Securities and Exchange Commission v. Faulkner et al

Filing 141

MEMORANDUM OPINION AND ORDER granting in part and denying in part 102 plaintiff's motion for preliminary injunction, asset freeze, appointment of receiver, and other ancillary relief. (Ordered by Judge Sidney A Fitzwater on 9/25/2017) (Judge Sidney A Fitzwater)

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

§
§
§
Plaintiff,
§
§ Civil Action No. 3:16-CV-1735-D
VS.
§
§
CHRISTOPHER A. FAULKNER, et al., §
§
Defendants. §
MEMORANDUM OPINION
AND ORDER
Plaintiff U.S. Securities and Exchange Commission (“SEC”) moves for a preliminary
injunction to enjoin defendants Christopher Faulkner (“Faulkner”), Breitling Energy
Corporation (“BECC”), and Breitling Oil & Gas Corporation (“BOG”) from allegedly
violating specific antifraud provisions of federal securities laws. The SEC also moves for
an asset freeze, appointment of receiver and other ancillary relief. In opposition, Faulkner
presents limited objections concerning the scope of the requested relief. Concluding that the
SEC has met its burden of establishing the needed scope of the requested relief, but that
Faulkner has demonstrated immediate and ongoing harm due to a lack of defense funds, the
court by contemporaneous order largely—but not entirely—grants the relief the SEC seeks.1
1

Pursuant to Fed. R. Civ. P. 52(a), the court sets out its findings of fact and
conclusions of law in this memorandum opinion and order. The SEC’s motion is before the
court under the procedure permitted by Rule 43(c) and is being decided on the papers,
without an evidentiary hearing. See, e.g., John Crane Prod. Solutions, Inc., v. R2R and D,
LLC, 861 F.Supp.2d 792, 793 n.2 (N.D. Tex. 2012) (Fitzwater, C.J.) (following similar
procedure when addressing motion for preliminary injunction).

I
In this securities fraud civil enforcement action, the SEC alleges that, since 2011,
Faulkner and his codefendants have orchestrated a massive scheme that has defrauded
investors in Faulkner’s oil-and-gas companies of approximately $80 million. Although the
intricacies of the alleged scheme are beyond the scope of this memorandum opinion order,
its basics can be briefly summarized as follows. According to the SEC, Faulkner—while
misrepresenting his education and experience—sold “working investments” in various oil
and gas prospects through his companies.2 Faulkner oversold the available units for each
project and inflated the estimated costs to be incurred. Despite representing to investors that
their funds would be segregated, Faulkner and his companies commingled and
misappropriated significant portions of this money through tens of millions of dollars in cash
disbursements and reimbursements of Faulkner’s personal expenditures.3 Throughout the
scheme, Faulkner signed, and BECC filed, inaccurate and misleading financial reports with
the SEC. Investors in Faulkner’s companies ultimately received only a small fraction of their
investment principal. The SEC alleges that, in conducting this scheme, Faulkner and other
defendants have violated § 17(a) of the Securities Act of 1933 (“1933 Act”) and § 10(b) of

2

The SEC alleges that Faulkner used different companies at different times in his
scheme. These companies included BOG, BECC (a publicly traded company), Crude
Energy, LLC, and Patriot Energy, LLC.
3

