Sun River Energy Inc v. McMillan et al

Filing 99

Memorandum Opinion. (Ordered by Judge Sidney A Fitzwater on 3/25/2015) (ykp)

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF TEXAS
DALLAS DIVISION
SUN RIVER ENERGY, INC.,
Plaintiff,
VS.
HARRY NEAL McMILLAN, et al.,
Defendants.

§
§
§
§ Civil Action No. 3:13-CV-2456-D
§
§
§
§
§

MEMORANDUM OPINION
Following the receipt of additional briefing, the court enters this memorandum
opinion explaining its award of short-swing profits to plaintiff Sun River Energy, Inc. (“Sun
River”) in a judgment filed today.1
I
Sun River sued defendants Harry Neal McMillan (“McMillan”) and Cicerone
Corporate Development, LLC (“Cicerone”)2 under § 16(b) of the Securities Exchange Act
of 1934 (“Exchange Act”), 15 U.S.C. § 78p(b), to recover short-swing profits that McMillan
and Cicerone realized from transactions in Sun River common stock and derivative
securities. After the court addressed the parties’ cross-motions for summary judgment and
defendants’ motion to amend the scheduling order, it conducted a bench trial. In its January

1

The court sets out in this memorandum opinion its findings of fact and conclusions
of law. See Fed. R. Civ. P. 52(a)(1). All findings of fact are based on a preponderance of
the evidence standard.
2

Sun River also sued CE McMillan Family Trust (“the Trust”), but it dismissed with
prejudice its action against the Trust by November 14, 2014 stipulation of dismissal.

13, 2015 memorandum opinion and order, the court found that Sun River’s action was not
time-barred, and it interpreted SEC Rule 16b-6(c)(2), 17 C.F.R. § 240.16b-6(c)(2), and
decided how it should be applied when calculating the amounts of short-swing profits that
defendants must disgorge. Sun River Energy, Inc. v. McMillan, 2015 WL 158837, at *5, 8
(N.D. Tex. Jan. 13, 2015) (Fitzwater, J.). The court also concluded that additional briefing
would be helpful in calculating Sun River’s recovery of short-swing profits, and it
established a procedure for each side to file supplemental briefs and responsive briefs. Id.
at *8-9. These briefs have been filed and considered.
II
A
Sun River seeks to recover the sum of $949,104.12 from McMillan, and the sum of
$1,015,212.30 from Cicerone, and to hold McMillan and Cicerone jointly and severally liable
in the sum of $697,807.90. Defendants do not contest that Sun River is entitled to recover
the sum of $1,015,212.30 from Cicerone. But they maintain that Sun River is only entitled
to recover the sum of $669,104.32 from McMillan, and that McMillan and Cicerone are only
jointly and severally liable in the sum of $501,104.32.
Based on certain matched transactions, defendants acknowledge that McMillan is
liable for $501,104.32 in short-swing profits. On two grounds, however, defendants contend
that McMillan is only liable for $168,000 more than that (i.e., $669,104.32 in total), and that
defendants’ joint and several liability is lower than what Sun River claims. First, defendants
maintain that the maximum number of shares that can be attributed to McMillan from the
-2-

April 8, 2011 deemed sale from Cicerone to Joshua Pingel (“Pingel”) is 175,000 based on
McMillan’s 50% ownership interest (his pecuniary interest) in Cicerone at the time of the
deemed sale. Second, defendants contend that the number of shares attributed to McMillan
from the Pingel deemed sale must be further reduced from 175,000 to 105,000 to avoid
double counting, because 70,000 of the shares have already been matched to seven other
purchases.
B
In April 2011 Cicerone and McMillan entered into an agreement with Pingel under
which Pingel agreed to transfer to McMillan all of his interest in Cicerone in exchange for
350,000 shares of Sun River common stock, $50,000 in cash, and a truck. Sun River Energy,
Inc. v. McMillan, 2014 WL 4771852, at *2 (N.D. Tex. Sept. 25, 2014) (Fitzwater, C.J.) (“Sun
River I”). In Sun River I the court held that this transaction was a “sale” for purposes of
determining liability for short-swing profits. Id. at *13 (“Regardless whether the transaction
involved a change in beneficial ownership, a reasonable trier of fact could only find that it
was a contract to dispose of securities, meeting the broad definition of ‘sale’ in § 78c(a)
(14).”).
Defendants maintain that McMillan’s beneficial interest in the deemed sale to Pingel
is limited to 175,000 shares based on his pecuniary interest—i.e., his 50% ownership
interest—in Cicerone at the time of the sale.

