Securities and Exchange Commission v. Guardian Oil & Gas Inc et al

Filing 17

Memorandum Opinion and Order denying 8 First MOTION to Dismiss . (See order for specifics) (Ordered by Magistrate Judge David L Horan on 12/23/2014) (mcrd)

IN THE UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF TEXAS
DALLAS DIVISION
SECURITIES AND EXCHANGE
COMMISSION,

§
§
§
Plaintiff,
§
§
V.
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§
§
GUARDIAN OIL & GAS, INC., ET AL., §
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Defendants.
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No. 3:14-cv-1533-BN

MEMORANDUM OPINION AND ORDER DENYING MOTION TO DISMISS
Defendants Guardian Oil & Gas, Inc. (“Guardian”), Guardian Oil & Natural Gas,
Inc. (“GONG”), and Rick D. Mullins have filed a Federal Rule of Civil Procedure
12(b)(6) and 12(b)(1) Motion to Dismiss. See Dkt. No. 8. Plaintiff Securities and
Exchange Commission (“S.E.C.”) has filed a response, see Dkt. No. 9, and Defendants
have not filed a reply, and their extended time to do so has passed, see Dkt. No. 14.
For the reasons explained below, Defendants’ 12(b)(6) and 12(b)(1) Motion to
Dismiss [Dkt. No. 8] is DENIED.
Background
On April 25, 2014, Plaintiff S.E.C. filed its complaint against Defendants
Guardian, GONG, and Rick D. Mullins for violating Section 17(a) of the Securities Act
of 1933 (“Securities Act”) [15 U.S.C. § 77q(a)], Section 10(b) of the Securities Exchange
Act of 1934 (“Exchange Act”) [15 U.S.C. § 78j(b)], and Rule 10b-5 [17 C.F.R. § 240.10b5]. See Dkt. No. 1.
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Plaintiff’s complaint alleges that Guardian is a privately held non-operating oil
and gas exploration and development company that is managing partner of limited
partnerships formed to raise money from the sale of securities in the form of
partnership interests to acquire working interests and net revenue interests in oil and
gas exploration projects. The complaint alleges that GONG was established in 2010
and was managing partner of limited partnerships formed to raise money from the sale
of securities in the form of partnership interests to acquire interests in oil and gas
exploration projects and that Mullins is the president, chairman, and co-founder of
Guardian and served as director and president of GONG in 2013.
According to the complaint, between August 2010 and June 2012, Guardian and
GONG established a separate limited partnership for each of their respective oil and
gas prospects, and Defendants told investors that these partnerships were formed to
acquire a portion of the working and net revenue interests in specific wells. Plaintiff
alleges that, for each limited partnership, Mullins created a private placement
memorandum (“PPM”) in which he described the details of that partnership’s oil and
gas project, including the potential benefits and risks related to that project.
The complaint alleges that, from August 2010 through May 2013, Mullins,
through Guardian and GONG, raised approximately $6.5 million by selling partnership
interests in oil and gas programs operating in Texas and Louisiana. Plaintiff contends
that Guardian and GONG, both controlled by Mullins, served as managing general
partners in the respective drilling programs and that Defendants made numerous false
representations and omissions to investors. Plaintiff claims that Defendants falsely
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represented to investors that their contributions would be used solely for the specific
drilling project that they invested in and that Defendants did not disclose cash-flow
problems, deteriorating financial conditions, intermingling investor funds, using
investor funds to pay unrelated expenses, and not owning an interest in the drilling
project they sold to investors.
Defendants filed a Rule 12(b)(6) and 12(b)(1) Motion to Dismiss, asserting that
Plaintiff’s complaint fails to plead with Federal Rule of Civil Procedure 8’s required
plausibility and Federal Rule of Civil Procedure 9(b)’s required specificity and fails to
plead facts sufficient to support scienter. See Dkt. No. 8. Defendants also assert that,
if Plaintiff alleges that the participants received, agreed to, and relied on Defendants’
PPM, this Court lacks subject matter jurisdiction, warranting dismissal under Rule
12(b)(1). See id.
Legal Standards