According to the SEC, Faulkner has personally received at least $23.8 million in
investor funds. The SEC alleges that Faulkner personally obtained approximately $10
million from BOG investors alone. Faulkner does not contest any of the SEC’s figures.
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the Securities Exchange Act of 1934 (“1934 Act”), and SEC Rule 10b-5, promulgated
thereunder.
The SEC now alleges that, after it filed this lawsuit, Faulkner, BOG, and BECC have
continued to defraud investors. It maintains that records seized though a subpoena indicate
that, since June 2016, over $110,000 in production revenue checks from oil and gas operators
payable to BOG has been deposited into four accounts that Faulkner controls or beneficially
owns. None of these funds has been used to pay BOG investors; instead, the funds have been
misappropriated to pay Faulkner’s personal expenditures.
In light of foregoing and ongoing conduct, the SEC filed a motion for a preliminary
injunction, ex parte temporary restraining order, asset freeze, the appointment of a receiver
to conserve the assets of Faulkner, BECC, and BOG, and other ancillary relief (including
sworn accounting, document preservation, and expedited discovery). On August 14, 2017
the court issued an order appointing a temporary receiver, and it also granted a temporary
restraining order and asset freeze order, without prejudice to granting the remaining relief
that the SEC requested. The court then established a procedure for considering the instant
motion.
Only Faulkner has filed an opposition response. He does not contest the majority of
the SEC’s requested relief. Instead, he contends that the court should narrow the scope of
any orders to only address the oil and gas assets of BOG and BECC, and that the court
should permit Faulkner and other insureds to access the directors and officers insurance
policy (“D&O Policy”) issued to BECC. The SEC’s motion is now ripe for decision.
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II
“The court need not address the merits of the SEC’s preliminary injunction application
insofar as it seeks relief that defendants do not oppose.” SEC v. AmeriFirst Funding, Inc.,
2007 WL 2192632, at *1 (N.D. Tex. July 31, 2007) (Fitzwater, J.). Similarly, the court need
not address the merits of the SEC’s motion to the extent it relates to requests for relief that
defendants do not fairly address, such as the SEC’s request for relief in the form of
expedited discovery and a sworn accounting. Id. Therefore, the court focuses its analysis
on Faulkner’s two objections to the scope of the SEC’s requested relief.
III
A
The availability of a preliminary injunction in an SEC civil enforcement action is
derived from explicit statutory authorization. Under § 20(b) of the 1933 Act, 15 U.S.C. §
77t(b), and § 21(d) of the 1934 Act, 15 U.S.C. § 77u(d), the SEC can obtain injunctive relief
upon “a proper showing” that there is a “reasonable likelihood that the defendant[s][are]
engaged or about to engage in practices that violate the federal securities laws.” SEC v. First
Fin. Grp. of Tex., 645 F.2d 429, 434 (5th Cir. Unit A May 1981) (citations omitted); SEC v.
Zale Corp., 650 F.2d 718, 720 (5th Cir. Unit A July 1981) (“[T]he Commission is entitled
to prevail [on its permanent injunction application] when the inferences flowing from the
defendant’s prior illegal conduct, viewed in light of present circumstances, betoken a
‘reasonable likelihood’ of future transgressions.”); SEC v. Blatt, 583 F.2d 1325, 1334 (5th
Cir. 1978) (“The critical question in issuing the injunction and also the ultimate test on
