’s
assertion that Servergy was a “great company” that presented an “interesting” investment
opportunity. The Commission also bases its material misrepresentation claim on the fact that
Paxton claimed to have personally met with Servergy’s management and that Servergy’s share
price would double before the potential investor returned from vacation. Finally, the Commission
argues that Paxton should be held liable for his post-investment comments in 2013. The Court will
address these statements in turn.
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a. Puffing Statements
The first “misrepresentation” offered by the Commission is Paxton’s assertion that
Servergy was a “great company” that offered an “interesting” investment opportunity. The
Commission also alleges Paxton emailed a potential investor, “this is the company that I told you
I found very interesting.” The Commission alleges these are actionable material misrepresentations
and cites several cases in which factual assertions were found to be actionable. See, e.g., Novak v.
Kansas, 216 F.3d 300, 315 (2d Cir. 2000) (finding defendants’ statement that “the inventory
situation was in ‘good shape’ or ‘under control’” was not puffery when “they allegedly knew that
the contrary was true”); Warshaw v. Xoma Corp., 74 F.3d 955, 959 (9th Cir. 1996) (finding
defendants’ statement that the company was doing “fine” when defendants knew that the revenues
were slowing may, when taken in context, be actionable); Huddleston v. Herman & MacLean,
640 F.2d 534, 544 (5th Cir. 1981), 459 U.S. 375 (1983) (finding a “deliberate misstatement of the
cost anticipated on the basis of known events” was material) rev’d in part. The Court is not
persuaded by these cases because Paxton made no similar deliberately false factual assertions. The
Commission has not alleged—much less with the requisite particularity—that Paxton knew his
statements contained “concrete factual or material misrepresentations.” Southland Sec. Corp.,
365 F.3d at 372; see Fed. R. Civ. P. 9(b). And Fifth Circuit precedent indicates that puffing
statements such as calling something a great company “are the vague and optimistic type that
cannot support a securities fraud action.” Southland Sec. Corp. v. INSpire Ins. Sols., Inc.,
365 F.3d 353, 372 (5th Cir. 2004); Carlucci v. Han, 886 F. Supp. 2d 497, 524 (E.D. Va. 2012)
(calling something a “great investment” is “non-actionable” puffery and “the sort of opinion and
exaggeration that is immaterial as a matter of law”); In re Fleming Cos. Inc. Sec. & Derivative
Litig., No. MDL-1530, 2004 WL 5278716, at *9 (E.D. Tex. June 16, 2004) (internal quotation
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marks omitted) (“Vague, loose optimistic allegations that amount to little more than corporate
cheerleading are puffery . . . and are not actionable under federal securities law.”).
The Commission attempts to revive its material misrepresentation claim by highlighting
Paxton’s relationship with members of the Investment Group. The Commission alleges the context
in which the statements were made render them material. The Commission offers Alpine Bank v.
Hubbell to support this assertion. 555 F.3d 1097, 1106–07 (10th Cir. 2009) (“In determining
whether a statement is puffery, the context matters. . . . What is said to a particular person may
take on meaning that would not be present if made to a large group.”). But the Commission ignores
the holding in that case. In Alpine Bank, a consumer sued a bank over an advertising slogan:
“So . . . you’re about to buy a new home, or build one. You concentrate on your dream. We’ll take
care of everything else.” Id. at 1107. The Tenth Circuit determined “this slogan cannot trigger
liability because it amounts to mere puffery. . . . A reasonable person desiring the Bank to perform
in a particular way would need a more specific assurance than ‘we'll take care of everything else.’”
Id. Here, as in Alpine Bank, a reasonable potential investor would need more specific assurance
than Paxton saying Servergy was a “great company.” While context may be important, the
Commission has not pleaded with particularity any statements amounting to more than mere
puffery that could support a Rule 10b-5 or Section 17(a) securities fraud action under Fifth Circuit
b. Other Alleged Misstatements
The other three communications that the Commission bases its misrepresentation claim on
also fail. The Commission alleges that Paxton told potential investors that he had met with
Servergy’s management but does not allege facts to show that this truthful statement was
misleading. The next alleged “misstatement” is similarly flawed. The Commission claims Paxton
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told an investor that the offering price would double before the individual returned from vacation,
but the Amended Complaint did not allege that the statement was false or misleading. Finally, the
Commission alleges Paxton should be liable for the communications following the investment in
early 2013. But statements following a sale of securities are not made “in connection with the
purchase or sale” of securities. See 15 U.S.C. § 78; Arst v. Stifel, Nicolaus & Co., Inc., 86 F.3d 973,
977 (10th Cir. 1996) (holding that an “allegedly deceptive practice [that] occurred after the sale”
could not “have had an impact on [Plaintiff’s] decision to sell his shares” and thus “was not ‘in
connection with’ the purchase or sale of a security [under] § 10b” (emphasis in original)); Town
North Bank, N.A. v. Shay Fin. Servs., Inc., No. 3:11-CV-3125-L, 2014 WL 4851558, at *25
(N.D. Tex. Sept. 30, 2014) (dismissing securities fraud claim based on post-sale misstatements or
omissions). The Court finds that the Commission has not sufficiently pleaded facts that could
plausibly support a fraud claim based on a material misstatement.
2. Liability Based upon an Omission
The Court has determined that under the facts alleged, Paxton has made no material
misrepresentations to support a plausible claim under Rule 10b-5 and Section 17(a). But Paxton
could also be liable under a fraudulent omissions theory. The Commission alleges that Paxton
violated Rule 10b-5 and Section 17(a) because Paxton had a duty to disclose his compensation yet
failed to do so. In a securities fraud omissions case, the defendant must have a duty to speak to be
found liable. Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164,
174 (1994) (“When an allegation of fraud is based upon nondisclosure, there can be no fraud absent
a duty to speak.” (quoting Chiarella v. United States, 445 U.S. 222, 235 (1980))). Paxton argues
that the fraud claims under Rule 10b-5 and Section 17(a) should be dismissed because the
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Commission has failed to adequately allege Paxton had a duty to disclose his compensation to
a. A Duty to Speak
The Commission alleges generally that Paxton had a duty to inform the potential investors
that he was being paid by Servergy to promote its stock. The Commission has pleaded facts that
show the omission was material because the Complaint alleges the investors would not have
invested had they known Paxton was being paid to promote Servergy’s stock. See TSC Indus. v.