“Federal courts are courts of limited jurisdiction, and absent jurisdiction
conferred by statute, lack the power to adjudicate claims.” Stockman v. Fed. Election
Comm’n, 138 F.3d 144, 151 (5th Cir. 1998). The Court “must presume that a suit lies
outside this limited jurisdiction, and the burden of establishing federal jurisdiction
rests on the party seeking the federal forum.” Howery v. Allstate Ins. Co., 243 F.3d 912,
916 (5th Cir. 2001). “When a Rule 12(b)(1) motion is filed in conjunction with other
Rule 12 motions, the court should consider the Rule 12(b)(1) jurisdictional attack before
addressing any attack on the merits.” Ramming v. United States, 281 F.3d 158, 161
(5th Cir. 2001) (per curiam).
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The Court must dismiss a complaint for lack of subject matter jurisdiction
“‘when the court lacks the statutory or constitutional power to adjudicate the case.’”
Home Builders Ass’n of Miss., Inc. v. City of Madison, 143 F.3d 1006, 1010 (5th Cir.
1998) (quoting Nowak v. Ironworkers Local 6 Pension Fund, 81 F.3d 1182, 1187 (2d Cir.
1996)). The United States Court of Appeals for the Fifth Circuit recognizes a
distinction between a “facial” attack to subject matter jurisdiction, which is based
solely on the pleadings, and a “factual” attack to jurisdiction, which is based on
affidavits, testimony, and other evidentiary material. See Paterson v. Weinberger, 644
F.2d 521, 523 (5th Cir. 1981); accord Ramming, 281 F.3d at 161 (“Lack of subject
matter jurisdiction may be found in any one of three instances: (1) the complaint alone;
(2) the complaint supplemented by undisputed facts evidenced in the record; or (3) the
complaint supplemented by undisputed facts plus the court’s resolution of disputed
facts.”). Regardless of the nature of the attack, the plaintiff seeking a federal forum
“constantly bears the burden of proof that jurisdiction does in fact exist.” Ramming,
281 F.3d at 161. Where, as here, a defendant files a Rule 12(b)(1) motion to dismiss,
the attack is presumptively facial, and the Court need look only to the sufficiency of the
allegations of plaintiff's complaint, or on the complaint as supplemented by undisputed
facts, all of which are presumed to be true. Williamson v. Tucker, 645 F.2d 404, 412
(5th Cir. 1989); Paterson, 644 F.2d at 523. On a factual attack, however, the Court “is
empowered to consider matters of fact which may be in dispute,” Ramming, 281 F.3d
at 161, and, to oppose the Rule 12(b)(1) motion, “a plaintiff is also required to submit
facts through some evidentiary method and has the burden of proving by a
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preponderance of the evidence that the trial court does have subject matter
jurisdiction,” Paterson, 644 F.2d at 523.
In deciding a Rule 12(b)(6) motion, the court must “accept all well-pleaded facts
as true, viewing them in the light most favorable to the plaintiff.” In re Katrina Canal
Breaches Litig., 495 F.3d 191, 205–06 (5th Cir. 2007). To state a claim on which relief
may be granted, plaintiff must plead “enough facts to state a claim to relief that is
plausible on its face,” Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007), and
must plead those facts with enough specificity “to raise a right to relief above the
speculative level,” id. at 555. “A claim has facial plausibility when the plaintiff pleads
factual content that allows the court to draw the reasonable inference that the
defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678
(2009). “The plausibility standard is not akin to a ‘probability requirement,’ but it asks
for more than a sheer possibility that a defendant has acted unlawfully.” Id. “A claim
for relief is implausible on its face when ‘the well-pleaded facts do not permit the court
to infer more than the mere possibility of misconduct.’” Harold H. Huggins Realty, Inc.
v. FNC, Inc., 634 F.3d 787, 796 (5th Cir. 2011) (quoting Iqbal, 556 U.S. at 679).
While, under Rule 8(a)(2), a complaint need not contain detailed factual
allegations, the plaintiff must allege more than labels and conclusions, and, while a
court must accept all of the plaintiff's allegations as true, it is “‘not bound to accept as
true a legal conclusion couched as a factual allegation.’” Iqbal, 556 U.S. at 678 (quoting
Twombly, 550 U.S. at 555). A threadbare or formulaic recitation of the elements of a