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review is whether defendant’s past conduct indicates that there is a reasonable likelihood of
further violations in the future.”); cf. SEC v. Cavanagh, 1 F.Supp.2d 337, 360 (S.D.N.Y.
1998) ( “‘[A] more substantial showing of likelihood of success, both as to violation and risk
of recurrence [is required] whenever the relief sought is more than preservation of the status
quo.’” (quoting SEC v. Unifund SAL, 910 F.2d 1028, 1039 (2d Cir. 1990)), aff’d, 155 F.3d
129 (2d Cir. 1998) (Reavley, J.); SEC v. Tyler, 2002 WL 32538418, at *2 (N.D. Tex. Feb.21,
2002) (Solis, J.).
The showing is usually made with proof of past substantive violations that indicate
a reasonable likelihood of future substantive violations. First Fin. Grp. of Tex., 645 F.2d at
434 (citations omitted); Tyler, 2002 WL 32538418, at *2 (citations omitted). Additionally,
“[w]hen scienter is an element of the substantive violation sought to be enjoined, it must be
proven before an injunction may issue.” Tyler, 2002 WL 32538418, at *2 (citing Aaron v.
SEC, 446 U.S. 680, 699-700 (1980)). “[I]n SEC civil enforcement actions for preliminary
injunctive relief under the antifraud provisions of the federal securities laws . . . the proper
standard of proof is the preponderance of the evidence.” First Fin. Grp. of Tex., 645 F.2d
at 434.
B
The court has broad equitable power in securities fraud cases to fashion appropriate
ancillary remedies necessary to grant full relief. SEC v. Posner, 16 F.3d 520, 521-22 (2d Cir.
1994). Moreover, the appointment of a receiver is a “‘well-established equitable remedy
available to the SEC in its civil enforcement proceedings for injunctive relief.’” AmeriFirst
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Funding, 2007 WL 2192632, at *3 (quoting First Fin. Grp. of Tex., 645 F.2d at 438.)
The district court’s exercise of its equity power in this respect is
particularly necessary in instances in which the corporate
defendant, through its management, has allegedly defrauded
members of the investing public; in such cases, it is likely that,
in the absence of the appointment of a receiver to maintain the
status quo, the corporate assets will be subject to diversion and
waste to the detriment of those who were induced to invest in
the corporate scheme and for whose benefit, in some measure,
the SEC injunctive action was brought.
First Fin. Grp. of Tex., 645 F.2d at 438. (discussing applicability of receivership where
automatic stay in bankruptcy was in effect) (footnote omitted). In First Financial Group of
Texas the Fifth Circuit noted that, in reviewing a district court’s decision to enter a
preliminary injunction in favor of the SEC,
[t]he prima facie showing of fraud and mismanagement, absent
insolvency, is enough to call into play the equitable powers of
the court. It is hardly conceivable that the trial court should
have permitted those who were enjoined from fraudulent
misconduct to continue in control of (the corporate defendant’s)
affairs for the benefit of those shown to have been defrauded.
In such cases the appointment of a trustee-receiver becomes a
necessary implementation of injunctive relief.
Id. (quoting SEC v. Keller Corp., 323 F.2d 397, 403 (7th Cir. 1963)). Receivers may also
be appointed over individual—not only corporate—defendants if their fraudulent conduct
makes such an appointment appropriate. See, e.g., Janvey v. Alguire, 647 F.3d 585, 598 (5th
Cir. 2011); SEC v. Stanford Int’l Bank, Ltd., 2009 WL 8707814, at *1 (N.D. Tex. Oct. 9,
2009) (Godbey, J.).
Beyond appointing a receiver, “[t]he court is also empowered to freeze defendants’