Northway, Inc., 426 U.S. 438, 449 (1976) (explaining that a fact is material if there is a substantial
likelihood that a reasonable investor would consider the information important in making an
investment decision). But the issue in this case is determining whether a duty existed, not whether
the omission was material. “As the Supreme Court explained in Matrixx, whether a defendant
owes a duty to disclose turns on whether the omission renders his statement false or misleading,
not whether the omitted information was material.” In re BP P.L.C. Sec. Litig., 852 F. Supp. 2d
767, 802 (S.D. Tex. 2012) (citing Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (2011)).
While Paxton’s compensation may be material, “[Section] 10(b) and Rule 10b-5(b) do not create
an affirmative duty to disclose any and all material information.” Matrixx, 562 U.S. at 44; see also
Kunzweiler v. Zero.Net, Inc., Civ. A. No. 3:00-CV-2553-P, 2002 WL 1461732, at *9 (N.D. Tex.
July 3, 2002) (“[T]he materiality of the information claimed not to have been disclosed . . . is not
enough to make out a sustainable claim of securities fraud. Even if the information is material,
there is no liability under Rule 10b-5 unless there was a duty to disclose it.”). Thus, to survive this
motion to dismiss on an omissions theory, the Commission must have pleaded with particularity
facts sufficient to show that Paxton had a duty to speak.
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b. The Investment Group’s “Express Policy”
The Commission alleges that Paxton owed a duty to reveal his compensation to his
Investment Group because he was in a relationship of trust. The circuits are split on whether a
fiduciary-like relationship can trigger a duty to speak. Compare United States v. Schiff, 602 F.3d
152, 162–63 (3d Cir. 2010) (rejecting argument that omissions theory of fraud can be premised on
a fiduciary duty to disclose and holding that “[t]his argument reaches too far,” “is not supported
by the language of § 10(b) and Rule 10b-5,” and the “legal support for [the] fiduciary duty theory
is also weak”), with SEC v. Dorozhko, 574 F.3d 42, 49 (2d Cir. 2009) (alterations in original)
(holding that “nondisclosure in breach of a fiduciary duty satisfies § 10(b)’s requirement . . . [of]
a deceptive device or contrivance”). The Fifth Circuit has not addressed this specific issue, but the
Court agrees with another court in this circuit that found a fiduciary relationship triggers a duty to
speak. See, e.g., Kadlec Med. Ctr. v. Lakeview Anesthesia Assocs., No. CIV.A. 04-0997, 2005 WL
1309153, at *4 (E.D. La. May 19, 2005) (“Generally, a duty to disclose information will not exist
absent some confidential, fiduciary, or other special relationship which, under the circumstances
of the case, justifies the imposition of a duty to disclose information.”).
In the Commission’s first round of briefing, it offered SEC v. Kirch to assert that Paxton
owed a duty to his Investment Group to disclose his Servergy compensation. 263 F. Supp. 3d 1144,
1150 (N.D. Ill. 2003). The Court distinguished this case in its Opinion and noted the Original
Complaint did not allege any “express policy” in Paxton’s Investment Group on disclosing
compensation when promoting stocks. The Commission now alleges for the first time in its
Amended Complaint that Paxton owed a duty to reveal his compensation because there were
“express policies” within the Investment Group. Specifically, the Amended Complaint alleges that
the Investment Group had an “established policy and expectation that members participating in an
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investment deal do so on what Investor 1 calls an ‘equal dollar-for-dollar basis,’ in which everyone
takes the same risk and receives the same benefit and that no one member makes money or
otherwise benefits off of the investment of another member.” The Amended Complaint alleges
Investor 1 informed Paxton of these policies and practices. The Commission argues that because
Paxton knew of these express policies, the members of the Investment Group “formed a formal
fiduciary relationship, by agreement or otherwise, and an informal fiduciary relationship of trust
and confidence.” The Commission offers Alexander v. Martin to support this informal fiduciary
theory based on a special relationship of trust and confidence. No. 2:08CV400, 2010 WL 3715165
(E.D. Tex. Aug. 20, 2010). In Alexander, the court found a genuine issue of material fact regarding
the existence of an informal fiduciary relationship where a girl’s uncle previously acted as her
trustee, controlled other aspects of her life, used his position to try to influence her in business and
personal affairs, and approved decisions for purchases of his niece’s home, car and education. Id.
Paxton relies on a number of cases to show that he did not have a fiduciary relationship
with his Investment Group. In U.S. v. Skelly, the court recognized that the jury charge wrongly
“omitted the elements of ‘reliance and de facto control and dominance,’ which are required to
establish a fiduciary relationship.” 442 F.3d 94, 99 (2d Cir. 2006); see also United States v.
Chestman, 947 F.2d 551, 568 (2d Cir. 1991) (internal quotations omitted) (“[A]t the heart of a
fiduciary relationship lies reliance, and de facto control and dominance . . . The relation exists
when confidence is reposed on one side and there is resulting superiority and influence on the
other . . . A fiduciary relationship involves discretionary authority and dependency: One person
depends on another—the fiduciary—to serve his interests.”). The Commission does not allege that
Paxton asserted control or dominance over his investment club members. There are cases from the
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Fifth Circuit, in a different context, supporting Paxton’s position. In Welk v. Simpkins, the Fifth
Circuit held, “Mere subjective trust alone is not enough to transform arms-length dealing into a
fiduciary relationship. Businessmen generally do trust one another.” 402 F. App’x 15, 20
(5th Cir. 2010). Another court in this circuit found that allegations of “subjective trust” and
“personal relationships” are insufficient to establish a fiduciary duty that creates a duty to disclose.
Town N. Bank, N.A. v. Shay Fin. Servs., Inc., No. 3:11-CV-2135-L, 2014 WL 4851558, at *18,
*27 (N.D. Tex. Sept. 30, 2014).
The Commission’s allegations of the Investment Group’s express policies and practices do
not give rise to a fiduciary relationship. Unlike Alexander, Paxton had no family relationship, did
not control other aspects of the investors’ lives, and did not use his position to try to influence the
investors’ business and personal affairs. 2010 WL 3715165, at *12. Courts “do not create such a
relationship lightly,” and the relationship must be “mutual and understood as such by both parties.”
