We haven’t presented 2023’s Bad Guys in Energy, but we have SEC v. Bowen, Baker, Cannon Operating and others as an example of garden variety securities fraud. The opinion addresses a defendant’s effort to defeat the SEC’s fraud claim by attacking the complaint. The “bad guys” are only alleged at this point.
Bowen, Baker and others raised $2.1MM from 140 investors for Cannon Operating. Bowen solicited investors directly and he and others, none of whom are registered brokers, received commissions. Bowen reviewed and edited offering materials written by Baker which included a private placement memorandum and a “Prospect Book”.
SEC’s allegations (among others)
- The materials contained misleading information; for example, production from one of Canon’s prior wells was continuing at “massive rates”;
- Subsequent actions of the defendants did not comport with statements in the materials;
- Defendants failed to correct misstatements and omissions in the materials;
- Investor funds were misused by payment of sales commissions;
- A promised segregated bank account was never opened;
- 85% of the funds promised for program costs did not happen;
- Bowen’s name as Cannon’s CEO was omitted from the materials. Due to prior securities violations he was barred from selling securities;
- The materials failed to disclose negative information about Cannon and Baker;
- Cannon never drilled one of the wells.
- §10(b) of the Securities Exchange Act of 1934 and Rule10b-5 by engaging in fraud in the offer and sale of securities;
- §17(a), 5(a), and 5(c) of the Securities Act of 1933 by engaging in the unregistered offer and sale of securities and offering and selling securities as unregistered brokers.
Bowen moved to dismiss the fraud claims. Here is the analysis (with omissions):
- The SEC’s pleadings must meet a “facial plausibility standard”;
- The SEC cannot allege malice, intent, knowledge and other conditions of Bowen’s mind generally. The “who, what, when, where, and how” standard was not met;
- To be liable for a misstatement or omission Bowen must be the maker of the statement. The SEC did not plausibly allege that Bowen made the statements. Mere knowledge of another’s violation of Section 10b-5, or even aiding and abetting a violation, is not sufficient to establish primary liability under the Exchange Act;
- The Securities Act does not require that the defendant make the statement. Obtaining money by means of an untrue statement encompasses a broader range of conduct than making a statement. The SEC plausibly alleged that Bowen obtained money by means of untrue or misleading statements;
- The SEC met its burden to plausibly allege material misstatements or omissions. Materially requires the substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available;
- The allegation that Bowen’s name was not mentioned in the materials was sufficient because it alleged that the materials concealed the fact that Bowen previously had been sanctioned by the SEC;
- Failing to allege when Bowen helped prepare the documents did not adequately allege fraud based on the omission of Bowen’s identity;
- The SEC failed to allege scienter – the mental state that embraces an intent to deceive and manipulate or defraud which includes severe recklessness. Fraud cannot be predicated on incentive compensation, on one’s title or position, or paying commissions as directed by one’s employer.
The court granted Bowen’s motion to dismiss but gave the SEC a mulligan. Bowen has not escaped the clutches of the SEC.
Your musical interlude.