We discussed SEC v. Arcturus et al last week and promised more. Here it is.
Did defendants commit securities fraud?
It doesn’t matter. Violations of Sections 5 of the Securities Act and 15.A of the Exchange Act are strict liability offenses; the defendant’s state of mind is not a consideration. Thus, because they sold unregistered securities through the United States mail or interstate commerce these defendants were liable unless they could prove an exemption. They offered no proof of an exemption (such as registration) so they were liable.
But we still wanna know, did they commit fraud?
Yes. It is unlawful under the Exchange Act to use or employ any manipulative or deceptive or contrivance in contravention of SEC rules to sell a security. If a person makes a material misrepresentation or omission or uses some other fraudulent device in connection with the offer, sale or purchase of a security and acts in interstate commerce he is liable.
The test under Section 17 of the Securities Act is similar. The Fifth Circuit’s standard for misrepresentation is whether the information disclosed, understood as a whole, would mislead a reasonable potential investor. A statement or omission is “material” if there a substantial likelihood that a reasonable investor would consider the information important in making a decision to invest.
What information did the the Parvizian defendants omit? They sold working interests in a prospect that had been forfeited. In other words, they sold interests they didn’t own. Defendants argued that the interests were “in dispute” and they expected to get them back. As you might expect, the court said they should have told that fact to the investors.
Scienter is a mental state involving an intent to deceive, manipulate or defraud. It also includes severe recklessness, the definition of which is lengthy, but includes words like “highly unreasonable”, “extreme” and “inexcusable”. Selling interests that you know were terminated without disclosing that to investors evidences “a high degree of scienter”, said the court.
What about the brokers?
The interests were sold through the Balunas companies, who were not registered as brokers with the SEC. There were “consulting agreements”. Balunas would “introduce” prospective venturors and would receive 12% commission and a $4,000 monthly “retainer”. Balunas would cold-call prospects from a lead list.
The “introducing” part is important. A broker is “any person engaged in the business of effecting transactions and securities for the account of others.” A mere introduction is deemed not to be effecting a transaction.
Investors, think about this
Have you ever considered the relationship between “invest” and “investigate”. They both derive from Latin but, to my surprise, are not from the same root. Nevertheless, in real life – especially when taking a random phone call from a fast-talking stranger – one should do the first only after doing the other.
Musical Interlude; you can’t do it alone