Id. at *10. Even if Paxton were aware of the alleged policies, the Commission has not pleaded
facts indicating that Paxton agreed to abide by them. Because “[a] fiduciary duty cannot be
imposed unilaterally,” the Commission has not pleaded with particularly a set of facts that give
rise to a plausible duty to disclose. Chestman, 947 F.2d at 567; In re Enron Corp., 610 F. Supp. 2d
at 649 (holding that “unilateral expectations . . . do not give rise to . . . a duty to disclose”). The
Court finds that a securities fraud claim based on a fiduciary duty theory is not plausible. 2
The Commission attempts to revive its fiduciary argument by introducing the Texas state
law definition of fiduciary duty and arguing that it should apply here. The Court is hesitant to
The Commission also cites Aubrey v. Barlin to assert that a duty to disclose exists between parties who have a special
relationship of trust and confidence. 159 F. Supp. 3d 752 (W.D. Tex. 2016). In Aubrey, the court refused to recognize
a fiduciary duty because “prior arms-length transactions between the parties—those transactions that are entered into
for the independent benefit of each party—do not create a basis for a fiduciary relationship. Id. at 761. The court also
explained that “not every relationship involving a high degree of trust and confidence rises to the stature of a formal
fiduciary relationship. The standard for the formation of an informal fiduciary relationship is high, and courts do not
create such a relationship lightly.” Id. (internal quotations and citations omitted).
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analyze the present case under Texas state law, as the Fifth Circuit has not determined whether it
is proper to apply state law to federal securities fraud claims. The federal circuits are currently
split. The Second Circuit has adopted Whitman, which states where “the issue is a duty to disclose,
federal law must be paramount or the goal of the 1934 Act to assure transparency in the markets
would be severely compromised depending on the vagaries of individual states’ laws and policies.”
United States v. Whitman, 904 F. Supp. 2d 363, 370 (S.D.N.Y. 2012), aff’d, 555 F. App’x 98
(2d Cir. 2014); see Steginsky v. Xcelera Inc., 741 F.3d 365, 371 (2d Cir. 2014) (adopting Whitman
and finding the “duty springs from federal law, and that looking to idiosyncratic differences in
state law would thwart the goal of promoting national uniformity in securities markets.”).
Conversely, the Fourth Circuit has held that the “federal securities laws do not give rise to a duty
to disclose; rather, the duty to disclose material facts arises only where there is some basis outside
the securities laws, such as state law, for finding a fiduciary or other confidential relationship.”
Mueller v. Thomas, 84 F. App’x 273 (4th Cir. 2003). The Court agrees with the Second Circuit’s
reasoning, especially considering the ample volume of federal common law that has developed on
the duty to disclose in federal securities fraud litigation. See Chiarella, 445 U.S. at 228; Welk,
402 F. App’x at 20; Skelly, 442 F.3d at 98; Kirch, 263 F. Supp. 2d at 1144.
Even if the Court was convinced that Texas rather than federal common law should govern
the Court’s determination of whether Paxton violated federal securities laws, the Commission has
not sufficiently pleaded facts supporting a fiduciary relationship under Texas law. As under
federal law, a fiduciary relationship “exists only to the extent that the parties do not deal with each
other equally, either because of dominance on one side or weakness, dependence, or justifiable
trust on the other.” Pope v. Darcy, 667 S.W.2d 270, 275 (Tex. App.—Houston [14th Dist.] 1984,
writ ref’d n.r.e.). The Commission has not alleged dominance, weakness, or dependence; rather, it
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argues the Investment Group trusted Paxton to disclose his compensation. Yet the Supreme Court
of Texas has determined that fiduciary relationships do not arise from “mere subjective trust
alone.” Thigpen v. Locke, 363 S.W.2d 247, 253 (Tex. 1962). Federal securities law also makes
clear that a fiduciary or similar relationship of trust and confidence requires “influence of a
superior or dominating nature—not the ‘influence’ one peer might exert on another.” United States
v. Kim, 184 F. Supp. 2d 1006, 1011 (N.D. Cal. 2002); see also Chestman, 947 F.2d at 568;
Kornman, 391 F. Supp. 2d at 488. The “reliance” present in a “fiduciary relationship involves
discretionary authority and dependency.” Chestman, 947 F. 2d at 569 (emphasis added);
Kornman, 391 F. Supp. 2d at 487. Because Texas courts “do not create such . . . relationship[s]
lightly,” the Commission’s subjective trust argument is too thin a reed on which to base a federal
securities lawsuit. Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 177 (Tex. 1997).
c. The S3 Group
The Commission alleges that Paxton had a duty to disclose his compensation to members
of the S3 Group. The Commission claims Paxton formed a fiduciary relationship with S3 Group
members because he served as their attorney in forming two S3 entities. There are two issues with
these allegations. First, the Amended Complaint nowhere alleges that Paxton’s compensation was
material to any member of this S3 Group. More importantly, there is no allegation that Paxton was
serving as legal counsel to the S3 Group with regard to the Servergy investment. See Joe v. Two
Thirty Nine Joint Venture, 145 S.W.3d 150, 159–60 (Tex. 1998) (holding that a lawyer’s fiduciary
“duty to inform does not extend to matters beyond the scope of the relationship” and “a lawyer’s
fiduciary duties to a client, although extremely important, extend only to dealings within the scope
of the underlying relationship of the parties.”). The Court finds the Commission has not pleaded
sufficient facts to show Paxton had a duty to disclose his commissions to S3 Group members.
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3. Liability Based upon a Half-Truth
The Commission alleges that Paxton is liable under a half-truth theory. Absent an
independent duty to disclose, omissions are actionable when the defendant elects to disclose some
material facts, but fails to speak the whole truth. See First Va. Bankshares v. Benson,
559 F.2d 1307, 1314 (5th Cir. 1977) (recognizing that certain statements made will be materially
misleading if the defendant has concealed the fact that he has been compensated for promoting
securities). The Commission takes the position that every statement Paxton made encouraging the
Investment Group members to invest was a materially misleading half-truth. But the rule of
disclosure is “not as absolute as one might gather after reading First Virginia Bankshares. The
Fifth Circuit most likely would agree that a more precise statement of the rule is that a duty to
speak the full truth on a particular subject arises when a defendant undertakes to say anything on
that particular subject.” McNamara v. Bre-X Minerals Ltd., 57 F. Supp. 2d 396, 416 (E.D. Tex.
