Here are several things to note about SEC v. Arcturus et al:
- Pay attention to this post if you sell oil deals in the way these defendants did.
- This is a civil enforcement suit, so nobody’s headed to jail.
- Not all of the SEC’s many rules make sense. Think Leviticus and the wrong way to sacrifice a goat, except nobody’s headed for the unrelenting wrath of Yahweh.
- Your “good intentions” won’t save you.
- The SEC enforces when there are complaints. Break the rules and you‘d better go “yard” for your investors.
Parvizian controlled Arcturus and Aschere, buying and selling interests in drilling projects. Each project had a managing venturor which supervised the project. Each venture included a confidential information memorandum, PPM, joint venture agreement, subscription agreement, and investor questionnaire.
The SEC alleged that the defendants violated the Securities Act of 1933 and the Securities Exchange Act of 1934, and sought injunctions and money. The SEC contended that the projects were securities. Defendants referred to them as “joint ventures” and the investors as “partners” or “venturors”.
A “security” includes an “investment contract”, but that term is not defined in either statute. The courts say an “investment contract” is a transaction or scheme whereby a person:
- invests his money
- in a common enterprise
- expecting profits derived solely from the efforts of others.
- Parvizian’s power was limited to day-to-day management and was subject to the “affirmative vote” of the venturors.
- The venture was to be “managed and controlled collectively by all the venturors”, including the ability to call a meeting.
- The venturors had voting rights and could remove the managing venturor by a 60 percent vote.
- The court couldn’t find that the venturors had any real powers, based on the way the ventures were actually constituted.
- The venturors had no information about each other and thus no way to actually have a vote. Parvizian refused to disclose the identities of other venturors when requested.
- In a process never disclosed to the venturors, Parvizian combined the assets of the partnerships into pools of accounts held by a third party.
- Parvizian alone controlled and authorized every aspect of drilling and producing operations.
- The venturors had no personal or firsthand knowledge about any activities or decisions related to the venturess and relied completely on information from Parvizian.
- The venturors were unknowledgeable in the oil and gas business.
Courts focus on the “economic realities underlying the transaction and not in the name appended thereto.” Here are factors (among others) that made this investment a security:
- Access to information does not necessarily protect an investor from complete dependence from a third-party when that party is the sole source of the information and advice regarding the venture and the investor does not have the expertise necessary to make the essential management decisions themselves.
- Venturors are not similar to general partners when they have no real power.
- The partners were so dependent on a particular manager that they could not replace him or otherwise exercise ultimate control.
- The venturors were so inexperienced and unknowledgeable in business affairs as to be incapable of intelligently exercising their venture powers.
Did they commit securities fraud, … and what about the brokers?