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cause of action, supported by mere conclusory statements, will not suffice. See id. But,
“to survive a motion to dismiss,” under Twombly and Iqbal, a plaintiff need only “plead
facts sufficient to show” that the claims asserted have “substantive plausibility” by
stating “simply, concisely, and directly events” that Plaintiff contends entitle him or
her to relief. Johnson v. City of Shelby, Miss., 574 U.S. ____, 135 S. Ct. 346, 347 (2014)
(per curiam) (citing FED. R. CIV. P. 8(a)(2)-(3), (d)(1), (e)).
Analysis
A.

Plaintiffs’ allegations of covered securities do not warrant dismissal.
Defendants argue that the Court lacks subject matter jurisdiction because

general partnership interests are not included within the broad definition of securities
under the Securities Act and the Exchange Act and because Defendants’ partnership
interests allowed investors to choose their participation whether as a general partner,
a limited partner, or a general partner with an option to convert to a limited partner.
Defendants’ claim that their unique partnership form negates federal subject matter
jurisdiction lacks legal support, and the Court concludes that it has subject matter
jurisdiction over Plaintiff’s complaint and that this ground for Defendant’s motion to
dismiss fails.
As noted above, subject matter jurisdiction challenges take two forms: (1) facial
attacks that question whether a plaintiff has sufficiently alleged the existence of
subject matter jurisdiction, and (2) factual attacks that challenge whether subject
matter exists regardless of the pleadings and matters outside the pleadings may be
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reviewed. Defendants are not making a facial challenge, and Plaintiff has adequately
pleaded the existence of subject matter jurisdiction under the Securities Act and the
Exchange Act. See Dkt. No. 1 at 2-5.
At first glance, Defendants appear to challenge subject matter jurisdiction on
factual grounds, but their claim is really an attack on the merits of Plaintiff’s claim.
Defendants argue that the PPMs at issue in the complaint do not constitute securities
as defined by the Securities Act and the Exchange Act. That is, Defendants question
whether the Securities Act and the Exchange Act apply to the financial instruments
at issue.
But the Fifth Circuit “has held that a question of whether certain transactions
are securities within the meaning of the federal securities laws should not be
determined on a motion to dismiss for lack of subject matter jurisdiction unless the
complaint fails to meet the standards of Bell v. Hood.” Meason v. Bank of Miami, 652
F.2d 542, 547 (5th Cir. 1981) (en banc). Here, the Court concludes that Plaintiff’s
complaint does not fail to meet that standard – that is, this is not an instance in which
any of Plaintiff’s claims “has no plausible foundation” or “is clearly foreclosed by a prior
Supreme Court decision” – and so “the proper course is to find that jurisdiction exists
and deal with the objection as a direct attack on the merits of [Plaintiff’s] case.” Id.
(internal quotation marks omitted).
Plaintiff alleges that the interests that Defendants offered and sold were limited
partnership interests that are securities as that term is defined under the federal
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securities laws. See Dkt. No. 1 at 3. Plaintiff’s complaint further asserts allegations to
describe the circumstances surrounding the alleged securities investments at issue. See
id. at 4. If these allegations are true as alleged, Plaintiff has made out a plausible
assertion that the instruments at issue are covered by the federal securities laws,
where the Fifth Circuit has held that “[l]imited partnership interests may be
considered a security within the statutory definition.” Youmans v. Simon, 791 F.2d
341, 346 (5th Cir. 1986).
Defendants take issue with Plaintiff’s allegations and make contrary factual
assertions themselves, without coming forward with any evidence. That is, Defendants
assert that the PPMs permitted investors may participate as general partners and
that, “[t]o the extent the interests offered in this case are participations in what could
[] be viewed as a general partnership, dismissal for lack of subject matter jurisdiction
is appropriate.” Dkt. No. 8 at 27.
The Court disagrees with the conclusion that Defendants press. Defendants’
assertions regarding investors’ choice under the PPMs, even if factually credited in this
context, do not render Plaintiff’s claims under the federal securities laws without any
plausible foundation or clearly foreclosed by a prior Supreme Court decision. As
Plaintiff notes, Defendants contend that somehow the ability to choose whether to be
a general or limited partner at the outset takes all of Defendants’ offerings out of the
realm of securities law, even as to the interests of investors who chose to be limited
partners. See Dkt. No. 9 at 20. Defendants’ vague and unsupported theory of dismissal

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is not a proper Rule 12(b)(1) argument for lack of subject matter jurisdiction but rather
is direct attack on the merits of Plaintiff’s case.
And it is one that Defendants are making not by accepting as true and taking
on all well-pleaded facts, viewing them in the light most favorable to Plaintiff, to
determine if Plaintiff’s complaint has pleaded enough facts to state a claim to relief
that is plausible on its face. Rather, Defendants simply assert contrary or contravening
facts and ask the Court to accept those facts and disbelieve Plaintiff’s factual
allegations. That is not a proper basis for granting a Rule 12(b)(6) motion to dismiss,
as to which the Court cannot look beyond the pleadings. See Spivey v. Robertson, 197
F.3d 772, 774 (5th Cir. 1999).
Accordingly, Defendants’ motion to dismiss on the ground that the interests at
issue are not included within the broad definition of securities under the Securities Act
and the Exchange Act fails, and the resolution of that issue on the merits must await
another day.
B.