1999) (emphasis in original).
To survive a motion to dismiss under this theory, the Commission would have to identify
a statement made by Paxton regarding his compensation that was materially misleading. See id.;
SEC v. Curshen, 372 F. App’x 872, 880 (10th Cir. 2010) (emphasis added) (“Where a party without
a duty elects to disclose material facts, he must speak fully and truthfully, and provide complete
and non-misleading information with respect to the subjects on which he undertakes to speak.”);
Kunzweiler, 2002 WL 1461732, at *11 (emphasis added) (“[T]he Court must determine whether
the alleged material omissions could have rendered any identified affirmative statement or
statements made by the defendants misleading under any set of facts.”).
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The Commission offers SEC v. Gabelli to argue that literally true statements can create a
materially misleading impression. 653 F.3d 49, 57 (2d Cir. 2011), rev’d on other grounds, 133 S.
Ct. 1216 (2013). While this may be an accurate statement of law, the Commission has not
“identif[ied] which specific statements made by [Paxton] would qualify as misleading half-truths
such that the bonus commissions would constitute a material omission under subsection (b).” U.S.
v. Laurienti, 611 F.3d 530 (9th Cir. 2010). The Commission does not show how any particular
statement created a materially misleading impression. Rather, the Commission essentially argues
that any statement about Servergy made by Paxton to the Investment Group would qualify as a
material half-truth because he violated an “express policy” to not personally benefit more than the
other members from the Investment Group. But the half-truth theory of liability requires the
omission to be on the same topic as the statement made. See McNamara, 57 F. Supp. at 416; see
also Meyer v. Jinkosolar Holdings Co., 761 F.3d 245, 250 (2d Cir. 2014); FindWhat Investor Grp.
v. FindWhat.com, 658 F.3d 1282, 1305 (11th Cir. 2011); SEC v. Curshen, 372 F. App’x at 880; In
re K-Tel Int’l, Inc. Sec. Litig., 300 F.3d 881, 898 (8th Cir. 2002).
The Commission disagrees with these cases, claiming they “promote an impossible rule
under which he could only be liable for failing to disclose his compensation if he first disclosed
his compensation” (Dkt. #45 at p. 10). But this is not so. Paxton could be found liable under a halftruth theory of liability if he partially disclosed but materially understated his compensation; for
example, if Paxton informed his Investment Group that he was only receiving cash for promoting
Servergy when in reality he was receiving cash and stock. As its name suggests, half-truth liability
requires the declarant to actually speak about a topic to be found liable for omitting the remainder
of the truth. Because the Commission has not identified any statement about compensation, Paxton
cannot be found liable on a half-truth theory of liability.
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4. Liability Based upon General Fraudulent Conduct
The Commission broadly alleges that Paxton’s conduct constituted a fraudulent scheme
under Sections 17(a)(1), (3) and Rules 10b-5(a), (c). These scheme liability code sections focus on
acts and conduct rather than a misstatement or omission. The Commission offers several cases in
which courts have found scheme liability under these code sections for certain conduct. See, e.g.,
In re Smith Barney Transfer Agent Litig., 884 F. Supp. 2d 152, 161 (S.D.N.Y. 2012) (finding
scheme liability where Defendants created an in-house transfer agent to conceal a scheme designed
to channel transfer agent cost savings away from the funds). This “scheme liability theory [is]
recognized by a few courts . . . but not by the Fifth Circuit, itself, which, . . . limit[s] the reach of
§ 10(b) and Rule 10b-5 to a material misrepresentation or omission where there is a recognized
duty to disclose.” In re Enron Corp. Sec., Derivative & ERISA Litig., 586 F. Supp. 2d 732, 793
(S.D. Tex. 2008) (citing Regents of Univ. of Cal. v. Credit Suisse First Bos. (USA), Inc.,
482 F.3d 372, 384 (5th Cir.2007) (“‘[D]eception’ within the meaning of § 10(b) requires that a
defendant fail to satisfy a duty to disclose material information to a plaintiff.”), cert. denied,
552 U.S. 1170 (2008); Greenberg v. Crossroads Systems, Inc., 364 F.3d 657, 661 (5th Cir. 2004)).
And other “[c]ourts have not allowed subsections (a) and (c) of Rule 10b-5 to be used as a ‘back
door into liability for those who help others make a false statement or omission in violation of
subsection (b) of Rule 10b-5.’” Id. (citing SEC v. Kelly, 817 F. Supp. 2d 340, 343 (S.D.N.Y. 2011)
(quoting In re Parmalat Sec. Litig., 376 F. Supp. 2d 472, 503 (S.D.N.Y. 2005)). Here, the
Commission bases its fraud allegations primarily on Paxton’s failure to disclose his compensation.
The Commission may not use subsections (a) and (c) of Rule 10b-5 as a back door for liability.
See Regents of Univ. of Cal., 482 F.3d at 384 (holding that § 10(b) requires that a defendant fail to
satisfy a duty to disclose and “[m]erely pleading that a defendant failed to fulfill that duty by means
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of a scheme or an act, rather than by a misleading statement” is insufficient to support a securities
It is clear that the Fifth Circuit requires a breach of a duty to disclose to be liable under
Rule 10b-5. See Regents of Univ. of Cal. 482 F.3d at 384; In re Enron Corp., 586 F. Supp. 2d at
793. But the Commission argues that the Fifth Circuit has only considered Section 10(b) in
precluding scheme liability theories based on omissions; thus, these cases have no bearing on
Section 17(a) scheme liability claims. The Court is not convinced. Claims arising under Section
17(a) and Rule 10b-5 are often “analyzed as one” because the basic precepts are the same. SEC v.
Helms, No. A–13–CV–01036 ML, 2015 WL 5010298, at *1 (W.D. Tex. Aug. 21, 2015). The
primary difference between Section 17(a) and Rule 10b-5 is that Rule 10b-5 applies only to acts
occurring in connection with the “purchase or sale” of securities while Section 17(a) applies to any
“offer or sale.” SEC v. Spence & Green Chem. Co., 612 F.2d 896, 903 (5th Cir. 1980); see SEC v.
Tex. Gulf Sulphur Co., 401 F.2d 833, 884 (2d Cir. 1968) (noting that “[t]he only difference of
substance between § 17(a) and Rule 10b-5 is that the latter applies to purchasers as well as sellers.”
