Wednesday, April 08, 2015

SEC Fails to Establish Regulation D Violations

By Matthew Garza, J.D.

The SEC made a prima facie showing that partnership interests sold by a San Diego company represented a sale of unregistered securities in violation of Securities Act Section 5, but did not meet its burden on a motion for summary judgment to show that the sales did not qualify for a Regulation D exemption (SEC v. Schooler, April 3, 2015, Curiel, G.).

Background. The SEC first targeted Western Financial Planning Corporation (Western) and Louis Schooler in September 2012 for allegedly running a real estate investment fraud. The agency obtained an asset freeze and accused the company of selling unregistered securities in the form of units of ownership in partnerships that were organized to buy undeveloped land in Nevada. The partnerships paid exorbitant prices for the land and failed to disclose to investors that much of the land was encumbered by mortgages that Western used to finance the purchase of the land, the SEC said. “Comps” used by the company to demonstrate the value of the land to investors were in no way comparable, and Schooler paid off investors who discovered the scam in order to allow it to continue. The scheme attracted $153 million in investments from approximately 3,400 investors. This opinion addressed the SEC’s motion for summary judgment and disgorgement; earlier opinions in the case were issued on July 1, 2013, April 25, 2014, and July 30, 2014.

Regulation D. Using SEC v. Murphy, a Ninth Circuit case from 1980, as a guide, the court pointed out that the SEC had made out a prima facie case under Section 5 because it established the offer or sale of an unregistered security through interstate commerce. But since the SEC was moving for summary judgment and the defendant argued that the unregistered sales qualified for an exemption under Regulation D Rule 506(b), it was the SEC’s burden to show that the exemption did not apply.

The court initially held that although Western had sold 86 general partnership units in 23 different properties, the sales represented a single, integrated offering. With regard to the Regulation D limit of 35 investors, excluding accredited investors, the court found that the SEC had not carried its burden of showing that more than 35 of the 3,400 total investors counted against the Rule 506(b) purchaser limit because the SEC provided no evidence showing the net worth of any of the investors. The SEC also failed to show that the company had not provided the financial information required in a Regulation D offering because of the same lack of evidence regarding accredited investors. This requirement does not apply to accredited investors, the court pointed out, and the SEC did not establish the number of accredited investors.

General solicitation. Although the SEC cited evidence to show that Western engaged in general solicitation of the general partnership units, the court found that the evidence did not demonstrate sufficiently that the units were generally solicited or advertised. Statements by Schooler regarding cold calls and phone lists did not show that the partnership interests were sold in this manner. Schooler said he obtained clients this way, but this method is allowed under the SEC’s position in a 1985 no-action letter issued to E.F. Hutton & Co. Western additionally argued that any cold calls made were done by a separate entity separate from Western, and the SEC did not show that the agent was acting on Western’s behalf. Other evidence offered by the SEC was also not sufficient to establish a general solicitation.

The case is No. 3:12-cv-2164-GPC-JMA.