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assets to preserve the status quo and prevent dissipation of ill-gotten gains so that they remain
available to fund subsequent disgorgement orders and civil penalties.” AmeriFirst Funding,
2007 WL 2192632, at *3; see also SEC v. Brooks, 1999 WL 493052, at *2 (N.D. Tex. July
12, 1999) (Fitzwater, J.) (citing SEC v. Schiffer, 1998 WL 307375, at *7 (S.D.N.Y. June 11,
1998)).
IV
Based on the SEC’s briefing and the largely uncontested evidence, the court finds
from a preponderance of the evidence that the SEC has made “a proper showing” that there
is at least a “reasonable likelihood that the defendant[s][are] engaged or about to engage in
practices that violate the federal securities laws.” The court finds that there is a reasonable
likelihood that defendants, acting with scienter, obtained money and property through false
and misleading statements and omissions of material fact and engaged in a scheme to defraud
investors, in violation of the securities laws, including § 17(a) of the 1933 Act, § 10(b) of the
1934 Act, and SEC Rule 10b-5 promulgated thereunder. The court has therefore entered an
order granting the requested preliminary injunction.
V
Regarding the remainder of the requested equitable relief, the court first considers
Faulkner’s request that the court limit the scope of the relief to only address the oil and gas
assets of BOG and BECC. Faulkner contends that the requested appointment of a receiver
is overbroad in relation to the SEC’s purported aim to protect investor money from being
misappropriated. He maintains that because all assets of BOG and BECC will be under the
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receiver’s control, BOG’s and BECC’s investors will be sufficiently secure, and a
receivership that covers Faulkner’s assets generally and extends to companies not party to
this action is excessive and unnecessary. The court disagrees.
While a receivership over BOG and BECC would prevent the payments the SEC
alleges have occurred since this lawsuit was filed, such a more limited receivership would
not protect the investor proceeds that Faulkner has already allegedly misappropriated.
Indeed, the SEC has demonstrated through its extensive filings that Faulkner has already
obtained at least $23.8 million of investor proceeds through fraudulent cash disbursements
and reimbursements. Faulkner has offered no evidence to rebut these figures. Moreover, the
fact that Faulkner continued to misappropriate investor assets even after the SEC filed this
lawsuit gives the court little confidence that Faulkner’s asset management would improve
without supervision. Thus the court is left to conclude that a receivership that only reaches
BOG and BECC’s oil and gas assets will leave ill-gotten investor proceeds unsecured.
The court finds that the SEC has met its burden of demonstrating by a preponderance
of the evidence that the court should order an asset freeze and appoint a temporary receiver
covering Faulkner’s assets. This encompasses entities controlled by Faulkner to which the
unrebutted evidence indicates he may have redistributed either BOG’s or BECC’s investors’
assets—including the Breitling Royalties Corporation. Granting such relief will ensure that
these assets will be available to satisfy any judgment that either the SEC or a defrauded
investor may obtain. “The court is [] empowered to freeze defendants’ assets to preserve the
status quo and prevent dissipation of ill-gotten gains so that they remain available to pay
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subsequent disgorgement orders and civil penalties.” AmeriFirst Funding, 2007 WL
2192632, at *3; Brooks, 1999 WL 493052, at *2. The court concludes this power is both
necessary and appropriate to enable the temporary receiver to accurately assess and secure
assets likely needed for future disgorgement.
To ensure that the relief granted does not extend past what is reasonably necessary for
the receiver to determine the extent of Faulkner’s, BOG’s, and BECC’s assets and their
ability to preserve ill-gotten gains for future disgorgement, the court directs that the
temporary receiver file a status report with the court no later than the first business day of
each quarter, the first report being due January 2, 2018, informing the court his identification
of available assets and whether these assets can satisfy the SEC’s estimation of funds subject
to disgorgement.
VI
The court next determines whether to permit Faulkner and the other insureds to access
the D&O Policy and its proceeds. Faulkner specifically requests the court “to exclude the
D&O Policy from the receivership estate or to authorize the disbursement of its proceeds to
fund a legal defense.” D. Br. 15. To address Faulkner’s objection, the court must address
two separate questions: whether the D&O policy is part of the receivership estate, and
whether the court should advance defense costs.
A
Because relatively few cases arise examining the ownership of insurance proceeds in
the receivership context, “it is appropriate to consider the treatment of the issue under
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bankruptcy law, where the courts must frequently decide whether persons insured under a
D&O policy are entitled to the proceeds when the named insured is a debtor in bankruptcy
proceedings.” SEC v. Narayan, 2017 WL 447205, at *4 (N.D. Tex. Feb. 2, 2017) (Lynn,
C.J.) (internal quotation marks and citation omitted). In receivership actions, “there is clear
Fifth Circuit precedent on a closely related issue—the treatment of liability proceeds in the
context of bankruptcy.” Exec. Risk Indem., Inc. v. Integral Equity, L.P., 2004 WL 438936,
at *13 (N.D. Tex. Mar. 10, 2004) (Fish, C.J.).
Whether a D&O policy is part of a receivership estate depends on the entities and
individuals covered by the policy and the language of the policy itself. See, e.g., In re La.
World Exposition, Inc., 832 F.2d 1391, 1401 (5th Cir. 1987) (holding that when debtor
corporation owns D&O policy that exclusively covers its directors and officers, the proceeds
are not part of debtor’s bankruptcy estate). The relevant question is not who owns the policy
but who owns its proceeds. In re Edgeworth, 993 F.2d 51, 55-56 (5th Cir. 1993) (“In other
words, when the debtor has no legally cognizable claim to the insurance proceeds, those
proceeds are not property of the estate.”). The Fifth Circuit has addressed—albeit in
dicta—the options for a court when considering a D&O policy when:
(1) the policy-owning debtor is but one of two or more
coinsureds or additional named insureds, (2) the rights of the
other coinsured(s) or additional named insured(s) are not merely
derivative of the rights of one primary named insured, and (3)
the aggregate potential liability substantially exceeds the
aggregate limits of available insurance coverage.
In re Vitek, Inc., 51 F.3d 530, 535 (5th Cir. 1995) (emphasis omitted). Deeming such