(citing Ellis v. Carter, 291 F.2d 270, 272–274 (9th Cir. 1961)); SEC Rel. No. 3230 (May 21, 1942)
(“The new rule closes a loophole in the protection against fraud administered by the Commission
by prohibiting individuals or companies from buying securities if they engage in fraud in their
The Commission attempts to stretch Section 17(a) further, arguing that “Section 17(a)(3)
is broader than Rule 10b-5(c) at least insofar as 17(a)(3) does not require Paxton to have engaged
in conduct that was itself deceptive but rather only which ‘operated or would operate as a fraud’”
(Dkt. #47 at pp. 2–3) (emphasis in original). But the Commission ignores that this same
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language—operated or would operate as a fraud—appears in Rule 10b–5(c). 3 Section 17(a) merely
extends Rule 10b-5 liability to cover both buyers and sellers, offering and selling securities.
Section 17(a) does not give the Commission carte blanche to prescribe liability where Rule 10b-5
falls short. In omissions cases, the Fifth Circuit requires a duty to disclose to be found liable under
Rule 10b-5. See In re Enron, 586 F. Supp. 2d at 793 (holding that the Fifth Circuit does not
recognize scheme liability in omissions cases under Rule 10b-5 absent a recognized duty to
disclose). There is no authority to suggest that this Court should stretch Section 17(a) beyond its
scope to find Paxton liable under a scheme theory absent a recognized duty to disclose.
B. Fraud Under Section 17(b) of the Securities Act 4
The Commission alleges that Paxton defrauded investors under Section 17(b) of the
Securities Act by circulating communications describing securities without disclosing his
compensation arrangement. Section 17(b) provides:
It shall be unlawful for any person, by the use of any means or instruments of
transportation or communication in interstate commerce or by the use of the mails,
to publish, give publicity to, or circulate any notice, circular, advertisement,
The Commission further argues that Section 17(a) is broader because Rule 10b-5 requires a “deceptive” device—
language that is not found in Section 17(a). But the operative language of Section 17(a) and Rule 10b–5 is the same.
Compare 15 U.S.C. § 77q(a)(1) (“to employ . . . any device, scheme or artifice to defraud”), with 17 C.F.R. § 240.10b–
5(a) (“to employ . . . any device, scheme, or artifice to defraud”). The only place “deceptive” appears is in the heading
of Rule 10b-5. A “heading is but a short-hand reference to the general subject matter involved . . . But headings and
titles are not meant to take the place of the detailed provisions of the text . . . For interpretative purposes, they are of
use only when they shed light on some ambiguous word or phrase. They are but tools available for the resolution of a
doubt. But they cannot undo or limit that which the text makes plain.” Bhd. of R.R. Trainmen v. Baltimore & O.R.
Co., 331 U.S. 519, 528–29 (1947). There is no such ambiguity here, as the text of the statute is clear. Even if the
statute were ambiguous, the Court would find in favor of the defendant under the rule of lenity. See United States v.
Bustillos-Pena, 612 F.3d 863, 868–69 (5th Cir. 2010) (applying rule of lenity to ambiguous provision). The rule of
lenity dictates that any ambiguity in a statute should be construed in favor of the defendant. The fraud provisions of
the federal securities laws at issue here can be prosecuted criminally, see 15 U.S.C. §§ 77x, 78ff, and the rule of lenity
applies in the civil context when interpreting statutes that also have criminal applications. See Kasten v. Saint-Gobain
Performance Plastics Corp., 563 U.S. 1, 16 (2011) (“[W]e have said that the rule of lenity can apply when a statute
with criminal sanctions is applied in a noncriminal context.”); Leocal v. Ashcroft, 543 U.S. 1, 11–12 n.8 (2004)
(“Because we must interpret the statute consistently, whether we encounter its application in a criminal or noncriminal
context, the rule of lenity applies.”).
The Commission provides no new facts or legal authority in its Amended Complaint or briefing on its Section 17(b)
claim. As such, this section of the opinion will utilize authorities provided in the Original Complaint’s briefing.
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newspaper, article, letter, investment service, or communication which, though not
purporting to offer a security for sale, describes such security for a consideration
received or to be received, directly or indirectly, from an issuer, underwriter, or
dealer, without fully disclosing the receipt, whether past or prospective, of such
consideration and the amount thereof.
15 U.S.C. § 77(q). Paxton argues that the Commission’s Section 17(b) claim fails because Paxton
did not receive consideration for publishing, publicizing, or circulating any communications
describing securities. The Amended Complaint identifies two communications that require
analysis under Section 17(b). 5 The Court will analyze these communications in turn.
1. The Promotional Email
The Commission first alleges that Paxton violated Section 17(b) by forwarding one of
Mapp’s promotional emails to a potential investor on July 23, 2011.
a. Quid Pro Quo
In Paxton’s briefing following the Original Complaint, he argued the claim failed as to the
email because the potential investor did not invest, and therefore Paxton did not earn a sales
commission for that communication. Section 17(b) requires disclosure of compensation from an
issuer only if that compensation is received (i) as a quid pro quo (ii) for a communication
describing a security (iii) that is published or circulated by the means of interstate commerce.
United States v. Amick, 439 F.2d 351, 365 (7th Cir. 1971). The Commission argued that the quid
pro quo was the 100,000 shares Paxton received for his recruiting efforts. But the Amended
Complaint only alleges that Paxton was paid for his successful recruiting efforts. 6 Thus there was
The Commission argued in the original briefing that a third communication, a face-to-face meeting with Investor 1,
could serve as a basis for liability under Section 17(b). The plain language of the statute does not support this theory.
15 U.S.C. §77(q) (“[B]y the use of any means . . . of interstate commerce”).
At oral argument, the Commission argued that the statute calls for consideration “received or to be received,” but
the Amended Complaint does not allege that Paxton received or would ever receive any compensation for his
unsuccessful attempt to recruit the email recipient.
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no quid pro quo for the communication identified, as the email recipient never invested with
Servergy. See Amick, 439 F.2d at 365 (finding violation where defendant “published the article in
return for the promise of payment” (emphasis added)).