They rely on the conclusion in

Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 243 (1976), that
beneficial ownership status is determined before the purchase; the definition of “beneficial
-3-

owner” found in 17 C.F.R. § 240.16a-1(a)(2); the definition of “indirect pecuniary interest”
in 17 C.F.R. § 240.16a-1(a)(2)(ii); and the provision of 17 C.F.R. § 240.16a-1(a)(2)(ii)(B)
that a general partnership’s pecuniary interest is measured according to the partnership
agreement “in effect at the time of the transaction.” Defendants posit that, although
McMillan became a 100% owner of Cicerone as a result of the deemed sale, he was a 50%
beneficial owner at the time of the sale.
Relying on 17 C.F.R. § 240.16a-1(a)(2)(i), Sun River argues that McMillan had a
pecuniary interest in all 350,000 of the Sun River shares sold in the Pingel transaction
because he had an opportunity to profit from the transaction. It posits that the pecuniary
interest in the sale belonged entirely to McMillan because only he, as the sole remaining
investor in Cicerone, would have enjoyed the risks and rewards of owning these shares had
Cicerone not sold them. Sun River maintains that the opportunity to profit resulted from any
appreciation in Cicerone’s value following its disposition of Sun River stock at an attractive
price, and that only McMillan had the opportunity to profit from the sale because he was the
sole remaining investor in Cicerone and stood to enjoy 100% of the benefits that it received
from the transaction. Sun River also asserts that the 50% ownership interest of Pingel in
Cicerone should not be counted because he had no opportunity to profit from the sale.
The court disagrees with Sun River’s reasoning. Sun River is relying on a definition
of “pecuniary interest” —“the opportunity, directly or indirectly, to profit or share in any
profit derived from a transaction”—to determine the extent of that interest. Such a
measurement is not found in 17 C.F.R. § 240.16a-1(a)(2)(i), which is concerned with what
-4-

is necessary to have a pecuniary interest rather than the extent of that interest. Indeed, so far
as 17 C.F.R. § 240.16a-1(a)(2)(i) is concerned, a person has a “pecuniary interest” if he has
any direct or indirect opportunity to profit or share in any profit derived from a transaction.
The regulations do evince a standard of measurement, however, in another context.
17 C.F.R. § 240.16a-1(a)(2)(ii)(B) provides that a general partner’s indirect pecuniary
interest in the portfolio securities held by a general or limited partnership is the general
partner’s proportionate interest, as evidenced by the partnership agreement in effect at the
time of the transaction and the partnership’s most recent financial statements. In other
words, when the regulations do define the extent of a person’s pecuniary interest (here, an
indirect pecuniary interest), it is based on the interest “in effect at the time of the
transaction.” There is no suggestion in the regulations that the interests of owners in a
limited liability company’s portfolio securities should be treated differently, meaning that
McMillan’s pecuniary interest in Cicerone is determined according to what it was at the time
of the transaction, which is 50%.
Finally, 17 C.F.R. § 240.16a-1(a)(2) is consistent with an approach that relies on a
person’s ownership interest at the time of the transaction rather than as a result of the
transaction. It uses the present tense to define “beneficial owner” as “any person who . . . has
or shares a direct or indirect pecuniary interest in the equity securities[.]” 17 C.F.R.
§ 240.16a-1(a)(2). Applied to this case, it means that McMillan’s interest in Cicerone is
determined at the time of the sale of the Sun River stock to Pingel.
The court also disagrees with Sun River’s assertion that the 50% ownership interest
-5-

