The SEC lost a claimed Ponzi scheme case following a bench trial in a decision handed down late last week. The complaint alleged that a privately held exploration company defrauded promissory note investors by misrepresenting or not disclosing the use that would be made of the offering proceeds in violation of Exchange Act Section 10(b) and each subsection of Securities Act Section 17(a). SEC v. St. Anselm Exploration Co., Civil Case No. 11-cv- 00668 (D. Col. Decision issued March 29, 2013).
The defendants include St. Anselm Exploration Co or SAE, a private company in the oil and gas exploration business based in Denver, Anna Well, its president, Mark Palmer, a vice president, Michael Zakroff, the secretary/treasurer and business manager and Steven Etkind, a vice president of corporate development. The SEC’s complaint alleged that between 2007 and 2010 the company sold notes to about 200 investors, raising $49 million. In connection with the sale of those notes the Commission claimed two primary misrepresentations were made. First, that investor funds would be used for company operations and specifically drilling and property acquisition. Second that payments to investors would be funded by company operations, primarily asset sales. The agency also claimed that investors were not told their funds would be used to pay existing debt and that the company had insufficient capital to pay ongoing expenses without raising new money from promissory notes.
SAE’s business plan, according to the Court’s findings, was to identify and acquire oil, gas and geothermal prospectus for development and sale. The company was not involved in the production of oil and gas properties. To fund its operations the company historically relied in part on the issuance of promissory notes which were personally guaranteed by the company principals. Those guarantees gave them “skin in the game” the Court found despite the fact that at the time of execution the individuals may not have been fully able to cover them financially.
From 2006 through 2010 the company had more than sufficient revenue to cover its obligations aside from any cash generated from the sale of the notes. During that period revenues were about $61 million while total debt was about $57 million.
Notes were only sold to accredited investors. The subscription agreement told investors the proceeds could be used for any proper business purpose. Mr. Etkind and Ms. Hattig confirmed this point. While the SEC presented testimony from three investors suggesting that their investments could only be used for oil and gas operations, the Court did not find the claim credible in view of the plain language of the subscription agreements and the concession of each witness that the company could use its funding for any legitimate business purpose.
In early 2010 the fortunes of the company plummeted. A large Ponzi scheme in Albuquerque which claimed to be an oil and gas business filed for bankruptcy, destabilizing investors. Economics in the industry deteriorated. As a result an IPO by the company failed. Accordingly, later in the year the company restructured its operations, altering its historical methods of operation. Nevertheless, after considering the terms of the restructuring 196 of 198 note holders accepted the terms and were issued new notes. Currently the company is operating as an ongoing concern.
At the close of the evidence the Court found against the Commission, granting a defense montion under Rule 52(c), Federal Rules of Civil Procedure. That Rule permits the Court to consider and evaluate the evidence after trial. First, the Court concluded that the defendants did not make misrepresentations to investors regarding the use of the investor funds. To the contrary, “the Subscription Agreement plainly stated that investor funds could be used for any purpose at the discretion of the company.”
Second, the Court rejected the SEC’s claim that Mr. Etkind committed fraud by assuring investors that the company was not a Ponzi scheme. A Ponzi scheme, the Court held “is an investment scheme in which returns to investors are not financed through the success of the underlying business venture, but are taken from . . . “ money raised from other investors. Here the SEC failed to establish that SAE conducted “little or no legitimate business operations” or that it “produced little or no profits or earnings.” To the contrary the evidence demonstrates that the company is an operating business. In reaching this conclusion the Court specifically rejected expert testimony to the contrary offered by the Commission because it was predicated on an incomplete and truncated analysis of the company.
Finally, the Court rejected the SEC’s claims that the materials furnished to investors contained material omissions because they did not specifically state that investor funds could be used to pay off existing debt – apparently the predicate of the Ponzi scheme claim. Here the subscription agreement “was not misleading simply because it did not specifically enumerate debt service as a possible use of investor funds. Even after this language was removed in 2007, the remaining disclosure is certainly broad enough to encompass these types of expenditures . . . [and] all three investors who testified [for the SEC] at trial admitted that debt servicing was a legitimate business purpose and thus within the scope of the agreements.” Accordingly, the Court ordered judgment entered in favor of the defendants.