The Commission offered SEC v. Gagnon to assert that the Commission needed not prove
that Paxton successfully secured investments for Servergy; rather, Paxton needed only to have an
agreement to receive consideration to be liable under Section 17(b). No. 10-cv-11891, 2012 WL
994892 (E.D. Mich. Mar. 22, 2012). The Commission’s prior briefing purported that the Gagnon
court based its holding solely on the fact that the defendant had a compensation agreement with
an issuer. Yet the court found the defendant liable for not fully disclosing the nature of his
agreement after electing to disclose on his website that he would “earn commissions on the money
that I bring in, but I will hardly get rich.” Id. at *11. In reality, he received over $3 million for his
promotional efforts and the court held the defendant liable for not “fully disclos[ing]” the nature
of his arrangement. Id. (emphasis in original). The Amended Complaint does not allege that Paxton
elected to publicly disclose his compensation agreement, so Gagnon is inapplicable. The July 23,
2011 email cannot serve as a basis for a fraud claim because the Commission did not allege Paxton
was ever paid—or ever would be paid—for sending the email.
b. Due Diligence
The Amended Complaint alleges that Paxton failed to conduct due diligence on Servergy’s
claims before forwarding the promotional email but does not allege that Paxton had a duty to do
so. Even if the Commission had alleged such a duty, courts have held that failure to conduct due
diligence on a promoted stock does not give rise to liability. See SEC v. Tambone, 597 F.3d 436,
488 (1st Cir. 2010) (en banc) (“[W]e reject the SEC’s notion that a breach of a duty to investigate,
without more, is a breach of a duty to disclose.”); United States v. Schiff, 602 F.3d 152, 167
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(3d Cir. 2010) (“[T]he plain language of § 10(b) and Rule 10b-5 do not contemplate the general
failure to rectify misstatements of others”); Brown v. J.P. Turner & Co., No. 1:09-CV-2649-JEC,
2011 WL 1882522, at *4 (N.D. Ga. May 17, 2011) (dismissing Section 10(b) claim, observing that
“Plaintiffs do not cite any authority to suggest that a broker has the duty . . . to ensure the accuracy
of investment materials”). The Court finds that the Commission has not sufficiently pleaded facts
to support that Paxton had a duty to conduct due diligence with respect to the veracity of the
promotional email. More importantly, the Court has determined that the email may not serve as a
plausible basis for liability under Section 17(b) because the Amended Complaint does not allege
facts indicating that Paxton was paid or will be paid for his unsuccessful attempt to solicit the email
2. The Phone Call with Investor 2
The other communication upon which the Commission bases its Section 17(b) allegation
is Paxton’s phone call with Investor 2. Paxton argued that the Original Complaint failed because
there was no broad dissemination of the communication and the communication was not recorded.
Paxton supported his position by pointing out that there are no cases holding a defendant liable
under Section 17(b) for placing phone calls to potential investors, but this fact is not dispositive.
The Commission argued that any oral communication is sufficient to allege a Section 17(b)
violation and that broad dissemination is not required.
The Commission offered SEC v. Liberty Capital Group, Inc. to assert that Paxton did not have to be directly
compensated for the email to be found liable under Section 17(b). 75 F. Supp. 2d 1160 (W.D. Wash. 1999). But the
Amended Complaint does not allege facts to show that Paxton received or ever would receive compensation for his
unsuccessful attempt, so the method in which he would receive payment is irrelevant to the analysis.
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a. Recorded Communication
Because there are no cases under Section 17(b) on phone calls, the Court must look to the
text of the statute. Paxton’s position is that Section 17(b) is limited to the publication or circulation
of recorded communications because “communication” is found at the end of a list of recorded
communications. Paxton cited the Supreme Court’s reliance upon the noscitur a sociis canon of
statutory interpretation as a basis for his argument. See Yates v. United States, 135 S. Ct. 1074,
1085 (2015) (internal quotation marks omitted) (stating courts must rely on the “principle of
noscitur a sociis—a word is known by the company it keeps—to avoid ascribing to one word a
meaning so broad that it is inconsistent with its accompanying words, thus giving unintended
breadth to the Acts of Congress”). Paxton argued that under this canon, “communication” should
be interpreted narrowly because it accompanies a list of recorded communications. 8
The Commission did not offer any canons of statutory interpretation but argued that
“communication” should be interpreted broadly to include any oral communications. See
Communication, Black’s Law Dictionary (7th ed. 1999) (defining communication as “the
expression or exchange of information by speech, writing, or gestures”). But words in statutes
should not be interpreted in isolation, ignoring important contextual information. Deal v. United
States, 508 U.S. 129, 132 (1993) (recognizing the “fundamental principle of statutory construction
(and, indeed, of language itself) that the meaning of a word cannot be determined in isolation, but
must be drawn from the context in which it is used”).
Paxton also pointed to the legislative history of the Securities Act to show that Section 17(b) was not drafted to
prohibit oral communications. Committee on Interstate & Foreign Commerce, H.R. Rep. No. 73–85, at 24 (1933)
(explaining that Section 17(b) was “particularly designed to meet the evils of the ‘tipster sheet’ as well as articles in
newspapers or periodicals that purport to give an unbiased opinion”). However, this approach is unnecessary and
inappropriate for the Court because “[o]nly after we apply principles of statutory construction, including the canons
of construction, and conclude that the statute is ambiguous, may we consult legislative history.” In re Amy Unknown,
701 F.3d 749, 759–60 (5th Cir. 2012) (citing Carrieri v. Jobs.com, Inc., 393 F.3d 508, 518–19 (5th Cir. 2004)). The
statute is not ambiguous after applying principles of statutory construction.
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The Commission attempted to bolster its position by pointing to a case in which a court
found liability under Section 17(b) for communications that included an oral statement. The
Commission cited United States v. Wenger, where the Tenth Circuit held the defendant liable for
publicizing a stock by newsletter and orally through a radio program. 427 F.3d 840, 850
(10th Cir. 2005). The court found the defendant liable because “investors—such as the listeners to
[defendant’s] radio program and readers of his newsletter who testified in this case—base their
decisions whether to buy a stock in part on whether various opinions about the product are selfserving or not.” Id. Because the court did not indicate whether the radio program alone was
sufficient for liability, the Commission cannot use this case to show that an unrecorded single
phone call is sufficient to trigger liability under Section 17(b).