of Pingel in Cicerone should not be counted. Sun River maintains that Pingel lacked a
pecuniary interest in the transaction because he had no opportunity to profit from the sale of
the Sun River stock since he was a purchaser rather than a seller. To illustrate why this is
incorrect, the court will assume that Cicerone had sold 375,000 shares of Sun River stock on
April 8, 2011 to John Doe, and that McMillan and Pingel were Cicerone’s shareholders at
the time of the transaction. McMillan and Pingel, as Cicerone’s shareholders, would
undoubtedly have had a pecuniary interest in the transaction in Sun River stock.
This fact does not change simply by substituting Pingel as the purchaser. Pingel had
a pecuniary interest in the transaction, even though he was the purchaser of the shares,
because they were being sold by Cicerone, in which Pingel had an ownership interest at the
time of the sale. Although the transaction itself extinguished that ownership interest, it did
not deprive Pingel of the opportunity, directly or indirectly, to profit or share in any profit
from the transaction. Setting aside the fact that the transaction was a deemed sale for
purposes of determining liability for short-swing profits, had it been an actual sale, the Sun
River shares would have been part of the consideration (together with cash and a truck) that
Pingel received in exchange for his interest in Cicerone. The value of the Sun River shares
would have been a factor in determining what Pingel was willing to take in exchange for that
interest. He would have had the opportunity, at least indirectly, to profit or share in any
profit derived from the transaction in Sun River securities because of their impact on
Cicerone’s valuation, which, in turn, impacted the value of Pingel’s ownership interest in
Cicerone and what he was willing to accept in exchange for that interest. Sun River
-6-

implicitly recognizes this concept when it discusses in its response brief how the value of the
Sun River stock may have affected the Pingel transaction. But it does not recognize that this
demonstrates why Pingel had a pecuniary interest on the seller side of the transaction, and
should not be viewed for securities laws purposes merely as a purchaser.
C
The court also holds that the number of shares attributable to McMillan as part of the
Pingel sale must be reduced from 175,000 to 105,000 based on the fact that Sun River has
already attributed 70,000 shares to McMillan for his 50% beneficial interest in purchases
made on October 19, 2010, November 30, 2010, December 31, 2010, and January 3, 2011.
In fact, in Sun River’s supplemental brief, it matches 280,000 of the 350,000 shares from the
Pingel deemed sale with the January 14, 2011 New Mexico Energy transaction, in apparent
recognition that 70,000 shares have otherwise been matched.
D
The court therefore calculates the award of short swing profits and defendants’ joint
and several liability as follows. Defendants acknowledge that Cicerone is liable in the sum
of $1,015,212.30, the amount that Sun River claims. They concede that the sum of
$501,104.32 in matched transactions is awardable against McMillan. The court multiplies
105,000 shares of the Pingel deemed sale by $1.60 per share (the difference between the
January 14, 2011 per share market price of $3.45 and the April 8, 2011 per share market
price of $5.05), resulting in a profit of $168,000. The court adds this sum of $168,000 to the
sum of $501,104.32 that defendants concede is properly calculated. This results in a total
-7-

sum of $669,104.32 for which McMillan is liable. Because Cicerone had no pecuniary
interest in the deemed purchase of Sun River shares on January 14, 2011 as part of the New
Mexico Energy transaction, the court holds that McMillan is jointly and severally liable with
Cicerone in the amount of $501,104.32 (i.e., $669,104.32 - $168,000 = $501,104.32). The
court awards these sums, and imposes joint and several liability to this extent, by judgment
filed today.
March 25, 2015.

_________________________________
SIDNEY A. FITZWATER
UNITED STATES DISTRICT JUDGE

-8-