Plaintiff’s complaint satisfies the governing pleading requirements.
Defendants also assert that Plaintiff’s complaint fails to satisfy the requirements

of Rules 8(a)(2) and 9(b), compelling dismissal of Plaintiff’s Section 17(a), Section 10(b),
and Rule 10b-5 claims. But the Court concludes that Plaintiff has satisfied Rule
8(a)(2)’s short-and-plain-statement requirement and Rule 9(b)’s particularity
requirement for fraud claims.
First, Defendants assert that Plaintiff has failed to provide the newspaper items
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of who, what, when, where, and how as Rule 9(b) requires. The Court disagrees with
this assertion and concludes that Plaintiff’s complaint satisfies Rule 9(b)’s pleading
requirements. Under Fifth Circuit law, Rule 9(b) requires a plaintiff to 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. See
Southland Secs. Corp. v. Inspire Ins. Solutions, Inc., 365 F.3d 353, 362 (5th Cir. 2004).
Plaintiff’s complaint identifies Mullins, Guardian, and GONG as “who” and describes
their alleged misconduct – the “what, when, where, and how” elements – misleading
investors between August 2010 and June 2012 through misrepresentations in
Guardian’s and GONG’s PPM that were drafted by Mullins. See Dkt. No. 1 at 3-9.
Defendants also allege that Plaintiff’s complaint improperly lumps together
factual contentions against all Defendants. The Court disagrees. Plaintiff’s complaint
does not conflate allegations without distinguishing Defendants. See id. This is not an
instances, as in Bradley v. Phillips Petroleum Co., 527 F. Supp. 2d 625 (S.D. Tex. 2007),
on which Defendants rely, of blurring allegations against several dissimilar
defendants. And, even where Plaintiff’s allegations may cover multiple defendants, the
complaint adequately describes the nature of each Defendant’s relationship to the
scheme and identifies each Defendant’s role in the alleged fraud. See Steiner v.
Southmark Corp., 734 F. Supp. 269, 274 (N.D. Tex. 1990).
Instead of attacking Plaintiff’s failure to state a claim as required of a Rule
12(b)(6) motion to dismiss, Defendants’ motion to dismiss then attacks the strength of

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Plaintiff’s evidence in three areas: (1) cash flow and financial condition; (2) use of
funds; and (3) lies to investors. Defendants rely on matters outside of the pleadings –
uncited and not provided to the Court – to support their motion to dismiss. As
explained above, that is not a proper basis for a Rule 12(b)(6) motion, and the Court
will not incorporate any matters outside of the pleadings – which have not been
presented to the Court – and will not, under these circumstances, convert Defendants’
motion to dismiss into a motion for summary judgment. See generally FED. R. CIV. P.
12(d); Isquith v. Middle S. Utils., Inc., 847 F.2d 186, 193 n.3 (5th Cir. 1988).
Insofar as Defendants’ motion argues that Defendants did not actionably conceal
their allegedly worsening financial condition because “each and every PPM included
a provision pointing to the possibility of such a problem,” Dkt. No. 8 at 15, Defendants’
motion also fails. In support of this argument, Defendants reproduce language common
to all of their PPMs disclosing that “it is possible that a significant financial reversal
for the Managing Partner could impair its ability to meet its obligations to the
Partnership and adversely affect the value of the Units” and that “[t]he Managing
Partner’s net worth may not be sufficient to meet its obligations to the Partnership.”
Id. at 16. Even assuming these disclosures can properly be addressed on a Rule 12(b)(6)
motion, Plaintiff has pleaded that, notwithstanding any disclosures warning of possible
events, Defendants knew of their own dire financial condition at the relevant times
alleged. See Dkt. No. 1 at 6. In light of these allegations, the adequacy-of-disclosure
issue presented here is inappropriate for resolution by a Rule 12(b)(6) motion to

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dismiss. See Rubinstein v. Collins, 20 F.3d 160, 170-71 & n.41 (5th Cir. 1994).
C.

Plaintiff’s complaint adequately alleges scienter.
After attacking the strength of Plaintiff’s evidence, Defendants then argue that