The Court agrees with Paxton’s interpretation of Section 17(b) but utilizes an additional,
more specific contextual canon—ejusdem generis. The Supreme Court has recognized the utility
of the principle of ejusdem generis and explained, “When a general term follows a specific one,
the general term should be understood as a reference to subjects akin to the one with specific
enumeration.” Norfolk & W. Ry. Co. v. Am. Train Dispatchers Ass’n, 499 U.S. 117, 129 (1991).
Here, the term “communication” follows a list of tangible media, including circulars,
advertisements, newspapers, articles, and letters. Thus, the term “communication” should not be
interpreted so broadly as to include all unrecorded forms of communication. To hold otherwise
would be contrary to longstanding Supreme Court and Fifth Circuit precedent on this established
canon of statutory interpretation. See McBoyle v. United States, 283 U.S. 25, 25–27 (1931)
(utilizing the ejusdem generis principle in determining that “automobile, automobile truck,
automobile wagon, motor cycle, or any other self-propelled vehicle not designed for running on
rails” did not apply to an airplane); United States v. Kaluza, 780 F.3d 647, 657 (5th Cir. 2015)
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(utilizing the ejusdem generis principle in determining that “[e]very captain, engineer, pilot, or
other person employed on any steamboat or vessel” only applied to other persons conducting
“marine” employment functions). Finally, had the legislature intended the statute to cover all
unrecorded communications, it could have drafted the statute more broadly. See 15 U.S.C. § 77(w)
(providing it is unlawful “to make . . . any representation”); 15 U.S.C. § 77(x) (providing it is
unlawful if a person “makes any untrue statement”); 15 U.S.C. § 77l(a)(2) (providing it is unlawful
to offer or sell securities “by means of a[n]…oral communication, which includes an untrue
statement”) (emphases added). The Court finds that the phone call was not a recorded
communication as required under the federal securities laws. Thus, the Commission has failed to
allege facts that could plausibly support a violation of Section 17(b) based on the phone call to
b. Broad Dissemination
The Court has found that the Commission has failed to allege facts that could plausibly
support a violation of Section 17(b) based on either the promotional email or the phone call to
Investor 1. But the parties spent a considerable portion of their prior briefing arguing whether a
communication must be broadly disseminated to serve as a basis for liability under Section 17(b).
It is clear that the phone call to Investor 2 was not broadly disseminated—Paxton called a single
potential investor. Since the Fifth Circuit has not expressly ruled on whether broad dissemination
is required, the Court must look to the text of the statute. The statute provides that it shall be
unlawful for any person, “by the use of any means or instruments of transportation or
communication in interstate commerce or by the use of the mails, to publish, give publicity to, or
circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or
communication” describing a security without disclosing compensation. 15 U.S.C. §77(q). The
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ordinary, contemporary, common meanings of the words “publish,” “give publicity to,” and
“circulate” do not connote a private, singular communication with one intended recipient. See
Buzek v. Pepsi Bottling Grp., Inc., 501 F. Supp. 2d 876, 880 (S.D. Tex. 2007) (“It is of course a
truism that statutory construction begins with the ‘ordinary, contemporary, common meaning’ of
the words of the statute.”) (quoting Williams v. Taylor, 529 U.S. 420, 432 (2000)). “Publish” is
defined, “To distribute copies (or a work) to the public.” Publish, Black’s Law Dictionary (9th ed.
2009). Similarly, “publicity” is defined as “public attention; notoriety.” Publicity, Black’s Law
Dictionary (9th ed. 2009). The plain language of the statute does not lend itself to application to a
single phone call because the publicity element is absent. 9 Black’s does not define “circulate,” but
Webster’s defines it as “to pass from person to person” or “to come into the hands of readers.”
Webster’s New Collegiate Dictionary (1st ed. 1977). No one in common parlance refers to a single,
person-to-person telephone call as “circulating” a communication. See Bond v. United States,
134 S. Ct. 2077, 2090 (2014) (rejecting government’s statutory interpretation, reasoning that “no
speaker in natural parlance” would use the statutory term at issue to describe the defendant’s
Importantly, all of the cases in other circuits holding a defendant liable under Section 17(b)
have involved broadly disseminated and recurring publications. See Amick, 439 F.2d at 365
(finding violation where a defendant published a weekly article, Indiana Investor and Business
News, that was frequently utilized by numerous Indiana investors); Liberty Capital Grp., Inc., 75
F. Supp. 2d at 1161–62 (finding SEC adequately pleaded violation where it claimed that defendant
violated Section 17(b) “by publishing favorable accounts of publicly-traded companies in a
At oral argument, the Commission argued that the Court would have to draw a line regarding how broadly a
communication must be disseminated to trigger liability under Section 17(b). But the Court does not have to draw
such a line because the communications alleged—a single phone call and a single email—are decidedly not broadly
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newsletter and on the Internet” over a period of two years); Ginsburg v. Agora, Inc.,
915 F. Supp. 733, 736–37 (D. Md. 1995) (noting that defendants, as authors and publishers of an
investment newsletter, were “certainly within the class of persons potentially liable” under Section
17(b) where they “marketed [the newsletter] to the general public and, in May of 1993 . . . sent
[the newsletter] to between 6,800 and 7,200 subscribers”). While the Court need not determine
how broadly a communication must be disseminated to trigger liability under Section 17(b), the
Court finds that Section 17(b) does not cover a single phone call to one investor. The same
reasoning may be applied to the single-recipient promotional email.
The Commission has failed to allege that Paxton “published, gave publicity to, or
circulated” any recorded communication describing a security. The promotional email allegation
is deficient because the Amended Complaint does not allege that Paxton was paid or would be
paid for his unsuccessful recruiting effort, and the phone call allegation is deficient because the
call was not a recorded communication. 10 Thus the Court finds the Amended Complaint does not
allege facts to support a plausible claim under Section 17(b).
C. Failing to Register Under Section 15(a) of the Exchange Act 11
The Amended Complaint’s final allegation against Paxton is that he was required to register
as a broker but failed to do so. Section 15(a)(1) provides that it shall be unlawful to make use of
the mails or any means or instrumentality of interstate commerce to effect any transactions in, or
to induce or attempt to induce the purchase or sale of, any security unless such broker is registered.
15 U.S.C. § 78(o). The Exchange Act defines a broker as a person “engaged in the business of
Neither communication was broadly disseminated, but this is not the basis for the Court’s holding.