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circumstances “mid-continuum” cases, the Vitek panel suggests two possible paths forward.
First, the court can wholly include the proceeds of a policy in the estate of the debtor that
owns the policy—“even though there are other coinsureds or additional named insureds who
have some ‘interest’ in the proceeds.” Id. Or, second, the proceeds can be divided among
all coinsureds, on either a per capita basis or in proportion to the potential or actual liability
faced by each insured party. Id.
That a D&O policy is deemed to be part of a receivership estate, however, does not
preclude the advancement of defense costs. “‘It is a recognized principle of law that the
district court has broad powers and wide discretion to determine the appropriate relief in an
equity receivership.’” SEC v. Safety Fin. Serv., Inc., 674 F.2d 368, 372-73 (5th Cir. 1982)
(quoting SEC v. Lincoln Thrift Ass’n, 577 F.2d 600, 606 (9th Cir. 1978)). Accordingly,
several courts have concluded that the advancement of defense costs is appropriate, despite
the fact that they may be drawn from a D&O policy within a receivership estate. See, e.g.,
Stanford Int’l Bank, 2009 WL 8707814, at *3-4 (declining to determine whether D&O policy
proceeds were part of receivership estate, but holding that even if they were, court would
permit advancement of defense costs); Narayan, 2017 WL 447205, at *6 (noting that even
in cases where D&O policy proceeds are within bankruptcy estate, “courts have nonetheless
granted relief when the harm weighs more heavily against the directors or officers than the
debtor”) (citations omitted). In these cases, the courts balance the potential harm facing the
defendants moving for defense costs with the harm to the receivership estate if said funds are
released. In particular, they consider whether the harms are clear and immediate rather than
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hypothetical or speculative. See Stanford Int’l Bank, 2009 WL 8707814, at *3-4; Narayan,
2017 WL 447205, at *6; see also In re Allied Digital Techs. Corp., 306 B.R. 505, 514
(Bankr. D. Del. 2004); In re CyberMedica, Inc., 280 B.R. 12, 18 (Bankr. D. Mass. 2002).
B
In this case, the D&O Policy explicitly insures both BECC and its directors and
officers. In relevant part, the D&O Policy provides that “[t]he Insurer shall pay on behalf of
the Insured Persons Loss resulting from a Claim first made against the Insured Persons
during the Policy Period . . . for a Wrongful Act.” D. App. 38 Similarly, the Insurer
promises to “pay on behalf of the Company Loss resulting solely from and Securities Claim
first made against the Company . . . for a Company Wrongful Act.” Id. It specifically
defines the “Insured” as both the “Company”—listed as the BECC elsewhere in the D&O
Policy—and “Insured Persons”—further defined as including “any, past, present or future
director or officer, or member of the Board of Managers, of the Company.” D. App. 4, 39.
The definition of “Loss” includes both “damages, judgments, settlement, pre-judgment and
post-judgment interest” and “Defense Expenses in excess of the Retention that the insured
is legally obligated to pay.” D. App. 23, 40.
From this language, the court determines that the D&O Policy is at least in part within
the receivership estate. Its provisions clarify that the D&O Policy is one of the
“midcontinuum” cases contemplated in Vitek: both those covered by the receivership
(Faulkner and BECC) and those that are not (other yet unknown directors and officers) are
entitled to its proceeds to cover respective “Losses.” Because the scope of the receivership
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covers the assets of both Faulkner and BECC, however, the D&O Policy proceeds that would
be used to pay “damages, judgments, settlement, pre-judgment and post-judgment interest”
and “Defense Expenses” related to Faulkner’s and BECC’s conduct are within the
receivership estate. Therefore, they are subject to the receivership and the court’s asset
freeze order.
As the cited foregoing cases demonstrate, the fact that these funds are within the
receivership estate does not preclude the court from granting an advancement of defense
costs. In all of these cases, however, the respective courts received full briefing on this
particular issue from the receiver, the SEC, and, often, additional defendants. See Stanford
Int’l Bank, 2009 WL 8707814, at *3-4; Narayan, 2017 WL 447205, at *6. Here, the
temporary receiver has not had the opportunity to assess the risk that an indefinite
advancement of defense costs would pose to the receivership assets and defrauded investors.
Without this information, the court cannot effectively balance the harms implicated by this
decision. Therefore, the court declines to indefinitely provide Faulkner and other insureds
access to defense funds.
Faulkner has demonstrated, however, that he and other defendants face real and
immediate harm. Without access to the D&O Policy proceeds, Faulkner may be unable to
mount a defense in the present case. D. App. 2. Faced with this harm, the court will order
that the temporary receiver allow defendants access to the D&O Policy proceeds for the
period required for the court to decide this question on full briefing, or, if sooner, the date the
court by order denies such access. To avoid entry of such an order on October 16, 2017,
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Faulkner must by that date file a motion for the advancement of defense costs. Briefing on
the motion will follow the court’s local civil rules unless the court, on request of a party or
parties, sets a different schedule. In the meantime, the temporary receiver will be able to
make an assessment of any likely harms to the estate should the court allow further access
to D&O Policy Proceeds. This will allow the court to better engage in the required balancing
of harms analysis.
*

*

*

For the reasons stated, the court by separate order entered today is granting in large
part the SEC’s motion for preliminary injunction, asset freeze, appointment of receiver, and
other ancillary relief.
SO ORDERED.
September 25, 2017.

_________________________________
SIDNEY A. FITZWATER
UNITED STATES DISTRICT JUDGE

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