Plaintiff has raised three separate mental states – intentional conduct, recklessness,
and negligence – that conflict with each other and that Plaintiff has failed to plead
facts sufficient to support any mental state. This basis for dismissal fails.
First, Defendants incorrectly argue that the heightened pleading standards for
scienter in the Private Securities Litigation Reform Act (“PSLRA”) apply to the
Plaintiff’s complaint. The PSLRA requires private plaintiffs, not the S.E.C., to plead
facts giving rise to a strong inference of scienter, and the PSLRA’s heightened pleading
standard does not apply to S.E.C. civil enforcement actions. See S.E.C. v. Kornman,
391 F. Supp. 2d 477, 494 (N.D. Tex. 2005).
Although Rule 9(b) does impose heightened pleading requirements, it does allow
allegations of mental state to be pleaded generally. See FED. R. CIV. P. 9(b). To satisfy
the scienter requirement of a cause of action under Section 17(a)(1), Section 10(b)(5),
or Rule 10b-5, Plaintiff’s complaint must raise a reasonable inference of intentional
conduct or severely reckless conduct. See S.E.C. v. Reynolds, No. 3:08-cv-384-B, 2008
WL 3850550, at *6-*7 (N.D. Tex. Aug. 19, 2008). And, here, Plaintiff’s complaint has
adequately pleaded that Defendants acted with scienter under either standard by
which it may be satisfied. For example, as Plaintiff notes in response to Defendants’
motion to dismiss, the complaint alleges that Mullins controlled Guardian and GONG
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and drafted their PPMs; Defendants actively concealed their financial difficulties in
their PPMs; Defendants minimized their financial difficulties by labelling them
possible future events; Mullins and Guardian solicited funds for the Bull Moose
prospect but spent the funds on unrelated matters; Mullins and Guardian concealed
their misuse of Bull Moose investor funds by trying to obtain an interest in Bull Moose;
Mullins and Guardian solicited additional funds for well-deepening, sent those funds
to Bull Moose operators, and failed to disclose that those funds were rejected; Mullins
lied to Bull Moose investors and blamed poor financial performance on a non-producing
well; and Mullins and Guardian swapped Bull Moose investors’ partnership interests
with another well without disclosing their misuse of investor funds. See Dkt. No. 9 at
12 (citing Dkt. No. 1). Further, Plaintiff is under no obligation to plead only one
possible basis for meeting the scienter requirement. See generally FED. R. CIV. P.
8(d)(2) (“A party may set out 2 or more statements of a claim or defense alternatively
or hypothetically, either in a single count or defense or in separate ones. If a party
makes alternative statements, the pleading is sufficient if any one of them is
sufficient.”).
Defendant also confuses negligence with scienter where negligence is conduct,
not a state of mind. To plead violations of Sections 17(a)(2)-(3), Plaintiff is not required
to provide any evidence on mental state but only unreasonable conduct (negligence).
See Aaron v. S.E.C., 446 U.S. 680, 702 (1980); S.E.C. v. Seghers, 298 F. App’x 319, 327
(5th Cir. 2008). And the same allegations may be used to support both a finding that

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Defendants acted with scienter and that their actions were negligent. Because Section
17(a)(2) and (3) claims do not require mental state be pleaded or proved, and because
the complaint more than adequately alleges facts giving rise to an inference that
Defendants’ conduct was negligent, Defendants’ motion to dismiss fails on this ground
as well.
D.

Plaintiff’s prayer for an injunction is not subject to dismissal.
Defendants further ask the Court to dismiss Plaintiff’s prayer for a so-called

obey-the-law injunction as being overly broad. This request for dismissal is also denied.
First, Defendants’ request is not appropriate in a Rule 12(b)(6) motion to dismiss
because Defendants cannot allege that Plaintiff’s requested form of relief fails to state
a claim. Also, it would be premature to dismiss Plaintiff’s request for injunctive relief
as no fact-finding has taken place, and a motion to dismiss requires the Court to accept
the truth of the allegations set forth in the complaint.
Moreover, the court is not persuaded by Defendants’ reliance on S.E.C. v. Goble,
682 F.3d 934 (11th Cir. 2012). Although Defendants argue that Meyer v. Brown & Root
Construction Co., 661 F.2d 369 (5th Cir. 1981), shows that the Fifth Circuit would
adopt Goble’s reasoning, the Fifth Circuit’s subsequent decisions explained that Meyer
“did not hold that injunctions that order a defendant to obey a specific law are
problematic.” Rodriguez v. Countrywide Home Loans, Inc. (In re Rodriguez), 695 F.3d
360, 369 (5th Cir. 2012); see also United States v. Campbell, 897 F.2d 1317, 1324 (5th
Cir. 1990) (“A permanent injunction against future violations of a statute is permitted
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because such merely requires the enjoined party to obey the law.”). Even Meyer, by that
decision’s own terms, permits an obey-the-law injunction so long as it is “framed so
that those enjoined will know what conduct the court has prohibited.” 661 F.2d at 373.
Conclusion
Defendants’ 12(b)(6) and 12(b)(1) Motion to Dismiss [Dkt. No. 8] is denied.
SO ORDERED.
DATED: December 23, 2014

___________________________________________
DAVID L. HORAN
UNITED STATES MAGISTRATE JUDGE

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