Thursday, July 05, 2018

Fraudster's promises to basketball star were clearly out of bounds

By Rodney F. Tonkovic, J.D.

An attorney and business owner believed that he had no obligation to be truthful when telling a former NBA star how his investment would be used. The federal district court for the Northern District of Georgia found that the SEC made its case that the attorney made material misrepresentations when he told Charles Barkley that funds from the promissory notes Barkley bought would be used for specific business purposes. Instead, the funds were used to cover personal expenses and debts. While the attorney considered this to be a "business purpose," the court had no doubt that Barkley was deliberately misled (SEC v. Watkins, June 28, 2018, Jones, S.).

Donald V. Watkins, a member of the Alabama bar, is the sole owner of Watkins Pencor LLC and controls Masada Resource Group, LLC, both of which are purportedly involved in various ventures to convert waste into ethanol. According to the SEC's complaint, Watkins began having financial difficulties beginning in 2009, including hundreds of thousands of dollars owed to financial institutions, in alimony and legal obligations, and credit card bills. The Commission has charged Watkins with violations of the antifraud provisions of both the Securities Act and the Exchange Act arising from inducing clients to invest in purported waste-to-energy ventures but instead using the clients' funds for personal expenses.

At issue in this action was whether securities fraud was committed as to three promissory notes sold to former NBA star Charles Barkley. Between 2007 and 2012, Barkley invested or loaned Watkins at least $4 million. Barkley purchased notes in May 2010, May 2011, and May 2013 for, he was told, the purposes of securing waste management contracts for Masada, for a Masada acquisition, and to cover legal fees for a transaction, respectively. These funds were, in fact, used for personal expenses such as: housing for Watkins then-girlfriend, alimony, personal debts, and credit card bills.

There was no dispute that the notes were "securities" or that the emails between Watkins and Barkley involved interstate commerce. At issue, then, was whether Watkins made any material misrepresentations or omissions with scienter or negligence.

The court first determined that Watkins made material misrepresentations in connection with all three of the Barkley promissory notes. The court focused on the language in the emails themselves, noting that, in the first email, Watkins represented that the money would be used for specific international waste management projects. The money was instead used for Watkins' personal debts and expenses. This, and other similar representations in other emails pertaining to the second and third notes, was indisputably a material misrepresentation because a reasonable investor would wish to know that Watkins would use the funds for personal obligations instead of securing lucrative transactions. At minimum, Watkins had a duty not to misrepresent his expenditures, the court said.

The court then found that no reasonable jury could conclude that the misrepresentations were made without scienter. Watkins argued that he had "leeway" to use the money however he needed to grow the business. No so, said the court, explaining that a businessman cannot specifically represent that particular funds will be used for a specific project and then use the funds for other purposes; investors are entitled to accurate information. Watkins actual use of the funds further supported a finding of scienter: misappropriating investor funds for personal benefit demonstrates a high level of scienter. The evidence indicated that Watkins knew Barkley would not have invested if he knew the true use of the funds and, moreover, that Watkins felt that he was not obligated to be truthful. Even if there were no scienter, Watkins was at least negligent, the court said.

The case is No. 1:16-CV-3298-SCJ.