The allegations about Section 15(a) are the same as the Original Complaint except the Commission expands on
Paxton’s previous work as an investment adviser representative for Mowery Capital in the Amended Complaint. An
investment adviser is distinct from a broker under federal securities law. 15 U.S.C. § 80b-2(a)(11).
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effecting transactions in securities for the account of others.” 15 U.S.C. § 78c(a)(4). Paxton claims
that he was not acting as a broker as defined under the Exchange Act and thus did not have to
register with the Commission.
Paxton argues that the Section 15(a) claim should be dismissed because the Commission
fails to allege that Paxton “effected transactions” in securities “for the account of others.”
Specifically, Paxton argues that he did not actually handle securities, enter trades, or otherwise
exert any authority over anyone’s account. The Commission claims it does not have to allege that
Paxton had actual authority or control over his clients’ accounts or assets. The Commission
believes that control over accounts is merely a factor in determining whether a person is acting as
a broker. Paxton argues that control is an essential element under the statutory definition of
The Court must look to case law to determine which interpretation is correct, as the
Exchange Act does not directly define what is required to “engage in the business” of effecting
transactions “on the account of others.” Several courts have approached this issue by
distinguishing brokering activities from facilitating securities transactions. In SEC v. Kramer, the
Commission alleged that the defendant acted as an unregistered broker in violation of Section 15(a)
where he received transaction-based commissions for actively soliciting “intimate friends and
family” over a period of two years. 778 F. Supp. 2d 1320 (M.D. Fla. 2011). The court determined
that the defendant had acted as a facilitator rather than a broker because his conduct “consisted of
nothing more than bringing together the parties to a transaction,” and the Commission presented
no evidence of the defendant possessing “authority over the accounts of others.” Id. at 1339.
Similarly, in SEC v. M&A West, Inc., the court was unwilling to classify the defendant as
an unregistered broker where he was paid to facilitate securities transactions without actually
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controlling the accounts of others. No. C-01-3376 VRW, 2005 WL 1514101, at *9 (N.D. Cal. June
20, 2005). The court concluded, “In particular, no assets were entrusted to [defendant], and the
Commission identifies no evidence that he was authorized to transact ‘for the account of
others’ . . . Although [defendant] was in the business of facilitating securities transactions among
other persons, the Commission cites no authority for the proposition that this equates to ‘effecting
transactions in securities for the account of others.’” Id. at *9.
The Kramer and M&A West cases suggest that control over the account of others is an
element rather than a factor. The Commission offers a case that does not rely on control of accounts
as dispositive; rather, it utilizes a fact-intensive broker versus finder distinction to determine
whether an individual must register with the Commission. See SEC v. Offill, No. 3:07-cv-1643-D,
2012 WL 246061 (N.D. Tex. Jan. 26, 2012). In Offill, the court noted the,
distinction drawn between the broker and finder or middleman is that the latter
bring[s] the parties together with no involvement on [his] part in negotiating the
price or any other terms of the transaction . . . A finder, however, will be
performing the functions of the broker-dealer, triggering registration requirements,
if activities include: analyzing the financial needs of an issuer, recommending or
designing financial methods, involvement in negotiations, discussion of details of
securities transactions, making investment recommendations, and prior
involvement in the sale of securities.
Id. at *7.
The Commission also offers SEC v. Helms, in which the court found the defendant did
more than simply introduce the investor to sellers, triggering a registration requirement. No. A-13CV-01036, 2015 WL 6438872 (W.D. Tex. Oct. 20, 2015). In Helms, the “[investor] and
[defendant] exchanged multiple email communications concerning the . . . investment” and “[the
defendant] conveyed [the investor’s] questions about the investment to Sellers.” Id. at 3. The
Commission has not alleged that Paxton performed any of the functions identified in these cases,
such as answering any investors’ questions or otherwise doing more than introducing the investors
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to Mapp. The Commission alleges that offering to answer potential investors’ questions was
sufficient to trigger a registration requirement under Helms.
The Court disagrees with the Commission’s position and finds that Paxton was merely
facilitating securities transactions rather than performing the functions of a broker. Here, as in
Kramer, the Commission presented no evidence of Paxton possessing “authority over the accounts
of others.” See Kramer, 778 F. Supp. 2d at 1339. The Commission failed to allege that assets were
entrusted to Paxton or that he was authorized to transact for the account of others. See M&A West,
2005 WL 1514101, at *9. Further, Paxton did not transcend his role as a finder because he did not
perform the functions identified in Offill. 2012 WL 246061, at *8. Paxton was neither involved in
negotiating the price or terms of the transaction nor was he performing any of the other functions
of the broker-dealer. See id. Although Paxton had prior involvement in the sale of securities during
his tenure as a registered broker, this factor alone is not enough to classify Paxton as a brokerdealer rather than a finder. See id. The Court finds that the Amended Complaint has insufficient
facts to support a plausible claim under Section 15(a) of the Exchange Act.
This case has not changed since the Court conditionally dismissed the Commission’s
Original Complaint. The primary deficiency was, and remains, that Paxton had no plausible legal
duty to disclose his compensation arrangement with investors. The question before the Court is
not whether Paxton should have disclosed his compensation arrangement but whether Paxton had
a legal duty under federal securities law to disclose. As alleged, Paxton’s conduct simply does not
give rise to liability under the federal securities laws as they exist today. And it is not the province
of the Court to stretch federal securities laws beyond their scope to prescribe liability based on
moral considerations or policy concerns. The only issue before the Court is to determine whether
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the facts as pleaded give rise to a plausible claim under federal securities laws. With that limitation
in mind, the Court has determined that under the facts pleaded by the Commission in the Amended
Complaint, Paxton did not have a legal obligation to disclose his financial arrangement.
The Court finds that the Amended Complaint has not alleged facts sufficient to support a
plausible claim under Sections 17(a) and 17(b) of the Securities Act or Sections 10(b) and 15(a)
of the Exchange Act.
It is therefore ORDERED that Defendant Warren K. Paxton, Jr.’s Motion to Dismiss (Dkt.
#44) is hereby GRANTED and Plaintiff’s claims against Defendant Warren K. Paxton, Jr. are
DISMISSED with prejudice.
SIGNED this 2nd day of March, 2017.
AMOS L. MAZZANT
UNITED STATES DISTRICT JUDGE
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